Chapter 5

The Divided Private Banking Sector

In the early months of the US occupation, resuscitating Iraq’s private banking sector was a central tenet of the Coalition’s plans for Iraq’s economic reconstruction. All other measures – the restructuring of the state-owned banks, the establishment of the Trade Bank of Iraq, and the Central Bank of Iraq’s hard currency auctions – were created as half measures, intended only to create a system functional enough for jumpstart the Iraqi government. The long-term plan for the Iraqi financial system was always for the Iraqi private banking sector to lay the “foundation … of a free-market economy.”

Prior to the US invasion, the Iraq’s private banking sector was in a dismal state. Private banks had been forbidden until the 1991 Amendment to the 1976 Central Bank Law. Even then, foreign banks and foreign ownership of Iraq’s banks remained strictly prohibited. The public sector remained dominant with the two largest public banks, Rashid Bank and Rafidain Bank, holding ninety percent of the total banking industry’s assets. Four other specialized state-owned banks and seventeen private banks comprised the rest of the sector. Of those seventeen private banks, only one had capital reserves greater than one million USD.

After the war, the Coalition Provisional Authority that by liberating the private sector the dilapidated state of Iraq’s banks could be overcome. To clear the way, the CPA issued Order 40 ‘Bank Law,’ replacing the 1976 Central Bank Law and opening Iraq to foreign banks and foreign ownership of Iraqi banks. They hoped that Iraqi private banks would partner with multinational conglomerates to provide Iraqis the financial services they needed with the support of the experienced global banks. As NY Fed Michael Silva explains, these transnational partnerships would be the ones to “give the state-owned banks a real run for their money.”

What followed was a dramatic expansion of the international and local private banking sector. Bank managers could now operate their banks “as commercially viable entities without fear” of harassment or seizure by the Ba’athist party. Iraqi banks’ operations greatly diversified as they expanded their retail and commercial businesses. The early results of the restructuring process presented a similarly bright future for international banking in Iraq. Article Six of Section 2 in CPA Order 40 restricted the number of foreign banks in Iraq to six until 2008. Still, multinational banks lined up around the corner to get a first-mover advantage in Iraq’s budding economy. In January of 2004, the CBI granted licenses to three banks - HSBC, Standard Chartered, and the National Bank of Kuwait. “The real challenge”, NY Fed Vice President of Financial Services Michael Silva noted, was picking those three “among a number of very strong proposals.” The international interest and local expansion broadcasted a signal of health in the sector. By January 2004, the good fortunes of the sector prompted Silva to declare that “the most promising aspect of the Iraqi banking system” was its private banks.

By the measure of the number of new private banks, the CPA’s efforts to kick start the private banking sector worked too well. Since 2003, Iraq’s private banks have proliferated uncontrollably. When the United States officially withdrew from Iraq in 2011, the World Bank recorded thirty-eight private banks, a doubling in the number of private banks in eight years. For comparison, Iraq’s neighbors Jordan and Iran have twenty-three and twenty non-government owned banks, respectively. The explosion of private banks concerned the Central Bank. Small banks tend to be poorly managed and difficult to regulate. To prevent further increases in the number of banks and encourage consolidation, the Central Bank of Iraq raised capital requirements to 100 billion IQD (US $83 million) by June 2011 and 250 billion IQD (US $214 million) by June 2013. These efforts slowed the rate of growth but did not reverse the trends. By 2018, the Central Bank of Iraq listed sixty-eight private banks in operation. In a country where ninety percent of transactions occur in cash, the number of private banks is astounding. To unpack why one of the most underbanked countries in the Middle East has the most banks in the Middle East, a closer examination is needed of the evolution of private banks after 2003.

This chapter tracks the development of Iraq’s private banks into two separate spheres. In one sphere, indigenous Iraqi private banks unsystematically hold Iraqi civilians’ deposits and broker currency through the CBI auctions. In the other, multinational corporations operating in Iraq finance their projects through international Engineering, Procurement, and Construction (EPC) companies, global conglomerate banks’ regional branches, and foreign export credit agencies. Ultimately, I argue that the bifurcation of the private banking sector contributes to a dependency on foreign investment and the sustained outflow of capital from Iraq.