Recent protests in Iran were sparked when several credit institutions went bankrupt and their depositors lost their savings in an event that will affect thousands of people. Although on the surface this looks like a typical financial crisis, the failure of these institutions may strike a devastating blow — one that may reach a tipping point this time and lead to a run on the banks. The strong words coming from Washington and President Donald Trump may be taken as a signal that America is pushing for a regime change, a tactic that could succeed or backfire.

I traveled to Iran to visit my ailing grandmother in September 2016. What caught my eye was the sheer number of credit institutions and banks offering double-digit returns on deposits. Virtually everyone I knew had a substantial deposit with one of these so-called banks. Called cooperatives, they are private institutions that use the capital invested by their members to engage in business activities.

Cooperatives and Iran's Financial Market

The origins of the cooperatives (or Ta`avoni) go back to 1971 and were an effort by the government to privatize the economy. Over the years, their number grew rapidly and the scope of their activities widened. They even started to provide financial services to the extent that they morphed into shadow banks. Legally, the establishment of such an entity needs a permit from Iran’s Central Bank. However, some say many of them circumvented the rules and took advantage of rampant corruption during the presidency of Mahmood Ahmadinejad to set up shop and start receiving deposits.

Valiollah Seif, the president of Iran’s Central Bank, said in July that approximately 25 percent of the cash flow in Iran’s financial market was handled by such institutions in 2013. During my travels, I heard complaints about the government’s crackdown on these cooperatives. People I spoke with, not appreciating that this was just too good to be true, were foolishly concerned that the government was aiming to cap the interest these institutions were allowed to offer. I one day noticed seven different cooperatives located wall-to-wall on a street. Compared to my prior trips, their numbers had grown dramatically. I heard from someone that some of them even offer higher interest than what they advertise to attract high-net-worth individuals.

Where Trump Comes In

The failure of the cooperatives and the recent unrest happened at an interesting time: the Trump presidency. Back in 2009, President Obama didn’t show much eagerness for a regime change. Many think that President Obama’s lack of public support in effect extinguished the protests back then. Iranians may interpret President Trump’s recent statements as a signal that the time has come.

Iranians aren’t fans of the Trump administration and would very much prefer to handle the situation without any foreign intervention. When it comes to regime change, people fear that “foreign powers” may have prescribed for Iran a Syrian-style chaos, rather than a flourishing democracy. People point to the fact that regime changes in the Middle East, especially in Iraq, have resulted in a net negative.

Trump’s travel bans that affected the Iranians and the stance against the nuclear deal also left a bad taste for Iranian people, especially since the Nuclear deal had strong support of Iranians from all sides. But whether or not Trump’s tweets resonate on the streets of Tehran, they will have an impact of the economy. Iran’s rial exchange rate is directly affected by words coming from Washington. This exacerbates inflation, which is one of the main complaints of Iranian protesters.

That makes life harder for the Iranian government, which is still gasping for air after decades of economic sanctions and is slowly recovering from the damage done by Ahmadinejad. Tehran may not have the means to bail out a failed banking system. It took the “full faith and credit” of the United States, the most powerful economy in the world, to prevent the collapse of the banking system in 2008. However, for many developing countries, such a crisis will make their “full faith and credit” catch fire on the streets, as is happening in Iran currently. The Trump administration may be betting that the banking situation may prove insurmountable for the Iranian government, and all they have to do is to fuel the fire. They may be right.

The Financial Bubble Collapse

So how could the government not prepare for the eventual collapse of this financial bubble? One answer may be that bulk of these cooperatives came to life during the presidency of Ahmadinejad. His cabinet is mainly responsible for allowing the emergence of a shadow banking system in Iran. And given that his policies and rhetoric brought about the worst conditions in many years and increased sanctions, the government of President Rohani was stretched too thin attending to urgent issues of the time, including the nuclear issue.

During my stay, I kept counseling friends to withdraw their deposits or at least limit their exposure. I met someone who liquidated his entire net worth, quit working, and started living on 18 percent interest on his money. Later I learned there are many people like him. It felt like a financial virus that was in its incubation period.

In Iran, modern standards of banking such as capital requirements and financial disclosures are not properly followed. Some of the official banks even have de facto authority to engage in quantitative easing. There are a substantial number of banknotes in circulation. These notes look very similar to the official currency and are used in everyday commerce. In fact, these notes are sometimes preferable over the official currency as they come in much higher denominations and allow for easier transport. Although this is not advertised as banks having the ability to engage in quantitative easing, it has exactly that effect. Simply put, some banks print money on their own. Imagine Bank of America gave you a $1,000 bill that they printed and you could use that as currency anywhere.

Iran’s economy has been improving under President Rohani but at a much slower rate than people were anticipating, and it is still weak and sensitive. Any sign of problem leads to a noticeable jump in inflation. It appears that the failure of these cooperatives sent a shockwave that resulted in an overnight rise in the costs of many essentials food items, and this was simply too much to take for people who have been suffering under debilitating sanctions for several years.

As for the Iranian government, they were just about to enjoy the lifting of some of the sanctions and increased business relations with foreign countries, especially in Europe. Any large-scale crackdown on street protests would put Tehran’s business relations with Europe at risk too, pushing the economy even close to the brink.