The Impact of Central Bank of Iraq's Expansion of Foreign Currency Transfer Options on Local Banks

 

The Impact of Central Bank of Iraq's Expansion of Foreign Currency Transfer Options on Local Banks

In 2018, the Central Bank of Iraq announced major changes in foreign currency transfer options that impacted local banks significantly. The purpose of this article is to explore if the reforms have addressed the currency market challenges that pushed in the past toward expanding the foreign currency transfer options.

Local banks believe that due to a lack of competitiveness in setting exchange rates, the Central Bank of Iraq's daily dollar auction has been, on more than one occasion, one of the primary sources of internal and external stresses in the financial market system.

They also believe that it has enabled the exchange rate set by the daily dollar auction to deviate from the official exchange rate, which carries a large cost penalty on the non-competitive strategies pursued by local banks in responding to changes in the Central Bank of Iraq's foreign currency transfer policy. Currently, the policy primarily allows unlimited cash foreign currency transfer or only those listed in the policy through participation in the Central Bank of Iraq's daily dollar auction and the drain of Iraqi dinar liquidity.

There is a general agreement that access to foreign currency on an equal footing of opportunity should be made available to all authorized local banks in a competition-based method, while granting a range of technical facilities where the decisions are led by the efficiency of technology associated with different technologies employed by local banks. 

The capacity to bypass the interim Iraqi financial system is limited by cost effectiveness, operating scale, and scale economies. The participating local banks had access to reserve rent; part of the dollar auction sale is retained by the Central Bank of Iraq to be used as an interest-free loan and/or collateral for its own daily dollar auction sale. When their liquidity positions are threatened, eligible local banks may make use of this facility. 

The dollar auction that was in place because of tight monetary policy is no more, since there are several that trade Iraqi government securities in the secondary market. When they have pressing liquidity problems, eligible local banks can still seek refuge in the issuance of securities that can be accepted by the Central Bank of Iraq, as will be discussed later.

Analysis of the inclusion of Jordanian Dinar and Saudi Riyal in the list of permitted foreign currencies

The Central Bank of Iraq expanded in 2014 the list of permitted foreign currencies to include the Jordanian dinar and the Saudi riyal. This paper offers an early analysis of this measure aimed at reducing transaction and exchange costs for Jordanian and Saudi workers in Iraq and remitters from those countries to Iraq. 

Data consist of banking activity indicators before and after the adoption of the measure by Jordanian, Saudi, and foreign commercial and state banks, as well as Iraqi banking activity indicators before and after the adoption of the measure. 

The main issue identified here is related to the narrow-spread net asset and liability position of the Jordanian banking sector in Iraq in contrast with the wider spread net asset and liability position of the Saudi banking sector in Iraq. 

The analysis reflects that the exchange of the Jordanian dinar that flows from Iraq to Jordan at the Jordanian border and in the Jordanian exchange market is not, in the Jordanian commercial banks, deposited into the correspondent Iraqi dinars in Iraq account of the Jordanian commercial banks, whereas the exchange of the Saudi riyal that flows from Iraq to Saudi Arabia at the Saudi border to Iraq and in the Saudi exchange market is deposited into the correspondent Iraqi dinar accounts of the Saudi commercial banks. 

Therefore, the Saudi banks are the ultimate destinations of the Iraqi transactions and exchanges that are financed in Saudi riyals, and therefore the considerable Iraqi banking activity that takes place in Jordan is financed via local Iraqi stock of riyal.

Implications of allowing Iraqi banks to fund trade with Turkey in Euros

To analyze the implications of allowing Iraqi banks to finance imports of goods from Turkey in euros, rather than requiring the use of US dollars, we need to understand what underlay the former policy decision and what would drive the change of allowing trade finance in euros. 

This should enable us to focus our interpretations on the expected patterns of the results and better understand what underlies those patterns. What does the requirement that trade finance for buying goods from Turkey must be transacted in US dollars, including the implications for Iraqi dinar payments rather than deliveries, tell us about;

1. The lack of desire for US dollar liabilities? The desire to shift its asset holding away from US denominations? The deficiency of dollars in the underground market? 
2. The lack of desire for euro assets? The desire to shift the asset sides of its portfolios towards US-denominated assets? The deficiency of euros in the underground market?

Comparative study of foreign currency transfer options before and after the policy changes

The Central Bank of Iraq, on July 25, 2018, released letter number 4/4/1/4/3727. It was decided to expand the foreign currency sale window, including the choice of banks to choose between open documentary credit and selling the foreign currency for cash at the Iraqi local market price. 

This is the first time that the Central Bank participates in price-setting in the Iraqi cash market by opening the sale of the currency to banks from large international correspondent banks. The text describes in detail how the exchange rate was determined before the window breakage and also examines the connection between the Iraqi Central Bank window exchange rate and global factors. 

The text reaches conclusions that will be addressed in detail in the last section. A detailed description of the two policies will be provided by comparing the exchange rate determinants before and after the policy, as well as defining the bidder conditions before and after it.

Conclusion and recommendations for Iraqi banks in light of the new regulations

In this paper, we consider the impact of the Central Bank of Iraq's new regulations aimed at lifting previous restrictions on the repatriation of foreign currency, reducing bottlenecks and impediments to the importation of goods and services into the country, and encouraging the flow of international transfers through the financial system. 

Our hypotheses have been partially confirmed. It was found that the new circular letter has increased the independence of local banks from their correspondents abroad in this regard. In general, banking activities are expected to change markedly in the near future in terms of reducing the manual work done by local banks. However, the anticipated changes were mostly technology-led rather than affecting the fundamental role of banks in the payment system. 

The data indicated that the anticipated increase in the importance of securities transfers was seen to have a very limited impact on the large majority of local banks. In terms of the regulation itself, the new circular requires some additional amendments and clarifications regarding transaction details and upper value limits.

NOTE: The Arabic version of this article is available on Swediq News. Follow this link to access it: [تأثير توسع البنك المركزي العراقي في خيارات تحويل العملات الأجنبية على المصارف المحلية]