Iraq's banking system blighted by corruption

After decades of war and economic sanctions on Iraq, hopes were high following the 2003 US-led invasion that the nation's banking sector would play a major role in driving economic growth.

But 21 years later, Iraq's banks stand as a stark reminder of unmet expectations.

Instead of fuelling growth, the sector has become a tale of hijacked opportunities and widespread corruption, rendering development efforts futile.

“After 2003, the Iraqi economy emerged with structural imbalances amid wide destruction in the infrastructure due to wars,” Ammar Hamad Khalaf, deputy governor of the Central Bank of Iraq, told The National.

Shortly after the invasion that deposed long-time leader Saddam Hussein, a bloody insurgency from both Sunni and Shiite militants began, plunging the country into years of instability coupled with political infighting. All economic plans – particularly those to develop non-oil sectors – were shelved, and successive governments focused only on selling crude oil to feed the federal budget.

Nothing has changed significantly since.

“The behaviour of banks in Iraq follows the structure of the Iraqi economy, which relies on imports rather than local production,” Mr Khalaf said.

“Banks have focused extensively on financing foreign trade due to weakness in the agriculture, industry, and other sectors."

During Saddam Hussein's regime, Iraq's economy experienced financial repression – a condition, according to the World Bank, where governments manipulate the financial system to direct funds towards themselves. This often aims to offer cheaper loans to businesses and governments by lowering the returns for savers, thus easing their repayment burdens. The policies involved in financial repression can include capital controls, interest rate caps and preferential tax treatment.

The establishment of private banks was permitted only after 1991. By 2003, only 17 private banks operated, alongside five state-run counterparts.

In late 2003, a modern banking law was introduced to ensure the country’s banking regulatory structure conformed to international standards and to foster confidence in the system by forming a safe, competitive and accessible sector.

The following year, the Central Bank of Iraq Law was approved, establishing the CBI in its current autonomous form.

Since then, the number of private banks has grown remarkably to 54 – including 30 Islamic banks – alongside seven government banks. But many of the private banks are owned by companies or businessmen linked to political parties and politicians. Corruption, irregularities and embezzlement also mire state-run banks, according to government watchdog institutions.

Three of the seven state-run banks – Al Rafidain, Al Rasheed and Trade Bank of Iraq – still dominate the sector in Iraq, controlling about 85 per cent of deposits and 90 per cent of bank assets, said Mahmoud Dagher, former director general of the Department of Operations and Public Debt at CBI.

The rest of the deposits are with the private banks and “that is not sufficient to support the development process and the process of granting loans mainly to the private sector in Iraq”, he explained.

In addition, the government banks, he notes, still operate under outdated systems. The only exception is the Trade Bank of Iraq. This was established after 2003 to finance government imports when Al Rafidain and Al Rasheed banks were still under UN sanctions imposed on Iraq after it invaded Kuwait in 1990.

The only way to develop the banking sector is to encourage the private sector to launch projects in industry, agriculture, services, transportation and tourism, instead of only importing goods, added Mr Dagher.

Over the past two decades, most Iraqi banks have not offered a wide range of banking products like other banks in neighbouring countries or beyond. Instead, they have focused on more profitable fields, including US dollar transactions through the government-run US dollar auction. Across Iraq, they are mockingly described as “currency exchange shops”.

Since late 2022, the Iraqi banking sector has come under heavy scrutiny from the US Treasury Department, which has accused it of money laundering and supporting Iran and other US-sanctioned countries to access US dollars.

It has banned 32 banks from dealing in dollars and applied tight scrutiny measures on requests for foreign transactions to cover imports, such as severe examination. A total of 75 currency exchange and money transaction companies were banned.

Under pressure from Washington, Iraqi Prime Minister Mohammed Shia Al Sudani's government and the CBI introduced a series of financial and economic reforms early last year.

These include strict measures on foreign transactions in US dollars, requesting traders to file all details regarding the goods they want to import and the final beneficiary.

Others are activating the electronic payment system, encouraging banks to offer a variety of services and calling on the public and businesses to open accounts.

Despite the recent push for reforms, challenges persist.

Well-connected businessmen are still exploiting loopholes in the CBI-run Foreign Currency Selling Window to make obscene amounts of money from the margin between the official exchange rate and the one on the black market.

Ordinary citizens face hurdles in accessing essential banking services, from withdrawing their savings to navigating frozen credit cards and grappling with exorbitant commission rates mainly on pensions for those who live abroad.

Loopholes

The National spoke to a dozen businessmen who said the strict measures helped streamline the process of importing and forced many to make their transactions official.

However, there is still room for manipulation, they said.

“There are still ways to work around the procedures,” one businessman said. “Forged bills and arrangements at border crossings as well as manipulating the prices of goods by putting excessive prices by the exporters are among the common ways.”

Another loophole, which is outside the authority of the CBI, is corruption at the border crossings and tax evasion.

“Some importers can easily evade measures at border crossings when his bill says, for example, 1,000 pencils but in reality, only 500 enter the country,” another businessman said.

“He can register 1,000 pencils at the crossing border and can even pay taxes for them as the margin between the official and black market rate can still offer good profit."

Mr Khalaf confirmed these practices exist, saying a US company checks requests mainly in terms of prices, to make sure neither the importer nor exporter manipulates them.

Another way of gaining access to dollars is through travel money.

An audit conducted by the Federal Board of Supreme Audit (FBSA) found 151,940 people were falsely registered as travellers to gain access to dollars from February 1 to July 8 last year.

They purchased $607.76 million that ended up on the black market, according to a report the board sent to the CBI in December.

Separately, the audit also found the total amount of dollars sold to travellers from January 1 to September 19 last year was about $7.29 billion.

It found irregularities in the registration process by “entering inaccurate and unclear characters in the passport number field for some travellers despite passport numbers being a key identifier for completing the dollar sale”.

The FBSA also found discrepancies in the amount of dollars sold to travellers on the two CBI platforms and in some cases CBI employees purchased dollars twice a month instead of once as required.

'Hit the jackpot'

In a drawing room adorned with intricate tapestries and ornate furnishings, The National attended a tense meeting of businessmen, their faces etched with a mixture of frustration and resignation.

They had come together to solve a months-long financial debacle that had escalated far beyond the confines of legality, plunging them into the murky waters of tribal diplomacy.

With access to the government-run platform that offers US dollars at the official rate, a businessman lured other merchants into a deal promising huge profit from the margin between the official and black market rates, sources involved in the matter told The National.

As hundreds of millions of Iraqi dinars changed hands, the merchants received cash windfalls. But as days and months dragged on, the businessman found himself unable to repay his debts, leaving the merchants in a precarious position.

No official complaint was made against him and the businessman never faced trial.

“It’s clear we’re at an impasse,” a representative for the businessman, who lives in a neighbouring country, told the attendees, who exchanged wary glances. “We cannot continue down this path. It’s time to cut down our losses.”

His proposal hung heavy in the air and was met with murmurs of reluctant agreement.

To relinquish half of their 2 billion Iraqi dinars was a bitter pill to swallow, yet it seemed the only viable option in the face of mounting losses and uncertainty.

“We say that the one who loses half of his money is not a loser,” the owner of a famous restaurant chain in Baghdad told The National after the meeting.

“At least I have half of my capital in my hands – better than nothing,” he said.

“There is no business that can let you hit the jackpot like benefiting from margin in the exchange rate in a short period of time, so that is why we invested heavily with him.

“Over the past months, he was paying us on time but it sounds that he has faced problems recently,” he added.

De-dollarisation

The harsh UN-imposed economic sanctions after the First Gulf War in 1991 and the 2003 US-led invasion caused a substantial devaluation of the Iraqi dinar.

As a result, Iraqis have turned to the US dollar for a wide range of transactions, from wholesale trading to retail purchases.

Amid the lack of dollars in its coffers last year, the CBI put restrictions on dollar withdrawal and restricted all internal trade and transactions to Iraqi dinars in an attempt to de-dollarise the economy.

That caused concern and anger among Iraqis looking to gain access to dollars amid the instability of the local currency.

To ease pressure on the government to bring dollars in cash, the CBI announced last year it was allowing the banks to bring their assets from abroad independently by plane without going through the CBI.

However, that process has added more burden on clients especially after the CBI left the banks to decide how to implement the regulations for what is locally known and described by the CBI as the “imported dollar”.

For all incoming US dollar transactions to Iraq, the banks have added more commissions ranging from 3 to 5 per cent. Some banks are applying the “imported dollar” regulations retrospectively, causing more challenges to Iraqis.

For those wanting to withdraw more than $10,000, they have to submit an official request, explaining why they need such a large amount, with supporting documents. Clients also need to sign a paper listing the serial number of the dollar bills and they will be responsible if these dollars are found in US-sanctioned countries.

“On paper and government statements, they say, ‘come and withdraw your money’, but in reality, they are putting hurdles in our way,” Ziad Mohammed Qassim, 44, told The National.

“It is as if our savings are frozen now."

Foreign investors

After 2003, Iraq tried to lure foreign and international banks to open branches in the country but the volatile security situation, red tape and corruption prevented that from happening. Some regional banks from Lebanon, Iran and Turkey have opened branches, while others have invested in local banks.

Banning 32 banks and dozens of currency exchange and transaction service companies since late 2022, according to a list published by the CBI this year, allowed a handful of private banks to have a bigger share of US dollar transactions.

These are: Bank of Baghdad, The National Bank of Iraq, Credit Bank of Iraq, Mansur Bank and the Commercial Bank of Iraq. Regional banks and financial institutions from Jordan, Kuwait and Qatar have invested heavily in these banks.

Some banks are purely owned by Iraqi shareholders, while regional banks and financial institutions from Kuwait, Jordan and Qatar are partners in others such as the five aforementioned.

Some Iraqi politicians, mainly Iran-backed ones, have accused the US of targeting national Iraqi banks in which foreign investors have no shares, depriving them of profits after backlisting and banning them from dealing in dollars. They have said that the country's foreign exchange transactions are controlled by foreign countries they have been hostile to since 2003.

Their campaign against these banks has prompted the government, which is backed by Iran-allied political and militant factions, to ask concerned authorities to reconsider the percentage of shares that foreign investors can own in Iraqi banks, a move that could force their withdraw.

“The US Department of Treasury is fighting the banking system, they are derailing their work and sidelining all national banks in order to depend on one or two banks in neighbouring countries,” Hadi Al Amiri, a powerful Shiite politician who heads Badr Organisation, which has an influential militia, said recently.

“I consider it as a crime against the Iraqi banks, a crime against the Iraqi economy and a crime against the Iraqi people."

He was referring to the 32 banned banks that have lost huge profits from obtaining US dollars at the official rate.

After banning these banks and applying tight scrutiny on transactions, dollar flow to Iran also decreased.

The chief executive of one of these banks hit back.

“What is happening is that we have real and wide partnership with respected investors and correspondent banks globally and we are showing a great deal of discipline to local and international regulations,” he told The National on condition of anonymity, in line with his bank’s regulations.

“This is a moment of truth that shows the real banks and others who are mere kiosks to skim profits from the public funds to fill the pockets of the corrupt politicians and their backers beyond the borders.

“If the Iraqi government is serious about the reforms, it has to support us for the benefit of the economy and get rid of the others who have damaged the economy over the past two decades,” he said.

Mr Khalaf, the CBI deputy governor, rejected the idea that the US was targeting the 32 banned banks deliberately.

“I don’t think there is any fear of these measures as long as they primarily serve Iraq and facilitate foreign trade,” he said.

Push for modernisation

A few years after 2003, some e-banking methods were introduced, followed by more steps to enhance these services through legislations and incentive to banks to start providing debit cards and mobile payments.

In 2016, the CBI authorised two mobile wallets run by two prominent telecom companies. Several online payment companies were also licensed.

However, these services were limited.

As part of the series of financial and economic reforms, the Iraqi government is pushing for the use of electronic payment systems by the government and private sectors.

However, the usage of electronic payment systems in Iraq is still in its early stages and faces several obstacles. Among the challenges is the lack of infrastructure and technical capacity to support electronic payments, mainly the need for reliable and affordable internet connectivity, ATMs and point-of-sale terminals.

Another obstacle is the low level of financial literacy and awareness among the population.

At one of Baghdad’s fuel stations, sales stopped due to an internet outage and that led to a chaotic and tense scene with hums of idling vehicles and occasional blares of car horns adding to the growing sense of frustration. Paying with bank cards was made mandatory at fuel stations this year.

“Let’s take cash, for God’s sake,” one of the petrol station attendants told the manager who was on the phone with the service provider, trying to get an estimate on when the internet might be back up.

“No, we can’t. These are the government orders,” the manager replied.

“We are not against modernisation, but these things have to be implemented gradually and step by step to prepare the proper environment,” Muayad Hassan Jassim, 24, said as he was waiting in line.

“They have to have backup plans and accept cash in such situations. They have to put in mind that there are elderly people who know nothing about credit cards."

At some stations, the attendants ask clients with credit cards to pay those who do not have cards and take cash from them.

Since last year, many people have reported frozen credit cards abroad that took months to be reactivated, while others have reported online fraud.

The CBI has imposed limits on withdrawal from ATMs outside Iraq because it exchanged dollars at the official rate and some Iraqis would then send the dollars back to Iraq to sell on the black market.

Retired Iraqis living abroad have suffered due to restrictions on withdrawals from ATMs and having to provide a proof-of-life certificate.

They are now also paying extra commissions for transactions and withdrawals, they say.

Before the push for online payments, they had their relatives in Iraq receive their pensions and send money to them abroad. Now, they are paid by credit card and are unable to withdraw all their pensions at once.

In each withdrawal, they have to pay a commission.