Bourse and Bazaar | Esfandyar Batmanghelidj: Iran’s efforts to meet the action plan requirements set by the Financial Action Task Force (FATF), a global standard setting body, faced another setback as reports emerged that the Guardian Council had rejected aspects of the bill approved by parliament that would see Iran accede to the United Nations Convention Against Transnational Organized Crime, known as the Palermo Convention.

The political drama surrounding the FATF action plan has overshadowed the role of Iran’s private sector banks in improving their compliance protocols while actively pushing for stronger regulatory requirements. Banks such as Bank Pasargad, Middle East Bank, and Saman Bank enjoy both large market capitalizations and a crucial role as intermediaries with the international financial system, lending these relatively young institutions considerable influence. But policymakers in Europe, scrambling to preserve banking ties with Iran in the face of returning U.S. sanctions, have overlooked the imperative of engaging Iran’s private sector banks as agents for change.

Founded by some of the most capable bankers in Iran, many of whom studied outside of the country, Iran’s private sector banks serve as a kind of braintrust for the sector at large. The top bankers at Pasargad, Middle East, and Saman, hold degrees from University of Southampton, University of Wisconsin, and CASS Business School respectively.

The Association of Private Banks and Credit Institutions, an industry-body, actively lobbies officials at the Central Bank of Iran, at the Financial Intelligence Unit of the Ministry of Economic Affairs and Finance, and the relevant parliamentary committees. Anecdotes abound of private sector bankers arriving to the central bank late at night in order to sketch some key concept on the whiteboard on the eve of a major decision. Though not always successful in shaping policy to their designs, the private sector is far from passive when it comes to engaging government stakeholders.

Despite this track record as change agents within the Iranian financial system, private sector banks have been squeezed not just by domestic political opponents, but also by international pressures.

Mostafa Beheshti Rouy, a veteran banker and executive board member at Bank Pasagrad, believes that international sanctions, which have been largely justified by pointing to the lack of transparency in the Iranian financial system, counterintuitively made reforms that would increase transparency harder to achieve.

“If the objective was to promote greater transparency or to establish stricter anti-money laundering or counter-terrorist financing policies in Iran, it would have been simple to pave the way by encouraging specialized international firms to advise and assist the Iranian government and financial institutions to develop and implement the necessary legislation, procedures, and programs,” Beheshti Rouy argues.

In the absence of “practically any outside help,” over the last two decades, the Iranian financial sector was left to rely on internal expertise to design, draft, and implement the legal frameworks and compliance policies in accordance with international best practice.

Iran’s leading private sector banks have not waited for the FATF legislation to come into force in order to strengthen their internal procedures, particularly around know-your-customer (KYC) and know-your-transaction (KYT) due diligence. Concerns about the transparency and integrity of the Iranian financial system date back to the time of founding of Iran’s private sector banks two decades ago. “From the very first days” the creation of private sector banks in Iran was tied to a “special emphasis and attention in preparing corporate governance and risk policies,” says Beheshti Rouy.

When establishing Pasargad in 2005, Beheshti Rouy and his colleagues “studied all related literature, engaged best local consultants, and to the extent possible obtained valuable information from the internet.” From the outset, the bank sought to meet international best practice when developing its core banking system, payment systems, and enterprise resource planning (ERP) systems despite their relative isolation. In 2010, the bank was among the first to integrate sanctions screening software within its core banking system. Because of international sanctions, this software was not available in Iran and needed to be acquired from abroad.

These self-led efforts were successful in bringing Iran’s private sector banks closer to international standards for financial integrity, especially Iran’s lawmakers lagged behind in instituting the legal and regulatory reforms. Iran’s private sector bankers feel that this progress was indirectly recognized by the Obama administration in the implementation of Executive Order No. 13599 in 2012, which saw the Iranian financial sector sanctioned due to “deficiencies in Iran’s anti-money laundering regime and the weaknesses in its implementation, and the continuing and unacceptable risk posed to the international financial system by Iran’s activities.” While Iran’s private sector banks were designated under E.O. 13599 along with the rest of the financial sector, eight banks were declared “not-subject to secondary sanctions” as part of this designation.

Richard Nephew sees the distinct designation of the eight banks differently: “It had nothing to do with recognizing them as being well run or ordered.” Nephew is senior research scholar at Columbia University’s Center on Global Energy Policy and served as deputy coordinator for sanctions policy at the State Department at the time when E.O. 13599 was devised. He explains that U.S. officials “didn't have any derogatory information on those banks to justify designation in the traditional sense but had a legal requirement to make clear that U.S. persons were not permitted to engage in transactions with those banks.” Nephew acknowledges that the lack of derogatory information could theoretically reflect that the private banks were “were well run or ordered” but stresses that when it comes to sanctions designations, a lack of incriminating information does not mean that the U.S. authorities “thought private banks were special.”

Following implementation of the JCPOA, restrictions on private sector banks were reduced further. Iran received broad sanctions relief and was reconnected to the SWIFT international payments messaging system. But the stigma associated with sanctions continued to cloud efforts to facilitate business between Iranian and European banks, leading to Secretary of State John Kerry engaging in public outreach to global banks in an effort to reassure wary international banks.

As American policymakers struggled to assuage fears, Iran’s private sector banks doubled-down on their reform efforts in order to win approval from European export credit agencies for inclusion in financing guarantee agreements and to re-establish correspondent banking relationships.  As an example of a concrete measure, Beheshti Rouy points to his bank’s implementation SWIFT’s own sanctions screening service in an effort to identify and block “all suspicious transactions in our daily operations.”

Today, as sanctions are set to return and while the Trump administration pursues its “financial war” on Iran, Beheshti Rouy remains hopeful that the reforms made by the most advanced Iranian banks will offer some defense. He believes that the number of banks not subject to secondary sanctions under E.O. 13599 will likely reduce from eight to just three or four, but that Pasargad, “shall remain as one of the Iranian banks authorized by U.S. Treasury to continue humanitarian trade” due to its compliance profile.

Of course, Beheshti Rouy and his peers had much higher hopes for their financial institutions. He relays a sentiment shared by many of his peers: “If during these years we had access to international capital markets, were able to raise finance as our neighbors do, were able to engage international consulting companies, or were able to purchase the tools and software that other international banks possess, without a doubt we would have been different banks today.”

In October, Iran faces a deadline for meeting FATF’s action plan requirements. With the clock ticking down, it would behoove European policymakers, who remain committed to economic engagement with Iran, to empower Iran’s private sector banks to drive forward reforms.

As Laurence Norman of the Wall Street Journal has reported, five European central banks have indicated they would considered opening direct payment channels with the Central Bank of Iran to enable financial ties in the face of U.S. secondary sanctions—but fully implementing the FATF action plan is a precondition. Rather than sit back and hope that Iran achieves compliance, European governments should be more active in providing technical assistance, principally by encouraging or even funding European private sector consultants to consult Iranian private sector banks directly. These banks, in turn, will be able to exert a positive influence on figures such as Iran’s new central bank governor.

Such a bottom-up approach is commonplace. One notable program led by KPMG in cooperation with the Swedish International Development Cooperation Agency, focused on increasing risk management capacity among mid-career managers at financial institutions around the world. Run for over a decade, the program trained managers at 216 financial institutions in a list of countries including North Korea, but, indicatively, excluding Iran.

Ensuring Iran’s private sector banks can access such existing international training programs, banking technologies, and legal support despite returning U.S. sanctions would aid in the creation of the “different banks”—more robust and more transparent—that would pose a minimal threat to the integrity of the international financial system.