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					Banking Developments in Iraq

Prepared for:

Michael J Hodges
Director, Middle East
Project and Export Finance
HSBC Bank plc, London

Friday 20 February 2004
Topics to be covered

 HSBC’s History in Iraq
 Iraqi economy 1979-2003
 Progression and Profile of Iraqi Indebtedness
 Rescheduling
 Current Financial Institutions in Iraq
 Development Fund for Iraq
 Trade Bank of Iraq
 Iraqi Economy Future Prospects
 Additional Resources
 Foreign Direct Investment
 New Commercial Banking Laws

HSBC’s History in Iraq
 HSBC Bank Middle East Limited (formerly the British Bank of the Middle East) is
  headquartered in Dubai and is the largest non-indigenous bank in the MENA region. It has
  branches in the UAE, Oman, Bahrain, Qatar, Jordan and Lebanon. HSBC Holdings BV
  owns 40% of The Saudi British Bank and c.95% of HSBC Bank Egypt. HSBC also has a
  substantial banking operation in Turkey through its acquisition of Demirbank.
 The British Bank of the Middle East (acquired by HSBC in 1960) commenced life as the
  Imperial Bank of Persia in 1889.
 The Imperial Bank of Persia opened an office in Baghdad (1890) but this was closed four
  years later.
 The Imperial Bank of Persia opened branches in Basrah (1915) and Baghdad (1918) during
  the First World War, mainly to pay British troops.
 1940. Imperial Bank of Persia became the Imperial Bank of Iran.
 1941. Foundation of Rafidain Bank.
 1949. Imperial Bank of Iran became the British Bank of Iran and the Middle East.

HSBC’s History in Iraq (contd.)
 1952. The British Bank of Iran and the Middle East became the British Bank of the Middle
 1958. Hashemite monarchy in Iraq overthrown by regime of General Abdul-Karim Al
 1964. British Bank of the Middle East branches in Iraq nationalised; acquired by the
  Commercial Bank of Iraq.
 1992. HSBC acquires Midland Bank.
 Midland Bank was a major correspondent of the Central Bank of Iraq in the 1970s and
 Midland Bank arranged some £800 million of ECGD-supported finance to Iraq 1984-88.
 HSBC owns 46.5% of British Arab Commercial Bank (formerly UBAF Limited); Rafidain
  Bank is a 4.9% shareholder.
 HSBC remains keen to assist in the reconstruction of Iraq for the benefit of the country and
  its people.

Iraqi Economy 1979-2003
   Salient facts -   Population of 24 million.

                 -    Proven oil reserves of 113 million; second largest in the World after
                      Saudi Arabia; in fact probably double this because of lack of
                      exploration since 1990. Very low extraction costs at less than US$1 per

                 -    OPEC quota of 3.5 million b/d.

                 -    Proven gas reserves of 100 trillion cubic feet (tcf) - potential gas
                      reserves estimates at 325 tcf.

                 -    Agriculture historically the primary economy activity of Iraq but
                      badly neglected. Iraq originally Mesopotamia, located between the
                      Tigris and the Euphrates. “The Fertile Crescent.” 12% of land is
                      cultivable but half the fertile land is barren. Irrigation and fertiliser
Iraqi Economy 1979-2003 (contd.)

 Since 1979 Iraq’s economy has been devastated by pervasive mismanagement, three wars
  and thirteen years of UN sanctions.

 Per capita GDP has fallen from c. US$7000 in 1979 to c. US$500 in 2003.

 Unemployment at c. 60%.

 In 1979 Iraq was one of the most promising countries in the Middle East with foreign
  reserves of c.US$36 billion.

 1979     GDP         -          US$128 billion
 2001      GDP         -          US$ 40 billion
 2003      GDP         -          US$ 12 billion

Progress on and Profile of Iraqi Indebtedness

 Decision was taken to continue with the Five Year Economic Plan of 1981-85 in spite of the
  ongoing war with Iran.

 Iraq started the war with reserves of US$ 36 billion and no debts.

 April 1982 - Syria closed oil pipeline.

 1982-3. Iraq unable to make contractual payments
 – 85%-90% contractual dues deferred for 2 years and repayable in 4 semi-annual
 – First deferred payment agreement was an ECGD- guaranteed US$120 million transaction
   for a contract between John Laing International and the State Organisation for Roads and
   Bridges for the Army Canal Interchange project.

 New directives released making availability of external financing a necessary condition for
  the awarding of new non-military project contracts.

Progress on and Profile of Iraqi Indebtedness (contd.)

 1983-88. Many export credits signed.

 Morgan Grenfell and Midland Bank had successively the mandate for arranging ECGD

Progress on and Profile of Iraqi Indebtedness (contd.)

 Two “jumbo”general purpose commercial loans signed with Rafidain Bank.
 March 1983             -           US$500 million          -            UBAF led
 October 1985           -           US$500 million          -            GIB led

 1986 the disaster year - collapse in oil prices to c. US$6 and sharp decline in the value of the
  US Dollar
 1990 Financial collapse leading to the invasion of Kuwait.
 No debts subsequently honoured.
 Signed business contracts total US$57 billion (in which some US$52 billion are Russian)
 Iraqi secondary debt trades at 25-30%.

Progress on and Profile of Iraqi Indebtedness (contd.)

 Contracted debt of (?) US$113 billion breaks down as follows:-
 Paris Club                       -          US$41.5 billion (of which c. US$ 21 billion is principal)
 Gulf States                      -          US$45.5 billion
 Central European Official
 Bilateral                        -          US$5.0 billion
 Other Official Bilateral         -          US$9.0 billion
 Commercial Creditors             -          US$11.5 billion
 Other                            -          US$0.5 billion
                                             US$113 billion

Progress on and Profile of Iraqi Indebtedness (contd.)

 Breakdown of Paris Club debts (principal)
           Japan      -           US$4.2 billion
           Russia     -           US$3.5 billion
           France     -           US$3.0 billion
           Germany -              US$2.4 billion
           USA        -           US$2.2 billion
           Italy      -           US$1.7 billion
           UK         -           US$0.9 billion
           Austria    -           US$0.8 billion
           Canada     -           US$0.6 billion
           Others     -           US$1.7 billion
                                  US$21 billion

Progress on and Profile of Iraqi Indebtedness (contd.)

 Biggest non GCC creditors believed to be:-
           Russia    -            US$9 billion
           Japan     -            US$7 billion

 Korean debt may be undervalued. October 2003 Hyundai organising a coalition of firms
  owed money for work in Iraq to seek repayment of debts that may exceed US$10 billion.

 Biggest GCC creditors are believed to be Saudi Arabia (US$25 billion?) and Kuwait
  (US$12.5 billion?). Documentation probably weak. Iraq would probably regard these as
  grants rather than loans but NB Saddam request for cancellation.

 Liabilities also include UN compensation claims and signed business contracts.

Progress on and Profile of Iraqi Indebtedness (contd.)

 Compensation a fairly murky subject. The United Nations Compensation Commission
  received claims of US$320 billion relating to the invasion of Kuwait. C. US$45 billion
  awarded of which some US$27 billion unpaid. More to be evaluated but it is assumed
  most will be unsuccessful.

 Signed business contracts total US$57 billion (in which some US$52 billion are

 Iraqi secondary debt trades at 25-30%.


 Iraq’s theoretical obligations of US$ 300-400 billion are certainly unsustainable. (4
  million b/d of oil @ US$20 = US$29,200,000 p.a.).

 Various interim measures:-

      -   Debt moratorium until December 2004
      -   Compensation reduced from 25% to 5% of Iraq’s oil revenues.
      -   UN Resolution 1483 of May 2003 “until December 31 2007 petroleum products
          and natural gas originating in Iraq should be immune from legal proceedings
          against them, and not subject to any form of attachment, garnishment and that
          proceeds arising from the sales thereof shall enjoy privileges and immunities
          equivalent to those enjoyed by the United Nations.”

 Iraq can sustain debt of possibly US$50 billion.

Rescheduling (contd.)

 Meeting of Group Finance Ministers in Deauville on 17 May 2003 rejected idea of
  completely writing off Iraq’s debts.

 Under the so-called Naples terms of the Paris Club (export credit debts) countries with
  high indebtedness and per capita GDP of less than US$755 can have 50-70% of debts
  cancelled and the rest rescheduled over 15 years with a 7 or 8 year grace period. These
  would seem appropriate terms for Iraq.

 Possible timescale- IMF Agreement                        Q1         04
                      Paris Club Agreement                 Q3         04
                      London Club Agreement                Q1         05

 “Baker Initiative” - various countries have stated they will look favourably on generous
  write-off and rescheduling
 UN compensation awards unlikely to increase to more than a total of US$32 billion
 Business contracts likely to be bought out at US$5billion?

Current Financial Institutions in Iraq

 Ministry of Finance functioning.
 Minister of Finance - Kamel Al Ghaildani

 Central Bank of Iraq founded as National Bank of Iraq in 1949.
 Governor is Dr. Sinan Mohammad Rida Al Shabibi; born 1941; degrees from
 Manchester and Bristol Universities; has been working at UNCTAD for most of the
 recent past. The Central Bank is currently concentrating on the introduction of the new
 Iraqi Dinar (October 15th) and the payment of salaries and pensions. Its “mission
 statement” covers:-
 -    international banking
 -    supervision and regulation of domestic system
 -    control of foreign exchange

Current Financial Institutions in Iraq (contd.)

 -   partner of the Ministry of Finance (NB in the past the Central Bank was totally controlled
     by the Ministry of Finance)
 -   working with the financial sector to enhance economic growth and development of the
     private sector
 -   reforming the domestic banking sector through, inter-alia, the introduction of foreign

 Two state-owned banks -
 (a) - Rafidain Bank is the most important
     - Founded 1941
     - Absorbed other Iraqi commercial banks in 1974
     - 225 branches in Iraq
     - Chairman and General Manager. Dhia Al-Khaydoun.Senior Adviser - Haidar Al-Uzri
 (b) Rasheed Bank - founded out of Rafidain Bank in 1989.

Current Financial Institutions in Iraq (contd.)

 Both banks in a mess because of looting, bad loans to SOEs, bureaucratic systems and
  lack of trained staff / exposure to modern banking practices
 1990. 17 private banks allowed to be set up.
 -    Largest is Bank of Baghdad with 17/18 branches
 -    Other substantial banks include  -     Babylon Bank
                                             Basrah Investment Bank
                                             Sumer Commercial Bank
                                             Dar Al Salarm Investment Bank
                                             United Bank
                                             Middle East Bank
                                             Commercial Bank
 -    Private banks currently poorly capitalised and have until Q2 2005 to raise their
      capital to NID10 billion (US$5-8million)
 -    Private banks had market share of 6.6%.

Development Fund for Iraq (“DFI”)

 The DFI will increasingly be the main funding body for Iraq:-
 -    seized foreign Iraqi assets - US$1.7 billion
 -    seized domestic Iraqi assets - US$860 million
 -    Proceeds of oil revenues (also residue of Oil for Food Programme which ceased at
      the end of November 2003)
 Set up by CPA decree “for and on behalf of the Iraqi people.”
 Funds held at the Central Bank of Iraq
 Funds disbursed at the discretion of the CPA
 Funds to be used for
 -    humanitarian purposes
 -    reconstruction
 To be audited by the International Audit and Monitoring Board; includes representatives
  of the UN/IMF/AFESD/World Bank

Trade Bank for Iraq

 Formed in July 2003 under CPA order number 20 to serve as a credit-worthy trade
  finance bank for the bankings international trade; operational December 2003.

 Mission is “to facilitate and support the reconstruction of Iraq through trade finance
  activities related to exports from and imports in Iraq.”

 Authorised capital of US$100 million; 5% subscribed.

 Independent Government entity.

 President - Hussein - Al-Uzri.

 Has access to DFI funds.

 Issues letters of credit for imports; 97 issued by 20 January 2004 for USD205 million.

 Consortium headed by J.P.Morgan Chase has been awarded operating contract for 1 year.

Trade Bank for Iraq

           Operating Consortium Banks    Consortium Participating Banks   Export Credit Agencies
           JP Morgan Chase Bank          Akbank                           Export credit agency short
           (Coordinator)                 Bank of Tokyo-Mitsubishi         term insurance support is
           Australian & New Zealand      Credit Lyonnais                  available from the following
           Banking Group                 Caje de Ahorros y Pensiones      countries under framework
           Bank Millennium of Poland     de Barcelons “la Caixa”          agreements signed with the
           National Bank of Kuwait       Millennium BCP                   TBI: Austria, Australia,
           Standard Chartered Bank PLC   Royal Bank of Canada             Belgium, Czech Republic,
                                         SanPaolo IMI                     Denmark, Germany, Italy,
                                         Standard Bank Group              Japan, Luxembourg,
                                                                          Netherlands, Poland, Spain,
                                                                          Sweden, Switzerland, UK,
                                                                          USA; currently totals
                                                                          USD2.4 billion

Iraqi Economy Future Prospects

 Iraq will be heavily dependent on external aid for the next few years.
 Donors Conference held in Madrid 23rd/24th October.
 Some 75 countries attended.
 Funds to be disbursed through World Bank United Nations Trust Funds.
 US Government pledged some US$20.3 billion for Iraqi reconstruction. Breakdown:-
  US$ 5.7 billion   -         electrical system
  US$2.1 billion    -         oil infrastructure
 US$3.7 billion        -           potable water, sewerage etc.
 US$3.7 billion        -           transport, telecommunications, housing, construction,
                                   health etc.
 US$5.1 billion        -           security
 Additional funds pledged by other countries such as Japan, Saudi Arabia, UK, etc.
 Meeting in UAE at end of February to activate funds.

Iraqi Economy Future Prospects

 World Bank may lend US$4 billion of which US$500 million may be committed before
  1st July 2004; 50% on soft terms.
 OPIC is not yet open for Iraq but anticipates setting up operation in the very near future.
  It will particularly concentrate on the rehabilitation and development of the oil fields.
 IFC is putting together a US$200 million fund.
 ECAs unlikely to be on cover before resolution of Paris Club situation.
 ECA lending could be expedited through taking security on oil receivables. US EXIM
  Bank has stated “without a financing mechanism to maximise the use of future oil
  revenues for current reconstruction needs, it will be impossible to construct the stable
  and secure Iraq that both the Iraqi people and the world community seek.”
   – 25,000 b/d at US$15 per barrel with 10 year repayments can support c. US$1 billion
     of lending
   – commercial bank lending/project finance unlikely in the foreseeable future.

Foreign Direct Investment
 Absolutely vital to close the financing gap.
 Iraqis likely to be hesitant about foreign investment, particularly in the field of oil and
  gas. Will buy-back or PSAs be sufficient to get production up to (say) 6 million b/d by
 Minister of Finance announced in Dubai in September 2003
   – 100% investment permitted in all sectors save natural resources
   – possible through joint ventures, direct ownership, branches
   – full and immediate remittance of profits, dividends, interest and royalties allowed.
   – 15% marginal tax rate on corporate income starting 1 January 2004.
   – No local product requirement.

 Privatisation has been identified as vital and virtually all sectors theoretically available
  for sale or lease.
 However, both the CPA and the Governing Council are transitional bodies, and probably
  lack the legal authority to satisfy investors.
 4-5 million Iraqis in the diaspora will probably be keen investors; previously sent US$1
  billion p.a. to Iraq.
New Commercial Banking Laws

 Six foreign banks are to be allowed to be set up in the next 5 years.

 Number of foreign banks can be increased at the discretion of the Central Bank of Iraq.

 Foreign banks can either set up a subsidiary with capital of NID50 billion
  (NID1400=US$1) or a branch.

 Foreign banks can accept deposits immediately.

 Alternatively, foreign banks can purchase 49% of existing Iraqi private banks with the
  requirement to increase capital to US$5million within 18 months.

 Jordan Export and Finance Bank has announced its intention to take a minority stake in
  National Bank of Iraq.

 10 foreign banks have applied for a foreign banking license; HSBC, Standard Chartered
  Bank and National Bank of Kuwait are reported as being invited to proceed to next stage.
New Commercial Banking Laws

 28 January 2004: decision from Ministry of Finance to bank in Iraq.
 Subject: Deals with Foreign Bank
   “to all working banks in Iraq: Governmental, Commercial, Specialised and Private

    No deals may be made with Arab or foreign banks for the establishment of joint
    ventures or the taking of shareholdings at Iraqi working banks unless a legal
    permission is obtained from the Financial Committee of the Governing Council, the
    Ministry of Finance and the Iraqi Central Bank. Any deal made prior to this date is
    considered invalid if not approved by the Financial Committee of the Governing

    To note and work accordingly”
 Letters formally designating the three banks awaited from the Central Bank of Iraq.


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