Iraq is seemingly on the precipice of disaster. The government is divided, the economy is chaotic, and insurgents are trying to provoke a Sunni-Shia civil war by fomenting sectarian attacks. Yet a glimmer of hope can be found in the banking sector, where both foreign and domestic banks are trying to play their part in Iraq's future. Robin Wigglesworth reports.
The Central Bank of Iraq (CBI) is facing an uphill battle to reconstruct the country's banking sector. As the World Bank and United Nation's Joint Iraq Needs Assessment report in 2003 said: "In the medium term, the private sector will be a crucial means to achieve high growth and create employment. Also critical is the revival of a banking system that is able to operate on commercial lines." John Taylor, the US under-secretary of the Treasury for international affairs, has told a Senate committee that "strengthening and modernising the banking sector is central to achieving overall economic progress in Iraq".
With the aim of doing precisely this, the CBI finalised licenses for three foreign banks, HSBC, National Bank of Kuwait and Standard Chartered in 2004. Of the three banks, which were picked out of 15 initial applications, HSBC has been the most noteworthy, and will soon finalise its purchase of 70% of the Dar-Es-Salaam Investment Bank (DESIM), a commercial lender with personal banking operations. DESIM only has 14 branches and has only operated for the past five years
The investment is important, not only for Iraq and confidence in her economy, but also for HSBC's plan to become the premier Middle East bank. After having neglected to expand in Iran when it liberalised its banking laws, HSBC has been expanding in Kuwait, Qatar and now Iraq as part of its 'Middle East jigsaw'. HSBC originally intended to buy 51% of DESIB, but increased its bid and are promising considerable modernisation of the bank.
An HSBC spokesman earlier said the bank is "committed to playing its part in the reconstruction of Iraq and to investing in the country in the long term. In partnering with DESIB, HSBC believes that it can create a leading personal and commercial banking service". Since then, no comment has been made, due to fears that too much publicity could provoke attacks against HSBC staff. HSBC's Istanbul head office was attacked some years ago, and last year a man stormed an HSBC branch in Beirut, brandishing a grenade and threatened to blow up the branch in protest of the UK's support of the Iraq war.
Since the preliminary licenses were granted, the World Bank's International Finance Corporation (IFC) has set up the $105 million Iraq Small Business Finance Facility (ISBFF) with the intention of preparing Iraqi banks to meet the needs of smaller companies. Recently, the Arab Banking Corporation (ABC), Bank Melli Iran (BMI) and the Housing Bank for Trade and Finance of Jordan (HBTF), have also been licensed, either to follow the HSBC route by investing directly in an Iraqi bank, or by setting up local branches. However, some of the banks that received early licenses have been delaying entering the market, and whilst the CBI have extended the licenses until the end of 2005, they have warned the foreign banks that they would lose their licenses should they postpone opening subsidiaries or branches any longer.
Under the terms of the CBI, foreign majority-owned subsidiaries must hold a minimum capital of 50 billion Iraqi Dinars ($34m), open at least five branches, and adopt supportive lending policies. Staff training programmes and investment in advanced banking techniques - especially in areas of cash management and payment products - are also required.
There are 19 private banks in Iraq, but they are dominated by six large state banks, most notably Al-Rasheed and Rafidain, which control between 85-90% of the market. During the Saddam Hussein regime, the state banks merely acted as fiscal instruments for the ruling Baathist party, and rather than fuel the economy, drained it by acting as Hussein's personal bankers, in which capacity they were responsible for wide-spread 'capital flight' from Iraq.
When the Baathists and Saddam Hussein came to power Rafidain was the Middle East's largest bank, but now owes around $24 billion, and also holds the old regime's unpaid sovereign debts and credits, totalling $129 billion. Privatisation is a distinct possibility, as Rashidain remains Iraq's largest bank, with 153 domestic branches, 75% of the deposit base and $700 million in foreign currency.
Among the large private banking institutions are the Bank of Baghdad, Iraqi Middle East Investment Bank, Commercial Bank of Iraq, Investment Bank of Iraq and Credit Bank of Iraq. Their clients are frequently family members or business associates of the owners, and an effort needs to be made to further services for small and medium-sized businesses (SMEs).
According to the US Treasury Department, in late 2004, total assets were estimated at about $2bn, the equivalent to 10% of gross domestic product. The aggregate equity of Iraq's 25 banks was reported at a paltry $42m, and the sector's capital-assets ratio of 2.1% is extremely low by international comparison. Debt usually far exceeds capital leading to many banks being 'technically insolvent', and the large amount of non-performing loans (NPLs) are worsening the problem.
Whilst there are moves to stabilise the situation, Iraq is in many ways a typical war-time economy. Most transactions are cash or trade-based, and most people would rather keep their money under the mattress than in a bank. This in turn affects banks' deposit base and their ability to finance SMEs, deemed vital to Iraq's reconstruction. Another complicating factor is that the technology of most Iraqi banks remains primitive, even by Middle East standards. There is very little use of electronic banking and debit and credit cards, and the entire industry needs strong investment in IT projects across the board.
However, there is some cause for optimism. With the world's eye firmly focused on Iraq, it is unlikely to be allowed to descend further into anarchy, and the CBI has proven flexible towards foreign banks, global and regional alike, hopefully opening up the sector for considerable investment. Several Lebanese and Arab banks are reportedly interested in expansion in Iraq, and across Iraq, bank deposits are increasing. HSBC's move will hopefully embolden other foreign banks, who would bring commercial banking experience, efficient systems and organisation to a sector suffering from decades of atrophy.
Plenty must be done within Iraq as well, and encouragingly, both the government and the CBI have taken steps towards 'normalisation'. The government has been commended for its business polices by the IMF, and the CBI has raised minimum capital requirements for private banks to help promote consolidation through mergers and acquisitions, and restore solvency ratios. Recently, several banks, including the Gulf Commercial Bank, are increasing their capital towards the minimum 50 billion Iraqi Dinars ($34 million) capital required by the CBI.
Perhaps most impressive of the CBI's achievements is the stability of the Iraqi New Dinar. After the war ended, it was feared that the volatile Dinar would freefall and plummet in value, but since the introduction of new banknotes in January 2004, the Dinar has hardly budged from its value of 1465 to the benchmark US $. The exchange rate is free in theory, but the CBI has maintained the stability of the rate through robust intervention by buying and selling dollars when needed.
As with everything in Iraq, a lot depends on security. The international banking sector already has experience with starting afresh. After the Soviet Union collapsed and the Velvet Revolution swept Eastern Europe, entire monetary and fiscal systems needed to be established, but there they were welcomed with open arms. In Iraq they face a bloody insurgency and possible civil war.
Iraq has tremendous economic potential should the insurgency abate, the constitution prove successful, and the oil flow resume. With a fairly educated population, vast oil wealth, and a strong government, foreign banks and companies should flock to the land of two rivers. But this is contingent on the security issue being solved. Whilst HSBC's travails in Istanbul and Beirut have not deterred it from gambling on expanding in Iraq, it is a gamble nonetheless. As John Snow, the US Treasury Secretary said, "Capital is a coward. It doesn't go places where it feels threatened".
Banker Middle East 2005
