According to the 2006 Article IV Consultation Report by the International Monetary Fund (IMF), published in 2007, Iran has continued with reforms to strengthen banking supervision and has introduced significant changes in the financial sector through the adoption of a number of the 2000 Financial Sector Assessment Program (FSAP) recommendations. It has, however, achieved limited progress, and substantial work still needs to be done. The steps taken so far, as mentioned in the report, have been to move from compliance-based to risk-based prudential supervision, to update its information technology, and to consolidate the banks' internal control mechanisms. The IMF also affirms that Iran is working to bring more financial institutions under the supervision of the Central Bank of the Islamic Republic of Iran (CBI), the country's financial regulator. Looking forward, the IMF points to the need to revise Iran's legal framework so that it clearly spells out the provisions for CBI autonomy, accountability, and effectiveness in supervisory matters. The IMF also recommends that several prudential regulations be refined; that on-site inspection be fully integrated with off-site research; and that enforcement be strengthened. Further, the IMF report calls for increased CBI independence, the elimination of administrative controls, and the facilitation of greater exchange rate flexibility. Despite all this, however, there is little information directly addressing the compliance of Iran with the Basel Core Principles.

General Overview

In 2004, the CBI published a "History of Central Banking in the World and in Iran," in which it states that the CBI was founded as the regulatory body of Iran's monetary system on August 9, 1960, following the ratification of the Monetary and Banking Law (1954). The 1954 law vested the powers of banknote printing and coin minting solely to the CBI. According to the "History," the CBI's primary aim was to supervise banking activities, regulate monetary policy, control inflation, maintain price stability, and direct the country's deposits towards generative investments. It was established with a capital of 3.6 billion Rials - the Iranian currency, and began operations with a staff strength of 388.

The CBI's "History" enumerates the central bank's many responsibilities. These include the preservation of currency value, both domestically and abroad; to issue currency; to supervise and regulate foreign and domestic currencies; to regulate and supervise gold transactions; to regulate Iran's monetary and credit system; to supervise banking and credit institutions; to monitor credit levels and guarantee sufficient credit to meet the nation's needs; to keep ministerial, government agency, and government affiliate accounts; to maintain foreign and gold reserves; to represent the Iranian government in dealings with international financial bodies; to control the issuance of government bonds; and to transact and conclude payment agreements pertaining to the government of Iran's contractual arrangements with foreign nations. The "History" concludes that the CBI's overall mission is to ensure the economic growth of the country by enforcing monetary policies and to support the government in implementing economic stability and development plans.

Although the IMF has not yet undertaken a detailed assessment of banking supervision in Iran, its 2006 Article IV Consultation report, published in 2007, includes comments on the current state of reform in this area. According to the report, Iran has moved forward in strengthening its banking supervision and has introduced significant changes in the financial sector by adopting a number of the 2000 Financial Sector Assessment Program (FSAP) recommendations. Substantial work still needs to be done, however. The report mentions that Iran has moved from compliance-based to risk-based prudential supervision, updated its information technology, and consolidated the banking system's internal control mechanisms. The IMF's 2004 Article IV Consultation report listed prior regulatory reforms. These included reforms in licensing, net open positions in foreign exchange, the definition of statutory capital, capital adequacy, large exposures, connected lending, anti-money laundering regulations for banks, the unification of supervisory functions under a single department at the CBI, the initiation of on- and off-site inspections, and the development of standard reporting forms and supervision manuals. In the 2007 IMF report, Iran is credited with bringing more financial institutions under CBI supervision, as well. Looking forward, the 2007 IMF report points to the need for revising Iran's legal framework to clearly spell out the CBI's the autonomy, accountability, and effectiveness in supervisory matters. In addition several prudential regulations should be refined; on-site inspection needs to be more fully integrated with off-site research; enforcement should be strengthened. The CBI's independence needs to be increased, administrative controls eliminated, and greater exchange rate flexibility facilitated. The IMF that a Monetary and Capital Markets Department mission visited Tehran in December 2006 to provide technical assistance on bank supervision, and the World Bank is expected to provide support to Iran's efforts at bank restructuring and privatization. The IMF has also planned a Financial Sector Assessment Program update in 2007.

In the 2007 report, the IMF remarks upon Iran's overall financial system, which remains dominated by large state-owned banks and extensive regulations, including controls on rates of return. According to the report, state-owned banks (which hold 90 percent of deposits) comprise six commercial banks, four specialized banks, and one postal bank. Since 2001, six private banks have been licensed, and four large state-owned banks privatized. Further, these private sector banks have continued their robust growth and, by November 2006, had increased their market share to 15 percent. Two new private banks were licensed in 2005 and 2006, raising the participation of private banks to 101/2 percent of total deposits by year's end (p. 16). In addition, licensing applications to establish new banks have escalated despite a sharp and sizable increase in the required level of start-up capital. An executive order issued in July 2006 has given new impetus to privatization; calling for the privatization of all state-owned banks will be privatized by 2008-2009. The 2007 IMF report also notes that all banks operate under Islamic legal principles and the scope for competition is limited, with most banks lacking commercial autonomy. Commenting on financial soundness indicators, the IMF in 2007 report states that they slightly weakened in 2005/06. The report also notes that bank profitability declined, reflecting narrower rate-of-return margins, and the ratio of non-performing loans to total loans increased to 9.9 percent, from 7.7 percent in 2004-2005. Iranian authorities have attributed this to continued improvements and transparency in accounting and data compilation. As to the average risk-weighted capital/assets ratio, it remained almost unchanged at 9.8 percent, above the regulatory minimum. In this context, the 2007 IMF report calls upon Iran to pay close attention to the quality of bank portfolios in view of the strong growth in credit to the private sector in previous years. The report adds that the profitability of Iranian banks has improved and, for the first time, their capitalization exceeded the 8 percent level recommended by the Basel I Capital Adequacy Accord. Further, the share of credit subject to mandatory allocation was further reduced to about 25 percent in 2006, and offshore banks were supervised in accordance with the regulations for mainland banks.

The Principles

1. (1) Clear responsibilities and objectives for each supervisory agency.

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The 2007 IMF report mentions that the Monetary and Capital Markets Department mission to Iran has credited the CBI with substantial progress in strengthening financial sector supervision and regulation and was following up with ongoing revisions of the banking and central bank laws. The mission noted that legislative reform would enhance the CBI's independence and accountability in monetary management and supervisory activities, and would broaden the range of financial institutions subject to CBI supervision. Iranian authorities noted that progress had been made in drafting a new Money and Banking Law that provides more independence to the Money and Credit Council (MCC), and that a separate draft law would grant the CBI greater autonomy and tools for managing liquidity. Nonetheless, there is insufficient information as to Iran's compliance with this Principle.

1.(2) Operational independence and adequate resources.

II

The 2006 IMF report mentions that the CBI has been granted organizational independence, with the Governor of the CBI being directly appointed by the President. The Governor of the CBI has also replaced the Minister of Finance as the chairperson of the MCC. However, in a 2006 report the IMF recommended that a clear mandate and greater central bank independence in the use of monetary policy instruments were needed to achieve well-defined, time-bound objectives. The IMF's 2007 report further recommended a gradual elimination of distortionary regulations and controls, which inhibited "efficient intermediation of financial savings and encouraged the development of circumventing mechanisms" (p. 16). Nonetheless, there is insufficient information as to Iran's compliance with this Principle.

1.(3) A suitable legal framework for authorization and ongoing supervision.

II

The 2004 Article IV report by the IMF observed that reforms were under way to amend Iran's banking legislation (Monetary and Banking Act of Iran) to incorporate the concept of bank soundness; clearly define services that banks and other financial entities were allowed to provide; and enlarge the range of sanctions against banks that do not comply with regulations. However, there is insufficient information as to Iran's compliance with this Principle.

1.(4) A suitable legal framework to address compliance with laws as well as safety and soundness concerns.

II

The 2004 Article IV Report by the IMF observed that reforms were under way to amend the banking legislation (Monetary and Banking Act of Iran) to incorporate the concept of bank soundness; clearly define services that banks and other financial entities were allowed to provide; and enlarge the range of sanctions of those banks that do not comply with regulations. However, there is insufficient information as to Iran's compliance with this Principle.

1.(5) Legal protection for supervisors.

II

There is insufficient information as to Iran's compliance with this Principle.

1.(6) Arrangement for sharing of information between supervisors and protection of confidentiality of shared information.

II

There is insufficient information as to Iran's compliance with this Principle.

2. Clearly defined permissible activities for banks and control of the use of the word 'bank'.

II

There is insufficient information as to Iran's compliance with this Principle. The 2004 Article IV report by the IMF did observe that reforms were under way in Iran to clearly define services that banks and other financial entities were allowed to provide . The reforms, according to the IMF, aim to eventually bring all deposit-taking institutions under the supervision of the CBI (2004).

3. Criteria for structure, directors, operating plan, controls, financial condition and capital base.

II

There is insufficient information as to Iran's compliance with this Principle.

4. Authority to review and reject transfer of ownership.

II

There is insufficient information as to Iran's compliance with this Principle.

5. Authority to review major acquisitions and investments.

II

There is insufficient information as to Iran's compliance with this Principle.

6. Minimum capital adequacy requirements (meet Basle Capital Accord for internationally active banks).

II

In its 2006 Article IV report, the IMF notes that the profitability of Iranian banks had improved and, for the first time, their capitalization exceeded the 8 percent level recommended by the Basel I Capital Adequacy Accord. Apart from this statement there is insufficient information as to Iran's compliance with this Principle.

7. A method exists for the evaluation of procedures related to loans, investments and portfolio management.

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There is insufficient information as to Iran's compliance with this Principle.

8. Policies, practices and procedures for evaluating the quality of assets and the adequacy of loan loss provisions and reserves.

II

There is insufficient information as to Iran's compliance with this Principle.

9. Prudential limits and management information system on concentration of exposure.

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There is insufficient information as to Iran's compliance with this Principle.

10. Arm's length rule and monitoring for connected lending.

II

There is insufficient information as to Iran's compliance with this Principle.

11. Policies and procedures for country risk and transfer risk.

II

There is insufficient information as to Iran's compliance with this Principle.

12. Measuring and monitoring market risk. Limit and/or specific capital charge on market risk exposure.

II

There is insufficient information as to Iran's compliance with this Principle.

13. Comprehensive risk management processes.

II

There is insufficient information as to Iran's compliance with this Principle. There is, however, some information regarding Iran's risk management process. As stated in the 2006 IMF report, Iranian authorities have admitted to the need for close scrutiny of the risks to financial stability. They also agreed that the continued increase in non-performing loans was cause for concern, both for its fiscal implications and its repercussions on the health of financial institutions. However, the authorities pointed out that the increase reflected the adoption of more stringent classification rules. Further, they claimed that the recent increase in capital adequacy was largely a result of asset revaluations, but affirmed their commitment to recapitalize public banks. The authorities added that risks stemming from the excessive use of letters of credit in the past had been averted through effective supervision. However, the 2006 IMF observed that, even though there were no immediate threats to financial stability, Iran needed to take definitive steps to address banking sector weaknesses.

14. Adequate internal controls.

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There is insufficient information as to Iran's compliance with this Principle.

15. Strict "know-your-customer" rules and high ethical and professional standards.

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The 2007 IMF report states that Iran does not yet criminalize money laundering as a specific offence and does not yet have a framework for anti-money laundering (AML) in place. The report notes that the CBI issued an anti-money laundering regulation in 2002 that set out preventive measures for banks and certain other financial institutions. This regulation suffers from serious shortcomings, however. Iranian authorities have indicated to the IMF that both the AML law and the combating the financing of terrorism (CFT) law were being revised, and requested further assistance from the IMF in their efforts to strengthen its AML/CFT framework.

The same IMF report observes that Iran's criminal code includes terrorism offences, and the CBI has issued circulars requiring the banks it regulates to report the accounts of designated terrorist groups. Further, lists of suspected terrorists under UN Resolutions 1267 and 1373 are circulated to the banks. Also, though not specifically designed for CFT, there is a declaration system in place for cross-border cash movements. The IMF report raises questions about CBI's legal authority to freeze or block accounts and enumerates other weaknesses, including the vagueness of requirements for financial institutions to report suspicious transactions and the lack of laws making terrorism financing an offence. The IMF adds, however, that the CBI is currently in the early stages of developing a draft CFT law to strengthen the legal framework in this area. Also, at Iran's request, a Legal Department mission from the IMF has reviewed the progress thus far made in AML/CFT reform initiatives. The mission has made recommendations that Iran may incorporate in its AML and CFT draft legislation.

In 2007, the U.S. Department of State has confirmed that there are, as yet, no meaningful AML controls on the Iranian banking system, and cautions that the CBI's AML circulars addressing the reporting of suspicious activity and other procedures lack implementation. It adds that the 2003 anti-money laundering act includes customer identification requirements, mandatory record keeping for five years after the opening of accounts, and the reporting of suspicious activities. However, this act has not yet been implemented, purportedly due to pressure by vested interests within the government.

16. Effective supervisory system consisting of on-site and off-site supervision.

II

There is insufficient information as to Iran's compliance with this Principle. However, in its 2004 report on Iran, the IMF states that reforms in banking supervision had resulted in on- and off-site inspections using risk-based criteria. Looking forward, the 2007 IMF report points to the need to fully integrate on-site inspection with off-site research.

17. Regular contact with bank management and understanding of bank's operations.

CP

There is insufficient information as to Iran's compliance with this Principle.

18. Analytical reports and statistical returns on solo and consolidated basis.

II

There is insufficient information as to Iran's compliance with this Principle.

19. Independent validation of supervisory information through on-site examination or external auditors.

II

There is insufficient information as to Iran's compliance with this Principle.

20. Ability to supervise on a consolidated basis.

II

There is insufficient information as to Iran's compliance with this Principle.

21. Consistent accounting policies and practices that provide a true and fair view of the financial condition of the bank.

II

There is insufficient information as to Iran's compliance with this Principle.

22. Adequate supervisory measures to ensure timely corrective action.

II

There is insufficient information as to Iran's compliance with this Principle.

23. Banking supervisors must practice global consolidated supervision over their internationally-active banking organizations.

II

There is insufficient information as to Iran's compliance with this Principle.

24. International exchange of information with other supervisors.

II

There is insufficient information as to Iran's compliance with this Principle.

25. Supervision of local operation of foreign banks and information sharing with home country supervisors.

II

There is insufficient information as to Iran's compliance with this Principle.