Iraqi banks might offer huge growth opportunities in the future for investors willing to take some risks but the industry needs to consolidate first and change its business model, analysts and investors said.

With violence ebbing from the peak of sectarian warfare in 2006/07 foreign firms and banks are putting out feelers to the major oil producer, which was isolated for 20 years due to UN sanctions, wars and violence since the 2003 US-led invasion.

Iraq has signed multi-billion oil contracts, plans huge infrastructure projects and hopes to diversify the economy, opening the door to plenty of deals for banks if security improves further.

But officials say that Iraq first needs to overhaul a banking sector dominated by seven state banks and some 36 tiny private lenders with little interest in the overall economy.

'It's painful when we look at international private banks and then our banks. The difference is huge in terms of performance, the size of deposits,' said Dhiyaa Al Khayoon, adviser for banking affairs at the Iraqi finance ministry.

To create more competitive lenders the central bank has asked private banks, which tend to have little contact with the outside world, to increase their capital to ID250 billion ($214 million) by 2013, according to a memo seen by Reuters.

'We hope that this measure will force them to find a foreign partner,' Khayoon said.

Anticipating mergers, foreign investors have started buying into Iraqi banks, said Salam Smeism, analyst and Iraqi bourse board member, citing the example of Bahrain's Ahli United Bank, raising its stake in Commercial Bank of Iraq to 49 per cent in June.

'I do expect many mergers among private banks,' she said.

Foreign frontier market funds also are positioning themselves.

'We like the banking sector as it is a good proxy for the Iraqi economy. Their earnings will increase tremendously as Iraq is being rebuilt and oil revenue is increased,' said Henrik Kahm at asset manger FMG, which has a fund dedicated to Iraqi stocks. – TradeArabia News Service