Assessing the Vulnerability of Iraq’s Banking System to Oil Shocks: Testing the Moderating Role of Credit Prudential Policies

Abstract

The primary objective of this study is to assess the vulnerability of Iraq’s banking system to oil price shocks and to test the moderating role of credit prudential policies. Using monthly data for 2016–2024, a vector autoregression (VAR) model and an interaction regression model with Newey–West robust standard errors were employed to examine the effects of oil shocks on four indicators of banking soundness, namely capital adequacy, liquidity, non-performing loans, and return on assets. The impulse response function results showed that a positive oil shock increases liquidity and profitability and reduces non-performing loans in the short run; however, in the long run, it leads to a decline in capital adequacy. The parallel-market exchange rate also exerts an adverse effect on banking indicators. The moderation test using an interaction term showed that the coefficient of BRN × MPI was negative for all indicators and statistically significant at the 1% level, demonstrating that contractionary credit policies, such as increasing reserve requirements or imposing restrictions on the loan-to-deposit ratio, significantly mitigate the adverse effects of oil shocks. These findings confirm the effective shock-absorbing role of macroprudential policies and highlight the need for a countercyclical approach to enhance the resilience of Iraqi banks against external volatility.