There is huge potential for Islamic finance in Iraq, said the country’s central bank, adding that it was looking at ways to encourage the sector's growth in response to demands from Islamic banks.

Islamic banks first opened in Iraq in the 1990s and seven of the country's 42 banks are now Sharia-compliant.

"There is a great demand for Islamic banks in Iraq. The problem is Iraqi banking law does not differentiate between regular and Islamic banks," Iraqi central bank senior adviser Mudher Kasim was quoted as saying in our sister publication, the Gulf daily News.

"The central bank at the moment is studying a new law for Islamic banks," he added, giving no timeline.

Demand from the world's 1.3 billion Muslims for investments that comply with their beliefs has soared and assets that comply with Islamic law are estimated to be worth up to $1 trillion.

The central bank's move is in response to Islamic banks' requests to loosen broader banking rules on the size and type of investments they can make relative to capital and cash reserves.

The rules are meant to ensure banks are solvent, but Islamic banks derive much of their profits from investments, which are distributed among account holders in place of interest.

Iraqi law restricts investment in real estate, where Islamic banks in the Middle East have concentrated much of their cash in recent years, to no more than 15 per cent of capital, Kasim said.

He said that was one area of Iraqi banking law under review.

Abdul-Hussein Al Rabaie, of Iraq's Al-Bilad Islamic Bank for Investment and Finance, said business had soared since it opened in 2006, but legal constraints have hampered further growth.

Another law restricts total investments to less than 20 per cent of capital and cash reserves.

"We have problems with the central bank. I want to take part in development and investment in Iraq, but I cannot have a ceiling on investment," he said, adding that Iraq's Islamic banks were pushing for a cap of 50 per cent.

They are also pushing for a cut in the reserve requirement for Islamic banks to 15 per cent of capital and cash reserves, from 25 per cent now, and for looser capital adequacy rules.

Basel II international banking guidance says an institution's total regulatory capital must be at least 8 per cent of its risk weighted assets, based on measures of its credit risk, market risk and operational risk.- TradeArabia news Service