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Will the CBI Try Dinar QE?

By Mark DeWeaver.

This year the Ministry of Finance (MoF) is set to sell IQD 11 trillion in new debt to the state sector banks, thereby partially filling the hole in the central government budget left by the recent collapse in oil prices. The new issuance should bring total treasury bills outstanding to IQD 18 trillion, a 156% increase over the end of last year and more than double the previous peak level of November, 2010.

T-bill issues of this magnitude could potentially provide a sizable boost to money supply growth. Consider what would happen if the state banks didn’t keep any of the new bills on their balance sheets but instead sold all of them to the CBI (Central Bank of Iraq). The central bank would pay the banks by crediting their reserve accounts, thereby monetizing the increase in government debt by “printing” new money. (Such operations are allowed under Article 26, Section 2 of the CBI Law.)

The resulting IQD 11 trillion increase in base money (commercial bank reserves + cash in circulation) could increase Iraq’s M2 money supply by as much as IQD 15 trillion (assuming the current M2 multiplier of 1.37 times). (M2 includes base money and commercial bank deposits.) That would be a 17% jump, a dramatic acceleration from December’s year-on-year M2 growth of just 3.3% to growth rates last seen in 2013. (See Chart.)

Engineering a monetary stimulus of this magnitude might be a good policy for the government to pursue. With GDP growth at a multi-year low (see my last post) and year-on-year inflation dropping to -0.41% in January, why shouldn’t the CBI attempt its own version of “quantitative easing?”

Yet it is far from clear that the government has any such plan.

This year’s T-bill sales will not be unprecedented. From April, 2009 – April 2010, total T-bills outstanding rose by IQD 7.2 trillion—the same 17% of initial base money that IQD 11 trillion would represent today. And none of those earlier T-bills were sold to the CBI. In fact, the central bank hasn’t had any T-bills on its balance sheet since March, 2006.

If this precedent is repeated, this year’s new issuance will have no impact on the money supply at all.

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Private Banks Investigated for Money Laundering

By Amina al-Dahabi for Al-Monitor. Any opinions expressed are those of the author, and do not necessarily reflect the views of Iraq Business News.

A prominent economic official in the Iraqi government, who preferred to remain anonymous, said in an interview with Al-Monitor that out of the 33 private Iraqi banks operating in the country, 29 were under investigation on charges of corruption and money laundering.

According to an article published Oct. 16 and based on the report issued by Special Inspector General for Iraq Reconstruction Stuart Bowen, money laundering through the Central Bank of Iraq has resulted in the loss of over $100 billion in the past 10 years, most of which was transferred into banks in Dubai and Beirut.

The economic adviser to the prime minister, Mazhar Mohammad Saleh, told Al-Monitor that he considered this phenomenon to be a major loss in the private financial sector, on which the recovery of Iraq’s economy was based. Saleh said the high number of banks under investigation was due to the government’s absence in private financial administration, and to the weakness of cash credit, pushing banks to look for profit-making operations that are often nonfinancial.

He said the audit policy of the Central Bank changed after 2003 from compliance auditing to preventive auditing. This new role is a supervisory task, not a controlling one, as the Central Bank monitors credit and liquidity to ensure their safety in accordance with financial ratios.

Saleh said the lack of credit ratings in banks led to the decrease of trust in the credit-worthiness of private banks. A third party, a specialized international company, usually conducts such operations, which would later be adopted by the Central Bank.

A major shareholder in one of the banks accused of illegal financial operations told Al-Monitor on condition of anonymity that former staff members of banks — who were trained in both Rafidain and Rasheed banks and who were still working in the private banking sector until recently — were laid off from private banks. The new CEOs that took over started meeting the demands of major shareholders leading illegal operations. This is why those currently under investigation are the CEOS of the 29 banks, whose inexperience contributed to the charges.

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Central Bank gets New Governor

By John Lee.

The Secretary General of the Council of Ministers, Ali Mohsin Ismail (pictured), has been appointed Governor o the Central Bank of Iraq (CBI), replacing Dr Abdulbasit Turki [Abdul Basit Turki Saeed].

His position as GSCOM is to be filled by Dr. Hamed khalaf Ahmad.

Mr Ismail said he was leaving his former position with full confidence and trust in his successor.

(Source: Iraqi Govt)

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Has ISIS Killed Its Golden Goose?

By Mark DeWeaver.

While it has long been assumed that ISIS gets most of its money from donors in the Gulf, recently declassified documents suggest otherwise.

Researchers at the RAND Corporation found that donations actually accounted for less than 5% of the group’s funding during the period from 2005 to 2010. (See this article.)

The city of Mosul, rather than Saudi Arabia or Kuwait, turns out to have been, as one researcher put it, “the area that was keeping the group afloat”—through extortion rackets, kidnapping, and robbery.

Following the fall of the city on June 10, it’s hard to see how this can continue to be the case. Out of a population of 1.8 million, the BBC has reported that 500,000 have fled. Presumably the wealthiest residents will not be returning any time soon. It is also unclear how Mosul’s remaining state employees are going to be paid. Obviously it won’t be possible to extort money from businesses without customers or collect ransoms from people who can’t afford to leave town. You can’t get blood from a stone after all.

It’s not even clear that ISIS could have stolen as much US$ 420 million from the Mosul branch of the Central Bank of Iraq (or, in some accounts, from a combination of the CBI and private banks). While this figure has been widely reported in the media, some analysts have dismissed it as wildly exaggerated.

In any case, looting can be only a short-term source of funds. Once the city’s homes and businesses have been stripped of cash and salable assets, this bonanza will come to an end as well.

ISIS apparently had a pretty good thing going in Mosul, where it could help itself to a share of the economy of one of Iraq’s largest cities with all but complete impunity. Once this golden goose has stopped laying, I wonder if they won’t end up concluding that they should have left well enough alone.

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Why Two Exchange Rates?

By Mark DeWeaver.

Since the Central Bank of Iraq (CBI) began changing the rules for its USD auctions in 2012, Iraq has been operating a de facto dual exchange rate system. (There’s a summary of some of the CBI’s recent rule changes on pages 12-14 of this report from Sansar Capital.) For those with access to the CBI auction—mainly banks and (as of March, 2013) importers using letters of credit—the rate has been fixed at IQD 1,166: USD 1.00. For the rest of us, the dinar has ranged from 1,194 to 1,292, with two major episodes of depreciation in mid-2012 and mid-2013 (see chart).

The ostensible purpose for this arrangement is to limit illicit outflows of foreign exchange to Iran and Syria. In practice, it serves mainly as a subsidy to banks, large importers, and anyone in a position to generate phony trade documents. The losers include everyone from foreign investors in Iraqi stocks to the government itself, which gets the CBI rate on its oil-export revenues.

Iraq is unusual in this regard. Dual (or even multiple) exchange rates are usually only found in countries suffering from chronic trade deficits and foreign exchange shortages. Typically the objective is to make foreign exchange available for “essential” imports or to control inflation by lowering import prices. Examples include Hitler’s Germany, China in the 1980’s and early ‘90’s, Burma prior to 2012, and Venezuela today. (See this note from the Asian Development Bank for an excellent introduction to this topic.)

It’s hard to see why Iraq belongs on this list. The country has a trade surplus, inflation is low, and the central bank has ample foreign exchange reserves. Even USD outflows to Iran are presumably no longer a major issue.

One exchange rate should be enough.

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Iraq’s Missing Market

By Mark DeWeaver.

In my last post I argued that Iraqi banks’ high cash/deposit ratios are due to the absence of an interbank market. If that is the case, you might think it would be easy to get the banks to put more of their deposits to work in the “real economy.” Couldn’t somebody (e.g. the central bank) simply set up a system through which they could make short-term loans to one another?

A few years ago I met someone at a conference on Iraqi banking who said he had helped to set up just such a system. According to him, the IT platform he worked on was already in place. The banks just weren’t using it.

If the issue isn’t primarily technical, what is it? I think the root of the problem is the dominant role of the state banks, which together account for about 80% of system-wide deposits.

Without their participation, an interbank market would not work. There would be no guarantee that at the end of a given day the private banks collectively wouldn’t end up with a cash deficit while the state banks had a surplus. In a market with only the private banks, those with extra funds might not have enough cash to meet the demand of those with a shortfall.

So why not get the state banks involved? Unfortunately, that wouldn’t be ideal either. Like state-owned enterprises in general, these banks can always count on a bail-out if they get into trouble. This means that as interbank lenders they could afford to act recklessly, making funds available to anyone willing to pay a high enough interest rate, regardless of counter-party risk. The result would be an increase in the state banks’ non-performing loan ratios and a corresponding hit to the government budget.

The absence of an interbank market thus turns out to be symptomatic of much deeper problems in the structure of the Iraqi financial system. Until these are resolved, the banks are unlikely to begin either lending to one another or lending out a bigger share of their deposits to the non-financial sector.

Posted in Investment, Mark DeWeaver on Investments and FinanceComments (4)

Are Iraqi Banks Too Liquid?

By Mark DeWeaver.

Fund managers visiting Iraq for the first time are often surprised by the large amounts of cash Iraqi banks typically hold. While the Central Bank of Iraq (CBI) requires lenders to hold 15% of their deposits in the form of vault cash and central bank reserves, most hold well over 50%. (See Chart.) “Cash in hand and at bank,” rather than loans, is usually a bank’s single biggest asset.

Bank managers will tell you that they need cash to meet unexpected large withdrawals by depositors. But this is true of banks everywhere. Why should Iraqi lenders be so much more liquid than their counterparts in other countries? Aren’t they being overly cautious?

Their behavior doesn’t seem so strange when you consider the fact that Iraq lacks an interbank market. Ordinarily, banks with a cash shortfall at the end of the day can borrow overnight from those with a surplus. As long as the public’s demand for banknotes is unchanged, withdrawals from bank A end up as deposits at bank B, ensuring that A’s demand for short-term money can usually be easily met.

In Iraq, a bank that ends up with a cash shortfall will be forced to borrow from the CBI, which offers seven-day facilities for this purpose. This is a much less attractive alternative than borrowing from another commercial bank.

Foreign institutions that are perceived to be in trouble may still be able to access funds in the interbank market provided that they are willing to pay a large enough premium over LIBOR. The central bank, however, is both lender and regulator. It is certainly not going to provide liquidity to the highest bidder regardless of the circumstances. (In fact, CBI facilities are available at a fixed rate—two percentage points above the CBI’s policy rate.)

It is thus not surprising that Iraqi banks choose to rely on their own funds. Their high levels of liquidity are not a sign of risk-aversion or incompetence, as is sometimes suggested. In the absence of an interbank market, liquidity risk is the biggest risk they face. They need to be ready not only for ordinary levels of withdrawals but for worst-case scenarios as well.

Posted in Investment, Mark DeWeaver on Investments and FinanceComments (8)

Capital Increase Déjà Vu

By Mark DeWeaver.

A year ago I wrote a post called “Will the Banks Get More Time,” in which I argued that most of the ISX-listed banks weren’t going to make the central bank’s deadline of June 30, 2012 to reach IQD 150 bn in paid-up capital. I posted pretty much the same thing back in May, 2011 (see this post), when the banks were having trouble meeting the June 2011 target of IQD 100 bn.

Today it’s looking like “déjà vu all over again.” This time the deadline is June 30, 2013 and the CBI’s final target of IQD 250 bn is fast approaching.

Rabee Securities’ most recent bank-sector report found that as of May 23 only 5 of the 21 listed banks had either reached the target or would reach it once ongoing capital increase procedures were completed. (The five were BKUI, BMFI, BMNS, BNOR, and BUND.) Two banks—BDFD and HSBC-subsidiary BDSI—have yet to reach even last June’s IQD 150 bn target. In aggregate the banks still need to increase paid-up capital by a further IQD 1.6 trillion from the current total of IQD 3.5 trillion.

The CBI now has the same three options it had last time. It can (1) give the banks more time, (2) force some of them to merge, or (3) shut down those that miss the deadline. I think (2) and (3) are quite unlikely, simply because none of the banks appears to be at risk of failure. Most are already more than adequately capitalized for the amount of lending they do.

Giving the banks more time is clearly the most sensible option. This is also what the CBI did in 2011 and 2012. In both cases the deadline was extended by six months.

Once again I find myself asking “why should this time be different?”

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