By Camilla Hall
Iraq’s push to attract international financial services companies could be undermined by a lack of banking reform that industry insiders say is also hurting the wider economy.
As Baghdad officials pop up in London and other western financial centres to woo foreign investors to their oil-rich country, the banking industry remains dominated by state banks, still ailing after the Saddam Hussein years.
While the slow pace of reform deters some international financiers, the bigger worry is that it is also choking the oil-rich economy where businesses rely on credit to expand. Without progress on restructuring its banking system, Iraq’s $130bn economy has little hope of competing with its Gulf neighbours.
“When we talk about reconstruction, rebuilding, it’s not only infrastructure, it’s everything, the whole system,” Rowsch Nori Shaways, deputy prime minister of Iraq, told the Financial Times at a recent investor conference in London. “To do this you need a modern banking system.”
But building that system has been proved to be an elusive task. The government often talks about the need to work harder on fixing the banking system but as the World Bank suggests in a report last year, the fundamental decision of what role the state banks will play in a modern financial system in Iraq still needs to be taken.
Before luring more international investors to Baghdad, the government has to make the financial services sector more appealing to the private sector, bankers say. At present, 36 private sector banks struggle alongside seven state lenders in what remains an uneven playing field.
An important impediment to the profitability of private sector banks is that the government and its state-owned companies, which take up the lion’s share of gross domestic product, are only allowed to deposit with state-owned banks. In addition, state companies cannot take loans from private banks. Taxes and any payments to the government can only be made through state banks.
State-owned banks also enjoy an implicit guarantee from the government, meaning that customers prefer to deposit with them rather than take the risk associated with a private sector bank, says Rayd Abu-Ayyash, head of strategic planning at Capitalbank, a Jordanian bank that operates an Iraqi unit.
While the state banks enjoy their advantages, two of the biggest state lenders, Rasheed and Rafidain, are still far from completing their restructuring, first agreed in 2006. Their balance sheets – ripped apart by looters during the nine-year US occupation, debt under Saddam’s 24-year dictatorship and dramatic changes in the exchange rate – remain in the quagmire that they were six years ago.
“Little progress has yet been achieved, including in the technical area of cleaning up the two banks’ balance sheets,” the World Bank said in its in-depth report on Iraq’s financial services sector published last year.
Officially, the Iraqi government accepts the need for financial reform, making the delays even more perplexing. “The state banks still dominate the banking sector,” says Ali Allawi, a former finance minister of Iraq. “The starting point must be the restructuring of the state-owned banks.”
Analysts suggest restructuring has been delayed because the government is to some extent comfortable with the state banks’ undertaking of fiscal activities. They also say that the banks’ restructuring may force more transparency on the government’s fiscal activity, a move that it may not yet be willing to take.
Restructuring of the state banks is “still slow”, says Mr Abu-Ayyash of Capitalbank. “Some of the reluctance of international banks to enter is caused by that.”
International lenders can see the potential for business in Iraq, which remains very under-banked. Banking assets represent 73 per cent of gross domestic product compared with 130 per cent in the Middle East and North Africa, according to the World Bank.
Despite a tough retail and corporate banking environment, Mr Allawi points to the opportunities that international investment banks can take in the restructuring of the banking sector itself, with the prospect of earning fees of $1bn to $2bn, he estimates.
International investment banks including HSBC are already involved in the planned initial public offerings for the Iraqi stock market. However, the three long-awaited IPOs in the telecoms sector, that are set to give the stock market a significant boost, are yet to materialise. Morgan Stanley, which was among the international banks represented at Iraq’s recent investor conference in London, are no longer a bookrunner on the IPO of Asiacell, one of the telecom operators, it was revealed this week.
Aside from the state banking concerns, international market players are also concerned about Iraqi links to banks in neighbouring Iran that face US sanctions.
Under US banking sanctions, foreign lenders face being cut off from the US banking system if they deal with designated Iranian banks. The US imposed sanctions on Iraq’s Elaf Islamic Bank in July for providing financial services to such banks.
While the possibilities are still there for international banks, a lot of the financial reforms to make it profitable for them “are still in the realm of planning”, says New York-based Zaab Sethna, partner at Northern Gulf partners, which invests funds in Iraq.
Or as ex-finance minister Mr Allawi puts it: “You have to have an appetite for a ride on the rollercoaster, but that is becoming less amplified.”
original source: http://www.ft.com/cms/s/0/c537bdf0-16aa-11e2-b1df-00144feabdc0.html#axzz29Tq8A81p