SPECIAL REPORT: LEBANON BANKING SECTOR WARNS of DE-BANKING AMID US SANCTIONS CRACKDOWN

7 November 2015 Revised by Bachir El Nakib (CAMS), Senior Consultant, Compliance Alert (LLC).

Last May 2015, the International Monetary Fund (IMF) warned against the exceptional risks and challenges facing Lebanon as a result of several political and security factors both at the domestic and foreign levels. These challenges also result from worrying economic factors in terms of growth, the damage to the economic sectors (tourism, real estate) and the deterioration of public finances.

On the other hand, the IMF reiterated the durability and flexibility of the [Lebanese] banking sector and its ability to confront challenges, as it registered in recent years good growth rates, maintained the stability of interest rates and successfully covered the needs of the public and private sectors.

The banking sector is facing many challenges including:

1. The slowdown in economic activity: Economic growth has significantly subsided in recent years from 7% to less than 2%. 

- Tourism sector activity shrank by about 40%,

- the commercial sector by about 30% and

- the real estate sector by about 25%.

- foreign direct investment shrank by about 42% and moved from $4.9 billion to less than $2.8 billion, while

- exports contracted by about 23% and moved from $4.3 billion to $3.3 billion. At the same time, the

- balance of payments moved from a surplus of nearly $3.3 billion to a deficit of nearly $1.2 billion.

2. The deterioration of public finances and the growing public debt constitute the biggest challenge for the banking sector due to their impact on the credit rating of banks with sovereign debt exposure (about 59% of the public debt, or approximately $39.2 billion), as well as on interest rates and the confidence of investors and depositors.

In this context, we notice the increased exposure of banks to sovereign debt compared with the total foreign currency deposits, which increased from 13.4% in 2012 to 15.7% in 2013, and the Lebanese pound deposits, which increased from 39.6% to 41.5%. This prompted global assessment institutions to decrease the credit rating of some major banks without relying on the financial strength of these banks. Also, in 2015, the fiscal deficit grew to 10.5% of GDP, while the public debt reached 143% of GDP.

3. The growing problems facing economic institutions as a result of instability, the declining economic activity, the rising operational costs and the difficulty of covering financial obligations. This led the institutions to ask the Central Bank of Lebanon and the commercial banks for facilities to settle their loans. Non-performing loans account for 5.4% of the total loans, and are covered with provisions of 76%. This rate is considered high compared with the regional percentage, which is close to 4.6%. Meanwhile, there are concerns over increasing non-performing personal loans amounting to approximately 27.8% of the total loans, knowing that 16.1% of them are housing loans as a result of the growing financial problems plaguing families.

4. Maintaining the banking sector growth pace:

• The asset growth pace fell from 8.5% in 2013 to 6.6% in 2014.

• The deposit growth pace fell from 9% in 2013 to 6.1% in 2014, knowing that the sector needs no less than 6% growth in deposits per annum to be able to cover the needs of the public and private sectors.

• The loan growth pace declined from 9.5% in 2013 to 9.3% in 2014 despite the incentives made to support interest and loans allocated by the Central Bank of Lebanon in 2014, which amounted to about 1.6 trillion Lebanese pounds [$1.06 billion], about 60% of which were allocated to the housing sector.

• Profit: in 2014, a slight decrease of 1% was registered. It reached about $1.63 billion versus a 4.9% growth rate in 2013.

5. The tight domestic market, the limited investment opportunities and the excessive liquidity in banks (30% of total deposits) because of a decline in foreign direct investment, a slowing economic activity and real estate and consumer loans reaching maximal levels. These conditions prompted banks to give more loans to the non-resident private sector. The rate of these loans increased from 12.4% of total loans in 2013 to 13.5% in 2014. Also, the tight domestic market exhorted banks to look for foreign markets.

6. Foreign — especially regional — proliferation risks: regional events increase the banks’ proliferation risks (Syria, Turkey, Iraq), and impede their expansion ability. It affects their activity and profitability and leaves an impact on the Lebanese activity and incomes in these countries. The Association of Banks [in Lebanon] (ABL) report pointed out that 17 Lebanese member banks are spread in 31 countries.

7. Regional competition: regional banks have been able to compete with Lebanese banks, as they now have the knowledge, experience, wide expansion and the ability to offer modern and advanced banking services to their customers.

8. Legislation and international law: They limit the banking sector activity and impose constraints given the international requirements of commitment to international sanctions (Syria, Iran ...), self-censorship in terms of transfers and deposits, the FATCA laws, the anti-money laundering procedures and the international standards relating to Basel (capital, solvency, liquidity). They also gradually restrict banking secrecy, especially after the adoption of the two laws related to tax information exchange between Lebanon and foreign countries, and the mandatory declaration of cross-border cash transfer.

Further more, on July 22, 2015 the US House of Representatives passed the Hezbollah International Financing Prevention Act to prevent Hezbollah — classified as a terrorist organization since 1995 — from gaining access to international financial institutions.

The move was no surprise. It aims to restrict the activities of Hezbollah, which represents Iran’s military wing in the Mediterranean region and is accused of supporting the Syrian regime. This process began two years ago, when a report issued by the US Treasury found that Hezbollah was laundering money through the now-defunct Lebanese Canadian Bank. A settlement deal was reached, whereby $102 million was paid to US authorities in lieu of prosecution. In June 2013, the US Treasury, under the Foreign Narcotics Kingpin Designation Act, decided to sanction four Lebanese citizens and three Lebanese institutions for their involvement in the organization of a network financing Hezbollah.

“This bill holds Foreign Banks — not just American banks, as was the case previously — directly liable. This also means that Central Banks also risk sanctions if they carry out any transaction linked to Hezbollah.” It seems that the House is taking this step to strengthen its previous measures at cutting off funding to Hezbollah, by expanding their scope, reinforcing their implementation mechanisms and urging all customers inside the US and abroad to exert more control and rigor.

What is striking is that this bill comes on the heels of the seizure of the Central Bank of Cyprus over the Lebanese-owned FBME Bank, following the release of a US Treasury report on July 15, 2015 indicating that the latter is involved in money laundering activities linked to Hezbollah. The Lebanese banking system is indirectly involved with this incident because, although FBME Bank is chartered in Tanzania, it is part of Saab Financial Group, which owns the Lebanese Federal Bank, an independent bank that meets all globally imposed control standards and was never embargoed by US authorities.

The bill gives the Treasury Department 120 days to prohibit the US accounts or "impose strict conditions" on the accounts of any foreign financial institutions — including central banks — that knowingly facilitate the activities of Hezbollah, including money laundering. The department can waive those requirements for "national security interests" but must inform Congress. 

The new bill eliminates a separate section on central banks that required Treasury to identify any central banks found to be supporting Hezbollah. The original legislation allowed sanctions to be avoided if the central bank could demonstrate that it has stopped or "taken significant verifiable steps" to terminate such activity and the foreign government has provided "reliable assurances" that support for Hezbollah won't continue in the future.

The bill also gives the president 30 days to provide Congress with a full list of all satellite, broadcast and other providers that "knowingly" transmit the content of Al-Manar TV. The bill requires a breakdown of which providers have been sanctioned and which haven't — the United States designated Al-Manar a terrorist entity in 2004 — and an explanation for the latter.

The effort follows years of warnings from the Obama administration to Lebanon that its financial sector — a key part of the nation's economy — must do more to crack down on ties with Hezbollah.

The Treasury Department blacklisted the Lebanese Canadian Bank in 2011, accusing it of laundering $200 million worth of drug proceeds per month. Soon after, Assistant Treasury Secretary for Terrorist Financing Daniel Glaser traveled to Beirut to warn Lebanon that its banks risked being blacklisted for helping Syria evade sanctions. And last year, Treasury sanctioned two Lebanese exchange houses, Kassem Rmeiti & Co. and Halawi Exchange Co., for the same reasons.

The bill further gives the president 30 days to determine whether Hezbollah meets the requirements for designation as a significant narcotics trafficker under the Foreign Narcotics Kingpin Designation Act or a significant transnational criminal organization. Both designations would give the government more authorities to target the group. It also requires the secretary of state to submit a report within 120 days on Hezbollah's involvement in the trade of conflict diamonds.

AIPAC has made the bill a legislative priority for this congressional session.

 

"AIPAC commends the House Foreign Affairs Committee for adopting critical legislation to cut off the terrorist group Hezbollah from the international financing system," the group said in a statement urging the Senate to follow suit.

However, the following question arises:

1. What impact will the US bill have on the Lebanese banking system and economy?

2. Will this step push the Lebanese banking authorities to adopt new measures?

Indeed, the Central Bank of Lebanon (BDL) has anticipated the recent congressional bill through its circulars. Basic Circular No. 128 of Jan. 12, 2013 specifies that banks and financial institutions operating in Lebanon must establish a compliance department as required by the rules of good governance, and Basic Circular No. 126 of April 5, 2005 expects local banks and financial institutions operating in Lebanon to strictly comply with the laws of the states of its correspondent banks and financial institutions. In other words, Lebanese banks are obliged to abide by US laws to safeguard the banking sector.

These circulars and their entry into force prompted the president of the Association of Banks in Lebanon to say, “Lebanese banks strictly comply with international sanctions and fully cooperate with the concerned countries in terms of fighting money laundering and terrorism. They have nothing to worry about.”

However, the assurances of the banks and the central bank governor and the existence of a regulatory framework and compliance policies are different than the confidence factor — which is the cornerstone of any economic and financial structure. The confidence factor is affected by such news, regardless of the source. The close correlation of the Hezbollah issue to the Lebanese banking sector, espoused by previous US measures, does not enhance the confidence of a sector that constitutes the basis of the Lebanese economy, which is suffering from pressures, including the size of its Treasury Bonds portfolio.

So far, things are still under control. In June 2014, Lebanese banks registered growth in their deposits, including nonresident deposits, and expectations indicate a yearly growth of 5% or 6%. Lebanese banks are aware of the sensitivity of this situation. Therefore, they decided to launch an awareness campaign in decision-making capitals, in particular Washington, to affirm their commitment to the implementation of US laws. Recent activity within the scope of this campaign included a visit by a delegation from the Union of Arab Banks to Washington in July 2014. Some say that the congressional decision is political, and the bill has yet to become a law as it must be subject to a vote by the US Senate, which has not yet included it on its agenda. This step definitely has an objective that is political par excellence aimed at stifling Hezbollah, despite the ongoing negotiations with Iran.

However, one may fear that these negotiations and related pressures might have side effects on the Lebanese banking sector. According to Tohme, “When the US Treasury directly accuses any financial institution, questioning its activity, this implies a death sentence for this institution. The Lebanese banking sector cannot afford any harm to its reputation.”

 

2015 BASEL AML INDEX REPORT

The Basel AML Index 2015 Report summarises the key findings and provides a detailed explanation about our methodology. See also what is new in the 2015 edition and the recent changes in our methodology. Our annual review section outlines the main discussions and feedback received from external experts with academic, supervisory and law enforcement background.

The Basel AML Index measures the risk of money laundering and terrorist financing of countries based on publicly available sources. A total of 14 indicators that deal with AML/CFT regulations, corruption, financial standards, political disclosure and rule of law are aggregated into one overall risk score. By combining these various data sources, the overall risk score represents a holistic assessment addressing structural as well as functional elements in the AML/CFT framework. As there are no quantitative data available, the Basel AML Index does not measure the actual existence of money laundering activity or amount of illicit financial money within a country but is designed to indicate the risk level, i.e. the vulnerabilities of money laundering and terrorist financing within a country.

OVERALL SCORE

The Overall Score indicates a country’s risk level in money laundering/terrorist financing based on its adherence to AML/CTF standards and other risk categories such as financial regulations, public transparency, corruption and rule of law.

 

Iran
 
1
8.59
 
Lebanon
 
28
7.06
 
Yemen
 
35
6.75
 
Algeria
 
41
6.57
 
Kuwait
 
58
6.25
 
United Arab Emirates
 
72
5.88
 
Bahrain
 
85
5.56
 
Morocco
 
86
5.56
 
Saudi Arabia
 
90
5.47
 
Qatar
 
114
4.93
 
Israel
 
115
4.92
 
Egypt
 
116
4.91
 
Jordan
 
117
4.91
 
Tunisia
 
127
4.63
 
Malta
 
143
4.03
 

Legend

152 countries listed
0-low10-high
Region and income data by World Bank
* : Overall score based on a new FATF evaluation,
      which includes an effectiveness assessment.

 

 
 

Download the 2015 Basel Index Report

Download File