BAGHDAD (Reuters) - Islamist insurgents have issued an ultimatum to northern Iraq's dwindling Christian population to either convert to Islam, pay a religious levy or face death, according to a statement distributed in the militant-controlled city of Mosul.

The statement issued by the Islamic State, the al Qaeda offshoot which led last month's lightning assault to capture swathes of north Iraq, and seen by Reuters, said the ruling would come into effect on Saturday.

It said Christians who wanted to remain in the "caliphate" that the Islamic State declared this month in parts of Iraq and Syria must agree to abide by terms of a "dhimma" contract - a historic practice under which non-Muslims were protected in Muslim lands in return for a special levy known as "jizya".

"We offer them three choices: Islam; the dhimma contract - involving payment of jizya; if they refuse this they will have nothing but the sword," the announcement said.

A resident of Mosul said the statement, issued in the name of the Islamic State in Iraq's northern province of Nineveh, had been distributed on Thursday and read out in mosques.

It said Islamic State leader Abu Bakr al-Baghdadi, which the group has now named Caliph Ibrahim, had set a Saturday deadline for Christians who did not want to stay and live under those terms to "leave the borders of the Islamic Caliphate".

"After this date, there is nothing between us and them but the sword," it said.

The Nineveh decree echoes one that the Islamic State in Iraq and the Levant, the former name for the Islamic State, issued in the Syrian city of Raqqa in February, demanding that Christians pay the jizya levy in gold and curb displays of their faith in return for protection.

The concept of dhimma, governing non-Muslims living under Islamic rule, dates back to the early Islamic era in the seventh century, but was largely abolished during the Ottoman reforms of the mid-19th century.

Mosul, once home to diverse faiths, had a Christian population of around 100,000 a decade ago, but waves of attacks on Christians since the 2003 U.S.-led invasion to topple Saddam Hussein have seen those numbers collapse.

The resident of Mosul who saw the Islamic State announcement estimated the city's Christian population before last month's militant takeover at around 5,000. The vast bulk of those have since fled, leaving perhaps only 200 in the city, he said.

(Reporting by Dominic Evans and Isra' al-Rube'i; Editing by Hugh Lawson)