Iraq’s largest oil refinery, Baiji
Iraq’s largest oil refinery, Baiji Reuters

The financial situation in Iraq, one of the world's largest reservoirs of crude oil, has become grave.

Iraq's crown jewel -- oil -- is not helping its crumbling economy. The OPEC country has boosted its oil production to 3 million barrels a day, thanks to help from international companies. However, economists say that this will not be enough. Foreign investors remain reluctant to put their money in Iraq because of a burgeoning financial pressure on banks, which continue to operate with low credit and limited lending capacity.

In spite of billions of dollars in international aid aimed at strengthening private sector businesses and restoring civil harmony over the past decade, Iraq continues to face gaping shortfalls in resources, with its banking sector being one of the worst hit because of weak capital reserves. The funds' shortage is a key factor behind the faltering efficiency of the Central Bank of Iraq (CBI), though its governor Dr. Sinan al-Shabibi effectively steered a policy to contain inflation in the economy.

Since the CBI remains overworked and understaffed, it is not able to develop new strategies to encourage foreign companies to set up shop on Iraq's turf. Subsequently, foreign investments in the country are dwindling at best.

The banking community also remains poorly balanced in its role as a lender or a credit provider. According to the CBI website, the country is home to seven state-owned banks, 23 private banks and 11 Islamic private banks, including Abu Dhabi Islamic Bank (ADIB), which just began operating in Baghdad, hoping to develop a better private banking scenario in the nation.

"Our challenges are clear. We aim to increase the private sector banks' share of the Iraqi market from the current level of less than 20 percent and to develop the Islamic banking industry there," Tirad Al-Mahmoud, CEO of ADIB told Reuters in an interview.

At least 85 percent of banking transactions are controlled by two state-owned banks, Rafidain and Rashid, while private banking remains confined to a deposit services and sporadic personal lending. Debt-to-equity ratios -- an indicator of what proportion of loans and equity banks use to finance their assets -- remain low across both public and private banks, as borrowers do not understand the process of applying for loans. This means that banks are using a higher portion of equity to finance their operations. Moreover, banks are awash with poor risk management regimes as they lack a credit bureau.

Last year, the World Bank foresaw that private banks would play a more important role in expanding credit flow with increased lending operations and stronger capital buffers. However, it was state-owned banks that dominated the banking sector in the first quarter of this year.

Meanwhile, Iraq, which is barely on the priority lists of governments' foreign policy programs, ranks ninth on the latest Index of Failed States, unchanged from last year. The country has seen a rise in poverty and a deterioration of economic activity -- key indicators of economic well-being. Furthermore, the push for economic reform remains weak amid an abuse of political power and a government that is not fully formed even two years after elections.

National unemployment remains sky-high at 19 percent, and 23 percent of Iraqi nationals languish below the international bread line. With no strategy for economic rehabilitation or market growth reform, prospects of alleviating poverty and generating more jobs in the troubled nation remain bleak, the Iraq Institute for Strategic Studies reported in a paper.

"The economy is in shambles; save oil there is hardly an economy," the paper summed up.

Economists say that banking reform is necessary if the nation is going to be able to cash in on its oil reserves to lure foreign investments.