Bank Keshavarzi – The Agricultural Bank: Islamic Republic of Iran
Bank Keshavarzy (BK) is a dynamic and innovative bank in government ownership, with a 70-year history. Within its rural-agricultural mandate, it offers an exceptionally broad array of financial products and services to all segments of the population: mainly small-holders, but also women, low-income groups and commercial farmers. Its potential is enormous, but hampered by a combination of macroeconomic factors and government control over banking. BK has a strong orientation to deposit mobilization and self-reliance, portfolio diversification, and profit-making. With 1,700 branches and close to 10m client accounts (in a population of 65m), its saver outreach (7.7m) and borrower outreach (1.04m) is vast. In a macroeconomic situation of incipient liberalization, it is ready for the transition to sustainable universal banking in rural and urban areas, with a continued focus on agriculture.
The core problem results from a contradiction between a high inflation rate and controlled profit rates (the Islamic equivalent to interest rates) on deposits and loans, resulting in negative real returns on deposits and capital erosion. With real inflation rates around 40% in recent years, depositors, financial investors and consumers lose 40% of the value of their funds every year. At profit rates between 0% (Qarz-Al-Hasanah) and 20%, depositors lose between 40% and 20% of the value of their money every year. To the same extent, the state unintentionally gains what may be seen as a usurious inflation tax. Borrower-investors are charged profit rates of 13%-25% (see Tables 4-5) by BK. They either gain unduly at the expense of the depositors and the bank; or they invest in low-return activities, thereby hampering personal income and economic growth.
The results of this situation are contrary to the principles of Islamic banking and may be interpreted as unintended usury. Gains and losses are unduly and unequitably distributed between depositors, borrower-investors and the state. The gains of the state from the inflation tax and of diligent borrower-investors from loans prized below the real costs of funds are at the expense of vast numbers of depositors and consumers, and of bank capital. This has hampered deposit mobilization and the overall volume of financial intermediation between depositors and borrowers; it has eroded the value of the capital of depositors and the bank; it has slowed down the growth of the Bank’s services; and it has restricted the Bank’s microfinance services to women and the poor the cost of which cannot be covered from the income of financial operations. Ultimately, this has distorted rural financial markets and undermined development. Low-income groups have been particularly affected: either by the negative real returns on their savings; or by the lack of access to credit.
Two related strategies are suggested: (a) bringing down the inflation rate; and (b) adjusting the profit rate structure, setting profit rates on deposits above the inflation rate and equating these profit rates of deposits with cost of funds in the determination of lending rates. Within such a conducive environment, BK will then vigorously mobilize its own resources, remunerate its depositors fairly and adequately, provide credit and other financial services to all segments of the population, have its loans repaid on time, and finance its expansion from its profits while preserving the value of its capital.
This paper, which was prepared for NENARACA, the regional agricultural credit association, suggests that to initiate this process, NENARACA could:
- support to participatory high-level policy seminars on market-based profit rates on deposits and loans with just and equitable real returns to all parties involved in the transaction;
- support to comprehensive participatory planning in BK and all its divisions with the objective of viable operations and sustainable financial services;
- staff training and exposure training abroad for decision-makers in preparation of the reform process;
- linkages with donor technical and financial assistance for the implementation of reform.