Economic growth in Iraq will accelerate to 12.6% this year, the fastest rate since at least 2006, according to forecasts from the World Bank. The country will also post its second consecutive current account surplus, at 9.1% of gross domestic product (GDP) in 2012, after posting deficits in both 2009 and 2010. 

The country’s growth is largely being driven by its rapidly growing oil output. Home to the world’s fifth largest crude oil reserves, Iraqi oil production inched past the 3 million-barrels-a-day mark in July – 300,000 barrels per day higher than the country's average output in 2011. With oil prices at about $90 per barrel, Iraq's production rate translates into roughly $100bn a year in revenue.


Iraqi banking sector assets have enjoyed rapid growth over the past five years on the back of these revenues and the country's overall rapid economic expansion. Between 2005 to 2011, total assets grew by a compound annual rate of 22.6%, and yet the country’s banking infrastructure and operations have failed to develop at an even pace.

Severe shortfall

Iraq is home to only about 900 bank branches for a population of roughly 30 million, according to a report published by Iraqi investment bank Dar Es Salaam in November 2011. By contrast, neighbouring Jordan, with one-fifth of the population, has more than 600 branches, highlighting just how underserved Iraq is.

Bank lending in Iraq amounted to a mere $5.8bn in the first half of 2010, the report said, citing the latest publicly available data from the central bank. This compared with $20bn for Jordan. The World Bank estimates that Iraqi banks extended $8.1bn of credit to the economy in 2010, or 9.8% of GDP, compared with an average of 55% for countries in the Middle East and north Africa. All of this helps explain why the Iraqi banking sector is awash with liquidity – it recorded a loan-to-deposit ratio of 37.9% and a loans-to-GDP ratio of 18.3% in 2011.

There are currently 51 banks in Iraq, seven of which are state-owned. The weaknesses of the banking sector is twofold: it remains dominated by state-owned institutions, while the plethora of small, privately owned banks are undercapitalised and therefore do limited lending. Three state-owned banks – Rafidain, Rasheed, and Trade Bank of Iraq (TBI) – account for roughly 85% of Iraq’s banking sector assets. The first two – often referred to as ‘sleeping giants’ – are widely regarded to be in urgent need of modernisation.

A World Bank report published in December 2011 noted: “The operations of the two largest state banks are inefficient and both suffer from the legacy of past losses, as well as from performing quasi-fiscal operations.” 

Both banks have become favoured vehicles for the government’s expenditure policies, detracting from a commercial pursuit of business interests. In 2006, the Central Bank of Iraq (CBI) and the Ministry of Finance signed a memorandum of understanding, which laid out a timeline for reforming both banks.

“Our bank and Rafidain Bank are currently being restructured together so that we are able to apply international standards in accountancy and auditing,” says Kadhim Nashoor, director-general and chairman of Rasheed Bank. “This is very important to foreign investors as they are looking for an advanced application of banking services. We are working hard to clean bad debts and old losses from the balance sheet, as well as reorganising the management structure and our asset liability committee.”

However, as the World Bank report noted, the implementation of the reforms “needs to be accelerated” and “as part of the overall strategy, state banks must become subject to normal supervision by the CBI". 

Unfair monopoly?

There are also concerns about the power that the state-run banks now wield over the economy. TBI was established in July 2003 to facilitate Iraq's international trade and the country's reconstruction after the expiry of the United Nation's Oil-for-Food Programme. Today, it acts as the guarantor on letters of credit (LCs) for other banks in Iraq and is the only bank authorised to issue LCs in excess of $4m. Somewhat unsurprisingly, the bank has attracted a lot of criticism for holding what many believe is an unfair monopoly on the market.

From its inception in November 2003 until August 2012, TBI issued $50bn-worth of LCs. Of these, 10,660 were on behalf of the public sector, while 1009 were for the private sector. It has since expanded its services into other areas such as project finance, corporate finance and retail banking, and it has overseen $34,936bn-worth of remittances and now operates 15 branches.

“The TBI was set up as a specialised trade bank, but now operates as a general commercial bank and has become an important player in the financial system,” noted the December 2011 World Bank report. “More fundamentally, the authorities need to consider the relative roles of state-owned and private banks, including the role to be assigned to the TBI.”

Indeed, there is a serious need to level out the playing field so that public and private banks can compete on an even footing. As things stand today, the government and public sector companies, which are the key drivers of the country’s GDP, are only allowed to deposit with and take loans from the state-owned banks. Furthermore, taxes and any payments to the government can only be made through state banks.

Discussions are under way among private banks to set up a self-funded deposit guarantee fund, but these are at an early stage. Given their low levels of capitalisation, much of Iraq’s private banking activity is limited to deposit services and a small amount of personal lending.

Consolidation calls

In an attempt to boost the role of private banks, the CBI drew up a three-stage programme in 2009, asking banks to increase their capital requirements to $85.8m and lowering its base rate to 6%. An initial deadline of June 2011 was set by the CBI for banks to meet these new requirements. However, more than a year later, four of the 22 private banks listed on the Iraqi Stock Exchange were still unable to meet this minimum capital requirement. The CBI’s next deadline is June 2013, when all private banks are expected to have minimum reserves of $215m. Many see this directive from the central bank as an effort to force a consolidation of the private banking sector.

“The CBI is asking private banks to increase their capital by mid-2013 because many of them simply do not have the resources to finance infrastructure projects so they either need to merge, or work with large state-owned banks,” says Hamdiyah Al-Jaff, chairwoman of TBI. “Private banks need to stop depending on currency trading to make money – they are currently making most of their profit by buying US dollars from the CBI and selling it on to the market.”

US dollars are disbursed into the market through the CBI, with private banks being the key recipient. On average, the CBI sells about $250,000 to private banks and $75,000 to currency exchange and money transfer shops on a weekly basis. Many industry participants complain that private banks prefer to make a quick buck by simply selling their dollars on at a higher rate. The CBI holds a daily auction at which it sells the dollar for ID1166, while private banks are selling them on for roughly ID1210 to a dollar.

In mid-2012, TBI initiated a project to create a syndicated loan with private banks. It is still negotiating with private institutions on this but the door is open for all of them to take part. 

Foreign influence

It is also hoped that the increasing entrance of foreign banks into Iraq may help to modernise the industry as these banks import their technology and expertise. There is a sizeable need to introduce modern information and communications technology systems across the banking sector. There are an estimated 270 ATMs across the country, but the banks have yet to see the benefits of linking these together. 

There are currently 12 foreign banks with a presence in Iraq, while several Middle Eastern banks have been showing a growing appetite to access the market in recent times. One such bank is Jordan’s Arab Bank, which is looking at re-entering Iraq in the near future. (It formerly had a presence there before being nationalised in 1964.) 

Awash with liquidity, the Lebanese banking sector, with total deposits amounting to $115bn in a country with a GDP of $41.5bn, is also expanding into Iraq. Lebanon’s Fransabank is currently considering its options, while fellow Lebanese lender Byblos Bank opened its third branch in Iraq in March 2012. The bank's activities in Iraq cover corporate, commercial and correspondent banking services, including transfers and trade finance. 

“We are doing a very good business in Iraq so we are likely to open one to two more branches there,” says Sami Haddad, general manager of international banking and investment at Byblos Bank. “One of our main growth opportunities today is expanding into Iraq.” 

However, investment banking remains virgin territory for the big international banks. Some have been trying to get a foothold into the market through acting as advisers on the planned initial public offerings (IPOs) of Iraq’s three telecom operators, Zain Iraq, Asiacell and Korek. All three are planning to list and between them could raise more than $3bn if the flotations run according to plan. Zain Iraq is being advised by Citigroup, BNP Paribas and National Bank of Kuwait, while Asiacell has appointed HSBC and Morgan Stanley to oversee its IPO.

Project finance

The real untapped opportunity in Iraq will be the billion dollars worth of infrastructure and project finance deals going forward. Central to unlocking that opportunity will be the approval of an Iraq infrastructure law that has been in the pipeline for several years already. In September 2012, Iraqi prime minister Nouri al-Maliki threatened to move forward with a draft law for Iraqi infrastructure – irrespective of whether he gets parliamentary approval on it.

Iraq’s 2011 to 2014 National Development Plan includes more than 2700 projects valued at roughly $186bn. The government estimates it must build 2.5 million homes by 2015, and in April 2011 it gave the green light on a $37bn plan to rebuild the country’s damaged infrastructure.

However, despite generating billions of dollars in oil income, Iraq does not have the necessary funds to build all of its much-needed infrastructure, such as roads, schools, power and water supplies. The infrastructure law would resolve this matter by allowing the government to take out loans with the companies working on projects and repay them at a later date.

“There is a critical need to attract foreign investment into the country,” says Hussain Qaragholi, president and executive director at the US Business Council in Iraq. “Seventy percent of Iraq’s budget is allocated towards operational costs such as paying public sector employees – this only leaves 30% for capital investment. The government is looking for investment but it is not used to dealing with investors as the country operated as a centrally planned economy for so many years.”

Opening the 'black box'

Mr Qaragholi was involved in the $22bn debt restructuring from the Saddam Hussein-era as well as the country’s debut $2.7bn sovereign bond issue, known as the ‘Iraq 2028s’. In 2011, he founded investment bank Phoenix Capital and is the chairman and managing director of the company, which has offices in both Baghdad and Washington, DC.

“We want to be the first investment bank and advisory firm in Iraq,” he says. “The idea is quite simple – Iraq to many people is a black box in that they are aware of the opportunities but they don’t know how to monetise it.”

Typically in large-scale infrastructure projects, the government needs to take some of the off-take risk but Iraq has not been able to make these legal guarantees as there has not been political consensus on these projects within parliament.

“International banks have been going to export banks such as Hermes, Saachi and the Export-Import Bank of the US, to buy insurance, but the export credit agencies won’t offer insurance without a sovereign guarantee,” says Mr Qaragholi. “So you need to crack this nut before the money will start to flow in. I think it will be another three years before investment banking arrives in Iraq.”  

The World Bank has forecast that Iraq’s GDP will grow by 12.6% in 2012 and 10.2% in 2013, following on from its growth of 9.6% in 2011. If this forecast is realised, Iraq will have achieved a compound growth of 36% in just three years. But sustained economic growth will only be possible if the financial sector is also allowed to flourish. 

As things stand today, Iraq’s financial sector remains underdeveloped and underperforming. Accounting for more than 75% of assets, the banking system is by far the most important part of the financial system. To ensure it can enable the economy to reach its full potential, the government urgently needs to prioritise the implementation of reforms, as well as establish solid regulation to open up the market to international investment and level the playing field for competition from the private sector.

This article was originally published in the December 2012 issue of The Banker magazine ( sister publication of fDi.