Fitch Ratings - London: Fitch Ratings has assigned Kurdistan International Islamic Bank (KIIB) a Long-Term Issuer Default Rating (IDR) of 'CCC+'. A full list of rating actions is detailed below.

KEY RATING DRIVERS

KIIB's IDRs are driven by its standalone strength, as indicated by its 'ccc+' Viability Rating (VR). KIIB's VR reflects its weak franchise, unstable business model and operations in the highly volatile operating environment of Iraq. The VR also reflects the bank's acceptable underwriting standards, plus adequate capitalisation and liquidity. The Viability Rating of 'ccc+' has been assigned below the 'b' category implied score due to our negative adjustment for its business profile.

Weak Operating Environment: Fitch's assessment of the Iraqi operating environment is constrained by the high dependence of the economy on the oil sector, the high involvement of the state in supporting credit growth, projects and job creation, and a weak regulatory and governance framework and business environment. Higher oil prices are expected to support GDP growth (8.6% expected in 2022, up from 3.8% in 2021).

Limited Franchise; Unstable Business Model: KIIB's business model is highly dependable on fee-based services, mainly to its clients in the Kurdistan region, with minimal market shares in Iraq, no competitive advantages and limited distribution capabilities. Given limited lending opportunities, loans represented less than 1% of total assets at end-1H21.

Acceptable Underwriting Standards: The bank has a conservative risk appetite. Underwriting standards are tight with business volumes heavily weighted towards corporates and public-sector entities working with the regional government in Kurdistan. The bank is mainly focused on providing fee-based services to its clients.

Small Financing Book: Around 90% of KIIB's assets are bank placements. While 60% are with counterparties rated 'B-' or above, 29% are with unrated banks, predominantly Iraqi banks. Around 18% of these placements are trapped in a Central Bank of Iraq's branch in Erbil. According to management, KIIB is in the process of resolving the issue of these placements with CBI. Loans represent less than 1% of total assets and are mainly provided to retail borrowers.

Volatile Profitability: KIIB is more profitable than domestic peers due to its non-interest-income-based business model but performance is volatile due to its dependence on foreign-exchange and investment income. Operating return on risk-weighted assets (RWAs) ratio fell slightly to 5.8% in 1H21 (6.2% in 2020; 1.3% in 2019; 4.1% in 2018), but remained well above that of private domestic peers. We expect the bank's core profitability to improve in 2022-2023 as higher oil prices should support business volumes.

Adequate Capitalisation: KIIB's equity to assets ratio was 41% at end-1H21. Its common equity Tier 1 (CET1) ratio and capital adequacy ratio (CAR) were 307% and 382% at end-1H21, respectively; the latter was considerably above the minimum regulatory requirement of 12.5%. KIIB has a low RWAs density (13% at end-1H21) due to the lack of lending and investment opportunities.  Our assessment of capital factors in the bank's focus on a weak domestic operating environment, unstable business model and low risk weight density.

Diversified Deposit Base; Adequate Liquidity: KIIB is mainly funded by equity (40.9% at end-1H21) and customer deposits (46.5%). The deposit base is well-diversified versus Fitch-rated private peers'. Virtually all deposits are held in current & saving accounts (CASA). Government, retail, and corporate deposits represent 16%, 37%, and 48% of the total, respectively. We do not expect changes in the deposits base over the rating horizon. Liquid assets covered 1.7x total deposits at end-1H21.