The Islamic financial sector has vast potential to perform efficiently in Iraq due to the unbelievable wealth the country retains, but unfortunately all the resources are unexploited and/or mismanaged. Iraq is a country with high financial potential, being rich in oil, gas and natural resources including phosphate, sulphur, water and many others. The country also has a high proportion of the young generation and is a pivotal site for historical archaeology and religious tourism, being the origin and shrine of many Muslim scholars and the righteous. However, all these potentials are not well exploited due to obvious reasons of political instability and corruption. Thus, I can easily say it is the country where opportunities continue to be lost. Iraq has all the elements to be a leading country in the MENA region, and the banking sector could be flourishing.
Review of 2022
Despite all the negative circumstances that have been prevailing over the past years, the annual revenues of oil sales alone reached US$75 billion, enabling Iraq to settle the war reparations to Kuwait and decrease public debt to 52% of GDP which was 344% in 2004. It is worth mentioning here that the Central Bank of Iraq (CBI) was able to rebuild its foreign currency reserve amounting to US$87 billion by the end of September 2022 and it may exceed US$100 billion by the end of this year. On the other hand, other surrounding countries are bleeding, witnessing currency depreciation and declining economic conditions.
The financial sector in Iraq is dominated by banks controlling 75% of the total assets, according to the World Bank. There are 74 banks with 904 branches spread out across the country, out of which 30 banks are Islamic and only one is state-owned.
The total banking assets were estimated at US$109.2 billion as of the end of 2021 and Islamic banks constitute a small portion of it (8.1%). Nevertheless, this share is increasing and Islamic banks are performing better than their counterparts in the conventional sector. It should be noted here that in Iraq, state-owned banks are the major players in the financial sector, owning 80% of the total assets. The Iraqi banking sector is underdeveloped with low banking penetration rates (the loans/GDP ratio was 18% at the end of 2020).
In terms of capital, Islamic banks have higher capital ratios than the conventional banks, representing 42% of total capital in Iraq. Such levels of capital can be consumed quickly in such a weak and volatile operating environment, claims Fitch Ratings.
Challenges specific to Islamic banking include low awareness of Islamic products, lack of standardization, limited product range and lack of Islamic liquidity tools. Many Iraqi banks deploy extra liquidity into CBI placements which act as a treasury function with no real banking activities.
Other challenges to the banking sector in general are a challenging operating environment, political instability, limited lending opportunities, lack of comprehensive banking regulations, weak enforcement of the financial regulations, issues in reporting and transparency triggering a lack of confidence in the banking system, money laundering concerns and underskilled human resources.
Preview of 2023
In this regard, the CBI has taken many initiatives to improve the regulatory environment by establishing guidance and requirement documents relating to organizing risk management controls, governing bodies’ functions including that of the Shariah board, internal and external Shariah audit and Shariah compliance.
In an attempt to enable investment and liquidity management tools, the CBI also issued Islamic financing controls, drafts of Takaful insurance regulation and the Islamic investment Sukuk law. Also, the CBI has been engaging with local and international Islamic organizations such as the AAOIFI and the IFSB.
Conclusion
Finally, it is obvious that Islamic banks have a stronger financial position than conventional banks. However, this is due to a low risk appetite and the lack of an investment strategy. On the other hand, they have been gaining more public momentum as shown by the exponential growth in deposits. They also have the support of the regulator who has been initiating efforts to facilitate the operating environment and encourage better banking practices.
However, it depends on the Islamic banks’ owners to decide which investment strategy they would like to follow to practice real banking. It is also crucial that political management is set on the right track to decrease the international and domestic effects on the whole country.
Wissam Jarkassi is the chief risk officer at the International Development Bank, Iraq and the founding director of B Perception Risk Consulting. He can be contacted at [email protected].