Since early this year the Kurdistan region has been facing the most serious banking crisis since 1991, as a result of continuing differences between the Kurdistan Regional Government (KRG) and the federal government over budget allocations and oil revenues. The dispute started in 2012 when the KRG started building its own pipeline to transport oil and natural gas from the Kurdistan region to Turkey, as a first step towards economic independence from the federal government. But making this step is not easy without the strong banking sector which is essential to a successful economy.
The political change in Iraq after the 2003 invasion of Iraq led to the ratification of a new constitution of Iraq in 2005, in which Iraqi Kurdistan is defined as a federal entity of Iraq. As is the case for the Iraqi economy, the Kurdistan economy is an oil-dependent economy. Given the fact that the Kurdistan economy depends on a 17% share of Iraq’s total revenue, this means that more than 95% of the KRG’s budget is based only on one resource – its oil revenue. Although the KRG argues that higher levels of development and economic growth are being achieved compared to other parts of Iraq due to the region’s relative security and stability; in fact, despite their identification of the need for economic strategies to develop other economic sectors such as agriculture, tourism, and other industries; over the past ten years they have not been successful in implementing them. Instead of pursuing these strategies, the KRG started to build up the economy through the rapid development of the oil and gas industry in the Kurdistan region.
The recent oil dispute revealed KRG’s financial vulnerability, when the KRG banks’ lack of liquidity resulted in local government failing to pay employees’ salaries. Later, Adham Karim Darwish, the Director General of the Central Bank in the KRG, announced that the lack of liquidity was due to the federal government’s refusal to transfer the Kurdistan region’s share of national oil revenues.
Whether this dispute is deemed an economic, political or even constitutional crisis between the KRG and the federal government, there are still some questions which remain to be answered about the failure of the Kurdistan regional banking system to provide the liquidity necessary to avoid this crisis.
After all, a strong banking system will help the government to measure and quantify economic activity, as well as to support private sector growth by providing access to finance. However, the high economic growth in the Kurdistan region during the last 10 years has not been reflected in development of infrastructure, especially in the banking sector. As can be seen, there are more than 70 private banks in the Kurdistan region, however they have not engaged in market activities in an effective and efficient manner.
Dr. Latif (an economic expert) argues that although the current banking crisis in Kurdistan was more a political than an economic crisis, there were still mechanisms that the KRG could have developed which would have led to a more solid banking sector enjoying stronger financial capabilities. In his view there is no comparison between this crisis and the financial crisis in developed countries in terms of banking system and financial liquidity.
While banks in the developed countries are financing commercial projects and giving loans to governments to finance large infrastructure projects, in the Kurdistan region the banking sector plays a limited role in business transactions and is isolated from other activities such as loans and savings. Due to past decades of unstable politics and insecurity in the Kurdistan region, Kurdish people have a strong preference for holding cash at home. This has created a inherent lack of trust in the banking system, as the Kurdistan people still do not believe in banks, being more interested in trust than in interest rates. As a consequence of this long time habit and the lack of a banking culture, the mission of banks to date in the Kurdistan region is limited to the role of mediator between the government and the employees.
It is also important to mention that although the Kurdistan region has pursued its own successful policies for oil and investment over the last decade, for banking purposes it remains close to Baghdad. This is because the Iraqi constitution did not grant fiscal and financial regulatory independence to the Kurdistan region central bank. As a consequence, the Iraqi federal government controls KRG financial policy, and thus the KRG has no direct authority over the flow of money into the market. This absence of a private entity is the reason for the lack of coordination between Kurdistan region banks and world class financial institutions.
In order to overcome this crisis and prevent future financial problems with the federal government, the KRG needs to adopt prudent fiscal policies and to make major reforms in the banking sector, namely:
- Place fiscal planning as a top priority for the new KRG cabinet.
- Establish a modern banking sector as a key to a successful economy, thereby instilling the trust in the banking sector needed to create the public confidence for citizens to deposit their money in these banks and to promote savings and credits.
- Recognise and address the shortages of technology and skills in the banking sector.
- Develop and issue new regulations to support the activity of private banks.