Nuclear deal may have swept away many sanctions, but Iran struggles to mesh with global financial system

By Paul Cochrane, in Beirut   Following the international agreement limiting its nuclear power ambitions, Iran is essentially open for business. However, certain US sanctions remain in place, adding to Western banks' caution in dealing with Iran, long a pariah to global investors and bankers. Indeed, the biggest challenge will be reintegrating Iran's financial institutions back into the international system after their years’ long experience of dealing with, and circumventing, sanctions.

The Islamic Republic of Iran has had to deal with financial sanctions imposed by the United States following the revolution in 1979, and then ramped up during the Bill Clinton and George W Bush administrations. But it was the multilateral financial sanctions imposed by United Nations Security Council resolutions (UNSCRs) and the European Union (EU) from 2007 onwards, and particularly in 2011, that hit Iran even harder, further narrowing an already limited window to operate financially in international terms.

“One of the Iranians’ primary objectives was that the financial sanctions originating from the EU and UNSCRs were removed within the comprehensive nuclear deal, whereas they were less concerned about US financial sanctions as Iran has lived with those for over three decades, and the systems to move around US sanctions have been well oiled within the country,” noted Emad Kiyaei, executive director of the American Iranian Council. The Iranians’ objectives have been largely met. The EU and UNSCR’s sanctions have been significantly eased, as have US measures, although crucial designations remain concerning terrorist financing and human rights. However, with Iran now open to the international system there are serious challenges ahead to integrate its financial system back into the fold.

Indicative is that the global anti-money laundering (AML) body the Financial Action Task Force (FATF) in October 2015, declared it “remains particularly and exceptionally concerned about Iran’s failure to address the risk of terrorist financing and the serious threat this poses to the integrity of the international financial system”. The body warned that if Iran fails to take concrete steps to improve its AML and combating the financing of terrorism (CFT) regime, it will consider calling on all countries and jurisdictions in February 2016 to strengthen counter measures.

Whether FATF will take such a decision is unclear – it stated the same concerns in June 2014, with an October 2015, deadline that did not result in any action – but reform is clearly needed. “Iran’s banking sector is in a difficult situation given they have shouldered the majority of the burden of the strangling sanctions. Major reforms are required, with many Iranian economists agreeing that the banking sector is a ticking bomb in terms of deficiencies and short-comings,” said Ali Vaez, senior Iran analyst at the Brussels-based non-governmental organisation the International Crisis Group.

Part of the problem is that smaller banks in Iran are almost designed to be sanctions-busting institutions. The more recent sanctions, especially those imposed on the Central Bank of Iran (CBI) and major state banks, affected the financial system, forcing it to change in response. “One phenomena witnessed under the [EU and UN] sanctions was the mushrooming of private banks. The Iranians needed ways to get around sanctions, so a lot of smaller banks were basically a part of a game of cat and mouse that allowed Iran to survive the storm of sanctions,” said Vaez.

Such fledgling banks developed ties with small-and-medium-sized banks in Asia, particularly Malaysia and India, but also Russia, the United Arab Emirates (UAE) and Oman, to indirectly access the international system. Creative means to move money were profligate, such as through trade-based money laundering and the bartering of goods, as well as the notorious “gold for gas” deals with Turkey that surfaced in 2014. Smuggling increased, empowering certain factions such as the Iranian Revolutionary Guard Corps (IRGC) to have a direct role in black market trades, and corruption spiked to keep trade flourishing, whilst diverting it through non-official channels.

“The sanctions led to the most comprehensive and innovative web of ML and anti-sanctions circumventing ventures on a national level in the history of sanctions. The mechanisms for breaking sanctions have been institutionalised,” said Kiyaei. “A major cause of corruption, nepotism and cronyism is due to the reliance on so many players to circumvent the sanctions. It’s a chronic problem, which does not bode well for a more transparent regulatory system to be put in place.”

Such an environment is going to be difficult to change in the immediate term. While the CBI implemented a formal AML regime in 2008, a more rules-based culture has not been embedded within financial institutions – many previously encouraged to break rules because of the sanctions. “Regulations can be copied and pasted, but implementation is another issue. There is now a mentality of constantly moving around restrictions, be it government imposed sanctions on how to lead your life – censorship – or sanctions on the central bank, financial institutions and the economy. This has created from an anthropological point of view a crazy society, a tendency towards circumvention,” said Kiyaei. 

Furthermore, there appears to be little political room to force through economic and banking reforms. “The difficulty is that (President Hassan) Rouhani almost exhausted his political capital to bring about this nuclear agreement, so there’s less appetite for structural reforms,” said Vaez.

If there was any doubt about the challenge faced by President Rouhani, Iran was ranked number one in the Basel Institute on Governance’s AML Index 2015, as well as in 2014, based on the risk of money laundering and terrorist financing. A caveat is due however, as the top ranking is due to a lack of data on the sector emanating from the CBI and the financial sector, according to the institute. Gauging the true extent of Iran’s AML deficiencies is therefore difficult, while with its well-entrenched siege-like mentality, the government in Tehran has not been willing to be transparent.

“When you cut off Iran from the world, the world is cut off from Iran, so when a major part of the economy goes into the shadows then regulatory transparency measures are almost impossible to implement. What is interesting is that the Iranians are obsessed with statistics – the data is actually pretty decent – just access to it from outside entities is deemed a national security issue at a time of sanctions, and there’s an access problem as there’s no presence of Western (financial services’) outfits,” added Kiyaei.

Iranian financial institutions have also faced obstacles in terms of accessing lists of designated individuals and entities under remaining sanctions, because – in a cold irony – relevant software could not be sold to Iran under the EU and US sanctions. While this limitation has been lifted, restrictions remain in place for certain listed software for nuclear or military industrial use.

“The Iranians wanted access to the Bankers Almanac (a US-owned reference on financial information) to do their job and have relevant codes, but software providers were accused of breaching sanctions. The Iranians have been going around in circles as they can’t buy information to do AML checks,” said Nigel Kushner, CEO of W Legal Ltd in London. “I’d be surprised if the majority of banks have any reputable screening in place.”

Meanwhile, Iranian financial institutions are struggling to break into key elements of the international finance system, which could slow down the urgency of adopting global norms and a compliance culture. Indicative is that Iran has been readmitted to the SWIFT payment system but institutions are struggling to find correspondent banks to handle transactions.

The newer “private banks haven’t necessarily got the knowledge or track record which some counterpart banks are looking for, so they will suffer in that aspect. Many (Western) banks are taking the line: the money we will make is not worth the exposure. I’ve not seen any signs of clearing banks jumping back into the Iranian market, and an additional issue at the moment in London is Iranian banks can’t find a clearing bank,” said Kushner.

Similarly, Western bank are reluctant to enter Iran amid uncertainty about sanctions, the country’s domestic environment, and past fines by US regulators against banks that violated the sanctions. “Big banks remain reluctant to re-engage in the Iranian market out of fear the [nuclear] deal is not as sustainable as it appears given opposition [by certain political factions] in Tehran and Washington DC, while banks paid huge fines for previous work with Iran so are very risk adverse,” said Vaez.

Some of the fines are particularly fresh. In November 2015, Deutsche Bank was fined USD258 million, and in October 2015, France’s Credit Agricole was fined USD800 million by the New York State Department of Financial Services for violating sanctions on Iran and Syria. In 2014, France’s BNP Paribas was fined nearly USD8.9 billion for violating US sanctions against Iran, Sudan and Cuba.

These fears are reinforced by US government statements that it is not yet time for business-as-usual with Iran. And past recommendations and regulatory settlement agreements restricting trade with Iran often still stand.

“In 2011, the US said Iranian banks were a source of concern for ML, so foreign banks will have to do enhanced due diligence, and secondly, many of the large UK clearing banks have been fined by US enforcement agencies over the past several years and entered into settlement agreements. In many cases they’re not to have any dealings with Iran or Iranian banks, and the US said (in January) the easing of sanctions does not supersede these agreements. So some banks have their hands tied behind their backs,” said Kushner.

An edited version of this article was published by the Money Laundering Bulletin (