Baghdad’s State Banks Face Lending Slowdown as Iraq Pushes for a More Active Financial Sector

Iraq’s banking sector is facing renewed pressure to strengthen lending activity after most state-owned banks reportedly halted or sharply reduced lending, with several institutions operating without clear credit plans for 2026. The development has raised concerns about the ability of Iraq’s banking system to support private investment, SMEs, housing and wider economic growth. 

According to a report published by Shafaq News on August 22, several Iraqi state banks have reduced lending because of the absence of defined credit strategies. The slowdown is affecting financing for construction and renovation, small and medium-sized businesses, investment projects, housing and electronic personal advances.

The issue is particularly significant for Baghdad, which remains the country’s primary financial and administrative centre and is home to major state-owned institutions including Rafidain Bank and Rasheed Bank.

The latest development comes during a broader period of restructuring for Iraq’s banking sector. The Central Bank of Iraq has been working to strengthen financial institutions, improve compliance standards and reconnect eligible Iraqi banks with international correspondent banking channels.

In July, Iraq announced an agreement with the US Treasury Department under which eligible Iraqi banks could return to international correspondent banking channels outside US-dollar transactions. Seven banks were identified as qualifying for the initial stage, subject to meeting further compliance and governance requirements. 

The development is important because access to international banking relationships is central to Iraq’s ability to facilitate cross-border trade, investment and payments.

The reform programme also reflects growing pressure on Iraqi banks to improve anti-money-laundering controls, governance and financial transparency. Private banks have been accelerating compliance measures following Central Bank of Iraq instructions, including stronger AML and counter-terrorist-financing controls and tighter monitoring of dollar transactions. 

At the domestic level, however, lending remains a major challenge.

Banks play an important role in financing businesses and households, but limited credit activity can restrict investment and make it more difficult for SMEs and entrepreneurs to expand. The latest calls for state banks to establish measurable lending targets therefore reflect a wider effort to make the financial sector more supportive of economic development.

Digital banking is another area receiving increasing attention in Baghdad.

Earlier this month, the Central Bank of Iraq met with the country’s Communications and Media Commission to discuss regulation of digital payment services and applications. The discussions focused on developing the regulatory environment for digital payments while strengthening consumer protection, transparency and legal compliance. 

The push toward digital payments forms part of Iraq’s broader attempt to modernise a banking system that has historically relied heavily on cash.

For banks, the transition presents both an opportunity and a challenge. Digital financial services can improve access to banking, reduce transaction costs and provide customers with faster payment options, but they also require stronger cybersecurity, regulatory oversight and technology infrastructure.

The Central Bank has also continued using conventional and Islamic financial instruments to manage liquidity. In August, it announced auctions for Central Bank bills and Islamic certificates of deposit, allowing conventional and Islamic banks to participate in the respective instruments. 

Iraq’s banking reforms are taking place against a difficult economic backdrop. The country’s heavy dependence on oil revenues makes government finances particularly vulnerable to fluctuations in production, exports and global oil prices.

Recent reporting indicated that Iraq was considering additional borrowing from domestic banks to meet public-sector salary obligations amid a decline in oil-related revenues. 

This makes a stronger banking sector increasingly important to the country’s economic resilience. A banking system capable of mobilising deposits and directing credit toward productive businesses could play a greater role in reducing the economy’s dependence on public expenditure.

For Baghdad, the reforms could also help strengthen the city’s position as Iraq’s principal financial centre.

Improved banking infrastructure, greater international connectivity and stronger compliance standards could make it easier for businesses operating in the capital to access international financial services and investment.

The challenge now is translating regulatory reforms into greater activity within the domestic banking system.

While Iraq has made progress towards reconnecting eligible banks with international financial networks, the latest lending slowdown shows that modernising the country’s banking sector involves more than international compliance. Banks will also need effective credit strategies capable of directing financing towards businesses, housing and investment.

As Iraq continues its financial-sector reform programme, Baghdad is becoming a key testing ground for the country’s attempt to build a more modern, internationally connected and economically productive banking system.

The next phase will likely depend on whether state-owned banks can restore lending activity while simultaneously improving governance, compliance and digital capabilities.