VZCZCXRO9977
RR RUEHBC RUEHDA RUEHDE RUEHIHL RUEHKUK
DE RUEHGB #2844/01 2371236
ZNR UUUUU ZZH
R 251236Z AUG 07
FM AMEMBASSY BAGHDAD
TO RUEHC/SECSTATE WASHDC 2996
INFO RUCNRAQ/IRAQ COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 02 BAGHDAD 002844 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN IZ
SUBJECT: BANKING SYSTEM IMPEDES INVESTMENT IN KURDISTAN 
REGION 
 
REF: BAGHDAD 1239 
 
¶1. This is a Kurdistan Regional Reconstruction Team (RRT) 
cable. 
 
¶2. (SBU) Begin Summary: Private sector leaders and senior 
government officials recently told PRTOff that the Dohuk 
Governorate's primitive banking system remains the single 
largest impediment to the province's economic development. 
The province's eight banks have limited technological 
capabilities, and the banks are unable to conduct electronic 
transfer of funds to each other. This perpetuates an 
inefficient, unsecured, and opaque (from a record-keeping 
perspective) cash-based payment system for goods and 
services. The implementation of capital investment projects 
-- initiated both locally and from abroad -- suffers from 
transaction inefficiencies, security issues, and the 
heightened overall business risk premium associated with 
frequently transporting and deploying large amounts of cash. 
In addition to the debilitating effects of their primitive 
technological capabilities, banks throughout the Kurdistan 
region suffer under the Iraq-wide systemic impediments 
identified in the March 2007, USAID-funded, Izdihar project 
report on the country's banking system. These include Center 
Bank of Iraq (CBI) disincentives to lending, poorly qualified 
and trained management and workers and insufficient internal 
and external auditing. Absent significant investments in 
training and technology, as well as implementation of the CBI 
reforms recommended in the Izdihar report, the Kurdistan 
region's dysfunctional banking system will continue to impose 
substantial opportunity costs on capital investment and GDP 
growth. End Summary. 
 
---------- 
Background 
---------- 
 
¶3. (SBU) Senior representatives from the Dohuk Governorate, 
the Dohuk City chamber of commerce, Rafidain Bank (State 
owned; Iraq's largest bank; largest bank operating in Dohuk), 
and the Iraq Middle Market Development Foundation (IMMDF) 
told PRTOff on August 16 that the province's undeveloped 
banking system must be improved, in order for Dohuk and the 
rest of the Kurdistan region to attract significant foreign 
investment -- especially from countries other than Turkey. 
Western businessman have repeatedly cited the lack of a 
properly functioning banking system as a major factor in 
their foreign direct investment decision-making process. 
 
¶4. (U) Most of the problems identified with the Dohuk banking 
system are endemic within the Kurdistan region's other two 
governorates of Erbil and Sulaimaniyah. While non-bank 
lenders such as the IMMDF and micro lender Al Thiqqa have 
stepped into the market and experienced high demands for 
loans, their activities remain dwarfed by those in the formal 
banking sector. 
 
--------------------------------------- 
Technological Limitations: Cash is King 
--------------------------------------- 
 
¶5. (SBU) Eight banks currently operate in Dohuk Governorate, 
five of which are state-owned. Each bank operates as an 
electronic island unto itself. No system exists to handle 
inter-bank transfers of funds. As bank customers are unable 
to initiate an electronic funds transfer from their own bank 
to a business or individual holding an account at another 
bank, even large business to business transactions are 
conducted on a cash basis. Jameel Mohammed Diab, the head of 
Rafidain Bank's operations in Dohuk City, told PRTOff 
recently, "It's a largely cash economy here." He explained 
that non-Turkish foreign investors have shied away from 
investment in Dohuk, in large part due to the inefficiencies, 
physical risks, and record-keeping challenges posed by 
enacting business transactions in cash. Jameel's comments 
were confirmed by the Chairman of Dohuk City's Chamber of 
Commerce, Ayad Abdulhalim, who stated, "Our bad banking 
system is our number one economic problem. It prevents us 
from attracting more foreign direct investment." Jameel's 
comments mirror those of the Chairman of the Sulaimaniyah 
Chamber of Commerce, who spoke with us in April 2007 (reftel). 
 
-------------------------------------- 
CBI Impedes Development of Bank Sector 
-------------------------------------- 
 
¶6. (U) In addition to surmounting their primitive 
technological capabilities, Dohuk banks face systemic 
development impediments emanating from CBI practices and 
policies. According to a March 2007 analysis of Iraq's 
 
BAGHDAD 00002844  002 OF 002 
 
 
banking system by the USAID-funded Izdihar project, the CBI 
pays banks an annual interest rate of 20 percent on the 
banks' 30-day deposits with the CBI. This is risk free income 
for the banks and poses a significant disincentive to bank 
lending. Comment: Why would banks choose to lend their funds 
to customers, who may or may not repay the loan, when the 
banks can earn more by investing their funds risk free with 
the CBI? End Comment. Indeed, under such circumstances, 
Iraq's banks exhibit very low levels of lending volume, 
relative to international norms. 
 
¶7. (U) According to the Izdihar report, over half of Iraqi 
private bank assets were in cash or deposits with the CBI in 
2005 (latest statistics available). In comparison, Western 
commercial banks typically hold less than five percent of 
their assets in liquid form as the potential for higher 
earnings exists in lending to the private sector. Among its 
other recommendations, the Izdihar report stated that the CBI 
should either reduce the rate it pays on funds deposited with 
the CBI by Iraqi banks, or limit the amount of such deposits. 
 
¶8. (SBU) Other systemic problems hamper the development of 
the region's banks. Jameel stated that Rafidain Bank's loans 
are always collateralized by real estate or other hard 
assets, and the interest rate charged on loans is 
standardized for all borrowers. In his opinion, this obviates 
the need for a risk assessment of the borrower. As a result 
of such institutionalized practices, the five 
government-owned banks in Dohuk Governorate lack sufficient 
risk management capabilities at both the tactical (i.e. 
individual loans) and strategic (loan portfolio) levels. 
 
¶9. (SBU) Coupled with the CBI's cursory auditing of banks' 
operations and the CBI's limited requirements for the 
production of meaningful financial statements and statistics, 
these impediments make the true credit risk embedded in any 
bank's portfolio is difficult to determine. The Dean of Dohuk 
University's College of Economics, Khalil Ghazi Besfki, told 
PRTOff on August 16, "The banks will do OK as long as land 
prices continue to rise, but we don't know what will happen 
if they fall." To help bolster oversight of lending 
portfolios at both the CBI and individual bank levels, the 
March 2007 Izdihar banking report recommended that the CBI 
require annual assessments of all existing commercial credit 
facilities, rather than the currently required biennial 
reviews. 
 
------- 
Comment 
------- 
 
¶10. (SBU) Kurdish regional banks have been largely 
ineffective. They have not fulfilled their primary economic 
role of attracting deposits and lending money to qualified 
borrowers at a rate commensurate with the assumed credit 
risk. The absence of these primary banking services has 
resulted from a lack of market-based improvements of the 
banking sector in the Kurdistan region and across Iraq, both 
prior to and after the 2003 U.S.-led invasion. Even with its 
relatively secure environment and its July 2006 investment 
law that allows a foreigner to own a bank (as opposed to the 
national investment law which prohibits foreign ownership of 
banks), few foreigners have considered establishing banking 
operations in the Kurdistan region. The Kurdistan region is 
not a nation, and its banking system remains subject to 
oversight and control from the CBI. Absent implementation of 
the CBI reforms recommended in the Izdihar report, as well as 
significant investments in training and technology, the 
region's banking system will remain dysfunctional and largely 
bereft of foreign direct investment. Problems in the banking 
sector -- and the cash-based economy resulting from them -- 
will continue to restrain capital investment and GDP growth 
across virtually all other economic sectors in the Kurdistan 
region. End Comment. 
CROCKER