A Closer Look at the Iraqi Banking Sector
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    A Closer Look at the Iraqi Banking Sector




    May/June 2013

    A Closer Look at the Iraqi Banking Sector

    SINGAPORE 048581
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    To request additional information, please contact: clientservice@sansarcapital.com

    Sansar Capital Management, LLC, 2013, SOURCE LINK

    Executive Summary

    The Iraqi banking sector is poised for significant earnings and asset growth over the next decade driven by a strong macro environment, increasing credit penetration and an improving security situation.

    The IMF forecasts Iraqi GDP to grow at a rate of 9.0% in 2013 on the back of 8.4% growth in 2012 placing Iraq solidly in the category of one of the fastest growing economies in the world.1

    KEEP IN MIND, the IMF determines a country's exchange rate by the country's GDP ~ RED LILY ~

    The IEA in its World Energy Outlook report stated that Iraq is expected to contribute 45% of the global incremental oil supply over this decade.2 As a result, the IEA central scenario forecast predicts Iraq GDP to grow 151% between 2011 to 2020.2

    WOW!! 45% is almost HALF!! Can you imagine the money?? Hang in there.. I don't care how long it takes. (Even though I need it now) ~ RED LILY ~

    Rising credit penetration is likely to further fuel banking sector growth. According to the World Bank, Iraqi domestic credit to GDP stood at a mere 9 percent of GDP at the end of 2011 as compared to a 55 percent of GDP average for the Middle East North Africa (MENA) region.3 Domestic credit to GDP grew at a clip of 89 percent CAGR between 2009-2011. 3

    Buoyed by strong economic growth and rising credit penetration, the 5 largest private Iraqi banks grew aggregate net income by 207% between 2010-2012. Dilution driven by increases in equity capital resulted in earnings-per-share growth to be lower but still impressive with aggregate EPS growth of 111% from 2010-2012.4

    The growth in GDP and banking sector earnings go hand-in-hand with the improving security situation.

    As violence declined by over 80% between 2006-2012, Iraqis in many parts of the country enjoyed relative calm and stability.5 In 2012, large U.S. cities like Chicago and New Orleans had higher violence related deaths per capita when compared to Iraq.6 That is not to say all areas in Iraq are safe. Violence in Iraq remains highly localized with 91% of the violence related deaths occurring in 7 of the 18 provinces and 2/3 of the violence being inflicted on 1/3 of the population.5 The remaining 11 provinces, including the southern oil-rich provinces, have had relative security and stability.

    While the mix of an improving macro environment and security situation offer attractive investment ingredients, many challenges remain for those interested in participating through public markets.

    Iraq continues to be ranked as one of the most difficult places to conduct business and is often ranked high on corruption indices. 7

    IMO, this has to change and may take years. They know no other way but to fight each other. Let's pray things will finally click in their heads as it relates to what Democracy truly means.

    Corporate governance at most publicly traded companies is poor and regulatory oversight weak;

    PUBLICLY TRADED COMPANIES is their ISX IMO.. We want to see this take off!!!

    anecdotal examples of management teams serving their own self-interest at the expense of other stakeholders remain abundant. In such an environment, investors are cautioned to carry out extensive due-diligence including having on the ground presence in Iraq.

    Methodology In this paper we examine the Iraqi private bank sector through the lens of the five largest private banks by deposits.

    These banks in order are North Bank (BNOR), Bank of Baghdad (BBOB), Iraqi Middle East Investment Bank (BIME), Kurdistan International Bank (BKUI) and Dar Es Salaam Investment Bank (BDSI).

    We note that Kurdistan International Bank is an Islamic bank and as such we have excluded it from most charts as we do not believe the numbers for Kurdistan International Bank are comparable on an apples-to-apples basis with the other four banks.

    We also note that we have used the latest available data wherever possible. Hence while some charts and tables will have data from 2012 others will go back to 2010. This inconsistency in dates was inevitable given a lack of more updated data in many cases.

    We also note that Investment Funds advised by Sansar Capital may hold positions in banks or their competitors discussed herein. Readers should therefore beware of potential conflicts and also refer to the Important Disclaimers section of this paper.


    This report would not have been possible without the input and support of many of our friends and colleagues. In particular we want to thank Wassim Al Jzrawy at Karmal Brokerage who was tremendously helpful in providing keen insights into individual Iraqi companies and facilitating access to information that has been used throughout this report. Taimur Baig at Deutsche Bank provided us with valuable input on macro-economic drivers and their impact on the overall economy. Finally, Timothy Moe at Goldman Sachs provided critical eyes to our analysis and assumptions.

    This report is prepared and published by Sansar Capital Asia Pte. Ltd. and Sansar Capital Management, LLC (together, “Sansar Capital”), an investment adviser advising clients with diversified global holdings, for informational and educational purposes only and is not intended to be relied upon as a forecast or as investment advice. Nothing contained herein constitutes a solicitation, recommendation, endorsement, or offer by Sansar Capital to buy, sell or hold any securities or other financial instruments or to pursue any investment style or strategy. All investments involve risks which are not discussed here.

    The opinions expressed herein are as of the date of the publication and may change as subsequent conditions vary. Therefore, Sansar Capital makes no representations that any information provided herein is accurate, current, or complete. Please refer to the important information disclosures and qualifications at the end of this material.

    Iraq: A Quick Glance

    SEE CHARTS PG 5: https://www.iraq-businessnews.com/wp-content/uploads/2013/05/Sansar-Capital-Iraq-Bank-Sector-Report-May-June-2013.pdf

    Accelerating GDP Growth: The IMF forecasts Iraq’s GDP to grow by 9% in 2013 on the back of 8.4% growth in 2012. The forecast for the medium-term anticipates Iraqi GDP to grow at a CAGR of 8.3% through 2018 placing Iraq solidly in the category of one of the fastest growing economies in the world.1

    Higher Oil Production: Underlying the economic growth forecast is a large increase in oil production. The IEA forecasts Iraq to provide 45% of the global incremental oil supply in this decade. In its central case, the IEA estimates that by the 2030s, Iraq will be the second-largest oil exporter in the world.2

    Improving Security: Violence in Iraq has significantly declined over the last several years. In 2012, large US cities like New Orleans and Chicago had higher violence related deaths per capita when compared to Iraq. Violence in Iraq remains highly localized however with 91% of deaths occurring in 7 out of the 18 provinces.5, 6

    Corruption: Despite all the improvements in security and GDP, Iraq struggles with a high level of systemic corruption and is often ranked as one of the most corrupt countries in the world.7

    Overview of the Banking Sector

    Iraq remains one of the most under-banked countries in the Middle East North Africa (MENA) region and by some estimates over 80% of Iraqis do not have a bank account.8

    Credit to GDP remains one of the lowest in the region and the world with domestic-credit to private sector at 9 percent of GDP as compared to a 55 percent of GDP average for the MENA region.9

    As relative stability and calm have returned to Iraq, the commercial banks have seen a significant growth in their businesses. According to Central Bank of Iraq data, cash credit, such as loans and overdraft facilities, have grown at an impressive CAGR of 50% from 2006-2011.

    CHART ON PG 6: https://www.iraq-businessnews.com/wp-content/uploads/2013/05/Sansar-Capital-Iraq-Bank-Sector-Report-May-June-2013.pdf

    Sources: World Bank 9, Central Bank of Iraq 10, Despite the impressive growth, Iraqi private banks will have to overcome some important challenges if they are to continue their growth at the impressive pace witnessed over the last five years. We believe some of those factors include: accessibility, an uneven playing field and trust.

    I. Accessibility – Access to bank branches or ATM machines remains highly limited to the general Iraqi population.

    There are approximately 900 bank branches covering a population of 33 million Iraqis equating to just one branch serving 36 thousand individuals.10 ATM machines are also highly limited with World Bank data indicating that there is only one ATM machine for every 100,000 inhabitants.9

    The MENA region has on average 32-times more ATM machines per inhabitant.10 The true comparison is even starker when one takes into account that most ATM machines are not connected to the national switch and as such customers of one bank cannot access their funds from ATM machines of another bank.8

    There are two important developments on the horizon that we believe could significantly improve access.

    The first is the implementation of the National Switch and the second is the establishment of the Iraq Interoperable Mobile Payment System (IIMPS) - both with the help of the USAID’s Iraq Financial Development Project.

    NOTE: Research 'National Switch' & 'Iraq Interoperable Mobile Payment System

    Last edited by RED LILY; 06-15-2013 at 03:35 AM.

  2. #2

    The State-owned Banks

    There are seven state-owned banks in Iraq which together account for 91% and 89% of the banking sector assets and deposits, respectively.12

    Of the seven state-owned banks, three banks account for the vast majority of all assets and deposits. Two of those banks, Rafidain Bank and Rasheed Bank, are a legacy of the old regime and sit on very large sums of losses. The third bank is the Trade Bank of Iraq (TBI) which was established to deal with trade related credit activities.

    Both Rafidain and Rasheed bank are currently undergoing restructuring by the Iraqi government with the help of The World Bank.


    The two banks sit on large sums of valuation losses on borrowing and lending activities that were structured under the previous regime when 1 USD was equivalent to 0.33 IQD as compared to the current official rate of 1 USD to 1,179 IQD. To put this in context, the World Bank estimated that in 2010, Rafidain Bank had 257 trillion IQD of valuation related losses on an asset base of 302 trillion IQD.13

    NOTE: 1 USD WAS EQUIVALENT TO 0.33 DINAR ($3.03 to the DOLLAR!! I will take it!! )

    The Iraqi government has been slow to recognize these losses.

    We, however, have seen some progress as total assets for the two state-owned banks declined by 68% from 2010 to 2011. 12


    We believe there may still be room for a further write-down of those assets. In 2010, the World Bank estimated the fair market-value of the assets for the two banks at 39.4 trillion IQD as compared to the 103.9 trillion IQD reported in 2011.13 It is worth noting that even after the write-down, the state-banks still have significantly more assets than the private sector banks.

    CHART PG 7: https://www.iraq-businessnews.com/wp-content/uploads/2013/05/Sansar-Capital-Iraq-Bank-Sector-Report-May-June-2013.pdf

    The state-owned banks play a less dominant role when it comes to private-sector lending. In 2011, the state-owned banks had a 67% share of cash-credit to the private-sector. Their share of cash-credit to government remained 100% as state-owned enterprises and government institutions can only borrow from state-owned banks.

    CHART PG 7: https://www.iraq-businessnews.com/wp-...-June-2013.pdf

    SEE SPREADSHEET PG 8: https://www.iraq-businessnews.com/wp-content/uploads/2013/05/Sansar-Capital-Iraq-Bank-Sector-Report-May-June-2013.pdf

    Even before recognizing valuation related losses, Rafidain and Rasheed are significantly undercapitalized. As a result, the Iraqi authorities laid out a plan to recapitalize Rafidain banks with 400 billion IQD and Rasheed bank with 300 billion IQD.12 The plans for this recapitalization have been in place for several years now and the Ministry of Finance has been slow to implement this.


    We believe, even after this round of capital injection, the two banks will remain undercapitalized with a limited ability to compete, on a relative basis with private banks, in extending credit.(a)

    Turning our attention to deposits, the state-owned banks control 89% of total deposits and 63% of private sector deposits. We believe much of this can be attributed to the uneven playing field between state and private sector banks. The state-owned banks enjoy implicit government guarantee on deposits and state-owned enterprises are required to maintain their deposits with state-owned banks.

    CHART PG 8: https://www.iraq-businessnews.com/wp-content/uploads/2013/05/Sansar-Capital-Iraq-Bank-Sector-Report-May-June-2013.pdf

    The other state-owned bank of significance is the Trade bank of Iraq (TBI). The bank was established in 2004 to carry out trade financing activities as Rasheed and Rafidain banks were prohibited from participating in those activities. The operations of TBI are generally viewed as opaque and there is a general lack of information about the bank.

    For the remainder of this paper we will focus our attention on private Iraqi banks as the state-owned banks are not publicly traded and do not offer investors a way to participate in the macro growth story. Furthermore, given the limited lending capacity of the state-owned banks, we believe that, going forward, the private-sector banks will play an increasingly bigger role.

    (a) With total 700b of equity capital the two banks could extend maximum credit of 5.6t IQD (700b x 8). In 2011 total credit for the two banks was 11.6t IQD or double the lending capacity available to the banks after the capital injection

    Last edited by RED LILY; 06-15-2013 at 03:34 AM.

  3. #3

    How Iraqi Banks Make Money

    Iraqi banks generate the majority of their revenue and profits, from one of the following sources:

    a. Trade-related activities
    b. Traditional lending activities
    c. Treasury and CBI deposits

    Up until the year 2008, many banks earned the majority of their revenue from deposits with the central bank or through treasury holdings. Interest rates that hovered over 16% provided little incentive for banks to lend or carry out any of the traditional banking activities seen in other countries.

    As inflation was brought under control in 2009, interest rates began declining and at the end of 2012, the CBI prime rate stood at 6%.14

    At the same time that rates declined, Iraqi banks were also required by the Central Bank of Iraq to raise equity capital (more on this later in the report). With low rates and large amounts of excess capital, banks looked at other venues for generating revenue including more lending activities.

    For the year 2011, commissions driven by trade-related activities (wire transfers, letters of credit, FX spreads) accounted for a range of 28% to 83% of net revenues for the four largest ‘traditional’ banks. North Bank (BNOR) had the highest percentage contribution from these activities at 83% of net revenues while Dar-Es-Salaam Investment Bank (BDSI) had the lowest contribution at 28% of net revenues.

    Traditional lending activities such as net interest income on loans became the second largest contributor of revenue with the four largest banks by deposits generating 13% to 49% of net revenues from these activities. A mirror image of the above, Dar Es Salaam Investment Bank (BDSI) had the highest contribution from net interest income at 49% of revenues while North Bank (BNOR) had the lowest with 13% of revenue.

    CHART PG 10: https://www.iraq-businessnews.com/wp-...-June-2013.pdf

    It is worth noting that contribution from net interest income is likely understated for most banks as loans/deposit ratios tend to be low; while not all deposits are used for loan purposes, all the interest expense is netted out against interest income. In the case of Dar Es Salaam Investment Bank, the source for net interest income is treasury holdings rather than interest from traditional lending activities such as loans. 15

    a. Trade-related activities


    General business trading activities of importing and exporting goods generate revenue for Iraqi banks through a number of sources. These can be primarily broken down into two major buckets:

    Commissions Income: Banks charge a commission to customers who are interested in making payments for goods they have imported. The payment can be in the form of a wire-transfer to the supplier or it could be in the form of a letter of credit:

    a) Wire-transfer: Banks typically charge a flat fee per wire and/or a percentage based on the amount of wire transferred. At the time of this writing, Bank of Baghdad for example charged a fee of $10.00 or 0.1% of the transfer amount whichever is higher. Iraq Middle East Investment Bank on the other hand charged a $3 fee + 0.1-0.2% of the transfer amount.

    b) Letter of credit: letter of credit (LC) transactions generate commissions and interest income on the amount of “credit” outstanding.

    FX Spread: In addition to charging commissions on the fund transfer, banks make money on the currency spread between the IQD/Dollar rate they receive from the central bank and the rate they charge the customers. Most banks realize these gains through wire-transfer activities, but letter-of-credit activities also generate some of this spread revenue.

    The Iraqi banks purchase the USD from the Central Bank at a fixed rate. This rate is the official exchange rate, currently at IQD 1,166, plus IQD 13 commission charged by the Central Bank for a total purchase price of IQD 1,179. The banks then turn-around and sell the currency at a profit. As we discuss in more detail later, Iraqi Central Bank regulations have vacillated between a market based approach and a regulated approach on the amount of FX spread that banks can earn on the transfers.

    CHART PAGE 11: https://www.iraq-businessnews.com/wp-...-June-2013.pdf

    As the chart above highlights, the spread between the official rate and market rate started to widen in 2011 and reached its peak in April 2012 at 1,263 IQD/USD. Many observers attributed this phenomenon to increased international isolation of Iran and Syria which resulted in increased outflow of U.S dollars from Iraq to neighboring countries. By some estimates from the Supreme Audit Board and later published by the Inspector General, over 80% of the dollar outflows from Iraq were for non-commercial reasons.17

    According to the Central Bank of Iraq, the following banks were the largest participants of daily auctions in 2012 which is used by banks to purchase dollars for the purpose of wire-transfers. The five largest participating banks accounted for 34% of the total volume for the entire year.

    SPREADSHEET PG 12: https://www.iraq-businessnews.com/wp-content/uploads/2013/05/Sansar-Capital-Iraq-Bank-Sector-Report-May-June-2013.pdf

    In order to reign in the exchange rate, the Central Bank of Iraq under the leadership of Dr. Sinan Shabibi passed a number of rulings to curb the weakening of the dinar. Some of these policies were later viewed as misguided and it is believed that they ultimately resulted in the downfall of the Central Bank governor. Below are some polices that were passed at various points of 2012.

    Instruction # 17 June 27, 2012

    In an instruction from the Central Bank of Iraq in June 2012, the Central Bank set a daily limit on volume of dollars banks could purchase at the currency auctions. The daily limit for currency exchange from cash was set at $1.25m/week for each bank. The daily limit on currency used for wire transfers were set as follows:

    • Group 1 (capital of IQD >150b) - $10m daily limit
    • Group 2 (capital of IQD 150b) - $8m daily limit
    • Group 3 (capital of IQD <150b) - $5m daily limit
    • Group 4 (branches of foreign banks) - $3m daily limit

    The above policy was ineffective in strengthening the dinar and resulted in more of the FX business going to smaller banks as large banks reached their daily limits quickly. It also limited the amount of dollars available in the market and caused the dinar to start weakening again. As a result, the Central Bank was forced to come up with new instructions less than two weeks later.

    Instruction # 18 July 10, 2012

    The Central Bank realized that daily caps set on previous instructions were too rigid and thus increased the daily limit for wire-transfers based on the schedule below. These instructions also increased the limit on cash transactions from $1.25m/week to $2.0m/week and set a cap/person of $5k. The CBI also noted that a cap of IQD 1,189 selling price limit set in a previous instruction was to be applied to both cash transactions as well as wire-transfers. This clarification was necessary as certain banks had understood the IQD 1,189 limit to be applicable to just the cash based transactions.

    • Group 1 (capital of IQD >150b) - $15m daily limit
    • Group 2 (capital of IQD 150b) - $12m daily limit
    • Group 3 (capital of IQD <150b) - $8m daily limit
    • Group 4 (branches of foreign banks) - $5m daily limit

    The increased supply of dollars after the July instructions began to show some results as the dinar strengthened from an average of 1,254 IQD/$ to an average of 1,228 IQD/$ between July 2012 to Sep 2012.

    Instruction # 19 October 1, 2012

    Less than three months after its revised instructions, the CBI came back with yet another set of regulations. This time the CBI removed the daily trading volume limits on banks and also removed the selling price cap that was previously set at IQD 1,189. The CBI still maintained the cash exchange cap at $5 thousand per person.

    The Era of Abdul-Basit Al-Turki

    The result of removing the daily caps and progressively increasing the supply of dollars to the market had the intended consequence of strengthening the currency but also the unintended consequence of allowing large sums of money to flow out of the country for non-commercial purposes. 17

    In October 2012, Dr. Sinan Shabibi was removed from his post and replaced with chairman of the Board of Supreme Audit Dr. Abdul Basit Al-Turki. Under the new leadership, the Central Bank of Iraq started to once again tighten the supply of dollars and began investigations into several banks and money exchange companies. The CBI also demanded more scrutiny of the required documents.

    As a result of the above policies, the trailing 3-month average daily volume of dollars purchased in the auction market declined from 268m/day in October 2012 to 190m/day in February 2013, a decline of almost 30%. This also resulted in the dinar once again weakening and it stood at IQD 1,270 as of April 17, 2013.

    Instructions dated March 24, 2013

    On the 24th of March 2013 the CBI passed a new set of instructions that go into effect on April 15, 2013. With the new regulations, banks have a limit of $500k/day of currency per customer when purchasing dollars for purpose of wire-transfer. The banks have no such limits on payments made via letters of credit. Furthermore banks are required to sell the currency to end customers who are importing goods to the country at a rate of 10 dinars above the price at which the Central Bank sells the currency to banks.

    By limiting the amount of dollars available for wire-transfers, the new regulation is intended to move business away from wire-transfers to letters-of-credit. The Central Bank views the latter as less prone to corruption and makes it more difficult to smuggle money out of the country.

    We note that Iraqi banks are already fairly active with letters-of-credit. In 2011, private bank letters of credit and letters of guarantee (pledged credit) accounted for 6.9 trillion Iraqi Dinars in 2011 as compared to loans, advances and overdrafts (cash credit) which were less than half that at 3.3 trillion Iraq Dinars. We also note that the former “pledged” credit is reported off-balance sheet and therefore understates the amount of true leverage at many banks.

    It is important to understand the credit policies of each bank around the type of collateral obtained against both cash as well as pledged credit. In order to evaluate the risk profile of a bank, we conservatively capitalize these off balance sheet assets in our analysis explained later in this paper.

    CHART PAGE 14: https://www.iraq-businessnews.com/wp-content/uploads/2013/05/Sansar-Capital-Iraq-Bank-Sector-Report-May-June-2013.pdf

    b. Traditional lending activities

    Lending remains a small business for many banks in Iraq with cash credit-to-GDP at a mere 9 percent as compared to 55% on average for the MENA region. 9 Put another way, neighboring Jordan with a GDP that is a quarter that of Iraq and a population that is one-fifth of Iraq’s population has domestic credit lending to the private sector at around $21b as compared to $10b for Iraq while its other neighbor, Saudi Arabia, with a similar population size to Iraq, has over $230b outstanding.9

    Source: Central

    Many factors have limited growth of lending activities in Iraq. First, lending criteria tends to be highly stringent with many banks demanding collateral equivalent to over 200% of the loan value. Furthermore, despite the fact that official interest rates and inflation rates have declined significantly, banks continue to require very high interest rates on lending activities, with average medium-term lending rates of 12.0% as of December 2012. 19 As a result, inflation-adjusted real interest rates have gone up since 2008 despite the improving security and political situation. Iraq today has one of the highest spreads between borrowing and lending rates in the MENA region.

    CHART PG 15: https://www.iraq-businessnews.com/wp-...-June-2013.pdf

    c. Treasury and CBI Deposits

    Keeping deposits at the Central Bank and earning the policy rate was one of the primary income sources for many banks until 2008. As the rate of inflation declined, the CBI actively reduced the policy rate from over 16% in 2008 down to 6% in 2011.14 This caused many banks to look at other ways of generating income and hence pushed them towards increasing traditional lending activities. The chart below compares interest income from cash holdings as a percentage of total revenue for Bank of Baghdad and Iraq Middle East Bank. We did not have sufficient data to make the same comparison for Dar Es Salaam and North Bank.

    CHART PG 15: https://www.iraq-businessnews.com/wp-...-June-2013.pdf

    Last edited by RED LILY; 06-15-2013 at 03:58 AM.

  4. #4
    Risk Analysis – CAMEL framework

    A common framework to analyze risk is the widely employed CAMEL framework. Developed by bank examiners in the United States, the system has been adopted internationally to evaluate credit worthiness. The acronym CAMEL stands for Capital, Asset quality, Management, Earnings, and Liquidity. Except for Management, each metric can be analyzed using quantitative methods. After analyzing these attributes, composite ratings are given from 1 to 5, with 1 being strongest and 5 being weakest. Furthermore, each category is then also subdivided by alphabetical letters with “A” being strongest and “C” weakest. Below, we take a closer look at the quantifiable aspects of the rating system.

    Capital adequacy:

    The goal of analyzing capital adequacy is to determine the sufficiency in which equity and other accounts can absorb shocks from losses or deterioration of assets. We look at how much equity a bank has relative to its risk weighted assets as defined by Basel II standards. Banks with high equity as a percentage of assets have lower leverage and are therefore better able to withstand losses from underperforming loans.

    As the below chart depicts, the four largest Iraqi banks by deposits had Capital Adequacy Ratios that were significantly higher than banks in other parts of the world. Given Iraqi banks are in the process of increasing their equity capital from 100b IQD in 2011 to 250b in 2013 the actual current capital adequacy ratios are likely to be multiple times greater than the data in the chart below.

    CHART PG 16: https://www.iraq-businessnews.com/wp-...-June-2013.pdf

    Asset quality

    Asset quality not only affects profitability, but also the ability of banks to maintain capital adequacy. While it is not always easy to get a good view on asset quality from the outside-in, there are a few basic metrics that can help in this process. In general, Iraqi banks have higher non-performing loans as a percentage of total loans, but a lower mix of loans-to-assets. The net result is that overall asset quality tends to be similar to U.S. banks when non-performing-loans are compared to total assets. Amongst the five largest Iraqi private banks, only two give us enough details to carry out a comparison with U.S. banks on NPL metrics.

    CHART PG 17: https://www.iraq-businessnews.com/wp-...-June-2013.pdf


    Growth, quality, and source of earnings are important, as they can dictate the ability of a bank to build up capital, invest, and grow. Our preferred comparison metric here is Return-on-Assets (ROA). Later in the report, we take a closer look at ROA and discuss why we believe both ROA and ROE currently understate the true growth in profits that Iraqi banks are generating. . Despite this, Iraqi banks enjoy very high ROA levels as compared to banks in the United States and the trend is continuing at a healthy pace.

    CHART PG 17: https://www.iraq-businessnews.com/wp-...-June-2013.pdf


    Liquidity assesses the banks’ ability to access capital to meet acute needs. Common ratios include loans/deposit and cash/total liabilities. As the chart below highlights, Iraqi banks are highly liquid and in many respects this results in underutilized balance sheets.

    CHART PG 18: https://www.iraq-businessnews.com/wp-content/uploads/2013/05/Sansar-Capital-Iraq-Bank-Sector-Report-May-June-2013.pdf

    CAMEL rating scores by Central Bank of Iraq for select publicly traded banks on the Iraqi stock exchange

    SPREADSHEET PG 18: https://www.iraq-businessnews.com/wp-...-June-2013.pdf

    Last edited by RED LILY; 06-12-2013 at 12:43 PM.

  5. #5
    Return on Equity – adjusting the reported numbers

    The top 4 Iraqi banks by deposits reported a median Return-on-Equity (ROE) of 18.7% in 2012. We, however, believe the reported numbers understate the true earnings power. The Central Bank of Iraq imposed arbitrary capital rules requiring all banks in Iraq to have a minimum of 250b IQD equity capital by June 2013. For many banks this resulted in book value growing by a factor of over 3x between 2009 – 2013. This massive capital increase caused most Iraqi banks to become significantly overcapitalized during the last few years and to currently sit on large sums of underutilized cash. Thus in order to understand the true earning power of banks, we look at them on an “adjusted ROE” basis.

    CHART PG 19: https://www.iraq-businessnews.com/wp-...-June-2013.pdf

    The process of calculating “adjusted ROE” involves two steps: the first is to adjust the Return-on-Assets to reflect a normalized productive asset utilization rate. The second is to adjust the overall leverage and capital structure of the balance sheet. These two factors can be summarized with the equation below.

    CHART PG 19: https://www.iraq-businessnews.com/wp-...-June-2013.pdf

    Return-on-Asset (ROA): The forced capital issuances and significantly underutilized balance sheets also have an impact on ROA. At the end of 2012, cash represented circa 50%-70% of total assets for the top 4 Iraqi banks. Thus, in order to adjust for this distortion, we must adjust cash holdings to a normalized level.

    The task of figuring out a ‘target cash level’ is not straight-forward. In 2008, for example, the Bank of Baghdad cash asset mix was approximately 37% and in 2012 it grew to 62% of the assets due to the forced issuance of new capital. However, when trying to determine the target cash-mix, it would be wrong to assume that pre-capital raise cash mix is the optimal mix. This is because in 2008 the interest rates on central bank deposits were high and banks could earn high rates of return by just holding cash on balance sheet. Over the past few years, just as banks were forced to raise equity and their cash balances ballooned, the interest rates declined significantly thus the same economic rationale for holding cash no longer applies today as it did in 2008.
    With no clear historical or peer data to rely on, we have assumed a target cash balance of 35%. We note this is likely to be conservative as certain banks like Bank of Baghdad and Iraq Middle East Bank maintained around that level of cash balance in an environment where interest rates on cash deposits were higher and the security situation was much worse – both of which provided a strong incentive to keep high cash balances. After having set the target cash mix, we can determine the incremental income as follows:

    2012 IQD, billions
    Bank of Baghdad
    Middle East Bank
    North Bank
    Dar Es Salaam
    (1) Total Assets
    (2) Cash mix
    (3) Target cash mix
    35% 35% 35% 35%
    (4) “Excess cash” [1 x (2-3)]
    209 257
    (5) Interest income/avg. interest bearing assets (2011)
    (6) Interest rate on cash deposits (estimated)
    4.0% 4.0% 4.0% 4.0%
    (7) Spread
    Incremental income [4 x 7]
    Less taxes (@15%)
    Incremental Net Income from cash

    Source: Sansar Capital, Rabee Securities 24, Company Reports4

    Leverage Adjustment: Another consequence of the capital-issuance rules set by the Central Bank of Iraq has been a decline in overall leverage as bank equity capital grew much faster than the banks’ ability to deploy this capital. Thus in order to adjust for this distortion, we must assume a steady-state capital structure when trying to determine the underlying return-on-equity potential.

  6. #6
    The Central Bank dictates that Iraqi banks must maintain a minimum Tier 1 capital ratio of 12% and that loans/equity should not exceed 8x. 12 As long as the incremental return on those deposits exceeds the incremental costs, profit driven institutions will try increase leverage until they reach the maximum amount allowed by regulators.
    Given the spread between lending and borrowing is high, banks in Iraq will be driven to come as close to the 12% Tier 1 capital ratio as possible. Converting the Tier 1 capital ratio to a simple leverage ratio (assets/equity) is, however, fairly nuanced. For sake of simplicity in this paper we will assume that this translates to a simple 8x leverage ratio (1/0.12). In reality this is likely to be conservative as banks with Tier 1 ratio of 12% would typically have a leverage ratio that is greater than 8x. The impact on net income from this adjustment is shown in the table below. We note that we have not assumed 35% cash on incremental assets as the risk-weight given to cash is 0 and therefore it does not count towards the 8x leverage target.

    SEE SPREADSHEET PG 21: https://www.iraq-businessnews.com/wp-...-June-2013.pdf


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