Iraq's informal banking system threatens financial stability, warn economists

Shafaq News/ Iraq’s informal “parallel banking system” threatens financial stability and hampers regulatory oversight, the Iraq Future Foundation for economic studies and consultancy warned on Saturday.

“Financial institutions operating outside official supervision had grown significantly over the past two decades, offering credit, deposit services, and cross-border money transfers,” the foundation’s head, Manar Al-Obaidy, stated. “These entities range from salary distributors and currency exchange shops to cooperatives and some non-profit groups.”

The foundation’s head attributed their growth to “a lack of regulatory enforcement and demand from small and medium-sized enterprises (SMEs).”

“SMEs represent about 84% of the informal economy in Iraq,” he added, highlighting that their exclusion from formal financial services drives them toward these parallel institutions.

Al-Obaidy cautioned that the parallel system “enables tax evasion, money laundering, and other illicit practices, while restricting authorities’ ability to monitor financial transactions.”

He called for stricter regulations to integrate the informal sector into the formal system. Measures could include banning unauthorized financial services, incentivizing SMEs to enter the formal economy, and placing informal institutions under central bank supervision.

“In severe cases, shutting down unlicensed entities and mandating all financial operations through formal institutions may be necessary,” Al-Obaidy said.

Iraq’s shadow economy has at times outgrown the formal sector, posing a persistent challenge for authorities, he noted, with past crackdowns often proving ineffective due to the system’s adaptability.

Al-Obaidy urged a balanced approach, combining legal enforcement with incentives to integrate informal institutions into the formal economy, to mitigate broader economic risks.