WASHINGTON -- When President Obama announced last month that he was cutting off a Baghdad bank from any dealings with the U.S. banking system, it was a rare public acknowledgment of a delicate problem: For months, Iraq has been providing economic assistance to Iran, skirting the sanctions imposed on Tehran because of its nuclear program.
The bank singled out by the United States, the Elaf Islamic Bank, is only part of a network of financial institutions and oil-smuggling operations that, according to current and former U.S. and Iraqi government officials, has provided Iran with a crucial flow of dollars at a time when sanctions are squeezing its economy.
The Obama Administration is not eager for a public showdown with the government of Prime Minister Nouri al-Maliki over Iran just seven months after the last U.S. troops withdrew from Baghdad.
Still, the administration has held private talks with Iraqi officials to complain about specific instances of financial and logistical ties between the countries, officials say, although they do not regard all trade between them as illegal.
In one recent instance, when U.S. officials learned that the Iraqi government was aiding the Iranians by allowing them to use Iraqi airspace to ferry supplies to Syria, Mr. Obama called Mr. al-Maliki to complain.
The Iranian planes flew another route.
David Cohen, the Treasury Department's undersecretary for terrorism and financial intelligence, indicated that Iran "may seek to escape the force of our financial sanctions through Iraqi financial institutions."
But, he added, "we will pursue, and are actively pursuing, efforts to prevent Iran from evading U.S. or international financial sanctions, in Iraq or anywhere else."
Some current and former U.S. and Iraqi officials and banking and oil experts, however, say that Iraqi government officials are turning a blind eye to the large financial flows, smuggling, and other trade with Iran.
In some cases, they say, government officials, including some close to Mr. al-Maliki, are directly profiting from the activities.
"Maliki's government is right in the middle of this," said one former senior U.S. intelligence official who now does business in Iraq.
In announcing that he was "cutting off" Elaf Islamic Bank, Mr. Obama said it had "facilitated transactions worth millions of dollars on behalf of Iranian banks that are subject to sanctions for their links to Iran's illicit proliferation activities."
But the treatment the bank has received in Baghdad since it was named by Mr. Obama suggests that the Iraqi government is not only allowing companies and individuals to circumvent the sanctions but also is not enforcing penalties for noncompliance.
Iraqi banking experts said the bank was still being allowed to participate in the Iraq Central Bank's daily auction at which commercial banks can sell Iraqi dinars and buy U.S. dollars.
These auctions are crucial for Iranian access to the international financial system.
Western officials say that Iran seeks to bolster its reserves of dollars to stabilize its exchange rates and pay for imports.
Iraqi and U.S. officials say Iranian customers are able to move large amounts of cash through the auction, and from there into banks in regional financial centers such as Dubai, United Arab Emirates, or Jordan, and then into the international banking system.
Mudher Salih, the central bank governor, said that Elaf Islamic Bank was being allowed back into the auction because Elaf officials had denied any wrongdoing.
"Elaf Bank is attending the auctions and they are telling us that they didn't violate the law, and saying that they didn't deal with any Iranian institutes," Mr. Salih said.
While Iraq has tried to impose more stringent reporting requirements that might pick up illegal transfers, officials say that banks, money traders, and their Iranian customers are finding ways around them, often by forging documents that make it look as if the money transfers are to finance legitimate trade between Iraq and other countries.
Thanks to Iraq's growing oil revenue, the Iraqi central bank has about $60 billion in foreign exchange reserves, held in accounts at the Federal Reserve Bank of New York, with which to meet the demand for dollars. But the new flight of dollars out of Iraq is prompting widespread criticism of the central bank and of the Iraqi government.
The accusations of high-level Iraqi government involvement in sanctions-busting have roiled Iraqi politics and reflect on Mr. al-Maliki, since many Iraqi officials now say that he has taken effective control of the Iraqi central bank.
Mr. Salih acknowledged the huge dollar transfers and said that they threatened the economic stability of Iraq by depleting the country's foreign reserves.
Several U.S. and Iraqi banking and government officials also say that Iranian organizations have gained effective control over at least four Iraqi commercial banks through Iraqi intermediaries. That gives Iran direct access to the international financial system, supposedly denied to Tehran by the economic sanctions.
Even as the United States has moved to tighten the vise against Iran this summer, the al-Maliki government has sought to enhance its economic and political ties with Iran.
Trade between Iraq and Iran, which fought a costly war from 1980 to 1988, has been growing rapidly ever since the U.S.-led invasion that toppled Saddam Hussein, and it is now estimated to be as high as $11 billion a year.
In recent weeks, an Iraqi delegation that includes the deputy prime minister and top officials from the ministries of finance and trade and the central bank met in Tehran with their Iranian counterparts for talks about further increasing economic ties.
An Iraqi government spokesman, Ali al-Dabbagh, said in a telephone interview that Iraq "is not intending to break any rules," but added that "we also have good relations with Iran that we do not want to break."
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