Cash only: Why the messy banking sector endangers Iraqi development

Shwan Zulal

By Shwan Zulal:

This article first appeared on Niqash

Iraq could be one of the richest countries in the world. Yet over three quarters of Iraqis do not have bank accounts. So where do they keep that wealth? And can the Iraqi banking system be dragged into the 21st century?

The banking sector in Iraq reflects the economic mess that the country is in. Basic modern banking practices – like electronic funds transfers for payroll or other banking needs – are almost non-existent and credit facilities are hard to come by. Automatic teller machines remain a novelty while mortgages and loans are a rarity.

Iraq has only a few banks with the ability to transfer funds electronically and the number of branches able to undertake this sits at around 240. Transferring funds directly to Iraqi banks remains a patchy process and it is more often done through other banks in the region, such as more reliable sister banks in Jordan or the United Arab Emirates.

Latest research estimates that around 80% of Iraqis do not have a bank account or even access to one. The public’s trust in the Iraqi banking sector remains low – which is why most banks in Iraq simply act as a glorified safety deposit box.

Meanwhile Iraq is on track to become one of the wealthiest countries in the world, with the fourth largest oil reserves in the world and the potential to be one of the globe’s leading oil exporters, eventually matching, or even surpassing, Saudi Arabia, currently one of the largest oil exporters in the world. But despite incoming revenue and the potential for growth, economic progress remains slow – and this is partly due to dysfunctional banking sector. There is talk of sector reform and new electronic banking systems – yet this vital sector is still underdeveloped.

The financial sector in Iraq is still in its infancy and a lack of understanding of it, by the political elite and economically illiterate policy makers, has not helped.

Politicians in Iraq keep failing to grasp the importance of this vital part of the economy, a part that could transform the country’s dated economic structure and bring it out of the cash economy and further toward the modern world of finance.

Iraq’s banks were nationalised in the mid-1960s, in line with the government’s nationalist and socialist policies of the time. Before then there had been a privatised banking system. In the early 1990s, former Iraqi leader Saddam Hussein’s regime tried to kick-start private banking again but two decades later not much progress has been made.

According to the website of Iraq’s National Investment Commission, the minimum capital required to set up a bank in Iraq is IQD100 billion (around US$85 million). Currently there are 49 banks with licenses to operate – 42 of these are private banks, including 11 Islamic banks and foreign banks. The rest of the licensees are state-owned banks like the giant Rasheed and Rafidain banks, which account for the vast majority of banking business in Iraq. There has also been a surge in the numbers of financial and investment firms, with around 40 such licences issued to date.

Interestingly, despite the capital requirement of IQD 100 billion though, some of the private banks have yet to comply with that regulation.

Iraq currently has around one local banking branch for every 60,000 people. Compared to other countries in the region, this is very low: for example, the average in Saudi Arabia is around one branch for every 3,500 citizens. Which means that despite the growth needed in the banking sector and the emergence of many small, boutique-style banks and investment houses, the population still has little, or no, access to banking facilities.

Most Iraqis rely on relatives and friends to borrow money. But obviously this can cause social problems. There are also small organizations that provide loans for start-up businesses but the amount that these schemes can lend is usually minimal.

There is also the issue of trust in the banking system. In a recent banking scandal in the semi-autonomous state of Iraqi Kurdistan, local businessmen, most of them based in the city of Sulaymaniyah, lost around US$500 million. This was due to the drop in value of Iranian currency, after US and European sanctions were imposed, which led to the failure of a small but active Iranian “bank”. The so-called bank had been operating as a middleman transferring funds to and from Iraqi Kurdistan, Dubai and Iran.

Incidents like this do not reinforce public trust in the banking sector; most Iraqis remain very sceptical about local banks due to a lack of rigorous regulation. And the weak banking culture simply encourages the current cash economy. All of which has stalled foreign and local investment needed to rebuild the country. It has also encouraged local businesses to be apathetic about taxation or social responsibility.

Another major issue plaguing Iraq’s banking sector, and for that matter, the private sector too, is the prevailing ideology of top-down politics and big government. Many Iraqi politicians, including Prime Minister Nouri al-Maliki’s ruling party, are suspicious of the private sector; they prefer to stick to what they know best, which is having the state control almost all economic activities – including the banks.

Looking around the world, it is clear that a strong banking sector is essential to a successful economy. Apart from helping the private sector and small business grow by providing financing, the government can also measure and quantify economic activity. Once the banking sector flourishes, and transactions are recorded and regulated, money laundering and corruption is automatically reduced.

Meanwhile on the positive side, the Iraqi stock exchange has been growing faster than any other index in the region, the main stocks being traded involve banking and projections for the stock market’s growth are very optimistic. This is a big vote of confidence in the future of the banking sector.

Additionally there have been talks of banking sector reform, which has included the introduction of electronic banking. While only 20% of Iraqis have a bank account, around 80% have a mobile phone and phone banking was a hot topic at the “Integrating the Banking and Financial Services Sector in Iraq” conference held by USAID and the Central Bank of Iraq last November.

However modernising Iraq’s banking sector will not be achieved solely by introducing new technology. Modernisation needs to start by opening up the markets and bringing in competition. As long as the public banks remain the dominant players in the market, there is not much chance of improving the current situation. Privatising the major banks would be a quick way of revolutionising the Iraqi banking sector. Having said that, this move seems unlikely given the current government record of maintaining control.

At least some of the problems Iraq has could be healed by a strong economy and more prosperous nation. And the long road toward this begins with better financial structures and a stronger banking sector, complete with all the regulations required.

A free market and the equal right of all consumers to participate in it, has helped to bring communities together. The failure of Iraqi politicians to grasp the urgent need to revamp the banking sector, and to understand the basic economics of growth, has had a significant impact on the pace of development in the country. The failure to carry out needed reforms – and not just those in the banking sector – is one of the major reasons that, as was reported recently, around 23% of the population in resource-rich Iraq are living below the poverty line.