IRAQ PRIVATE SECTOR GROWTH AND EMPLOYMENT GENERATION March 30, 2007 AN OVERVIEW OF THE IRAQI BANKING SYSTEM This publication was produced for review by the United States Agency for International Development. It was prepared by the joint venture of The Louis Berger Group, Inc. and The Services Group, Inc. under Contract # 267-C-00-04-00435-00. AN OVERVIEW OF THE IRAQI BANKING SYSTEM Acknowledgements We wish to thank David Munro, Senior Advisor, SME Bank Lending Department, Izdihar for authoring this paper. We also acknowledge the work of Cliff Ruder, Donal Cotter, Robert Viernum and Baljit Vohra for their inputs, editing and reviews of this document. DISCLAIMER The authors views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government. The IRAQ IZDIHAR project is funded by the United States Agency for International Development (USAID) and implemented by the joint venture partnership of: The Louis Berger Group, Inc. THE SERVICES GROUP Engineers Planners Scientists Economists International Economic Consulting TABLE OF CONTENTS INTRODUCTION ....................................................................................................................1 HISTORY AND CURRENT STATUS OF THE BANKING INDUSTRY .................................. 2 LEGAL AND REGULATORY ENVIRONMENT ..................................................................... 4 The CBI Law ............................................................................................................... 4 STATE-OWNED BANKS ....................................................................................................... 7 PRIVATE BANKS...................................................................................................................8 Relative Size of the Banks .......................................................................................... 9 Earning Assets ............................................................................................................ 9 Sectoral Loan Breakdown ......................................................................................... 11 Past Dues and Reserves .......................................................................................... 12 Related Party Lending............................................................................................... 12 CBI Reporting and Regulation .................................................................................. 13 Rates of Interest on Loans ........................................................................................ 14 Profitability Consciousness ....................................................................................... 15 The Credit Culture..................................................................................................... 15 Loans to Deposits ..................................................................................................... 15 Capital Adequacy ...................................................................................................... 16 Liquidity ..................................................................................................................... 17 Branch Systems ........................................................................................................ 18 Management ............................................................................................................. 19 Bankers Association and Training............................................................................. 20 NEW DEVELOPMENTS IN THE PRIVATE BANKING SECTOR: THE IRAQI COMPANY FOR BANK GUARANTEES................................................................................................. 21 SUMMARY AND RECOMMENDATIONS ............................................................................ 23 Recommendations for the CBI .................................................................................. 24 Recommendations for the Banking Community........................................................ 25 APPENDICES ........................................................................................................... 26 An Overview of the Iraqi Banking System 30 March 2007 Introduction This paper provides an overview of the banking system in the Republic of Iraq. It begins with a brief history of the modern banking industry. This is followed by a discussion of the current status of both the private banks and state-owned banks. The regulation and supervision of the industry are also discussed, including the role of the Central Bank of Iraq (CBI). The banking industry is currently dominated by the seven state-owned banks in Iraq. They include the two largest commercial banks, Rafidain and Rasheed. In addition, there are five other state-owned banks: Real Estate Bank, Agricultural Bank, Industrial Bank, lraq Bank, and the Trade Bank of Iraq. Collectively, the state owned banks control over 90% of the total banking assets in Iraq. Unless otherwise cited, financial information in this report was obtained from CBI’s Research and Statistics Department and from annual reports for individual banks for the year ending December 31, 2005.1 Generally, the financial information evaluated in this report is limited to balance sheet entries. Due to uncertain income-recognition standards and a lack of sufficient disclosure regarding asset quality, it is difficult to assess with any degree of certainty income statement entries. Moreover, the integrity of financial information reported by the banking industry is affected by nearly all banks claiming to be profitable, the inadequacy of loan loss provisions, and insufficient reserves against volatile investment portfolios in a market that has been in steady decline.2 Additional factors that affect the reliability of financial information reported by banks include decentralization of accounting functions within the banks, manual preparation of documents, lack of automation, and lack of management information systems. 1 Annual reports for 2006 have not yet been released. We were able to obtain annual reports for most of the operating private banks. Of these, Ashour Bank, Kurdistan Bank, Dijlah wal Furat Bank (Tigris and Euphrates Bank) and Mansour Bank had not completed a year of operations at the time this paper was written, and Dar as-Salaam and Commercial Banks had yet to finalize annual reports for 2005. 2 The Iraq Stock Exchange (ISX) reports a fall in index prices from nearly 20.0 in September 2003, to around 5.0 in October 2006. Average volume traded has fallen from around 5.5 billion shares to 1 billion in the same period. (As many shares are priced at ID 1, equivalent to $.000685, the actual amounts being traded are relatively small.) Source: ISX website, http://www.isx-iq.net/ IZDIHAR – USAID Contract # 267-C-00-04-00435-00 1 An Overview of the Iraqi Banking System 30 March 2007 History and Current Status of the Banking Industry Rafidain Bank was founded in 1941 as a private bank established by a member of the prominent Chalabi family. By the early 1960s, the following banks with foreign ties were represented in Baghdad: Ottoman Bank, Eastern Bank (British-owned), the British Bank of the Middle East; Federal Bank of Lebanon, National Bank of Pakistan, Arab Bank, Ltd., and Intra Bank (Lebanon). Iraqi banks operating then were Rafidain, Commercial Bank, Credit Bank and Bank of Baghdad. In 1964, during a wave of nationalizations under the first Ba’ath regime, banks were seized and merged into four groups operated by Rafidain, Commercial, Bank of Baghdad, and Credit Bank. In 1970, a further consolidation took place, with banks merged into either Rafidain or Commercial. In 1974, the Commercial group was placed under the Rafidain banner, leaving the country with one state-owned bank. On January 1, 1989, Rashid Bank was spun off from Rafidain (and encumbered with most of the latter’s non-performing assets). Following the first Gulf War, the government once again sanctioned the establishment of private banks. Prominent industrialists and trading families took advantage of this relative liberalization of the financial sector, and established banks whose raison d’etre was financing endeavors associated with the founders’ core lines of business. While direct lending to Board of Directors members is controlled by the CBI (prior approval must be granted), associated companies and firms may be assumed to account for a substantial proportion of the private banks’ portfolios. Nevertheless, there are banks that are actively engaged in supporting small enterprises – primarily traders. Examples are the Economy Bank, which has its head office in a market or suq just north of the Bab al-Sharjah Square, and the Basrah Private Bank, with its head office in Karrada but with a branch office abutting Sadr City (formerly Saddam City) and another branch in the Sheikh Omar area of the city, a district dotted with small workshops that make up this branch’s customer base. Even the relatively large Bank of Baghdad claims to extend many small credits in the several hundred dollars range, and to have a very diversified portfolio. Indeed, the impetus for establishment of these banks – aside from serving as funding arms for family enterprises of prominent shareholders – was an attempt to reach some of the vast majority of small businesses in Iraq not associated with the prior regime. The state-owned banks alone were allowed to