BABIL PRT: BABIL'S BANKS STRUGGLE TO FOSTER PRIVATE SECTOR

UNCLAS SECTION 01 OF 04 HILLAH 000045

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON PGOV EINV IZ
SUBJECT: BABIL PRT: BABIL'S BANKS STRUGGLE TO FOSTER PRIVATE SECTOR
DEVELOPMENT

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1. (SBU) SUMMARY: Babil's political, academic, and business
leaders have repeatedly identified access to capital and the
functionality of the banking sector as the top impediment to
greater private sector development in the province. While the
number of private sector banks in Babil has increased and the
ease of financial transactions has improved over the last few
years, most banks struggle to fill the primary role of financial
intermediaries: to attract deposits and lend funds to
"credit-worthy" enterprises. Many Babil residents polled by the
PRT avoid putting their savings into local banks because of poor
customer service, fears of publicizing their wealth, the
proliferation of counterfeit money, and religious
considerations. Despite the widespread utilization of
guarantees by the USAID-funded Iraqi Company for Bank
Guarantees, private banks' archaic collateral requirements
prohibit greater lending. State-run banks offer less hope.
Those that provide loans are rife with corruption, while others
solely serve the role of a government cashier. The PRT has
launched a new program to develop linkages between banks and
business incubators, such as the Small Business Development
Centers in north and south Babil. Still, national level
constraints such as land titling and the classification of
microfinance institutions as non-governmental organizations
limit greater lending to Babil's credit-thirsty private sector.
END SUMMARY.



FEEBLE LENDING

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2. (SBU) State-run banks in Babil serve less as banks in the
traditional sense than Sovietesque organs of the state that pay
out government salaries and subsidize niche sectors. Iraq's two
largest banks, Rafidain and Rashid, maintain branches throughout
the province. They offer few loans other than to state-owned
enterprises, but rather serve as cashiers for the state by
paying government salaries and receiving payments to government
entities, such as permits and fines. Rafidain and Rashid,
because they are involved only minimally lending, do not have
widespread reputations for corruption, although Babil customers
tell us that some baksheesh can facilitate what otherwise would
be protracted routine transactions. The other state-run banks
operating in the province are widely believed to be rife with
corruption. These include the Mortgage Bank, Industry Bank, and
the Agriculture Bank. A group of Najaf farmers recently
described to the PRT the manifold layers of "hidden official
fees" within the Agriculture Bank. Customers must pay off
numerous officials at all stages of the lending process; these
fees can add up to as much as 20 percent of the value of the
nominally zero-percent loan. The Mortgage Bank has a widespread
reputation of being the most corrupt bank in the province,
providing loans only to those with personal connections to its
employees.




3. (SBU) The number of private banks operating in the province
has jumped from two in 2003 to nine today, not including
microcredit organizations such as Izdaharona and CHF
International. Consistent with a 2007 USAID/Izdahar analysis of
the national banking sector, Babil's private banks appear to
maintain very low loan/deposit ratios. The director of the Bank
of Baghdad, which comes closest to resembling a modern bank,
told us that loans account for about 80 percent of business.
This appears, however, to be the outlier. The office manager of
Economy Bank said that 95 percent of its business is
facilitating government-funded projects, mainly in the
construction sector. (Note: This may be explained by the fact
that state-run Rafidain Bank is a 60 percent stakeholder in
Economy. End Note.) The head of the Beirut-based Iraq Middle
East Investment Bank touted the 4.5 billion Iraqi dinar (3.8
million USD) of lending it had provided since opening its Hillah
branch in the last four months, but conceded that lending only
accounted for about 20 percent of its business. Like other
private sector banks, the director said its core operations were
foreign exchange transactions; wire transfers; and current
(checking) and savings accounts.




4. (SBU) Microcredit organizations such as CHF International and
Izdaharona provide some microcredit lending to small
enterprises. From our outreach to the business community and
Babil, it appears CHF's loan programs are better known than
those of Izdaharona and that "word of mouth" marketing is
responsible for public awareness of the institutions' lending
programs. As of early 2009, CHF's portfolio in Babil was valued

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at USD 3.5 million, made up of around 2000 active clients.
Terms range from one to two years with an effective interest
rate of 25 percent. Loans are generally guaranteed by one or
two government employees and sometimes by collateral. Repayment
rates are 99 percent. The local head of CHF's implementing
partner told us CHF has used both the public Rafidain Bank and
the private Al-Warka to process its loans, but has been
generally unsatisfied with the Rafidain's untimely processing of
statements.



ARCHAIC COLLATERAL REQUIREMENTS

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5. (SBU) Despite the widespread utilization of guarantees by the
USAID-funded Iraqi Company for Bank Guarantees (ICBG),which
numerous banks throughout the province touted, archaic
collateral requirements inhibit more robust lending. Babil's
business community complains that few potential borrowers have
the necessary real estate collateral to secure a loan. The
government still owns 80 percent of the province's agricultural
land, and much of the province's commercial real estate stock
consists of long-term building leases to businesses on land
owned by the government; such leases cannot be used as
collateral for loans. Although ICBG guarantees 75 percent of
the value of all its loans, Bank of Baghdad also secures "most"
of its loans with gold. To demonstrate, Bank of Baghdad's
manager showed us a burlap sack of gold jewelry recently given
to the bank to secure a loan (for approximately 75 percent of
the value of the gold, measured by weight). Al-Warka Bank
secures all of its loans by taking possession of deeded real
estate. Iraq Middle East Investment Bank uses ICBG to secure
small loans, for which there must be two federal government
employee cosigners; for large loans, the bank requires real
estate as collateral. The cosignatory requirement is intended
as a means of recouping funds -- by docking the salary of the
government employee -- should the loan not be repaid. In
practice, however, numerous private bankers told us, this is
almost never done.



FINANCIAL SERVICES EVOLVE...

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6. (SBU) Private sector banks offer an array of financial
services and are showing increased technological sophistication.
Wire transfers, and letters of credit are widely available and
the ease of conducting these transactions has greatly improved
over the last few years. Private banks in Hillah offer foreign
exchange transactions, pending the availability of funds.
During a recent visit to the Economy Bank, however, the bank
manager told us that the bank had not had any US dollars in two
months, which he claimed was due to security along the route
from Hillah to Baghdad. Some private banks, including Bank of
Baghdad and al-Warka Bank, have ATMs, although there are no
secure networks that might allow an ATM card at one bank to be
used at a rival institution. Bank of Baghdad recently launched
a prepaid Visa card service that acts like a gift card. While
there are no outlets in Hillah that accept Visa, Bank of Baghdad
told us they launched the product to tap into Iraqi demand for
e-commerce. Despite this range of technological innovations,
however, many of these products are underutilized because of the
requirement that customers be deposit holders. A customer
hoping to send a wire transfer, therefore, must already hold a
current account at the bank.



... BUT CUSTOMER CONFIDENCE LAGS

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7. (SBU) Despite technological advances, customer confidence in
the banking sector has lagged. Nowhere do Babil's financial
institutions showcase their statist legacy more than in the
level of their customer service. While Bank of Baghdad has
automated customer tracking systems, other institutions rely on
paper-based transactions. Automated interbank systems are
beginning to come on line, but in the meantime checks can take
weeks to clear. Recently, Bank of Baghdad, after opening a few
hours late because of a power shortage, finally allowed the

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cluster of customers waiting outside the door in the mid-morning
heat to enter the bank only after they had queued up
alphabetically by last name. Banks also face a great deal of
micromanagement from their headquarters, which causes delays in
loan processing. Economy Bank only rarely has the discretion to
award loans (requiring Baghdad's approval first),whereas
al-Warka Bank said all decisions must come from its chairman in
Amman. When banking proves to be such a hassle, it is little
surprise many choose to keep their money in their mattress or in
gold. Given the routine delays in accessing funds when the
security situation is relatively good, many Babil residents have
also voiced fear that their deposits might be inaccessible
should violence spike, whether due to bank looting or a bank
run.




8. (SBU) Additionally, fears of publicizing one's wealth, the
proliferation of counterfeit cash, and religious concerns about
usury undercut demand for use of banking services. Babil
businessmen have told us that they fear depositing large sums of
money in any bank lest their wealth be known, even by bank
employees. By some estimates, as much as 20 percent of the cash
in circulation in Babil is counterfeit. Customers fear bring
their money to the bank, where counterfeit will be immediately
seized and destroyed with no compensation to the customer; there
is instead a better chance of being able to pass along fake
currency, even if unwittingly acquired, in the marketplace.
Finally, with only one Islamic finance institution operating in
the province (the newly established Elaf Bank),the more
religious elements in Babil tend to eschew financial
institutions altogether.



PRT BABIL'S SME-BANK LINKAGE PROGRAM

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9. (SBU) Babil PRT's first business environment conference in
February (reftel) revealed the mutual frustration felt by
capital-laden banks and the Babil business community. During
the conference, four independent working groups representing a
cross section of the Babil political, academic, and business
elite identified access to capital as the top constraint to
greater private sector development in the province. In
response, Babil PRT's economic development strategy reflects the
imperative that we move out of the business of doling out grants
and focus our efforts on building sustainable financial
institutions. We recently launched an initiative to facilitate
greater linkages between financial institutions and potential
borrowers through Babil's Small Business Development Centers.
The goal of the linkage program is to better inform the business
community, in particular SMEs, on each private bank's criteria
for approving a business loan. Since the terms and conditions,
interest rates, and collateral requirements differ from one bank
to another, an SME ought to be matched with the most appropriate
loan portfolio as communicated through its local business
association. In order for this model to be successful, the
business associations operating in Hillah need improved
relations with the banks so they remain up-to-date on the loan
programs offered. This model builds bank-SME trust and
intercommunication, increases the rate of SME loan approvals by
training prospective SME borrowers on "bankability," and builds
business sustainability with less reliance on business grants
from foreign donors.



COMMENT: NATIONAL LEVEL CONSTRAINTS ENDURE

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10. (SBU) Policy constraints at the national level undercut the
best of efforts to bring together local financial institutions
and potential borrowers at the provincial level. The fact that
real estate collateral is almost never seized and government
salaries of loan cosigners never docked for nonperforming loans
underscores the extreme institutional risk aversion to lending
to anyone but those already deemed "rich"; doing so denies
credit to scores of other potentially responsible borrowers.
Development of a universally recognized credit rating and
information system would obviate the need for archaic gold-based
collateral requirements, civil servant cosignatories, and
stringent real estate capital requirements. It would also
encourage lending based on technical loan criteria rather than
personal connections. Policy reforms that address Iraq's

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antiquated zoning and land titling system would expand the pool
of potential borrowers. The lack of deposit insurance makes
banks further risk averse about lending out customers' deposits.
Finally, the current classification of microfinance
organizations such as CHF and Izdaharona as non-governmental
organizations, subjects them to overly burdensome oversight by
the Prime Minister's office rather than an Iraqi entity well
versed in financial regulation.
HEATH