Islamic Banks In Iraq: Establishment Procedures, Legal Framework, Central Bank Instructions, And AAOIFI And IFSB Standards

I. Introduction

The activities of Islamic banks in Iraq are primarily governed by a specific legal framework established under the Islamic Banking Law No. 43 of 2015, while matters of general application remain subject to the Central Bank of Iraq Law No. 56 of 2004 and the Banking Law No. 94 of 2004, in addition to the Companies Laws, Anti-Money Laundering legislation, and other relevant legislation.

An Islamic bank cannot be established merely through the registration of a company; it requires a prior banking licence from the Central Bank of Iraq (CBI). The bank’s Memorandum of Association and Articles of Association must also expressly provide for the conduct of banking activities without receiving or paying interest and through structures that are consistent with the principles of Islamic Sharia.

The minimum paid-up capital required for an Islamic bank is IQD 250 billion, of which IQD 100 billion must be paid upon establishment, with the remainder payable in three equal annual instalments. The Central Bank may increase the minimum capital requirement.

The AAOIFI and IFSB standards do not all have the same legal status. The Islamic Banking Law gives the accounting and Sharia standards issued by AAOIFI (Accounting and Auditing Organization for Islamic Financial Institutions) mandatory effect in circumstances where no specific statutory provision exists. By contrast, the standards of the IFSB (Islamic Financial Services Board) are, in principle, international prudential and supervisory standards that require adoption or incorporation by reference through legislation or the Central Bank in order to become legally binding domestically.

A bank may rely on such standards as part of the applicable legal or regulatory framework where they have been expressly incorporated by reference, or as professional and technical evidence when interpreting contractual provisions and determining the applicable standard of care and compliance. However, such standards may not be relied upon to override mandatory statutory provisions or effective instructions issued by the Central Bank.

II. Establishment Procedures for Islamic Banks in Iraq

1. Legal Form of Islamic Banks in Iraq

An Islamic bank may be established pursuant to Companies Law No. 21 of 1997, as amended; Public Companies Law No. 22 of 1997, in respect of state-owned banks; Banking Law No. 94 of 2004; and Islamic Banking Law No. 43 of 2015.

The Memorandum of Association and Articles of Association must reflect the Islamic nature of the bank, particularly its commitment to refraining from dealing in interest, whether receiving or paying it; conducting financing and investment activities through Sharia-compliant structures; refraining from financing prohibited activities or goods; being subject to the supervision of a Sharia Supervisory Board and internal Sharia audit; and complying with applicable Sharia and accounting standards.

The mere use of the term “Islamic” in a bank’s commercial name is insufficient. Its legal status as an Islamic bank derives from the banking licence and compliance with the applicable substantive and supervisory requirements.

2. Banking Licence for Islamic Banks in Iraq

Under Banking Law No. 94 of 2004, prior approval from the Central Bank is required to establish a bank, open branches, or establish a subsidiary. No person may accept deposits or repayable funds from the public without the requisite banking licence or authorisation.

From a practical and legal perspective, the licensing process generally proceeds through the following stages:

• Submission of an initial application by the founders to the Central Bank;
• Submission of information concerning the founders, shareholders and ultimate beneficial owners;
• Disclosure of the proposed members of the board of directors and executive management;
• Submission of the business plan, organisational structure and internal control systems;
• Description of anti-money laundering and counter-terrorist financing systems;
• Submission of financial projections, balance sheets, profit and loss statements and cash-flow forecasts for the following three years;
• Submission of the proposed external auditor’s consent;
• Completion of the company’s incorporation and registration in the Commercial Registry;
• Submission of the final banking licence application; and
• Issuance of the Central Bank’s decision approving or rejecting the application and, where approved, registration of the bank in the register of banks.

For a company that has not yet been incorporated, the Banking Law provides for a two-stage licensing process: an initial stage for the founders followed by a final stage after the company has been incorporated and registered.

The Central Bank may also conduct financial, criminal and professional due diligence on qualifying shareholders and members of management before granting the licence.

3. Capital Requirements for Islamic Banks in Iraq

The paid-up capital of an Islamic bank must not be less than IQD 250 billion, payable as follows IQD 100 billion upon establishment; and the balance in three equal annual instalments from the date of licensing.

The Central Bank may increase the minimum capital requirement in accordance with the Banking Law or prudential requirements. The bank must also maintain the reserves and prudential ratios prescribed by the Central Bank.

Investors should note that the capital requirement is not the only licensing consideration. Licensing decisions also depend on the source of funds, financial soundness, ownership structure, integrity of the founders, management competence, business plan, and operational and supervisory infrastructure.

4. Sharia Supervisory Board Requirements for Islamic Banks in Iraq

The Islamic Banking Law requires each Islamic bank to establish a Sharia Supervisory Board subject to the approval of the Central Bank.

The Board consists of five members, of whom at least three must have expertise in Islamic jurisprudence and its principles; and at least two must have expertise and qualifications in banking, legal or financial matters.

Members of the Sharia Supervisory Board may not be directors, employees or board members of the bank, nor may they be shareholders.

The term of membership is three years and may be renewed in accordance with the applicable legal requirements. Importantly, the decisions of the Sharia Supervisory Board are binding upon the bank.

Its functions include supervising banking operations and activities; providing opinions on contracts, products and transactions; reviewing Sharia audit reports; preparing a report on the bank’s compliance with Sharia principles; and considering matters referred to it by the board of directors.

The bank must also establish an independent internal Sharia audit function to review its activities and assess compliance with Sharia principles and applicable Sharia and accounting standards and instructions.

III. Legal Framework for Islamic Banks in Iraq

1. Principal Legislation Governing Islamic Banks in Iraq

Islamic banks in Iraq operate within a multi-layered legal framework:

The Islamic Banking Law provides that, in matters not specifically addressed therein, Islamic banks are subject to the Central Bank Law, Banking Law, Anti-Money Laundering legislation, Companies Laws and Public Companies Law, as well as the accounting and Sharia standards issued by AAOIFI.

2. Permitted Activities of Islamic Banks in Iraq

The law permits Islamic banks to undertake a broad range of activities, including financing and investing in projects and activities that are Sharia-compliant; entering into contracts and agreements with individuals, companies and institutions; establishing or acquiring interests in companies with Central Bank approval and within prescribed limits; opening accounts and accepting deposits; acquiring, selling, leasing and investing in movable and immovable assets within the applicable legal limits; establishing investment portfolios and funds; issuing sukuk or mudarabah instruments in accordance with Central Bank requirements; providing custody, collection and payment services; investing deposits on an agency basis; and undertaking certain foreign-currency-related financing activities within applicable regulatory limits.

Conversely, Islamic banks are prohibited from receiving or paying interest; financing or investing in goods or projects prohibited under Sharia; financing intermediation in real estate projects; exceeding prescribed limits relating to fixed assets and investments therein; and undertaking activities that fall outside the scope of their licence, applicable instructions or prudential requirements.

The practical significance is that an Islamic bank cannot convert a conventional transaction into an Islamic transaction merely by changing the title of the agreement. The substance of the transaction is determinative, including its legal and economic structure, the transfer of ownership and the allocation of risk and entitlement to profit according to the relevant financing structure.

3. Contract Drafting and AAOIFI/IFSB Standards for Islamic Banks

The drafting of Islamic banking contracts is fundamental to ensuring the Sharia and economic integrity of transactions.

To ensure the effective application of AAOIFI and IFSB standards within contractual arrangements, banks should consider including express provisions incorporating such standards as applicable interpretive and, where appropriate, governing references.

In respect of AAOIFI standards, a contractual provision could provide that the interpretation of technical terms, such as Murabaha, Mudarabah and Ijarah, and the characterisation of the parties’ obligations shall be subject to the relevant Sharia and accounting standards issued by AAOIFI where no specific statutory provision applies. This would be consistent with the legal effect attributed to AAOIFI standards under the Islamic Banking Law.

As for IFSB standards, which principally address prudential and supervisory matters, contractual provisions may address disclosure mechanisms, risk allocation and professional standards of care, where the relevant IFSB standards have been incorporated by the Central Bank or adopted by the bank through its internal regulations.

Express contractual incorporation may transform such standards from purely advisory principles into contractual and professional benchmarks that may assist in establishing the applicable standard of compliance and interpreting contractual obligations before experts and courts in the event of a dispute.

Such provisions must not, however, be used to override mandatory legislation or effective Central Bank instructions.

IV. Central Bank Instructions and Standards for Islamic Banks in Iraq

1. Central Bank of Iraq Instructions for Islamic Banks

The Central Bank has issued implementing regulations governing Islamic banking activities, including provisions concerning Sharia Supervisory Boards; internal Sharia audit; the Sharia compliance function; risk management in Islamic banks; Islamic financial protection mechanisms; and liquidity lists applicable to Islamic banks.

The Central Bank has issued specific regulations governing Islamic banking operations, Sharia supervision, internal Sharia audit and Sharia compliance, as well as risk management. It has also issued regulations concerning Islamic financial protection mechanisms and liquidity requirements pursuant to decisions of its Board.

Such regulations acquire binding force where they are issued by the competent authority, duly notified or published in accordance with the applicable procedures, and based on the law or the regulatory powers granted to the Central Bank.

The Banking Law generally requires banks to operate in a sound and prudent manner in accordance with the law, their licensing conditions, and the regulations, principles, guidelines and orders issued by the Central Bank.

2. AAOIFI Standards Applicable to Islamic Banks in Iraq

AAOIFI principally develops Sharia standards for financial products and contracts; accounting standards for Islamic financial institutions; auditing, governance and ethics standards; and technical guidance relating to Islamic banking.

In Iraq, these standards are significant not merely as professional references. The Islamic Banking Law expressly incorporates them in matters where no specific statutory provision exists.

Accordingly, certain AAOIFI standards may form part of the applicable legal framework, particularly where expressly incorporated by legislation; incorporated through Central Bank instructions; incorporated into the bank’s internal regulations or contracts; adopted as binding by the Sharia Supervisory Board; or established as part of recognised banking practice or applicable accounting and disclosure requirements.

A distinction must nevertheless be drawn between legal incorporation and professional guidance. Where a standard has not been incorporated into applicable legislation, Central Bank instructions or the relevant contract, it may not independently create a civil obligation or administrative sanction. It may nevertheless assist a court or expert in determining the nature of a contract and the applicable standard of professional banking conduct.

3. IFSB Standards Relevant to Islamic Banks in Iraq

The Islamic Financial Services Board (IFSB) develops international standards of a prudential and supervisory nature, covering areas including capital adequacy; risk management; governance; disclosure and market discipline; Sharia governance; regulatory principles for Islamic financial institutions; and protection of depositors and investors.

The current IFSB framework includes important banking standards, including the revised IFSB-2 on capital adequacy, IFSB-22 on disclosure, and more recent governance and Sharia governance standards, including IFSB-30 and IFSB-31. IFSB-31 was adopted in July 2025, with implementation recommended from 2027 following a transitional period.

As a general principle, IFSB standards do not become automatically enforceable in Iraq merely because they have been issued by an international standard-setting body. They acquire direct domestic legal effect where adopted by the legislature, incorporated by the Central Bank through its instructions, or adopted by the bank as binding internal standards.

Prior to such incorporation, they constitute international benchmarks that may be relied upon for interpreting prudential obligations; assessing the adequacy of risk management systems; establishing the applicable professional standard of care; interpreting the duties of the board of directors and Sharia Supervisory Board; and benchmarking Iraqi practice against international standards.

V. Court Challenges Involving Islamic Banks in Iraq

1. Challenging Central Bank Decisions

Not all Central Bank decisions are subject to challenge in the same manner. The Banking Law regulates the review of final orders and decisions issued by the Central Bank and establishes the applicable procedures and limitations.

Depending on the circumstances specified by law, an affected party may be required to file a challenge within 30 working days from the date of receiving the decision, unless a shorter statutory period applies.

Decisions that may be subject to challenge under the Banking Law may include rejection of an application for a licence or authorisation; cancellation of a licence or authorisation; certain other final decisions specified by law; and disciplinary or supervisory decisions that are reviewable under specific provisions.

Before initiating a challenge, the affected bank or investor should determine whether the decision is final or merely preliminary; the authority that issued the decision; the date on which the decision was properly notified; the applicable statutory limitation period; the competent court or authority; whether the challenge suspends enforcement or requires a separate application; the legal or regulatory basis of the decision; and whether there are grounds relating to lack of jurisdiction, procedural defects, inadequate reasoning, illegality or abuse of power.

A successful challenge does not necessarily mean that the court will substitute its own technical assessment for that of the Central Bank on every banking matter. Judicial review generally focuses on legality, jurisdiction, procedure, reasoning, proportionality and absence of arbitrariness, while taking into account the technical nature of banking supervision.

2. Challenging Sharia Standards

AAOIFI or IFSB standards should not ordinarily be treated as independent administrative decisions capable of being challenged in their own right, unless they have become binding through legislation; Central Bank instructions; a final administrative decision; a contractual provision; or binding internal regulations of the bank.

In such circumstances, the subject of the challenge would generally be the decision, conduct or contract implementing the standard rather than the international standard in the abstract.

For example, where the Central Bank issues a regulatory requirement based on an international standard, a bank may challenge the decision on grounds including lack of jurisdiction; insufficient legal basis; violation of the hierarchy of legal norms; failure to publish or properly notify the requirement; ambiguity or inconsistency; retroactive application; or disproportionality in light of the bank’s activities or legal status.

Where a customer challenges a ruling or opinion issued by a Sharia Supervisory Board, the matter requires careful legal characterisation. While the Board’s decision is binding upon the bank internally under the Islamic Banking Law, it does not necessarily determine all civil consequences before a court, particularly where the dispute concerns contractual validity, performance, damages or recovery of funds.

3. Relying on Standards in Banking Litigation

AAOIFI and IFSB standards may be relied upon in banking disputes in a number of ways, including interpreting technical terms such as Murabaha, Mudarabah, Wakalah, Ijarah and Musharakah; determining whether a contract possesses the characteristics of the Islamic financing structure claimed by the bank; establishing breaches of disclosure or risk-management obligations; assessing compliance with decisions of the Sharia Supervisory Board; challenging the calculation of profits, allocation of expenses or distribution of risks; assisting banking, accounting or Sharia experts; and establishing the recognised professional standard of banking practice.

However, three distinct categories must be distinguished:

VI. Legality of Islamic Banking Activities in Iraq

As a general principle, an Islamic bank’s activities conducted pursuant to Central Bank instructions will be lawful where the following conditions are satisfied:

1. The instructions were issued by the Central Bank or another competent authority;
2. They are based on a statutory provision or valid regulatory power;
3. They do not conflict with applicable legislation or the Constitution;
4. They have been published or notified in accordance with the applicable procedures;
5. They apply to transactions conducted after their effective date, unless there is a valid legal basis for retroactive application;
6. The bank operates within the scope of its licence and regulatory authority;
7. The instructions do not alter the substance of a contract or impose obligations without an adequate legal basis; and
8. The principles of proportionality, clarity and non-discrimination are observed.

Central Bank instructions form an important component of the banking regulatory environment, as the Banking Law requires banks to operate in accordance with the regulations, principles, guidelines and orders issued by the Central Bank.

However, the Central Bank’s regulatory authority is not unlimited. Its instructions cannot amend legislation enacted by the legislature or create a new tax, penalty or proprietary right without an appropriate statutory basis.

Practical Example: Real Estate Murabaha

Where an Islamic bank enters into a Murabaha agreement with a company for the purchase of real estate, the validity of the transaction does not depend merely on the title given to the agreement. The following matters should be examined:

• Did the bank actually acquire the property or assume its risks before selling it?
• Was the acquisition price known and disclosed?
• Was the bank’s profit clearly determined in the agreement?
• Was ownership or legal control transferred in accordance with the nature of the transaction?
• Were the required real estate approvals and registrations obtained?
• Were fees and taxes calculated in accordance with applicable exemptions?
• Was the transaction approved by the Sharia Supervisory Board?
• Did the transaction comply with Central Bank instructions and applicable accounting standards?

If the bank neither owned the asset nor assumed any risk in relation to it, and the transaction was in substance a disguised interest-bearing loan, a dispute may arise concerning the true legal characterisation of the agreement, notwithstanding that the agreement is labelled a “Murabaha”.

VII. Practical Recommendations

• Conduct a preliminary legal review of licensing requirements, source of capital and beneficial ownership.
• Prepare a Memorandum and Articles of Association specifically tailored to the Islamic Banking Law rather than relying on standard corporate templates.
• Design financial products through cooperation between legal counsel, the Sharia Supervisory Board and the relevant banking functions.
• Establish a compliance matrix linking each activity to the relevant statutory provision, Central Bank instruction and applicable AAOIFI or IFSB standard.
• Properly document decisions and minutes of the Sharia Supervisory Board and the rationale for approving products.
• Ensure that contracts reflect the actual economic substance and flows of the transaction, rather than merely using Sharia terminology.
• Update internal policies whenever new instructions or circulars are issued.
• Do not rely solely on the commercial name or description of a product as “Islamic”.
• Obtain and maintain clear copies of the agreement, profit schedule, fees and default provisions.
• Verify ownership of the relevant asset or commodity in Murabaha and Ijarah transactions.
• Distinguish between current accounts, investment accounts and Wakalah accounts.
• Review the mechanisms for allocation of losses and risks in Mudarabah and Musharakah structures.
• Clarify the consequences of default and delay, as well as the treatment of insurance and security.
• Retain correspondence, Sharia approvals and accounting documentation in anticipation of any potential dispute.

Conclusion

Islamic banking in Iraq operates under a specific statutory framework while remaining integrated into the wider Iraqi banking system and subject to the supervision of the Central Bank. Accordingly, the legality of an Islamic bank’s activities requires the combination of four elements: valid licensing, banking regulatory compliance, Sharia compliance, and sound contractual and accounting documentation.

AAOIFI standards have a closer connection to the Iraqi legal framework due to their incorporation by reference under the Islamic Banking Law. IFSB standards, by contrast, constitute international prudential benchmarks whose domestic legal effect derives from legislative, regulatory or contractual adoption.

Challenges before the courts will generally concern the decisions and actions implementing such standards, subject to the applicable limitation periods and jurisdictional requirements, including the 30-working-day period applicable in circumstances specified by the Banking Law.

Ultimately, the most important practical consideration is not the title given to a banking product, but whether its legal and economic substance is consistent with Iraqi law, Central Bank instructions, Sharia supervisory requirements, and the professional standards incorporated by law or contract.

Sources

1. Central Bank of Iraq Law No. 56 of 2004.
2. Banking Law No. 94 of 2004.
3. Islamic Banking Law No. 43 of 2015.
4. Companies Law No. 21 of 1997, as amended.
5. Central Bank of Iraq instructions and regulations applicable to Islamic banks.
6. AAOIFI Standards.
7. IFSB Standards.

Frequently Asked Questions about Islamic Banks in Iraq

Islamic banks in Iraq are primarily governed by Islamic Banking Law No. 43 of 2015. They are also subject, where applicable, to the Central Bank of Iraq Law No. 56 of 2004, Banking Law No. 94 of 2004, Companies Law, anti-money laundering legislation and other relevant regulations.

Do Islamic banks in Iraq need a licence from the Central Bank?

Yes. An Islamic bank cannot operate merely by incorporating a company. It requires prior authorisation and a banking licence from the Central Bank of Iraq, and its constitutional documents must reflect its Sharia-compliant banking activities.

What is the minimum capital required to establish an Islamic bank in Iraq?

The minimum paid-up capital is IQD 250 billion. Of this amount, IQD 100 billion must be paid upon establishment, with the remaining balance payable in three equal annual instalments.

Are Islamic banks in Iraq allowed to charge or pay interest?

No. Islamic banks are prohibited from receiving or paying interest and must conduct financing and investment activities through structures that comply with Islamic Sharia.

What is the role of the Sharia Supervisory Board?

Each Islamic bank must establish a Sharia Supervisory Board approved by the Central Bank. The Board supervises banking operations, reviews contracts and products, examines Sharia audit reports and assesses compliance with Sharia principles. Its decisions are binding on the bank.

Are AAOIFI standards legally binding in Iraq?

AAOIFI standards may have binding legal effect where they are incorporated by legislation, Central Bank instructions, contracts or internal banking rules. The Islamic Banking Law also gives particular relevance to AAOIFI accounting and Sharia standards where no specific statutory provision applies.

Are IFSB standards legally binding on Islamic banks in Iraq?

Not automatically. IFSB standards generally operate as international prudential and supervisory benchmarks unless they are adopted through legislation, Central Bank instructions or binding internal standards.

Can Central Bank decisions affecting Islamic banks be challenged?

Yes, depending on the type of decision and the applicable legal procedure. In certain circumstances, a challenge may need to be filed within 30 working days from receipt of the decision.

Can AAOIFI or IFSB standards be relied on in banking disputes?

Yes. They may be used to interpret Islamic finance structures, assess risk-management and disclosure obligations, determine applicable professional standards and assist courts or experts, particularly where the standards have been incorporated into law, regulation or contract.

What should banks consider when structuring a Murabaha transaction?

The bank should verify that it genuinely acquires the relevant asset or assumes its risks before resale, that the acquisition price and profit are clearly disclosed, that ownership or legal control is properly transferred, and that the transaction complies with Sharia supervision, Central Bank instructions and applicable accounting standards.