In Iraq, life sometimes moves in rapid-fire motion and developments happen at such a pace that it is almost impossible to keep up. Viewed with the proper perspective of time and place, it is startling what has been achieved in remaking the country, its government system and its economy since the invasion by US-led coalition forces in 2003.

In seven years, a 35-year-old autocratic regime has been dismembered and replaced with a messy multi-party democracy, a statist economy has been sent into an even messier transition towards a free market, and massive volumes of laws have been torn up and rewritten. The wheels of change are turning, even if they often grind to a halt before starting up again, and all the while there is frustration and impatience that changes are not happening as quickly and comprehensively as needed.

Bureaucratic roadblocks

Consider the case of a multilateral institution-led reform project for elements of the banking sector. In December 2006 there was an agreement between the Central Bank of Iraq (CBI) and the International Monetary Fund over steps to be taken to reform the banking sector, focusing in particular on the public banks. For the next two years, despite some baby steps, progress was halting as reformers ran up against bureaucratic roadblocks. The World Bank stepped in with a $10m grant in April last year to fund implementation.

After months of diligent work, all the documentation was prepared for a programme that would see the supervision department of the CBI reorganised and training provided for all CBI staff that deal with supervision – 105 people in total. The training was due to start in September 2010 and, ahead of that, all the contracts were to be finalised at the end of June. But on June 13 there was an attack on the CBI and all the documents were destroyed – rather conveniently, some murmured. All the documents are now being replaced.

“The target [for completion of the CBI reorganisation and training] was the end of this year but, due to the circumstances, the World Bank has extended the project to June 2013,” says Dr Majid M H Al Soori, the mildmannered PhD in economics who has been tasked with overseeing the project and liaising between the CBI and the World Bank.

He rejects any suggestion, however, that the attack on the CBI was motivated by malfeasance. “There is corruption in all government departments and sectors. But the aim of the attack was just to show that the terrorists can enter anywhere, any time, and to give the appearance that the government cannot control everything. It was the same as the attacks on the ministries of finance and trade,” says Mr Al Soori.

Conflict of interests

There are calls for a wider overhaul of the CBI and a reset of its approach. Iraqi private bankers complain that it shows favouritism and accuse some CBI officials of conflicts of interest, charges that are hotly denied. “The CBI, and the government generally, needs to function as a regulator, not a competitor,” says one well-placed player in the Iraqi financial industry.

“A very independent central bank that has jurisdiction over all banks” is the single biggest reform needed to aid Iraq‘s banking sector, agrees James Hogan, CEO for Iraq at HSBC Middle East. “You sometimes get a sense that there are two sets of rules and there are inconsistencies on some occasions,” he says, while adding that on the whole he finds CBI staff “very supportive, responsive and well trained”. HSBC plans to work with the CBI to provide risk-management training for its employees as well as for local banks.

HSBC has also been pushing, along with others, for the creation of a custodian bank to underpin the development of Iraqi capital markets – the current lack of which is cutting off Iraq from institutional investors, since many of the major funds, including US-based mutual funds, are barred from investing in stock exchanges without custodian services.

Taha A Abdulsalam, CEO of the Iraqi Stock Exchange (ISX), supports the idea of a custodian bank and says there has been a board meeting to draft such a recommendation to the Iraqi Securities Commission. “This is something new for Iraq and for ISX, but we must follow the same procedures as others. We plan to accept many banks, not just one, to provide these [custodian] services.”

The second plank of the World Bank’s reform project, meanwhile, involves the two large state-owned banks, Rafidain and Rasheed, and focuses on organisational restructuring, financial restructuring and capacity building; this has been pushed back five months.

Reform of some type or another to the status and structure of Iraq’s state banks is certain (and, many argue, imperative to the health of the whole banking sector); but it is not likely that the state banks’ clout will be reduced to the level desired by their private sector counterparts.

“The pervasiveness of state-owned banks in the Iraqi market is largely due to the fact that they are old and well-established,” says Asif Al Masri, director of deals for Pricewaterhouse Coopers (PwC) in Jordan, who is involved in Iraqfocused projects. “The oldest public bank, the Agricultural Co-operation Bank, was established in 1935, whereas the Bank of Baghdad, the earliest of the private banking institutions, was established in 1992.”

But the state banks have their problems. According to the CBI, the policy of aggressive lending adopted by state banks, which does not take into account appropriate credit-rating systems, is causing them to face high default risks.

Article 16 of Iraq’s banking law states that the minimum capital adequacy ratio for banks is 12%. However, several state banks are not meeting this requirement, making them vulnerable to liquidity risk, says PwC. In 2008, Rafidain’s capital adequacy ratio stood at 2% while Rasheed’s varied between 2% and 5%.

In an attempt to lower the risk levels faced by some state banks and increase their liquidity, both Rasheed and Rafidain increased their capital in 2008 to ID400bn ($340m) and ID500bn, respectively, causing the state banks’ capital to form 50% of the total capital of banks in Iraq.

The banking law, drafted in 2003, was perhaps adequate for its purposes at the time, but now has weaknesses that must be addressed. As currently written, the law deals only with commercial banking – there is no mention of investment banking, Islamic finance or the development banks. A special legal programme is needed for the specialised agriculture, real estate and development banks, says Mr Al Soori, but establishing one is happening in “very slow motion”.

There has also been talk of creating an Iraqi credit information bureau – another essential building block for the construction of an international- standard banking system.

Vision for privatisation

Privatisation in Iraq – of the several dozen state-owned companies as much as of the banks – has been widely talked about for years with nothing tangible yet on the table.

“In June 2010, the Iraqi government announced that there is a vision for privatisation; however, this will not be in accordance with the requests given by the World Bank. Privatisation will be done in stages and at a slow rate in order not to cause significant disturbances to the market, as the proposed privatisation projects currently employ more than half-a-million Iraqis and any fast movement towards privatisation will surely affect those workers,” says PwC’s Mr Al Masri.

This slow progress is a point worth expanding to apply to all categories of economic reform in Iraq. Many of the hurdles, such as endless red tape or insidious institutional corruption, are inexcusable and unnecessary, but they are administrative and thus easier to overcome than the mental blocks.

“The main thing is to restructure the mentality as well as the procedures,” says Mr Al Soori. “And the mentality is very difficult to change because for 35 years [Iraqi bankers] were isolated from the international system.”

A change in mindset is crucial, but so is patience on the part of observers, who must remember how radically Iraq’s reality has been altered in less than a decade. At the political level, due to the recentness of the collapse of Iraq’s command economy, “there is no common understanding about the market economy, investment or economic development”, says Mr Al Soori. “This is the problem politicians are facing – if they don’t understand the economic issues, how can they solve them?”