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U.S. Bans 14 Iraqi Banks in Crackdown on Iran Dollar Trade; Treasury Department, Federal Reserve Bank of New York bar the lenders from conducting dollar transactions

WASHINGTON-The U.S. has barred 14 Iraqi banks from conducting dollar transactions, U.S. officials said, part of a sweeping crackdown on the siphoning of U.S. currency to Iran and other sanctioned Middle East countries.

The ban, which was imposed Wednesday by the Treasury Department and the Federal Reserve Bank of New York, is likely to provoke new tensions between Baghdad and Washington and could spark more economic turmoil for ordinary Iraqis.

It signals a hardening of sanctions enforcement against Iran only months after the Biden administration appeared intent on lowering tensions with Tehran. The Treasury recently approved a payment of 2.5 billion euros, equivalent to about $2.8 billion, toward unpaid debts by the Iraqi government for Iranian electricity and gas imports, which had been frozen by sanctions.

Earlier this week, the Pentagon dispatched a warship and jet fighters to the region, saying it was in response to Iranian threats against commercial shipping in the Persian Gulf.

U.S. officials said they were taking action against the Iraqi banks after uncovering information that they engaged in money laundering and fraudulent transactions, some of which may have involved sanctioned individuals and raised concerns that Iran could benefit.

U.S. officials said the main goal of the dollar restrictions was to choke off money-laundering in Iraq.

“We have strong reason to suspect that at least some of these laundered funds could end up going to benefit either designated individuals or individuals who could be designated,” said a senior U.S. official, adding “of course the primary sanctions risk in Iraq relates to Iran.”

Most of the banks targeted by the U.S. are small institutions, even by Iraqi standards. Several have ties to influential Iraqis, are known for having financial connections with Iran or for heavy involvement in the dollar transactions, according to two Iraqi banking experts.

Among those on the U.S. list are Al Mustashar Islamic Bank, Erbil Bank, World Islamic Bank, and Zain Iraq Islamic Bank. None of them returned messages seeking comment on the U.S. action. A spokesman for the Central Bank of Iraq also didn’t respond to a request for comment.

At a Baghdad branch of Al Taif Islamic Bank, another of the targeted banks, several customers in line Wednesday evening were seeking to buy dollars for overseas travel or were receiving dollars in money transfers from abroad. “Things are normal and people as you see receive and send money normally,” said a teller, who declined to give his name.

“We have strong reason to suspect that at least some of these laundered funds could end up going to benefit either designated individuals or individuals who could be designated,” said a senior U.S. official. “And of course the primary sanctions risk in Iraq relates to Iran.”

Iran has long used neighboring Iraq as a source of hard currency denied to it by U.S. sanctions, drawing on its strong links to many Iraqi politicians and the easy availability of dollars in Iraq’s loosely regulated currency markets.

The dollar has functioned as a virtual second official currency in Iraq since greenbacks flooded into the country after the 2003 U.S. invasion. Two decades later, Iraq still keeps its foreign currency reserves at the New York Fed, depositing the proceeds from its sales of oil in official accounts there.

Iraqi banks and currency-exchange houses figured out how to make huge profits from the dollar, using fraudulent import transactions and other schemes, according to current and former U.S. and Iraqi officials. The dollars bought from the central bank at a fixed rate could be resold at the often sharply higher market rate.

Blocking access to dollars is a slow death sentence for many Iraqi banks, which have few depositors and make minimal commercial loans, relying on dollar transactions for most of their profits, U.S. officials and Iraqi bankers say. Over two decades, the Iraqi dollar trade has become a source of its endemic corruption, as bankers formed alliances with Iraq’s powerful militias and politicians to secure access to U.S. currency.

When the Treasury and the Central Bank of Iraq cut off four other banks from access to dollars and imposed tighter controls on wire transfers in November last year, the Iraqi dinar plunged against the dollar and prices of imported goods shot up, resulting in a three-month crisis for Iraqi Prime Minister Mohammed al-Sudani.

The measures triggered daily dollar transfers through Iraqi commercial banks, which sometimes totaled over $250 million a day, to fall by 80% or more, as lenders struggled to comply with requirements to provide detailed information about where the money was going.

The tighter scrutiny of dollar transactions since last year helped the Fed identify the 14 banks that were conducting suspicious transactions, the officials said.

Several of the banks had stopped conducting wire transfers in recent months, another U.S. official said, apparently unable to supply sufficient information for the Fed to approve the transaction.

Some employed new schemes for moving dollars illicitly, including shifting transactions to different banks in hopes of escaping Fed scrutiny, the senior official said. Others tried using scores of cash cards loaded with dinars in Iraq and then transported to nearby countries where the funds could be withdrawn in dollars, he added.

To escape scrutiny, some banks also expanded their use of Western money-transfer firms and informal Middle East networks for moving cash, known as hawalla, he said.

The officials played down the impact of the latest U.S. move on the Iraqi economy, citing internal statistics that showed the 14 banks combined held only 1.29% of Iraq’s total banking assets. Much of Iraq’s legitimate banking activity is conducted by state-owned banks and the country has another 46 commercial banks unaffected by the dollar ban, they added.

One effect of the move could be to drive back up the unofficial Iraqi exchange rate, which has fallen to as low as 1,470 dinars to the dollar since reaching over 1,620 Iraqi dinars to the dollar earlier this year. U.S. officials said they expected any increase to be temporary.

Since the Treasury and the New York Fed began scrutinizing dollar activity more aggressively last fall, the number of fraudulent transactions being funneled through Iraq’s foreign-exchange system has been reduced, the officials said, which will lessen the economic impact of banning additional banks.

“Because there’s more real trade occurring, versus essentially trade-based money laundering, we expect a much less meaningful drop in activity,” said the senior official.

Sudani has said that the greater scrutiny of dollar flows by U.S. and Iraqi authorities since last fall caused economic upheaval. But the Iraqi premier has acknowledged the weakness of Iraq’s banks and credited the stricter limits on dollar transactions with halting fraudulent transactions.

“Unfortunately we do not have a banking system, whether government or private one, and this is a real problem,” Sudani said in remarks at the Iraq Forum, a policy conference in Baghdad put on by the Middle East Research Institute, in May. “It was a money laundering process, smuggling of currency and a fake trade with fake documents.”

U.S. officials have pressed Iraq for years to strengthen its banking controls. In 2015, the Federal Reserve and the Treasury Department briefly shut off the flow of dollars to Iraq’s central bank over concerns that the currency was ending up at Iranian banks and possibly being funneled to Islamic State militants, officials said at the time.

But successive U.S. administrations feared that cutting off Baghdad’s access to dollars completely would plunge the country into economic turmoil, jeopardizing other goals, such as preventing the re-emergence of Islamic State and driving Baghdad away from Tehran. But U.S. officials say they hope Baghdad will begin to take more steps against money laundering and fraud in its banking system.

“What we’re looking for is for Iraq to take more proactive action, because what we don’t want is just to have to constantly play whack-a-mole,” said the senior official.

Ghassan Adnan in Baghdad contributed to this article.

Source: The Wall Street Journal Online July 19, 2023

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