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Embargoed Until 10:00 a.m. EDT Contact: Tony Fratto
Friday, October 10, 2003 (202) 622-2910

Reconstruction of Iraq’s Banking Sector

John B. Taylor
Under Secretary of Treasury for International Affairs

A Briefing Sponsored by the
Bankers Association for Finance and Trade
and the
Arab Bankers Association of North America
Renaissance Mayflower Hotel
Washington, D.C.
October 10, 2003

Good morning. It is an honor to be here with this distinguished group of bankers and other guests.

In just five days, a major financial event is scheduled to take place in Iraq. A new national currency will be put into circulation. It is a major logistical event as well. It involves the printing of 2,300 tons of currency at facilities around the world, the air shipment of this currency to Baghdad by 27 747s, the delivery by convoy to nearly 250 distribution points around the country, and finally the hand- to-hand exchange of the new currency for the Saddam dinar and the Swiss dinar used in the north. This exchange is part of a financial reconstruction plan developed well before the start of the military action in Iraq. 

Today I would like to discuss another closely related and equally important part of that same financial reconstruction plan: the rebuilding of Iraq’s banking system. A sound banking system and a sound currency go hand in hand. They jointly provide the financial foundation of a market economy, which will allow the Iraqi people to end the years of economic chaos and ruin caused by Saddam and achieve economic prosperity. In particular, banks will serve as the distribution points for the upcoming currency exchange, and they have already helped in our interim currency plan where we made payments of over billion U.S. dollars to Iraqi pensioners and civil servants.

Let me begin with our assessment of the state of the banking sector in Iraq, and then review the stabilization program we implemented as soon as Saddam fell.

I will then sketch out our future plans as we work with Iraqi financial officials in the finance ministry, the central bank, and the rest of the financial sector.

What we expected and what our banking experts found.

We began obtaining information and developing plans for economic reconstruction late last year. From the start, we recognized that rebuilding and modernizing Iraq’s banking sector would be an essential part of economic reconstruction. We consulted, therefore, with Iraqi expatriates and other knowledgeable people. We knew, of course, that the banks were the most significant part of the financial sector and that two state-owned banks, Rafidain and Rasheed, dominated the sector. In the years before Saddam’s rule, Rafidain had been one of the most respected financial institutions in the Middle East. We expected that Iraq’s banks were directed by Saddam’s regime, but we recognized that a thorough on-the-ground assessment would be needed to determine the state of the payments system, the adequacy of internal controls, and the size of the non-performing loan problem. 

Choosing, Deploying, and Hearing from the Financial Experts

We began choosing Treasury financial experts to go to Iraq for this on-the-ground assessment in January. Some were deployed to Kuwait in March. As early as April, while major military actions were still taking place in Baghdad, these experts went to cities in southern and northern Iraq, such as Basra, Um-Kasr, and Erbil, to begin assessing the financial sector. They first went to the local bank branches. Later, when the environment in Baghdad was permissible, these experts went to Iraq’s Central Bank, to Rafidain Bank, and to Rasheed Bank. 

We greatly appreciate the work of these dedicated people, especially those who were there for the initial assessments. We were, of course, anxious to hear the reports of what they found. But before reviewing the financial information, let me relate some of their personal stories about those first post-Saddam days. 

The most often told stories we heard were about the heroic work of Iraqi people, who wanted to save the banking system—the records, the assets, the vaults, the computers—from destruction by the remnants of old regime and by looters. One uplifting story was about the deputy governor of the Central Bank and his efforts to secure assets stored in a destroyed central bank vault. For days he trudged through sludge and raw sewage to monitor the process of cleaning up the area around the central bank vault, so that it could be opened. 

He had to fire several workers who were trying to break into the vault. He said that his efforts were motivated by the desire to save the assets for the Iraqi people.

Other stories involved central bank employees taking computers to their homes in order to secure records and property from looters.

The Initial and Subsequent Assessments

The initial assessments conducted by our financial experts have provided much insight into the banking system of Iraq. These assessments have since been supplemented and improved by the work of the World Bank staff in their recent needs assessment for reconstruction, which includes of course financial reconstruction. The staff of the International Monetary Fund has also been very helpful.

The information gathered confirmed most of our expectations, but has also revealed unusual characteristics of the banking sector. The banking sector accounts for only a small part of the economy. The two state-owned banks, Rafidain and Rasheed, have roughly $2 billion in assets and about 90 percent of total banking sector assets. The rest of the banking sector is comprised of 4 state-owned specialized banks and 17 private banks.

Prior to the conflict, Rafidain and Rasheed banks made loans to state-owned enterprises, largely influenced by Saddam’s regime. They also made smaller consumer loans, based on surprisingly conservative loan to value ratios. Loan portfolios of these banks, however, accounted for a small proportion of total assets. We found that deposits of the state-owned enterprises were greater than their loans. Records also show that Iraqi Treasury bills made up a substantial part of bank assets. These government securities will continue to be an important source of income for the banks. 

Rafidain and Rasheed both had large and geographically dispersed branch networks, providing Iraqis with access to some level of basic banking services. Small loans or lines of credit were largely collateralized with real-estate. We learned that branches tended to work as unit banks and that branch managers operated with small loan limits authorized by Baghdad. As a result, there were a large number of small loans on the books of these banks. Bank branches had no inter-bank voice and data communications. Records were provided only once per month from branches to headquarters in Baghdad. 

Assessments of the 17 private banks are almost complete. These banks are small in relation to the two large state-owned banks. The largest bank has only about $1 million in capital. Nevertheless, they will play a role in Iraq’s future. We know, for example, that remittances are starting to go through these banks. Some cash remittances apparently go to families in Iraq via Jordanian firms that charge a commission to carry cash over the border. We expect remittance activity to increase, as banks install wire transfer technology. Remittances by Iraqis overseas are a large pool of resources for Iraq that will help finance investment and consumption.

About 4 million Iraqis live abroad, and in recent years they have transferred over $1 billion per year to relatives in Iraq.

Based on initial assessments, banking institutions and infrastructure in Iraq are in dire need of modernization and the economy is in need of more robust financial intermediation. Banks have largely been cut off from international technology, standards, and business practices for the last thirty years. Systems are antiquated – remember DOS?

Managers have had little opportunity to operate their banks as commercially viable entities without fear of Saddam. Iraqi bankers, particularly those who remember the better economic days of the pre-Saddam era, are eager. The idea of operating in a commercially-oriented, liberalized banking system has been met with great enthusiasm, as some of you, who have had contact with Iraqi bankers, know. One of our experts reported that bank staff cheered and hugged one another (and the expert) when they learned that they will be able to operate on a commercial basis again. Iraqi bankers have also shared their excitement about “new opportunities on the horizon” with the press and have been actively participating in a newly formed Iraqi Bankers’ Association. 

What has been done.

Much has already been accomplished in banking sector reconstruction and more needs to be done.

Reopening the Banks

One of the most important accomplishments to date in the banking sector in Iraq was the reopening of most of the branches of the two largest state-owned banks, Rafidain and Rasheed, which enabled cash-strapped Iraqi families to gain access to their savings. Rafidain and Rasheed together now have over 280 branches open across the country, nearly their pre-war level. Opening these branches was no small feat. Many of the banks’ branches were damaged and we were fearful of a bank run once the banks reopened. Due to careful planning, individual Iraqis now have access to their deposits and there were no bank runs. The two banks are now able to service all of their pre-war banking customers and are providing deposit and lending services in Iraqi dinars and US dollars. By mid October, satellite voice and data systems for Rafidain, Rasheed, and the central bank will be installed at 80 locations, enabling the bank branches to communicate more efficiently.

As I already mentioned, these banks will play important roles in the currency exchange, and they have already been instrumental in facilitating the payment of civil servants and pensioners. They are also expected to become active participants in the new central bank currency auctions, which began last week.

Jump Starting Banking Activities -- Trade Bank of Iraq and small business lending

Two important initiatives to jump-start essential banking services are the creation of an Iraqi Trade Bank and the provision of small and medium enterprise loans. 

Trade Bank. Currently, trade is taking place in Iraq at the retail level. In Baghdad’s markets one can find consumer goods – from refrigerators to satellite disks – imported from neighboring countries. But in order for Iraq’s reconstruction to move forward as quickly as possible, and for private sector activity to take off, there needs to be an efficient system for importing a broad range of capital goods and services. With time, Iraqi banks will be able to provide trade finance services. But as the process of strengthening Iraqi banks goes forward, there is an immediate need to do this.

Recognizing this need, in July, the CPA announced the intention to create the Trade Bank of Iraq. Subsequently, CPA conducted a competitive bidding process to identify a consortium of international banks to support the operations of the Trade Bank. This Iraqi-staffed institution will facilitate imports to and exports from Iraq by putting in place the people and systems needed for the country to trade more efficiently and on a larger scale with the rest of the world. 

Small business lending. While the Trade Bank of Iraq will focus on large transactions, it is also important to address critical needs at the other end of the spectrum – at the level of small and medium enterprises. Indeed, one of the key lessons from the transition experience of Central and Eastern Europe and the Former Soviet Union is that small business development is critical to sustainable private-sector led growth – generating as much as two-thirds of all new jobs. A number of transition economies now have in place special programs designed to target this sector. Many of these – such as the Russia Small Business Fund – have proven to be highly successful: they have grown rapidly and repayments rates have usually been in excess of 98 percent. 

Drawing from this experience, Iraq’s commercial banks have begun to offer small business loans. The CPA has awarded $15 million for a National Micro and Small Enterprise Credit program. These initiatives, while helpful, will by no means satisfy the need for business financing. Accordingly, a small business loan facility, backed by the International Finance Corporation (IFC), is being planned for Iraq, and will be featured at the upcoming donors’ conference. 

Strengthening the system – laws, regulation, and supervision

In addition to strengthening specific banks and jump-starting the provision of essential products and services, it is crucial to strengthen the financial system more broadly – including the relevant laws and regulations. In consultation with the International Monetary Fund, the CPA worked with the Iraqi Governing Council, other Iraqi officials, and Iraqi private banks on a revision of a banking law. The new Banking Law was announced on September 21 by Iraqi Minister of Finance, Kamel Al-Gailani. The revised Central Bank Law is almost complete.

The new Banking Law is the critical foundation for developing a modern, sound, and open banking sector. The law establishes a more robust set of market-based rules and conditions under which banks can operate and be licensed in Iraq. Under the law, domestic banks are required to increase their capital to 10 billion Iraqi dinars within 18 months, which we expect will encourage much needed consolidation and foreign investment. The law also requires banks to maintain long-term capitalization consistent with international standards and sets more rigorous qualifications for bank licensing and for bank managers and boards of directors.

The new Banking Law also allows for foreign participation in the market. I do not need to tell this audience that foreign bank entry will play an important role in increasing the availability of credit, providing a network of relationships to Iraq that will support economic growth, and in accelerating the process of strengthening the banking sector through competition and the transfer of technology, know-how, and best practices. Transition economy experiences with financial sector reforms show that one of the most important contributors to modernizing financial sectors is bringing in foreign banks.

The current legislation allows for 6 foreign banks to enter the market over the next 5 years. The Central Bank of Iraq, with assistance from CPA, is developing procedures for foreign bank licensing and for establishing representative offices. 

Creating a sound supervisory and regulatory regime is also critical. Central Bank regulations and supervisory capabilities are being developed to support the new banking legislation. In particular, the Central Bank is strengthening its ability to supervise Iraqi banks. In fact we are beginning to hear stories of commercial banks complaining about the Central Bank’s enforcement of supervisory regulations. I would say that is a healthy sign that the Central Bank is gaining independence and starting to do what it is supposed to do. 


The steps I have described are already helping to establish a sound and efficient financial system in Iraq. Much has been accomplished in these early stages of reconstruction, and there is still much more to be accomplished. I look forward to exchanging ideas and getting valuable input from you on how we can best move forward.


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