Foreign banks return to Iraq

Iraq's banks look set to bounce back this year, shrugging off the crippling impact of nationalization, a decade of sanctions and a US-led invasion. Economic reforms introduced by the Coalition Provisional Authority and the US-appointed Iraqi Governing Council have opened the way for the entry of foreign banks and the consolidation of the local private banking sector.

In December the central bank closed the bidding process for foreign banks looking to enter the Iraqi market. When Euromoney went to press, successful applicants were yet to be announced. Licences are expected to be awarded this month. After this time no other foreign banks will be allowed to open branches in the country until 2009.

Licensees are expected to set up within six months, with a fast track entry process for two of the six banks. Iraq's finance minister, Kamel al-Gailani, says "prompt and substantial lending will be a significant criterion in early entry determinations".

The central bank's ability to tender licences hinges on legislation introduced in September last year. As well as abolishing most restrictions on trade, capital flows and foreign investment, the reforms open the way for foreign banks to enter Iraq as branches, subsidiaries or representative offices or through joint ventures with 17 local private banks. Licensees will be allowed to purchase up to 100% of local banks or start their own operations, and an unrestricted number of foreign financial institutions will be allowed to purchase up to 50% of local banks. Foreign majority-owned subsidiaries must have capital of at least $25 million. There is no restriction on where money is invested, although each bank will be expected to open at least five branches.

Iraq's banks were nationalized in 1964. Private banks were permitted to reopen only in the early 1990s, and faced a tough operating environment because of UN-imposed sanctions. They suffer from severe undercapitalization and have a limited capacity to provide such services and products as credit cards, cash machines and letters of credit. They have also struggled to compete with the six state-owned banks, which hold more than 75% of total deposits.

According to Ahmad Salman Mohammed, deputy governor of the central bank, it is hoped that foreign banks will bring capital into Iraq while providing employment and training opportunities, modernizing the banking sector and bringing finance for trade, industry and construction. The World Bank and United Nation's Joint Iraq Needs Assessment of October 2003 says: "In the medium term, the private sector will be a crucial means to achieve high growth and create employment." The report adds: "Also critical is revival of a banking system that is able to operate on commercial lines."

It is thought that as little as a third of Iraq's total money supply in circulation is inside the banking system. Although there is a big consumer base for banks and financial institutions, security concerns and fears of restrictions on withdrawals mean that most Iraqis have long kept their savings at home. According to one analyst covering the region: "With a predominantly urban population, a cash-based economy and an undeveloped banking system, Iraq is likely to have an under-utilized pool of savings. Once stability returns I would expect that there will be strong demand for banking products."

The Iraqi market therefore appears ripe for the picking. "Once the security situation improves, Iraq is a country with great potential and it will be a very attractive market for foreign banks to enter," says Nour Nahawi, head of the Arab world division, Arab Banking Corporation (ABC). Although licence applicants have played their cards close to their chests, rumours abound about which banks are hoping to expand into the volatile but potentially lucrative market. Standard Chartered, HSBC, and ABC are among names that have emerged so far.

A spokeswoman for HSBC would not comment on whether there was going to be a bid by the bank, but says: "We would like to help in the financial reconstruction of Iraq and we are keeping a close watch on the situation there to see how best we might do this." HSBC is the world's second-largest bank by market capitalization and the largest in the Middle East, with operations in 12 countries.

Standard Chartered, which owned Iraq's Eastern Bank from 1957 until the sector was nationalized, is also cagey. It confirms that an application had been requested, but could not tell Euromoney whether a bid was submitted.

ABC, the largest capitalized Arab bank, was also unwilling to confirm a bid, although it was more open about its interest. Nahawi said: "We are very much interested in Iraq, as it complements our core business in the Middle East."

Although the criteria for foreign banks laid down by the central bank appears to favour international, rather than regional institutions, Nahawi believes that ABC "is the best placed among regional and international banks to enter Iraq, with experience in the country and close proximity to the market via our base in Bahrain and 14 branches in Jordan". If the bank receives a licence, he adds, it would then decide whether to affiliate with a local bank or to set up its own branches.

Those awarded operating licences by the central bank will not, however, be the first foreign banks to enter the country. The Trade Bank of Iraq, a 13-bank consortium headed by JPMorgan Chase and including the Royal Bank of Canada, Standard Chartered, the National Bank of Kuwait, ANZ Grindlays and Crédit Lyonnais, got up and running last month. The tender process attracted six bids, involving some 58 institutions, indicating a strong level of interest among foreign banks in breaking into the Iraqi market.

The creation of the consortium institution is seen as the first step toward integrating Iraq into the international financial system. According to the joint World Bank and UN assessment, the bank should "assist in providing needed liquidity to the emerging private sector". It should facilitate trade flow funding, while also training local staff and promoting the growth of the banking system.

By mid-December, it had already begun issuing letters of credit for government ministries, to enable them to buy equipment and other materials from foreign suppliers. This service was made possible by more than $2 billion in short-term export guarantees released by 16 countries on December 5. The chief contributors were the US and Japan, which each offered around $500 million in loan guarantees.