Economic Analysis: The Impact of Declining Private Sector Deposits on the Iraqi Banking System

Economic Analysis: The Impact of Declining Private Sector Deposits on the Iraqi Banking System

9-18-2024

Researcher Shaza Khalil*
An unofficial Iraqi financial report revealed a significant decline in the acquisition of private sector deposits by 12 local banks, compared to a significant increase in the share of banks that have banking relationships with American financial institutions. This shift is considered a significant turning point in the Iraqi financial landscape, and it not only reshapes the banking sector, but also has a significant impact on the Iraqi economy in general and on the daily lives of citizens.

The rise of US-linked banks
According to a report issued by the Iraq Future Foundation for Economic Studies and Consultations, three Iraqi banks with correspondent relationships with US banks accounted for about 47% of total private sector deposits in the Iraqi banking system in the first half of 2024, a significant increase from the 34% they accounted for in 2019. In contrast, local banks without international financial relationships saw their share of deposits decline, falling from 42% in 2019 to 36% in mid-2024.

This trend is expected to worsen, with US-linked banks expected to account for more than 50% of private sector deposits by the end of 2024. The Central Bank of Iraq has acknowledged that reliance on correspondent banks for external transfers plays a crucial role in this new distribution of deposit shares. But this shift has far-reaching implications for the Iraqi financial system and its citizens.

Impact on the Iraqi economy
Loss of confidence in local banks The decline in deposits in local banks that lack US correspondents is the result of several factors, including corruption and liquidity risks. Banking expert Abdulrahman Al-Shaikhli explained that corruption in these institutions undermines trust between depositors and banks. This can limit banks’ ability to attract deposits and maintain liquidity, hampering their role in financing the economy.

This loss of confidence could exacerbate Iraq’s liquidity crisis, reducing capital flows to local businesses and hampering economic growth. When private banks fail to inspire confidence, individuals and businesses may refrain from depositing or turn to alternative banking options, limiting the capital available for lending and investment.

Capital concentration The increasing dominance of U.S.-linked banks is leading to a concentration of capital in a few institutions, potentially leading to monopolistic trends in the Iraqi financial sector. While these banks may provide greater stability due to their international connections, they may reduce competition in the market, creating inefficiencies. This concentration could lead to higher borrowing costs for Iraqi businesses, particularly small and medium-sized enterprises that rely on domestic financial services.

In an economy like Iraq, where diversification away from oil is essential, the banking sector plays a crucial role in supporting new sectors. Weak local banks could hamper financing of vital sectors such as agriculture, industry and non-oil exports, which are critical for long-term sustainable growth.

Restricting access to financial services The decline of local banks means that many Iraqi citizens, particularly in rural or underbanked areas, may face reduced access to basic banking services. Banks affiliated with the United States may focus on large clients, leaving small businesses and individual depositors with fewer options. This could increase financial exclusion, making it harder for ordinary Iraqis to obtain loans, save money, or conduct everyday banking transactions.

Moreover, reputational risks associated with corruption in some local banks may make citizens reluctant to deal with these institutions, limiting their ability to participate in the formal economy. This may push more people to use informal financial channels, increasing the risk of fraud or loss, and weakening the stability of the economy as a whole.

The suffering of traders and private sector workers Traders also expressed their concerns about the difficulties they face in conducting financial transactions through Iraqi banks. Ahmed Al-Fahd, a member of the Federation of Chambers of Commerce in Baghdad, pointed out that the procedures related to financial transfers via the electronic platform are often complicated and time-consuming, sometimes reaching 10 days. This creates delays and uncertainty for traders who rely on fast transfers to complete international trade operations, especially with regard to imports.

This low efficiency in the banking system leads many traders to resort to cash transactions or international banking options, which reduces confidence in local banking institutions and complicates efforts to monitor financial flows and regulate them according to international standards.

The CBI’s reforms, which aim to expand electronic financial transactions and provide new benefits to depositors, are essential steps to modernize the banking sector. However, these measures must be accompanied by stronger efforts to combat corruption, enhance transparency, and restore trust in local institutions. Without addressing these fundamental issues, the divergence between U.S.-linked banks and local banks could deepen, leading to a banking system divided as some institutions dominate the market while others struggle.

This evolving situation poses challenges to the stability of the Iraqi economy as a whole. A well-functioning and stable banking sector is essential to foster investment, support businesses, and build public confidence in the financial system. As the government seeks to attract foreign investment and encourage private sector growth, the stability and efficiency of the banking system will be of paramount importance.

In conclusion, the current trend of deposit concentration in banks affiliated with U.S. financial institutions reflects deeper issues within the Iraqi banking system, including corruption, inefficiency, and the inability of local banks to inspire confidence among depositors. While these banks may provide greater stability, their increasing dominance risks marginalizing local institutions and restricting access to basic financial services for many Iraqis. The government and the Central Bank of Iraq should prioritize reforms that aim not only to modernize the financial system but also to restore confidence in local banks. Addressing these challenges is critical to ensuring sustainable economic growth, stability, and prosperity for Iraqi citizens.

Economic Studies Unit / North America Office

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