How Did Sanctions Impact the Cost Efficiency of Iranian Banks?
This research note presents the main findings of a book chapter titled “The Impact of Sanctions on the Banking System: New Evidence from Iran” in the Research Handbook on Economic Sanctions, edited by Peter A.G. van Bergeijk. The book chapter can be seen at this link.
To what extent have the imposed sanctions influenced the performance of Iranian banks?How has the Joint Comprehensive Plan of Action (JCPOA), before and after the US withdrawal, affected the efficiency of Iran’s banks? The results of stochastic frontier analysis show that, on average, the cost efficiency scores of Iranian banks show a decreasing trend over the last few years and increases in bank costs reflect the intense impact of sanctions. Moreover, the results reveal that although the JCPOA significantly decreased the cost inefficiencies of Iranian banks, this was only for a brief time period and only seen until before the US withdrawal from the agreement in May 2018.
Between 2006 and 2012, the United Nations Security Council, the United States, and the European Union levied several waves of increasingly severe unilateral and multilateral sanctions and restrictions on technology transfers, financial transactions, investments, revenue repatriation, and on various state and private entities in Iran. The sanctions intensified in 2012, when the US and the EU agreed to impose oil sanctions and impede Iran’s access to SWIFT worldwide messaging system used to arrange international money transfers.
With Iran cut off from the financial world, the Iranian rial significantly weakened through the years as inflation accelerated, eventually reaching IRR 12,350 to the dollar in June 2013 with an inflation rate of 45.1%. Access to capital in Iran was severely limited which forced the government to intervene in banks’ credit allocation. During this period, profitability and access to liquidity in Iranian banks fell substantially and the number of non-performing loans increased.
In May 2018, the US administration announced its unilateral withdrawal from the JCPOA, leading to significant inflation and pressure on Iran’s economy and banking system. While most Iranian banks were reconnected to the SWIFT network and could engage in international transactions, that again changed in 2018. The US Department of Treasury targeted 50 Iranian banks and their foreign and domestic subsidiaries. However, a key difference from previous rounds of sanctions was a lack of international support for the unilateral US approach, especially within the EU (Dizaji and Farzanegan, 2021).
Accordingly, a key question arises: how have the sanctions imposed since 2018 influenced the Iranian banking system? And what has been the impact of the JCPOA agreement on the efficiency of Iran’s banks?
Sanctions and the Capital Adequacy Ratio (CAR) of the Banking System
In March 2012, nearly all Iranian banks were disconnected from the SWIFT payment system. The capital adequacy ratio (CAR) of the banking system decreased from 8.4% in 2012 to 5.8% in 2015 (IMF, 2017:10). Figure 1 displays the CAR of Iranian banks between 2014Q1 and 2018Q2. This figure shows that in general CAR had a decreasing trend over this period. It fell from 8.9% in 2014Q1 to 4.5% in 2018Q2. There were exceptions in some quarters between 2016 and 2018 (i.e., 2016Q3, 2017Q1, and 2017Q2) where the trend was upward. It seems that the implementation of the nuclear agreement halted the decline of the CAR. However, following the US withdrawal from the nuclear deal (at the end of 2017 and beginning of 2018), the CAR continued its decline.
The Role of Sanctions Intensity
The difference between periods of unilateral and multilateral sanctions raises the question of whether the intensity of sanctions is significant to the impact on bank costs. In order to answer this question, a stochastic cost frontier model is used to analyse an unbalanced panel data for 12 Iranian banks (Eghtesad Novin, Tejarat, Karafarin, Mellat, Parsian, Pasargad, Refah, Saderat, Industry and Mine, Sarmayeh, Sina, Export Development). The unbalanced panel data includes thirteen years (from 2006 to 2018) where a dummy variable that captures the intensity of sanctions was used. This variable is coded as an ordinal variable (1–3) which includes three categories: limited sanctions (1) for the period 2016–2018; moderate sanctions (2) for the period 2006–2011; and extensive sanctions (3) for the period 2012–2015. Instead of using a mere dummy variable for economic sanctions, the three-part category ordinal measure better encapsulates the impact of the sanctions. Specifically, as extensive sanctions place comprehensive economic and financial pressures on the target economy, they should have a greater substantial impact than limited or moderate sanctions (see Caruso, 2003; Dizaji, 2018; Dizaji and Farzanegan, 2021).
The results confirm the increasing and statistically significant impact of sanctions on banks’ costs. According to the findings, an increase in the intensity of sanctions is associated with a larger increase in banks’ costs. Each level of increase in the intensity of sanctions with respect to the coding approach increases banks’ costs by approximately 6%, ceteris paribus.
Table 1 shows the average cost efficiency scores for 12 Iranian banks over the period from 2006 to 2018. Sina Bank has the maximum average cost efficiency score of 93.8%, while Parsian Bank shows the minimum average cost efficiency score of 55.8%. These numbers indicate that to operate efficiently, Sina Bank could only reduce its input costs by 6.2% while Parsian Bank could reduce its costs by 44.2% to reach the efficient frontiers.
Technical Efficiency Effects Model for Partial Lifting of Sanctions
I use a dummy variable to capture the impact of the nuclear agreement and lifting of some sanctions. It takes the value of 1 for the years 2016–2017, i.e., after the nuclear deal was implemented and before the US withdrawal, and 0 otherwise. The results show that the nuclear agreement between Iran and the world powers within the framework of JCPOA had a negative and statistically significant impact on Iranian banks’ costs before the US withdrawal from the nuclear agreement. Further analysis reveals that, after the US withdrawal, the JCPOA did not contribute significantly to Iranian banks’ efficiency. Moreover, the results indicate that both private and commercial banks performed better than government-owned and development banks during the sanctions period in terms of their total costs.
This study confirms the hypotheses regarding the positive impacts of sanctions on the Iranian banks’ costs and the negative impact of lifting sanctions (through the JCPOA agreement) on costs. The results indicate that the nuclear agreement between Iran and the world powers had been successful in reducing the Iranian banks’ inefficiency only when the US was involved in the agreement. However, after the US withdrawal, the JCPOA did not have significant contribution on banks’ cost efficiency.
Sajjad F. Dizaji appreciates the financial support from the Qatar National Research Fund and the support from Coventry University during his research.
References
Caruso, R. (2003), “The impact of international economic sanctions on trade: an empirical analysis”. Peace Economics, Peace Science and Public Policy, 9(2), Article 1.
Dizaji, S.F., (2021), The impact of sanctions on the banking system: new evidence from Iran, In: Bergeijk, P.A.G. van. (Ed). Research Handbook on Economic Sanctions, Edward Elgar. (pp. 330-350).
Dizaji, S.F., Farzanegan, M.R. (2021), Do Sanctions Constrain Military Spending of Iran?, Defence and Peace Economics, 32(2), 125-150.
Dizaji, S.F. (2018), Economic Diplomacy in Iran: reorientation of trade to reduce vulnerability. In Bergeijk, P.A.G. van & Moons, S. (eds). Research Handbook on Economic Diplomacy: Bilateral Relations in a Context of Geopolitical Change. Edward Elgar (pp. 273–296).
IFSB (2019), Data by Country. https://www.ifsb.org/psifi_03.php.
IMF (2017), Islamic Republic of Iran: Selected Issues paper, IMF country report, No. 17/63, February 2017.
