Rebuilding a war-torn country, reshaping a former state-run economy and creating a private sector out of thin air are challenging enough. Doing so in the absence of a robust financial infrastructure to underpin it all is nigh on impossible. All three objectives hinge upon the creation of a banking system ready and willing to help consumers purchase goods, to assist companies in buying capital equipment, and to fund expansions.

The task in hand

 The financial architecture to support a growing, privatised economy is a bottom-up operation. Iraq remains a cash economy with a thriving black market. Private banks are thin on the ground, lending is sparse and there is no ingrained credit culture. State-owned banks hold 80% of deposits. Earning assets as a share of total deposits is on average less than 5%. Credit to the economy as a percentage of GDP is a mere 3.7%, among the lowest in the world. Iraqi business owners and entrepreneurs tend to rely on retained profits, their own wealth or loans from friends and family.

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 In terms of commercial banking in the country, the landscape is principally local Iraqi banks and joint venture banks that have come in (see chart, below). Products offered are in four main areas: remittances/cash transfers and some foreign exchange; trade finance; commercial lending; and securities and stockmarket trading. Activity in all of these areas is fairly limited.

 In the trade finance arena, letters of credit (LCs) are available. The public-sector Trade Bank of Iraq has been active in trade finance and in issuing LCs. The sticking point remains that for LCs the Iraqi private banks have very limited access to clean lines of credit from international banks. Private sector importers typically have to deposit the full amount of the LC as cash collateral. Meanwhile the exporter, if an international firm, will require a confirmation by a reputable bank. Many of the private-sector banks in Iraq have established correspondent banking relationships with major global banks, but few of them have yet to receive clean lines of credit.

 Iraqi banks do very little lending overall, including commercial lending, preferring instead to invest customer deposits in treasury bills issued by the Central Bank of Iraq, which for quite some time was earning them more than 18% a year and was deemed a safer bet than providing loans. That may begin to change given that the central bank has lowered the interest rate to just under 7%, but it remains to be seen whether the loss of that attractive arbitrage will incentivise the banks to lend commercially and whether the shareholders of the banks, having seen the returns plummet, will put pressure on the bank management or support the management to begin lending.

 Private banks that do lend to companies typically do so for a term of up to one year maximum, and only if real estate is put up as collateral (which they value very conservatively); charges can be upwards of 20% a year. Commercial lending, in any case, is a loose term in Iraq as commercial, corporate and private banking tend to be intertwined.

 Public-sector organisations are trying to plug the gaps. The government agency USAID’s Tijara Provincial Economic Growth Programme, designed to support improved access to finance and business development services in the micro, small and medium-sized enterprise sectors, says that since its inception less than two years ago, the level of microfinance and bank financing has more than doubled from the baselines set by Tijara’s predecessor, Izdihar project, and innovative financing mechanisms – such as SME-focused lending units in a few private banks – are helping expand financial services offerings where they never existed before.

 A progress report published in September 2009 says under Tijara, cumulative small, medium and micro enterprise loan disbursements have reached $344m. SME lending units in nine private banks affiliated with the Iraqi Company for Bank Guarantees have been launched in 34 branches in 16 provinces, shelling out for more than $16m in loans. Meanwhile, the Iraqi Company for Financing SMEs came into being this summer and in its first two months of operation made 200 loans totalling $3.5m.

 But clearly there is wide scope for foreign financial institutions to move in and serve this under-banked market.

Opportunity knocks

 Since 1992, 37 private banks have been established in Iraq: 30 commercial banks and seven Islamic organisations. Three foreign banks have representative offices: Standard Chartered Bank (Erbil), Arab Banking Corp and TC Ziraat Bank (Baghdad). The central bank has given preliminary approval to other foreign banks – including Bank Melli Iran, Commercial Bank of Kuwait, Arab Bank of Jordan, Housing Bank for Trade & Finance Jordan and Ahli United Bank of Bahrain – but it is not thought likely that these would open ‘independent’ operations in Iraq in the immediate future. It was recently announced that the government of Syria is also working on a joint-venture bank in Iraq. Lebanon’s Byblos Bank and Bank Audi have presences in Kurdistan.

 “The opportunities are endless to run a profitable countrywide banking and financial services network,” says Dijlah & Furat Bank for Development and Investment in a market report on Iraq. “The need for real and proper financial intermediation is omnipresent, ie, to attract savings and time deposits and lend funds to the creditworthy enterprises, expediting trade and economic development.”

 The bank – which started operations in 2006 and states as its mission “to become Iraq’s premier Islamic bank” – has two branches in Baghdad, one branch each in Sulaymaniyah, Karbala and Erbil, and will soon have operations in Basrah, Anbar, Samarra and Dahuk.

 “The private banks that succeed will be the ones which develop market-driven liability and asset products and market them efficiently to all classes of customers. This will be backed up with trained bankers, modern systems and technology, and an extensive branch network,” the bank concludes.

 Islamic finance is indeed a growing area in Iraq. A half-dozen Islamic banks have established in the past five years. “Islamic banks are coming in and they are being relatively aggressive in their lending,” says Hussain Ali Qaragholi, senior vice-president and Iraq business head for one of those banks, Abu Dhabi Islamic Bank.

Making a play

 Given the high level of investor interest in Iraq and the increasing levels of capital inflows, an influx of banking players and the introduction of new financial products in a range of areas is a near certainty. The stock market is attracting growing regional interest and investors are seeking ways to enter the equity market through the Iraqi Stock Exchange, which now trades in 39 listed companies in banking, insurance, investment, manufacturing, industrial, hotel and service sectors.

 “Politico-economic trends are moving in a positive direction for business in Iraq,” says Mr Qaragholi. “On the political front we have had democratic elections and on the economic front we have had major announcements from international and regional companies concerning planned investments in Iraq.

 “We have had announcements from the Iraqi government on infrastructure projects – ports, railways, power stations, housing – and there is a lot of appetite for more projects from strategic and financial investors. Funding will be critical for the success of these projects.

 “From a bank’s perspective, we are positive that there are significant first-mover advantages in getting involved in asset-based commercial lending and project finance in Iraq.”

Foreign-iraqi joint venture banks

The cost of this supplement was underwritten by the United States government. Reporting and editing were carried out independently by fDi Magazine.