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WorldApril 1 2014

Putting Iraq back on the banking map

After years of neglect, the Iraqi banking sector offers promise once again. Mobile banking, trade finance and infrastructure financing opportunities are proving attractive to existing lenders and the wave of new entrants looking to break into the market. But, before the tide can finally turn, there are regulatory issues that need addressing.
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Putting Iraq back on the banking map

The decade since the US invaded Iraq in 2003 has been one of the most important in the country’s history, as it seeks to move away from being a centrally planned economy and aims to restructure key sectors. This has resulted in huge changes taking place across many industries, but one area that has been noticeably slow to develop has been banking.

Today, Iraq remains essentially a cash economy, with many international companies carrying hundreds of thousands of dollars with them in order to carry out even the most basic transactions. Yet, in spite of the prevailing volatile security situation on the ground, there is now a growing commitment to invest in Iraq’s financial infrastructure – both from local banks (of which there are 51) and their foreign counterparts (which number 16). 

'Vibrant' opportunity

A milestone was reached in November 2013 when Standard Chartered became the first UK bank to establish a branch in the country, opening its first outlet in Baghdad. It is opening a second branch in the northern city of Erbil in March and a third in the southern oil hub of Basra towards the end of 2014.  

Standard Chartered has been attracted by the financing opportunities for large government infrastructure projects planned in Iraq. The country's National Investment Commission has drawn up a $357bn national development plan for 2013 to 2017 aimed at jumpstarting its economy, and has declared that it will need to spend $1000bn on infrastructure over the next 10 years. 

"Iraq represents a significant opportunity for Standard Chartered – we have a lot of clients who are very actively involved in the reconstruction of Iraq and they asked us to be there,” says Gavin Wishart, chief executive of Standard Chartered in Iraq. “The fundamentals are compelling – there are opportunities across many sectors such as oil and gas, telecommunications and infrastructure. We can see a vibrant economy developing in the future.”

Standard Chartered’s existing clients in Iraq are drawn from the US, Europe, the Middle East, South Korea, India, China and Australia. “We are seeing an increasing number of our clients contacting us from around the world who are interested in doing business in Iraq, as well as other international banks who want us to help them on the ground in Iraq,” says Mr Wishart.

The bank is also going to be acting as a financial adviser to the Iraqi government as well as advising both private and state-owned banks.

“The initial thrust will be to assist local banks through specialised small and medium-sized enterprise training programmes, as well as helping them to develop their technology. The real opportunity for banks to leapfrog ahead is through the implementation of technology," says Mr Wishart.

Next stage

Years of neglect has meant that Iraq’s banking infrastructure is desperately in need of investment – something that banks are now starting to address. National Bank of Iraq (NBI) is undertaking a major push on the technology front – it will be introducing internet and mobile banking during 2014, as well as installing 20 ATMs. “We are hoping to introduce mobile and internet banking by the end of April,” says Ayman Abu-Dhaim, vice-chairman of NBI. “And our target is to get all the ATMs installed by the fourth quarter of this year.”

Aside from focusing on its digital offering, Mr Abu-Dhaim says he believes that a large source of future growth will come from trade finance, with NBI enjoying double-digit growth in its letters of credit (LC) business between 2011 and 2013. The bank is increasing its capital base from $150bn to $250bn – a process it was hoping to complete by the end of the first quarter of 2014 – so that it can continue to grow this side of the business.

“Iraq’s trade volumes are growing rapidly but currently businessmen and companies depend heavily on exchanges to change and transfer money,” says Mr Abu-Dhaim.   

As the guarantor on LCs for other banks in Iraq and the only bank authorised to issue LCs in excess of $4m, state-owned Trade Bank of Iraq (TBI) already derives a huge part of its revenue from trade finance. Since its inception in November 2003, TBI has issued more than $50bn-worth of LCs. The bank is also a key player in financing the government’s key projects.

“TBI is actively participating in all major infrastructure projects with fund-based and non-fund based credit facilities,” says Hamdiyah Al-Jaff, chairwoman of TBI. “Investment banking and project finance are the biggest opportunities in Iraq.”

A deadlock?

As things stand, however, the government and public sector companies, which are the key drivers of Iraq’s gross domestic product, are only allowed to deposit with and take loans from the seven state-owned banks. These banks account for roughly 85% of Iraq’s banking sector assets and therefore are deemed to hold an unfair monopoly in the market.

“The development of the private banking sector requires a levelling of the playing field with state-owned banks,” noted the IMF in its Iraq country report published in July 2013. “Options include opening up the market for trade finance for government imports and allowing private banks to honour customers’ cheques to the government. In addition, the competitiveness of the private banks depends on the modernisation of their operations (many banks still lack a core banking system) and strengthening of their governance structure.”

However, Mr Abu-Dhaim says that private sector banks are unlikely to develop any appetite for project finance unless two key hurdles are addressed. “The first major hurdle is that the collateral isn’t there. Banks normally ask for real estate but most of the projects are granted by the government, which means that the deed and ownership of the land is kept in the government’s name. This means banks are expected to rely on the cash flow of the project, which isn’t sufficient, and they are afraid of ending up in court because the legal framework isn’t clear,” he says.

“Second, the size of the projects in question are very large – on average greater than $50m – so one bank can’t support this on its own which means banks have to get together to do a syndication but lots of banks are saying that they don’t want to take the risk and they can make easy money through currency trading. This means they’re ignoring all other proper credit functions.”

Currently, private banks are making the lion’s share of their profit by buying US dollars from the the Central Bank of Iraq’s (CBI's) daily dollar auctions and selling them onto the market at a higher rate of exchange.  

Private power

In an effort to increase the firepower and role of Iraq’s private sector banks, the CBI drew up a two-stage programme in 2009, asking banks to increase their capital base to $85.8m by June 2011. The CBI’s next deadline was June 2013, by which date all private banks were expected to have minimum reserves of $215m.

“Last year’s capital increase requirement wasn’t met by some private banks,” Abdul Bassit Turki, the governor of CBI and chairman of the Federal Board of Supreme Audit told The Banker on the sidelines of the Iraq Finance 2014 conference held in Dubai at the end of January 2014. “The ones that didn’t meet the requirements will either have to merge or withdraw – I expect five banks will face problems now.”

The CBI governor also disclosed that he had received several applications from foreign banks for licences. “We are going to grant approval to two banks in the coming months, one of which will immediately open even branches,” he said.

Meanwhile, the US’s Citibank established a representative office in Baghdad in 2013, which is aimed at supporting corporate customers, while JPMorgan has been strengthening its ties with the TBI. The entrance of an increasing number of foreign banks into Iraq will certainly help to modernise and shake up the industry as these banks import their technology and expertise. They will hopefully also help dilute the domination of the seven state-owned banks. 

There is clearly room for many more new entrants; Iraq remains one of the most under-banked countries in the Middle East and north Africa (Mena) region and it is estimated that more than 80% of Iraqis do not have a bank account, according to the US Agency for International Development. Meanwhile, credit to GDP in Iraq remains one of the lowest in the world, with domestic-credit to private sector at 9% of GDP, compared with a a 55% of GDP average for the Mena region.

Increased technology and digitisation will be central to improving accessibility. However, Iraq's central bank also needs to prioritise regulatory reform in order to ensure the growth of the project finance market and to create a level playing field so that the private banks can play a greater role in driving Iraq’s economy forward. Sustained and healthy economic growth will only be possible if the key structural weaknesses of the banking sector are addressed.

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