Malaysia and Saudi facing Iran’s rising finance power

By Arno MaierbruggerGulf Times Correspondent BangkokWith the easing of economic sanctions against Iran, the country is expected to unleash its enormous potential of Islamic finance and enter the global stage with new Shariah-compliant products at a size that could threaten the dominance of Malaysia and Saudi Arabia in the sector.It is by far not common knowledge that Iranian banks represent the world’s largest financial system based on Shariah law, and the country’s Islamic banking asset were $482bn as per 2014, according to the Dubai Center for Islamic Banking and Finance, which is almost a quarter of total global Islamic finance assets, more than Malaysia’s, Saudi Arabia’s and the UAE’s Islamic assets combined and close to ten times the Islamic banking assets of Qatar.However, due to the sanctions, the country has so far only marginally participated in the global Islamic finance sector – or the entire global finance sector, for that matter – and thus did not benefit from the rapid global growth of Islamic finance in the recent past.The entire banking system in Iran is Shariah-compliant, and there are no conventional banks to compete with. According to The Banker magazine, which issues the global annual list Top 500 Islamic Financial Institutions, Iran’s biggest banks are Bank Melli Iran with Shariah-compliant assets (as per The Banker’s 2013 list) of $76.6bn and Mellat Bank with $72.6bn in assets, although it is not entirely transparent how much of their assets frozen abroad are counted in. The asset size compares to the largest non-Iranian Islamic bank, Saudi Arabia’s Bank Al Rajhi, which has assets worth $71.3bn. Eight out of the 15 largest Islamic banks in the world are Iranian, according to the list.However, Iranian banks are not in a good shape with regards to their profitability, and also have one of the highest amounts of bad debts in the Middle East behind Libya and Yemen mainly as a result of loose and ineffective monetary policy in the past. The value of toxic debt has been officially set at $32bn, but, unofficially, could be more than double that amount, reports say.The current government of moderate and conciliatory President Hassan Rouhani and the expected easing or lifting of sanction later this year could, however, fundamentally change the banking sector with the subsequent entrance of foreign players and investors in the market, the introduction of modern capital market regulations and the planned establishment of a local credit rating agency that would develop a comprehensive rating model for Iran’s financial institutions, the first of its kind.Rouhani has especially declared his intention to further develop the sukuk market in Iran. Islamic bonds were first issued in Iran in 1994 and since then were used mainly by municipalities and infrastructure and transport companies, including airlines. Iranian banks are using the musharaka version of sukuk, which is technically an investment partnership, rather than the non-Iranian markets’ more popular versions of murabaha and ijara which could be an inspiration for Iranian banks to focus on developing alternative sukuk structures. There are also plans to boost sukuk issuances through Iran’s economic free zones, including Kish Island, which would mainly use it for project and infrastructure finance. However, the big question will be whether such sukuks will be issued in local or foreign currency as investors are currently confronted with inflation rates of the Iranian rial of above 15% annually which is heavily distorting the risk-reward profile of investing into sukuk in Iran as compared to other markets.