London/Dubai: Iraq’s Islamic banking sector assets are likely to continue growing over the medium term, says Fitch Ratings. This will be supported by the government’s strategy for promoting Islamic finance and financial inclusion amid the low banking penetration in Iraq. The Iraqi banking sector is, in general, underdeveloped and fundamentally weak. There is a lack of confidence in the banking system, and low awareness of the Islamic finance industry, which could slow the sector’s growth trajectory.

The Islamic banking sector’s medium-to-long-term growth potential in Iraq (B-/Stable) is positive. Demand will be supported by the country’s predominantly Muslim population, which has very low banking penetration. Iraq’s credit/GDP ratio was low at only 15% at end-2021. About 81% of the adult population did not have a bank account in 2021, versus 60% in the Arab world, according to World Bank. About 24% of the unbanked population cited religious reasons as a barrier, amongst the highest globally.

The Central Bank of Iraq (CBI) seeks to increase financial inclusion by promoting Islamic banking and digitalisation as part of its strategic plans for the banking sector. The CBI has been working on reforming the Islamic banking system with the introduction of new regulations and instructions for Islamic banks since 2015.

The Iraqi Islamic banking sector is small, with an 8.1% market share of the total banking system’s assets at end-2021 (2017: 5.3%) and a 3.7% market share of the total banking system’s deposits (2017: 3%). Islamic banks’ total assets reached IQD12.9 trillion (USD8.8 billion) at end-2021, representing sizeable growth of 18.2% yoy (2020: 9.7%). It outpaced conventional banks’ 2021 asset growth of 15.1% yoy (2020: 4.1%). The Iraqi banking system had IQD159.4 trillion (USD109.2 billion) total assets at end-2021.

Islamic banks have high capital ratios – higher than conventional banks, although such levels of capital can be consumed quickly in such a weak and volatile operating environment. Islamic banks’ capital represented 42.2% of the total capital of Iraq’s banking sector at end-2021, despite a much smaller market share of assets than conventional banks.

Iraq’s share of global Islamic banking assets remained small at 0.4% at end-3Q20 and was lower than in neighbouring Jordan (0.7%) and Oman (0.7%), according to the Islamic Financial Services Board (IFSB), mainly due to the weak operating environment. Thirty out of 76 Iraqi banks were Islamic in 2021, made up of one state-owned bank and 29 private banks.

Key banking industry issues include a challenging operating environment, political instability, limited lending opportunities, lack of comprehensive regulations governing the industry, weak financial regulation enforcement, issues in reporting and transparency (contributing to the lack of confidence in the banking system), money laundering concerns and under-skilled human capital.

Islamic banking-specific challenges include low awareness of Islamic products, lack of standardisation, limited product range, and a lack of Islamic liquidity-management tools. Some Iraqi banks act largely as treasury functions, deploying excess liquidity into CBI placements with no real banking business models.

Iraqi capital markets, including the sukuk market, are significantly underdeveloped with issuers generally not having access to domestic or international capital markets. Additionally, the takaful market was almost absent in Iraq before 2019. However, in 2019 the CBI issued takaful regulation and established the first takaful insurance company, allowing Islamic banks to offer takaful products.

The CBI has adopted the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) standards and joined the IFSB. In 2018, the CBI issued regulations on sharia supervisory boards, sharia and internal auditing and sharia compliance for Islamic banks. The CBI has also established the supreme sharia advisory committee within the central bank.

-Ends-

Fitch rates one Islamic bank in Iraq – Kurdistan International Islamic Bank.

Media Relations: Louisa Williams, London, Email: louisa.williams@thefitchgroup.com
Additional information is available on www.fitchratings.com

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