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Iraq: a frontier for brave bankers: even a shattered economy such as that of post-war Iraq needs a viable banking sector, but restructuring will be a formidable process.

THE WORLD BANK AND UNITED Nation's Joint Iraq Needs Assessment report (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 John Taylor, or Johnny Taylor may refer to: Academic figures
  • John Taylor (1704-1766), English classical scholar
  • John Taylor (1781-1864), British publisher and Egypt scholar
  • John Taylor (Oxford), Vice-Chancellor of Oxford University 1486-1487
, the US Undersecretary of the Treasury for international affairs, told the Senate committee: "Strengthening and modernising the banking sector is central to achieving overall economic progress in Iraq."

A dysfunctional banking system can have a severe impact upon real economy--consumption, investment and exports. Iraqi policymakers face the challenge not only of liberalising a repressed re·pressed
Being subjected to or characterized by repression.
 financial services industry but also of reforming, or creating from scratch, the institutions required to underpin a market-oriented system.

The interim government in Baghdad has devised a long-term strategy for reactivating economic activity on the basis of structural reforms, including price liberalisation n. 1. Same as liberalization.

Noun 1. liberalisation - the act of making less strict
liberalization, relaxation

alleviation, easement, easing, relief - the act of reducing something unpleasant (as pain or annoyance); "he asked the nurse
, taxes to promote private-sector participation in the reconstruction process, foreign direct investment (FDI FDI

See: Foreign direct investment
) into industries besides petroleum and banking regulations in tune with best practices in developing countries.

However, such an ambitious policy agenda will also require establishing the legal, institutional and regulatory frameworks for the smooth functioning of markets. Dr. Sinan Al Shabibi, governor of the Central Bank of Iraq The Central Bank of Iraq (Arabic: بنك العراق المركزي) is Iraq's central bank. The current Governor of the Central Bank of Iraq is Sinan Al-Shibibi. , formerly a senior economist for the UN Conference on Trade and Development, told the American-based journal Institutional Investor Institutional Investor

A non-bank person or organization that trades securities in large enough share quantities or dollar amounts that they qualify for preferential treatment and lower commissions.
. There is a great potential in this country. The prospects are very bright. Once security is under control, Iraq will be very attractive to investors." A new central bank--restructured under a nine-member governing board comprising the governor, two deputy-governors, three senior managers and three full-time outside directors--has introduced a law that provides for independence and accountability and prohibits the bank from extending credit to the government.

Henceforth, monetary and credit policy actions will not require the approval of the Ministry of Finance. The central bank's extended powers mean that it now holds the responsibility to control money supply, regulate interest rates, and license and supervise Iraq's commercial banks.

However, as the International Monetary Fund (IMF IMF

See: International Monetary Fund


See International Monetary Fund (IMF).
) noted: "The latitude for proper monetary and exchange rate policy actions is limited by a lack of appropriate instruments, the current low level of foreign exchange reserves Foreign exchange reserves (also called Forex reserves) in a strict sense are only the foreign currency deposits held by central banks and monetary authorities. , and constraints on institutional and physical infrastructure capacity."

A new commercial banking legislation, based on global standards and adopted in October 2003, lays down stringent fit-and-proper criteria for bank ownership and higher minimum capital requirements Capital requirements

Financing required for the operation of a business, composed of long-term and working capital plus fixed assets.
, as well as plans to open the sector to foreign competition.


The existing financial system comprises the Central Bank of Iraq (CBI CBI
cumulative book index

CBI Confederation of British Industry

CBI n abbr (= Confederation of British Industry) → C.E.O.E.
), six state-owned 'monolithic' banks and 19 small private banks--formed during the early 1990s. The CBI and state banks--notably Rafidain and Al Rasheed--were merely fiscal instruments for the Baathist party, or more specifically, they acted as Saddam Hussein's personal bankers and as such were responsible for massive 'flight capital' from pre-conflict Iraq.

According to the US Treasury Department, total assets are now estimated at about $2bn, equivalent to 10% of gross domestic product, while the aggregate equity of Iraq's 25 banks is reported at a mere $42m. The sector's capital-assets ratio of 2.1% is extremely low by international comparison.

Most, if not all of Iraq's banks are 'techically insolvent', possessing negligible capitalisation, while the true value of assets falls well short of liabilities to depositors and other creditors, including foreign banks and western export credit agencies Export Credit Agency

An agency established by a country to finance its nation's goods, investment, and services, often offers political risk insurance.

Moreover, the bad debts of these 'typical' Iraqi banks exceed their own paid-up capital Paid-Up Capital

The total amount of shareholder capital that has been paid in full by shareholders.

Paid-up capital is essentially the portion of authorized stock that the company has issued and received payment for.
, while reserves are far too small to cover loan losses. Inadequate accounting systems and poor regulations enabled banks to conceal non-performing loans (NPLs) in their accounts by constantly rescheduling principals and capitalising interest arrears in order to maintain the status quo [Latin, The existing state of things at any given date.] Status quo ante bellum means the state of things before the war. The status quo to be preserved by a preliminary injunction is the last actual, peaceable, uncontested status which preceded the pending controversy. .

The main reasons for NPLs are excessive directed lending for the financing of ballooning budget deficits, funding operations of public enterprises and large, uneconomical projects during the past three decades. Other irregular practices such as inside lending to former ruling elites/ cronies have also resulted in huge bad debts.

The Old Iraq lacked a commercial banking culture, with lending based on cronyism Cronyism
Tammany Hall

Manhattan Democratic political circle notorious for spoils system approach. [Am. Hist.: Jameson, 492]
, not credit quality.

To date, effective competition remains weak, and therefore concentration in the banking sector is extremely high. The two big banks, Rafidain and Al Rasheed, control 85%-90% of total banking assets. During the 1980s, Rafidain (founded in 1941) was the largest Middle Eastern bank with assets of $47bn, but today it owes some $24bn to western and regional Arab banks, as well as Paris Club Paris Club

A monthly meeting in Paris attended by creditors of 19 countries to discuss debt issues. Among other things, the Paris Club addresses the issue of coordinated debt relief for developing countries that cannot service their debt.

Rafidain Bank also carries the old regime's [unpaid] sovereign debts and letters of credit. Until the issue of $127bn-plus external debt is settled, international trade-finance business is closed to state-owned banks. The Trade Bank of Iraq, a consortium of 13 international banks led by JP Morgan Chase (US), was established in December 2003 to handle all trade documentation, covering Iraqi exports/imports and is solely responsible for issuing and confirming letters of credit.

The distressed banks are unable to provide services and products largely taken for granted Adj. 1. taken for granted - evident without proof or argument; "an axiomatic truth"; "we hold these truths to be self-evident"
axiomatic, self-evident

obvious - easily perceived by the senses or grasped by the mind; "obvious errors"
 elsewhere in the world, including corporate financing, structured trade finance, cash management/treasury services, mortgages, insurance, leasing, credit cards, and cash machines (ATMs).

Iraq remains a predominantly 'cash-based' economy, where banking is confined to deposit taking and a few short-term loans. It is estimated that only one-third of the total money supply in circulation is inside the banking sector. Apparently, most Iraqis elect to keep their savings "under the bed".

Meanwhile, the domestic payments system is almost primitive--money transfers between two banks, or even between branches of the same bank, can take over a week. Due to the absence of electronic links and a depleted de·plete  
tr.v. de·plet·ed, de·plet·ing, de·pletes
To decrease the fullness of; use up or empty out.

[Latin d
 telecommunications infrastructure, the system is largely 'manually-based', with banks processing checks via messengers. This has often led to long delays and high levels of credit float.

Substantial investment in IT systems is urgently needed. Neither SWIFT (Society For Worldwide Interbank Financial Telecommunications Society for Worldwide Interbank Financial Telecommunications (SWIFT)

A dedicated computer network to support funds transfer messages internationally between over 900 member banks world-wide.
)--a messaging system that facilitates global funds transfers--nor MICR (Magnetic Ink Character Recognition) The machine recognition of numeric data printed with magnetically charged ink. It is used on bank checks and deposit slips. MICR readers detect the characters and convert them into digital data.  (Magnetic Ink Character Recognition (business, printer) Magnetic Ink Character Recognition - (MICR) A character recognition system using special ink and characters which can be magnetised and read automatically. )--a secure, high-speed method of scanning and processing information used by banks--are available in Iraq.

The CBI has raised minimum capital requirements for private banks to help promote consolidation and restore solvency ratios. The move should encourage mergers and acquisitions within the sector. By April 2005, core capital (shareholders' funds) must reach $5m. Among the large private institutions are the Bank of Baghdad, Iraqi Middle East Investment Bank, Commercial Bank of Iraq, Investment Bank of Iraq and Credit Bank of Iraq. The clientele group frequently includes family members or business associates of the owners. A recent Citigroup report shows that the total deposits of private banks were mostly invested in treasury bills and affiliated companies Affiliated Companies

A situation that occurs when one company owns a minority interest (less than 50%) in another company.

Also refers to companies that are related to each other in some way.

An affiliated company is sometimes referred to as a subsidiary.


Foreign participation can take several forms under the new banking law: Wholly foreign-owned banks i.e. fully-fledged branches; joint-venture banks with one or more foreign or indigenous partners; subsidiaries; foreign ownership of shares in local banks; and representative offices. The latter cannot provide banking services but may facilitate offshore businesses between foreign and local parties. Six foreign banks have already been licensed to begin operations. The CBI is now evaluating over 30 licence applications, many of which expressed interest in acquiring a minority stake in private banks. Nour Nahawi of Arab Banking Corporation (ABC ABC
 in full American Broadcasting Co.

Major U.S. television network. It began when the expanding national radio network NBC split into the separate Red and Blue networks in 1928.
) remarked: "Once the security situation improves, Iraq is a country with great potential which will be a very attractive market for foreign banks."

The six institutions are HSBC HSBC Hongkong and Shanghai Banking Corporation
HSBC Humane Society of Broward County (Florida)
HSBC Humane Society of Bay County (Bay County, Michigan) 
, Standard Chartered, National Bank of Kuwait The National Bank of Kuwait first opened in Kuwait in 1952 to become the first national bank in the Gulf Region. NBK was founded by Khaled Zaid Al-Khaled. NBK is currently the largest financial institution in Kuwait and one of the leading banks in the middle east with branches in , ABC, Bank Melli Iran Bank Melli Iran (BMI), also called the National Bank of Iran, is the first national Iranian bank. The bank was established in 1927 by the order of Majlis (the Iranian Parliament) and since then has constantly acted as one of the most influential Iranian banks.  and Jordan's Housing Bank for Trade & Finance. The central bank expects the first three banks to begin operations by end-2004 and the rest by end-March 2005. Under the terms, foreign majority-owned subsidiaries must hold a minimum capital of 50bn New Iraqi Dinars ($34m); open multiple branches [at least five]; 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.

A host country has certain expectations from an influx of foreign banks, which include modernising the existing banking sector through the transfer of technology and managerial expertise; introducing new capital for trade, industry and construction; promoting foreign investment; and the mobilisation of domestic savings. The World Bank notes: "Foreign banks will help improve the quality, pricing and availability of financial services, both directly, as providers of such enhanced services, and indirectly through competition with domestic banks, which will encourage the latter to introduce similar improvements."


The problems of the non-enforcement of prudential regulations, a lack of commercial lending traditions, the absence of collateral laws, undeveloped accounting rules, bad and dubious debts, negligible capitalisation and a shortage of professional bankers all contributed to 'systemic risks' under the Baathist regime. Rehabilitating an entire banking industry is a long-term process, which will require vast international assistance on a scale similar to that provided to former Eastern Bloc countries in the early 1990s.

The ultimate goals should be the creation of stronger banks underpinned by ample liquidity, capital and solvency, thus facilitating savings, investment and prudent lending. The main challenges will be to foster a vibrant financial system that can channel domestic savings into future productive investments. In a Letter of Intent (October 2004) to the IMF, which outlines economic and financial policies, the interim government has pledged to improve the payments system by establishing an automatic clearing house and passing payments system law to regulate its activities. This will have the effect of making the CBI operations more transparent, particularly through the regular dissemination of monetary statistics and regular ongoing external audits, carried out to international accounting standards. A full restructuring plan for state-owned banks is expected by June 2005.

An upgrading of technological infrastructure requires funding and technical support from the World Bank and the International Finance Corporation. Iraq needs fully computerised, 'Real-Time' network systems, whereby inter-bank clearings are settled in central bank funds and information about participating banks' net credit worth/ daily positions are readily available online. The experience of advanced (OECD OECD: see Organization for Economic Cooperation and Development. ) countries shows that a reliable payments system lowers the requirement for working capital and significantly reduces transaction costs Transaction Costs

Costs incurred when buying or selling securities. These include brokers' commissions and spreads (the difference between the price the dealer paid for a security and the price they can sell it).
 while providing the necessary support for an active policy of asset-liabilities management, the basic criteria for fostering a market economy.

Equally important, bank supervisors should receive training in areas including international operations, financial controls and risk-management techniques, which are necessary for the onsite/offsite examinations of banks.

Unlike other Middle Eastern countries, the Basle Committee's 25 core principles of effective central bank supervision, chiefly capital adequacy, stringent reporting of balance sheets, careful monitoring of loans, strict criteria for asset-classification, interest suspension, risk-weighting and bad debt provisions, among others, had no significance in Iraq.

In essence, a prudent supervision system is critical to preserve Iraq's solvency within the industry. As the World Bank pointed out: "An effective regulatory regime creates an environment that encourages prudent risk-taking."

The World Bank could fund the recapitalisation of the six government banks. As occurred in East Asian countries during the 1997/98 financial crises, state agencies could take over bad debts.

Restructuring of public enterprises, as well as development of private debt-and-capital markets, should complement financial reforms.

Efficient financial inter-mediation requires sustained macroeconomic mac·ro·ec·o·nom·ics  
n. (used with a sing. verb)
The study of the overall aspects and workings of a national economy, such as income, output, and the interrelationship among diverse economic sectors.
 stability, low inflation and positive real interest rates. Such conditions lead to lower transaction costs, reduce commercial risk and foster confidence in the stability of a fledging financial system.


Continuing operational and security risks are seriously hindering the transition to an open, market-based economy, and the reintegration reintegration /re·in·te·gra·tion/ (-in-te-gra´shun)
1. biological integration after a state of disruption.

2. restoration of harmonious mental function after disintegration of the personality in mental illness.
 of Iraq into the global financial system.

Abdul Aziz Hassoun, director of Iraq's North Bank, believes security worries "are being exaggerated", and banks reluctant to enter Iraq are missing out on a lucrative opportunity in a "virgin land". However, John Snow, the US Treasury Secretary, put it succinctly: "Capital is a coward. It doesn't go places where it feels threatened."

A recent IMF report commends Iraq's interim government and its predecessor, the Coalition Provisional Authority The Coalition Provisional Authority (CPA) سلطة الائتلاف الموحدة was established as a transitional government following the invasion of Iraq by the United States,  (CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. ), for introducing several milestone reforms--a new currency underpinned by Forex Forex

See: Foreign exchange
 reserves, banking and taxation laws, and restoring much of pre-invasion oil production capacity, despite the "precarious security situation and economic collapse". But widespread disorder and violence remain a formidable problem. The Fund acknowledges: "Iraq continues to suffer repeated attacks by insurgents Insurgents, in U.S. history, the Republican Senators and Representatives who in 1909–10 rose against the Republican standpatters controlling Congress, to oppose the Payne-Aldrich tariff and the dictatorial power of House speaker Joseph G. Cannon.  against government officials and police officers, as well as sabotage of crucial infrastructure ... this has severely hampered the economic recovery and reconstruction."

Thus, the restoration of national security and rule of law, though unlikely in the near-term, are vital for carrying out financial reconstruction as in Central Eastern European countries after the fall of communism.
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Title Annotation:Business & Finance
Comment:Iraq: a frontier for brave bankers: even a shattered economy such as that of post-war Iraq needs a viable banking sector, but restructuring will be a formidable process.(Business & Finance)
Author:Siddiqi, Moin A.
Publication:The Middle East
Geographic Code:0BANK
Date:Dec 1, 2004
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