Foreign banks are hunting for stakes in private Iraqi banks as the sector appears ripe for investment and consolidation but local banks are reluctant to take partners, fearing a loss of control, banking officials say.

Iraq's financial sector is considered fertile ground for investment as the war-shattered nation rebuilds its vast oilfields and battered infrastructure eight years after the U.S.-led invasion that toppled dictator Saddam Hussein.

But a poor credit culture, lack of a modern banking system and the dominance of state banks have slowed development.

Foreign institutions could take a stake in as many as six Iraqi banks in the next two years, while three others are set to merge, central bank and other officials said.

"We expect during the coming two years we will see increasing movement from foreign banks entering as shareholders of Iraqi banks," said Waleed Eedi, head of the central bank's statistics and research department.

France's Societe Generale and the Bank of Abu Dhabi in the United Arab Emirates have shown interest, one banking official said. They could join HSBC, Qatar National Bank and National Bank of Kuwait, who already operate in Iraq.

Iraq's central bank began a three-stage programme in 2009 for banks to raise capital and modernize, opening the way for mergers and foreign bids.

The deadline for the first stage was the end of June, when banks were required to reach capital levels of $85 million.

Among the banks that may merge or seek foreign partners are Erbil Bank for Investment and Finance, Bank of Huda, Dijlah and Furat Bank for Development and Investment, Gulf Commercial Bank, Trans Iraq Bank and Cihan Bank for Islamic Investment and Finance, Eedi said.

Ashur International Bank for Investment, Mosul Bank for Development and Investment and Union Bank of Iraq are planning to join in a three-way merger.

The three filed a formal notification with the central bank of their intent to merge. The central bank is likely to approve the deal by year-end, an official said.

"The three banks have written a formal letter explaining that they need to create bigger banking units capable of competing and providing broader services," Eedi said.

Reuters contacted two of the three merging banks, which confirmed the plans. Five of the other six banks said they were not in talks with foreign banks and did not intend to negotiate.

State-run Rafidain and Rasheed banks might take a 24 percent stake in Dijlah and Furat for Development and Investment, one bank official said.

Iraq's private banking association, the Iraqi Private Banks League, said international banks were hunting in Iraq after some local institutions said they would not be able to raise their capital in response to the central bank measure.

"There are attempts from Arab and foreign banks to possess Iraqi bank assets," said Abdul-Aziz Hassoun, the league's executive director.

But he said local banks were reluctant to give up control. "There are a lot of offers from foreign banks, but the condition of the foreign banks is that they want to take over management," he said. Iraqi owners "want to stay, managing the bank".

In a sign of the foreign interest in Iraq, London-based Standard Chartered Plc is in talks to buy a stake in Warka Bank, one of Iraq's biggest private banks, a central bank official said on Monday. Standard declined comment.

But the issue of control is cropping up in those talks. The central bank official said Standard Chartered wanted more than 50 percent, but Warka wanted to give up less than 49 percent.

Since early 2006, several foreign banks have entered Iraq and acquired stakes in local banks, including UK-based HSBC in the Iraqi Dar el-Salam bank, Qatar National with Mansour Bank and National Bank of Kuwait with Credit Bank.

Modernising

Iraq nationalised its private banks in 1964, according to Hassoun, and private banking only reopened after the U.N. imposed sanctions in 1991.

The OPEC oil producer has seven state-run banks as well as 23 private and 12 Islamic private banks, both Iraqi and foreign, the central bank website said.

But much of the private banking activity is limited to deposit services and personal lending. The two main state banks, Rafidain and Rashid, have a virtual monopoly on assets.

Last July, the banking association said government banks held 87 percent of deposits, while private banks had 13 percent.

Ashur Bank, one of the three involved in the local merger, said its motivation for the union was to provide more and better services to clients and to compete with government banks.

"We should not stick to the same traditional services which help neither the bank nor the clients," said Ayad al-Bayyati, head of the credit department at Ashur.

The central bank has approved the entry of two Turkish banks into the Iraqi market this year, AlBaraka and Vakifbank , and is reviewing two requests submitted by Lebanese banks to open in Iraq.

Under central bank policy, banks that fail to reach the required capital, merge or find foreign partners will become small money exchanges or money transfer companies, Eedi said.-Reuters