Despite Challenges, Banks Look to Set Up Branches in Iraq

DUBAI — Iraq is still struggling to overcome an economic legacy of war, insurgency, political rifts and fragile security. For its nascent banking sector, the challenges do not stop there. According to the Web site of the Central Bank of Iraq, the country is served by 7 state-owned banks, 32 private banks and 15 foreign banks. But analysts say that a handful of state-owned banks — and two in particular, Rafidain Bank and Rasheed Bank — dominate 90 percent of the business.

“Because the public banks were given the chance to utilize the massive funds of the public sector, private Iraqi banks were naturally sidelined,” said Bassem Khalil al-Salem, executive chairman of Capital Bank of Jordan, which owns 72 percent of National Bank of Iraq, a private bank.

“There’s a resulting lack of trust by consumers who fear that private banks could collapse, which presents a huge challenge to the growth of private banks,” Mr. Salem said.

In addition, “there’s no level playing field in Iraq because most government agencies and state-owned companies — and employees — are restricted from dealing with private banks, so they only deal with public banks,” said Mouayed Makhlouf, regional director in Dubai for the Middle East and North African operations of the International Finance Corp., the World Bank unit that focuses on the private sector.

As a result, he said, “the private sector, consisting of nearly 40 banks, is very small with very little lending activity.”

With access to public funds drawn from the oil industry, public banks are well capitalized. Private banks, on the other hand, must fight for deals in the hotly competitive infrastructure, construction and manufacturing sectors.

Making a tough environment tougher, the central bank introduced a law two years ago setting a minimum capital requirement for all Iraqi banks of $215 million, to be met by June this year.

“There’s a big issue regarding adequacy of capital in small, private banks and with the central bank asking to gradually increase capital, there’s likely to be much consolidation among these banks,” said Tawfiq Tabbaa, a managing partner at the international law firm Eversheds, based in Iraq and Jordan. “Some banks will likely close down. Others will merge together or be acquired by other banks.”

Add in high compliance costs for risk management and measures to combat money laundering, and the task of operating a private bank in Iraq could seem daunting. Yet several more foreign banks have expressed interest in entering the market recently, chasing opportunities in project finance in a country that analysts say has untapped potential.

Among them is Standard Chartered Bank, which generates 90 percent of its profit and revenue from consumer and wholesale banking services across Asia, Africa and the Middle East. In its latest move, the bank is planning to set up not one, but three new offices in Iraq.

Standard Chartered already has a representative office in Erbil, the chief city of the oil-rich Kurdish autonomous region in northern Iraq.

To service the expanding Iraqi activities of its clients, it is applying to the Iraqi central bank for licenses to upgrade its Erbil office to full branch status this year and to open a branch in Baghdad, to be followed by a branch in the southern city of Basra in 2014. It also plans to appoint a chief executive in Baghdad to focus on running its Iraqi business.

“A lot more of our clients, whether it’s Western multinationals, Korean construction firms or Saudi oil companies, are in advanced stages of going into Iraq, and our move is about following them, not going in for new clients,” Viswanathan Shankar, the bank’s chief executive for Europe, the Middle East, Africa and the Americas, said during an interview in his offices at the Dubai International Financial Center.

“Iraq is a virgin market in the region that can’t be ignored because of its rich economy and oil reserves,” said Mr. Makhlouf of the I.F.C.

“Government policies, financial regulations and political stability are definitely hurdles, but the strength of the economy and oil revenue to support growth give Iraq the potential to be one of the best places to invest in the region, and private banks see that,” he said.

The I.F.C.’s investments in Iraq focus on developing the banking, logistics, telecommunications and hospitality sectors through commitments that reached $500 million from 2011 to 2012. This includes a $70 million loan to help renovate a cement factory operated by an Iraqi subsidiary of the French company Lafarge, to aid the country’s reconstruction.

The I.F.C. plans to invest $100 million to $130 million a year in Iraq, depending on the security situation, according to its Web site.

“There’s a big increase of Asian companies coming to the market, particularly Korean companies interested in project finance and, as a result, welcoming the involvement of foreign banks,” said Mr. Tabbaa of Eversheds, who is currently processing the legal paperwork for a couple of banks based in Turkey and Abu Dhabi looking to register branches in Iraq and two multinational companies seeking project finance to put together Iraqi programs.

“There will be movement into the market, and if Standard Chartered Bank is confident, that’s quite significant,” Mr. Tabbaa said.

Korean companies like Hanwha have been active in Iraq. The construction company signed a $7.75 billion deal last May to build 100,000 housing units near Baghdad.

With deals like these expected to grow in number and size, banks see plenty of incentive to take on the hurdles, and the risks, of the Iraqi market: The profit of National Bank of Iraq rose sixfold in 2012 alone, noted Mr. Salem, of Capital Bank of Jordan.

“We were waiting for clarity on the security issue and we think it’s improving, though not perfect,” said Mr. Shankar, of Standard Chartered Bank. “We have been doing some business in Iraq, enough to build a body of knowledge about what’s going on, that we feel comfortable entering — with eyes wide open.”