Last month, Central Bank of Iraq governor Al-Shibibi told AFP he was hoping foreign banks would play a bigger role in developing Iraq’s financial system. From the banks’ point of view, he said, “the prospects are good, except for security.”
But the foreign institutions that have already entered the Iraqi market through investments in local banks don’t yet seem to be finding all that many good opportunities to grow their lending businesses. In fact, their loan-deposit ratios tend to be even lower than those of their wholly locally owned counterparts.
Consider the 13 ISX-listed banks in the chart, for example, of which the following five (the starred ones) have foreign investors: BMNS (National Bank of Qatar holds 23%), BBOB (Burgan Bank, 50.6%), BCOI (Ahli United Bank, 49%), BNOI (Capital Bank, 59.2%), and BDSI (HSBC, 70.1%). As of the end of last year, the last four of these had the lowest loan/deposit ratios in the sample. Only one of the five had a ratio above 20%, while the subsidiary of global giant HSBC ranked last with a ratio of just 4%. (The ratios are computed by dividing the “monetary credit” by the “current and deposit accounts” balance sheet items given in the companies’ 2009 annual reports.)
And while capital adequacy might be a constraint on lending even for banks with large deposit bases, this doesn’t appear to be the explanation for the poor showing of the foreign-invested banks as they don’t tend to have less capital. In fact, from the chart you could only conclude that capitalization and the L-D ratio are completely unrelated.
So why aren’t the foreign-invested banks lending? Presumably security is not the primary issue for banks that have already entered the market. More likely reasons can be found in the responses of executives polled by the Economist Intelligence Unit last July, 64% of whom said they would not invest in Iraq. In addition to violence and lack of infrastructure, they were deterred by “corruption, the bureaucracy, inadequate contract protection, and credit risks.” (See Joel Wing’s August 30 “Musings on Iraq” post at http://musingsoniraq.blogspot.com for more on the EIU survey.)
If these are the main obstacles to bank lending as well, the real problem is not the security situation but the weakness of the Iraqi state. Until there is some improvement on this front, it would not be surprising if lending remained anemic at private-sector banks in general, whether foreign-invested or wholly locally owned.
William Wakeham, Managing Director at A.A.I.B. Insurance Brokers, a company specialising in Iraq commented; the apparent conservative lending policies of the private sector banks may well be influenced by the perceived problems in the wider environment such as corruption, bureaucracy, contract protection rights, credit risks etc – all important elements to consider, but there are also other forces at play here.
It’s acknowledged that banks can play an important role in recycling savings deposits into productive loans, however the Iraqi private banks are small by international standards and are still in a market that is evolving and is emerging from years of conflict.
At this stage of market maturity it may well be the case that the lending opportunities available to them are now too limited, or that those opportunities that do exist do not meet with the lending criteria that have been drawn up – the potential rewards of advancing funds are simply not worth the risks to which the banks would be exposed to.
It will also be the case that some potential borrowers will be better served by other financial institutions, such as development banks or micro finance schemes and so the banks will avoid them, whilst some other potential borrowers will not stand up to scrutiny – a poor track record of the borrower, unacceptable amount, terms, or use of the requested loan, insufficient collateral used as backing, the high risk of potential for default etc.
A proper balance needs to be struck between playing a positive role in helping to revitalise the private sector, or help meet public borrowing needs, versus productively managing the assets of the bank and safeguarding the interests of its shareholders.
The banks themselves are competing for capital. Investors will assess the respective risks, prospects and potential returns before investing in banks, and banks also will consider their lending opportunities and how these fare against their risk assessment criteria.
Prudent lending policies and (low bad debt provisions or loan write offs) will help deliver the assurance to investors that capital is being well managed and productively applied rather than eroded.
Across the world banks are increasingly under pressure from regulators to bolster capital adequacy and improve capital management and to improve internal risk management standards - and lending policy and practices play a key part of this. Over the last two years we have seen in Europe the Middle East and elsewhere a tightening up of credit availability and a constrained ability to finance lending to commercial customers and to private customers.
The banks are there for the long term. They have branch networks to operate, payment services to deliver, credit management duties etc – banks of all types play a central role in an economy. Fundamentally commercial banks exist to generate adequate returns to shareholders, commensurate with the risks taken. Finally, at the core of any banking system is a need for trust and confidence in the regulation, institutions, management and the policies that they follow. If conservative lending practices help create and maintain these things, then they are to be applauded.