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Financial challenge tests Iraq’s resolve

13 May 2026

 

On 21 April, as a fragile ceasefire held between the US and Iran, the Trump administration halted a $500m shipment in cash headed for Iraq, as it sought to clamp down on Iranian-backed Shia militias in the country. 

That cash, derived from Iraqi oil exports and routed via the US Federal Reserve to the Central Bank of Iraq (CBI), is a vital cog in Iraq’s financial arteries, enabling it to cover foreign exchange demand.

This was not the first time that Iraq’s financial system has felt the US’s warm breath on its neck.

Back in February 2025, the US Treasury Department blacklisted five Iraqi banks from participating in dollar transactions, citing concerns about their role in illicit financial flows that benefited Iran’s Islamic Revolutionary Guards Corps.

Iraq has also itself often circumscribed dollar use within its own financial system.

In July 2023, the CBI banned 14 banks from conducting dollar transactions in a crackdown on dollar smuggling. In February 2024, it banned a further eight banks from dollar transactions as part of a crackdown on fraud and money laundering.

Dollar pressure

The recent halt in US dollar cash shipments has nevertheless added pressure to Iraq’s parallel currency market gap, says Lucila Bonilla, lead emerging market economist at Oxford Economics.  

“The gap between the parallel exchange rate has widened noticeably against the official peg, to around 20%,” she says.

“Dollar demand has risen as citizens and traders seek to hedge uncertainty – dollar deposits are up, and there are reports of a notable shift in the composition of cash holdings toward dollars.”

Ratings agencies see the US move on Iraqi dollar use as a challenge, but one that might not prove too onerous.

“Iraq can overcome a short-term war as it has $100bn of reserves and its debt profile is bearable,” says Gilbert Hobeika, a director at Fitch Ratings.

“But a longer-term conflict will hurt Iraq as the economy is reliant on oil revenues and government involvement, while facing at the same time risk from the US stopping delivery of US dollars.”

How persistent the pressure proves will depend largely on the duration of the Hormuz shock and how the relationship with the US evolves.

“Forming a new government that is palatable to the US could ease the pressure, though Iraq’s protracted government formation process adds uncertainty to that timeline,” says Bonilla.

The US-Iran war is putting even more pressure on banks.

“There are uncertainties with regard to depositors,” says Hobeika. “The public sector banks have weak management and governance structures. Financial reporting is weak, and that puts pressure on asset quality and capitalisation.”

If the conflict lasts a long time, the government will start withdrawing funds to pay salaries and contractors.

“That will affect deposits at the public sector banks in the near term,” says Hobeika.

State-heavy system

Iraq’s banking system is dominated by a handful of state-owned banks with a market share of 75%-80%, and then 60-plus private banks competing for the remaining 20%-25% of the pie. 

“Private banks have struggled to compete in a market with limited opportunities, small deposit bases and a narrow range of products, often focusing on very basic activities,” says Lea Hanna, an analyst at Moody’s.

“In 2019, we had a wave of Islamic banks getting bans on dealing with US dollars – reducing what had been a primary source of business.”

A few private banks have benefitted since then, namely those with majority ownership by foreign banks such as National Bank of Iraq, a subsidiary of Capital Bank of Jordan, and Bank of Baghdad, a subsidiary of Jordan Kuwait Bank.

“Supported by their affiliates, these banks are relatively well run compared to domestic peers and have ample capital buffers,” says Hanna.

“They have captured a large market share of US dollar transfers thanks to their strong US correspondent banking relationships that allow them easier access to US dollars. They have seen a surge in their profitability and an increase in their deposit base.”

Financial reform

The CBI has attempted to introduce reforms to the banking system, as part of a wider effort to enable it to channel funding to the private sector.

In early 2025, it increased the minimum issued and paid-up capital requirement to ID400bn ($305m), along with a requirement to establish correspondent banking relationships for foreign-currency trading. The plan was to increase these in ID50bn increments every six months, to hasten sector consolidation.

However, of Fitch’s rated banks, just two – state-owned Trade Bank of Iraq and Mansour Bank, a subsidiary of Qatar National Bank – met the full capital requirement.

“While a lot of banks managed to increase their capital, a number of them didn’t and have been struggling to improve their systems and compliance with anti-terrorism and anti-money laundering regulations,” says Hobeika.

“These systems take a long time to improve, and it costs the banks too. For that reason, they have agreed with the central bank to postpone implementation to 2027/28.”

The expectation is that the number of private Iraqi banks will shrink from 60 to about half that number by 2028.

“Iraq’s banking sector is undergoing a significant overhaul, with the Central Bank pushing through higher capital requirements, improved anti-money-laundering compliance, and a shift towards commercial banks managing their own international correspondent relationships. These moves are welcomed,” says Bonilla.

But the harder work remains, argues Bonilla: state-owned banks still carry high levels of non-performing loans, weak governance and a history of politically directed lending, while private sector credit remains among the lowest in the region.

“The stakes are high as the IMF estimates that a comprehensive reform of the financial sector, alongside broader governance and regulatory changes, could double Iraq’s non-oil growth potential over the medium term, adding around 4 percentage points to GDP,” says Bonilla.

“For now, the reforms address the plumbing. The structural transformation of a banking system to serve the private sector is still largely ahead.”

Clouded outlook

So far, Iraq’s financial system seems to have averted a worst-case scenario of large-scale deposit withdrawals related to the Iran conflict.

Any deposit withdrawals seem to be more related to the introduction of a digital custom system ASYCUDA (Automated System for Customs Data) aimed at helping the government collect revenues, which saw a lot of traders trying to bypass the custom charges.

“This drove some exporters or traders to source US dollars outside the banking system, in the parallel market, to avoid stricter requirements and up-front payment of customs duties. That has now eased,” says Hanna.

Looking ahead, Fitch anticipates that most government financing is likely to come from the CBI through indirect purchases of government securities.

The central bank’s total claims on the central government represented about 52% of the domestic debt stock and 25% of the total debt stock at end-2024, notes the agency.

It envisages that a smaller portion will come from the government’s cash deposits, anticipated to fall to an average 12% by 2027.

Fitch says the CBI’s balance sheet limits refinancing risks, while the FX reserves are large enough to absorb the expansion of that balance sheet without putting pressure on the exchange-rate peg with the US dollar.

Surging foreign direct investment comes as a source of comfort, with annual inflows rising from around $2bn in 2022 to $5bn-$7bn from 2023 onwards. 

Reform of the financial system will remain at the top of the new government’s in-tray.

The regional environment is unconducive to this mammoth task, and it can only hope that an end to the conflict would support ongoing Iraqi efforts to build a financial system comparable to that of some of its Gulf neighbours.

MEED’s June 2026 report on Iraq also includes:

> OVERVIEW: Iraq enters era of resilience, reform and rising risks
> OIL & GAS: Iraqi oil and gas sector in crisis
> POWER & WATER: Focus shifts to delivery of Iraq utilities expansion
> CONSTRUCTION: Momentum builds in Iraq’s post-war construction sector

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James Gavin

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