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Iran banking

07 March 2018 Nazanin Soroush

On 23 February 2018, the intergovernmental organisation, the Financial Action Task Force (FATF) announced that it will extend its suspension of countermeasures against Iran for another six months.

  • Although the FATF decided to continue its suspension of countermeasures against Iran, Iran remains on the FATF’s ‘high risk’ banking jurisdiction list.
  • Iran is highly unlikely to fulfil its requirements under the FATF action plan, meaning the suspension of FATF countermeasures against Iran is not sustainable.
  • Iran is likely to face increasing banking difficulties in the one-year outlook, as it is unlikely to adopt meaningful reforms to address FATF concerns and as the US is likely to adopt a more stringent enforcement of its existing sanctions, increasing financial pressure on Iran and raising contract risks and borrowing costs.

There are three major factors impeding Iran’s ability to reconnect to major international banks: residual primary US sanctions that ban Iranian access to the US financial system and therefore complicate dollar currency conversion and transactions; Iran’s deficient anti-money laundering and counter terrorism-financing (AML/CTF) infrastructure and consequent status as a “high-risk jurisdiction” by the FATF; and the widespread and opaque influence of commercial and banking entities affiliated to Iran’s Islamic Revolution Guards Corps (IRGC), designated under secondary US sanctions for sponsorship of terrorism and Iran’s ballistic missile programme.

The FATF angle

The FATF, the multilateral body setting international AML/CTF standards, reiterated on 23 February that Iran remains a “high-risk jurisdiction”, advising its members to observe “enhanced due diligence” in Iran-related transactions. The FATF revealed that Iran had failed to complete the majority of its action items under an agreed plan by the 31 January 2018 deadline. Nevertheless, the FATF decided to continue the suspension of its countermeasures against Iran given the ongoing Iranian commitment to address its AML/CTF deficiencies, specifically citing draft legislation before Iran’s parliament. This refers to the “reforming the counter-terrorism financing law” legislation submitted to parliament by the Rouhani administration in November 2017. The FATF originally suspended its countermeasures against Iran in June 2016, and then again during its June and November 2017 sessions, given Iranian high-level political commitment to the agreed action plan, with June 2018 as the next FATF review deadline.

The FATF specified nine action items that Iran must complete. Most importantly, Iran must “adequately” criminalise the financing of terrorism, including removal of exemptions for groups (in Iran’s wording) “attempting to end foreign occupation, colonialism and racism”, in an apparent reference to Lebanon’s Hizbullah. Iranian compliance with this FATF requirement is extremely unlikely: politically, Iran’s dominant hardline conservative faction is very committed to Hizbullah as a pillar of its regional policy, while support for such groups is enshrined within the Islamic Republic’s constitution.

US/regional pressures

Given Iran’s continued isolation from major international banks, Iranian banks have relied on a series of indirect channels to avoid US restrictions, including relations with second- and third-tier European banks, sale of Iranian crude in euros, trade in local currencies (including with Chinese and Russian banks), and likely use of off-shore clearing houses and/or banks with greater risk appetite for dollar currency conversions (see Iran: 26 May 2016: First successful currency conversion of large dollar sums to pave way for resolving Iran's banking issue). However, the sustainability of these workaround routes will be contingent on US interpretation and enforcement of its residual sanctions. For example, under the Obama administration, the US Treasury encouraged foreign banks to resume business with Iran, specifying that US sanctions do not prohibit foreign banks from using dollars in their possession in Iran-related transactions, thus facilitating indirect dollar conversion. However, under the Trump administration, the US may well narrow the scope for such transactions, and/or dealings with third parties that offer Iran scope to conduct business in dollars, thereby limiting Iran’s access to US dollar-denominated flows, thus raising contract risks and borrowing costs.

IHS Markit expects that the US is likely to increase financial pressure on Iran via a more aggressive and stringent enforcement of its residual sanctions, and also probably via the FATF mechanisms, within its broader strategy of countering Iran’s expansionist policies. On 14 February, the Financial Times reported that unspecified United Arab Emirates (UAE) banks have restricted transactions with Iran under US pressure, quoting an unnamed former senior Iranian official. IHS Markit cannot verify this claim independently, but finds it credible. In November 2017, Iranian media reported that the UAE’s Emirates NBD, one of the largest banks in the Middle East, had given an unspecified number of Iranian merchants 30 days to close their accounts, without offering further details. Previously, in May 2017 Iran’s Financial Tribune reported that UAE banks, particularly RAK Bank, had suspended the accounts of approximately 400 Iranian companies, also without offering details.

Given the expectation of tighter controls, the parallel market valuation of the rial dropped from 40,000 against the dollar in October 2017 to nearly 50,000 on 13 February (see Iran: 16 February 2018: Iran takes action against currency traders, boosts deposit rates amid significant banking-sector strains). Subsequently, Iranian detention of 90 foreign-exchange dealers, closing of foreign-exchange shops, and increasing deposit interest rates on 14–15 February have reversed the decline, with the rial appreciating to 45,000 on 22 February.

Outlook and implications

Despite the FATF continuing the suspension of its counter-measures against Iran, Iran is likely to face increasing banking difficulties in the one-year outlook, given the clear risk that it will fail to implement FATF requirements, increasing contract risks and borrowing costs. The threat of US withdrawing from the Iran nuclear agreement or re-imposing its secondary sanctions on Iran (which broadly prohibit non-US businesses from engaging with Iran), combined with pressure on Iran’s financial partners, more stringent enforcement of US sanctions prohibiting Iranian access to the US financial system, including potentially limiting Iranian ability to use workarounds, and a more forceful posture by the US against terrorism financing would enable it to escalate pressure on Iran without necessarily withdrawing from the Iran nuclear agreement at this stage, reducing the risk of US withdrawal in May 2018 (see Iran: 17 January 2018: US president’s statement on Iran sanctions waivers increases risk of snapback, undermining JCPOA’s longevity). Although this decreases Iran’s economic benefits from the agreement, Iran is nonetheless likely to continue its nuclear compliance, not least because of its continued ability to export crude oil thereunder.



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