Islamic banking operations account for 1.5% of total assets of Iraqi banks and could rise to 6% in the next three years if stability returns to the country and a legal framework is put in place to regulate the industry, experts said.
There are eight Islamic banks among Iraq's 32 private banks while foreign Islamic lenders, such as the UAE's Abu Dhabi Islamic Bank, have also opened branches in the oil producing country, according to the central bank.
Most banking activities are conducted by state-owned banks Rafidain and Rasheed.
"Assets of Iraqi banks currently amount to approximately 200 trillion dinars; 90% of which is held by state banks, which are commercial, and only 10% is held by private banks that practice commercial and Islamic banking," Mathhar Saleh, former vice-president of Iraq's central bank, told Zawya.
"Islamic banks account for 1.5% of total assets of Iraqi banks, amounting to nearly 3 trillion dinars, and this could grow to nearly 6% in the next three years if there is political and economic stability and with the introduction of the necessary legislation," he said.
Saleh said Islamic banks are still operating under a 1994 law that regulates commercial banks and that no legislation had been introduced to help develop a fully Islamic financial sector.
NEW ISLAMIC PRODUCTS
Sadeq Shammari, managing director of Iraq's National Islamic Bank (NIB), said Islamic banks were waiting for legislation to expand their offering of products.
He said existing products were mostly based on murabaha, a common sharia-compliant sale contract, but that banks were looking to launch mudaraba, an investment management partnership, and other Islamic finance instruments.
"The biggest challenge facing Islamic banks in Iraq is the absence of a legislation regulating the work of Islamic banking. There are serious attempts by the Central bank of Iraq to draft legislation on Islamic banking, but it is still under consideration," Shammari told Zawya.
"We are awaiting the issuance of such legislation on Islamic banking to be able to launch new products."
Another challenge facing the sector in Iraq is a lack of expertise on Islamic banking transactions and instruments, he said.
NIB's total assets grew by 38% in the first half of 2014 to 702 billion dinars, compared to 507.7 billion dinars in the same period last year.
Predominantly Muslim Iraq, home to around 2.8 million people, offers growth potential for Islamic banking and the country requires foreign investment across most sectors to rebuild its infrastructure.
But the security situation in Iraq has deteriorated sharply after Islamic State militants occupied large parts of the country. The International Monetary Fund expects the economy to contract 2.7% in 2014 after growth of 4.2% last year.
Shammari, who is also a member of the World Union of Arab Bankers, said one of the biggest challenges facing Islamic banks in the Middle East was the attempt to adapt laws and regulations to Basel III banking standards, which are being phased in from 2015 to 2019.
Shammari called on Arab central banks to activate monitoring of Islamic banks' capital adequacy and the extent to which they comply with sharia law. He said a dedicated department should be set up for Islamic banks.
"Research centers should be established to develop Islamic banking products...rules of governance, transparency, disclosure, accounting and auditing, financial solvency, risk management, bad debts and financial supervision," he added.
A study conducted by Thomson Reuters showed that Islamic commercial banks had assets of about USD 1.2 trillion by the end of 2013. According to Kuwait Finance House, assets are expected to grow to USD 2 trillion by the end of 2014.