Economic Analysis: The Impact of Declining Private Sector Deposits in Iraq’s Banking System

Economic Analysis: The Impact of Declining Private Sector Deposits in Iraq’s Banking System

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BY: Shatha Kalel
An unofficial Iraqi financial report has revealed a significant decline in the acquisition of private sector deposits by 12 local banks, contrasting with the increasing share held by banks that maintain correspondent relationships with U.S. financial institutions. This shift marks a pivotal moment in Iraq’s financial landscape, one that is not only reshaping the banking sector but also exerting considerable influence on the broader Iraqi economy and the everyday lives of its citizens.

The Rise of U.S.-Connected Banks
According to the “Iraq Al-Mustaqbal” Foundation for Economic Studies and Consultations, three Iraqi banks, each with correspondent dealings with U.S. banks, acquired nearly 47% of total private sector deposits in Iraq’s banking system in the first half of 2024. This marks a substantial increase from their 34% share in 2019. In contrast, local banks without international financial links have seen a decline in their share of deposits, dropping from 42% in 2019 to 36% by mid-2024.

This trend is expected to intensify, with the U.S.-connected banks anticipated to control over 50% of private sector deposits by the end of 2024. The Central Bank of Iraq has acknowledged that the reliance on correspondent banks in foreign transactions plays a critical role in this redistribution of deposit shares. However, this change has far-reaching consequences for Iraq’s financial system and its citizens.

The Effects on the Iraqi Economy
Loss of Confidence in Local Banks The decline in deposits within local banks that lack U.S. correspondents stems from several factors, including perceived corruption and liquidity risks. Banking expert Abdul Rahman Al-Shaikhli highlighted how corruption in these institutions undermines the trust between depositors and banks. A damaged reputation can significantly limit a bank’s ability to attract deposits and maintain liquidity, thus impairing its role in financing the economy.

This loss of confidence could exacerbate a liquidity crisis in Iraq, reducing the flow of capital into local businesses and constraining economic growth. When private banks fail to inspire confidence, individuals and businesses may withhold deposits or turn to alternative banking options, limiting the capital available for lending and investment.

Concentration of Capital The growing dominance of U.S.-connected banks centralizes capital within a few institutions, which may lead to monopolistic tendencies in Iraq’s financial sector. While these banks may offer greater stability, given their international connections, they may also reduce competition in the market, creating inefficiencies. This concentration could drive up borrowing costs for Iraqi businesses, particularly small and medium-sized enterprises (SMEs), that rely on more localized financial services.

For an economy like Iraq’s, where diversification away from oil dependency is essential, the banking sector plays a crucial role in supporting new industries. The weakening of local banks could hinder the financing of important sectors such as agriculture, industry, and non-oil exports, all of which are vital for long-term sustainable growth.

Impact on Iraqi Citizens
Limited Access to Financial Services The decline of local banks means that many Iraqi citizens, particularly in rural areas or regions underserved by major banks, could face reduced access to essential banking services. U.S.-connected banks may focus on larger corporate clients, leaving small businesses and individual depositors with fewer choices. This could exacerbate financial exclusion, making it harder for ordinary Iraqis to secure loans, save money, or conduct everyday banking transactions.

Furthermore, the reputational risks associated with corruption in some local banks mean that citizens may be hesitant to engage with these institutions, limiting their ability to participate in the formal economy. This could push more people into using informal financial channels, increasing the risks of fraud or loss, and weakening the overall stability of the economy.

Challenges for Merchants and Private Sector Workers Private sector merchants have also expressed concerns over the challenges they face in conducting financial transactions through Iraqi banks. As Ahmed Al-Fahd, a member of the Baghdad Federation of Chambers of Commerce, highlighted, the procedures for financial transfers via the electronic platform are often complex and time-consuming, sometimes taking up to 10 days. This creates delays and uncertainties for businesses that rely on efficient transfers to conduct international trade, particularly for imports.

The inefficiencies in the banking system, particularly the rejection or banning of transfers by financial auditing companies, lead many merchants to resort to cash transactions or international banking options. This shift not only reduces trust in local banking institutions but also complicates the efforts of Iraqi regulators and policymakers to monitor and manage financial flows in compliance with international standards.

Broader Economic Implications
The Central Bank of Iraq’s ongoing reforms, which aim to expand electronic financial transactions and offer new incentives for 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 core issues, the disparity between U.S.-connected banks and local banks may deepen, potentially leading to a bifurcated banking system where only a few institutions dominate the market, leaving others to struggle.

This evolving situation poses challenges for Iraq’s broader economic stability. A well-functioning banking sector is crucial for fostering investment, supporting businesses, and managing public trust 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 critical.

Conclusion
The current trend of deposit consolidation in banks connected to U.S. financial institutions reflects deeper systemic issues within Iraq’s banking sector, including corruption, inefficiencies, and the inability of local banks to inspire confidence among depositors. While these U.S.-connected banks may offer more stability, their growing dominance risks sidelining local institutions and limiting access to essential financial services for many Iraqis. The government and the Central Bank of Iraq must prioritize reforms that not only modernize the financial system but also restore trust in local banks. Addressing these challenges is crucial for ensuring long-term economic growth, stability, and prosperity for Iraqi citizens.

Economic Unit/North America Office
Al Rawabet Center for Research and Strategic Studies