Iraq banks to see positive growth and economic revival

Iraq banks to see positive growth and economic revival


Iraq’s banking sector is poised for significant earning and asset growth over the next decade, according to a new report released by Sansar Capital Management LLC.

The IMF forecasts Iraq’s GDP to grow by 9 per cent this year — driven by a strong macro environment, increasing credit penetration and the improving security situation in the country. The banking sector, in particular, is expected to maintain a steady growth over the next few years.

The Sansar Capital’s report points out that rising credit penetration is also expected to further stimulate the growth inthe banking sector. The report cites a World Bank study which shows that Iraqi domestic credit to GDP stood at a mere 9 per cent of GDP at the end of 2011 as compared to a 55 per cent of GDP average for the Middle East and North Africa (MENA) region.

Domestic credit to GDP grew at a clip of 89 per cent CAGR between 2009 and 2011. Moreover, according to Central Bank of Iraq data, cash credit, such as loans and overdraft facilities, have grown at an impressive CAGR of 50 per cent from 2006-11.

The detailed report analyses the Iraqi private banking sector through the perspective of five of the country’s largest private banks by deposit.

The report reveals that supported by the strong economic growth and rising credit penetration, these five banks saw their aggregate net income grow by 207 per cent between 2010-12. Dilution driven by increases in equity capital resulted in earnings-per-share growth to be lower but still impressive with an aggregate EPS growth of 111 per cent from 2010-12.

The report highlights how banks with the highest return-on-equity (ROE) and growth profiles trade at the lowest valuation — an odd idiosyncrasy in the Iraqi markets. Sansar believes that this is an example of market inefficiency, which provides opportunities for those paying attention.

The reportalso closely examines the financial statements of the Iraqi banks and demonstrates that adjusted underlying profitability and return-on-equity for these banks significantly exceeds the reported numbers with some banks approaching 60 per cent underlying ROEs.

The Iraqi Middle East Investment Bank, the third largest publicly traded bank in terms of deposits, performed well in the past few years, having been able to attract large sums of quality deposits at very low interest rates. In 2012, Iraqi Middle East Investment Bank had the highest return-on-equity and the highest operating profits growth among the large Iraqi banks. Since 2009, the bank profit before taxes have grown by 330 per cent, a CAGR of 63 per cent.

According to the report, the growth in Iraq’s banking sector earnings and GDP —which IEA forecasts will grow 151 per cent between 2011 and 2020, driven by the country’s increasing oil revenues, go hand-in-hand with the improving security situation in the country. As violence declined by over 80 per cent between 2006-12, Iraqis in many parts of the country enjoyed relative calm and stability.

However, despite the impressive growth, Iraqi private banks will have to overcome some important challenges if they are to continue their growth at the excellent pace witnessed over the last five years.

Accessibility is among the biggest challenges facing the country’s banking industry. Access to bank branches or ATM machines remains highly limited to the general Iraqi population. There are approximately 900 bank branches covering a population of 33 million Iraqis equating to just one branch serving 36,000 individuals.

The trust issueOther challenges include an uneven playing field enjoyed by the state-owned banks and a general mistrust of the banking system.

This problem is further exasperated by the lack of any deposit insurance institutions that would guarantee the return of customers’ deposits in the event of a bank failure.

The report also raises some concerns regarding corporate governance and transparency at some banks.  In the example of North Bank, it highlights how audit and financial concerns raised by the accountants in the Arabic reports were missing from the English translated reports provided by the bank.

“Iraq’s banking sector, though certainly on the growth path, is not without its share of challenges. However, what is important to note is that all the challenges and hurdles can be overcome, especially with the combined efforts of the government and private sector.

In particular, we believe that the private sector can help improve accessibility to branch networks and services while the government can help level the playing field between the state-owned and private sector banks. Of course, gaining the trust of the population would require efforts from both sides,” said Sanjay Motwani, president of Sansar Capital.
The report pointed out that Iraqi banks generate large sums of their revenue and profits from trade-financing related activities.

For the year 2011, commissions driven by trade-financing related activities (wire transfers, letters of credit, FX spreads) accounted for a range of 28 per cent to 83 per cent of net revenues for the four largest ‘traditional’ banks. Traditional lending activities, such as, net interest income on loans became the second largest contributor of revenue for the four largest banks, by deposits generating 13 per cent to 49 per cent of net revenues from these activities.

The Sansar Capital report concludes that while the mix of an improving macro environment and security situation offer attractive investment ingredients in Iraq, many challenges remain for those interested in participating through public markets. In such an environment, investors are cautioned to carry out extensive due-diligence, including having on the ground presence in the country.