In the last couple of years, transparency and information sharing among the world’s financial systems have become a prime focus. The role of compliance in financial institutions has thus jumped to the front seat. Lebanon, like almost all countries in the world, had to comply with these regulations, despite its location and close commercial ties with several countries under the watch, such as Syria, Iraq, and others.“The role of financial compliance has actually been gaining momentum ever since the September 11 events,”
Mr. Chahdan Jebeily, Group Chief Legal & Compliance Officer at Audi Group says, “those events acted as an eye opener on crime and terrorism financing. The financial crisis of 2008 then reinforced the currents, calling for tighter controls and transparency, and highlighting the global need to fight tax evasion.”
The heightened sense of urgency accompanying the successive regulations has led the Lebanese banks to move quickly. How serious is failing to comply? Simple. If American correspondent banks resort to de-risking Lebanon for failure to comply, then Lebanese banks will lose their access to the U.S. dollar and the U.S. markets.
De-risking is when correspondent banks halt dealing with a bank they deem risky because of its loose compliance procedures or doubtful cases, which will in turn raise their own risk and cost them fines and long lawsuits with their own governments.
The loss of access to the largest financial market in the world is a death penalty for Lebanon’s financial system, as the country has a highly dollarized economy (64.8% of private deposits and 74.8% of loans are in USD) and a domestic currency that is pegged to the U.S. dollar. Lebanon cannot afford to be cut off from the U.S. markets, and turning to European banks will not help, as they are likely to follow the lead of American correspondent banks in cutting exposure to Lebanese banks. Even one major correspondent bank de-risking a Lebanese bank will represent a substantial threat, as it can start a chain of reactions across the remainders of banks. Hence, the negative implications of not abiding by laws greatly outweigh any presumed gains from ignoring them.
Luckily, this is a black swan scenario. Lebanese banks have developed sound relationships with their correspondent banks. Open communication, strict abidance by regulations and laws and quick responses are only few of their committed efforts.
Malek Costa, Group Head of compliance at BLOM Bank, explains that “BLOM was well equipped even before the start of the compliance era. Foreign correspondent banks were pleased to see how updated and efficient our monitoring systems were, and Lebanese banks worked hard to convince foreign correspondent banks of their readiness to take on regulatory challenges.”
Lebanese banks can only capitalize on their competence in dealing with international regulators and banks. Indeed, to foreign correspondent banks, Lebanese banks only make for a small volume of business and income. “Our bargaining power with correspondent banks is narrow. As a banking sector, we only have our professionalism, our sound risk management, and our safe dealership to use in convincing the foreign banks to maintain relationships with us.” Mr. Jebeily says.
For Lebanese banks, the matter of compliance is a question of survival and cultural evolution. The compliance role was non-negotiable for the banks’ leaders, one that needed to be protected and implemented sharply. This is why over the past 5 years, compliance departments tripled in sizes as more circulars from the Central Bank of Lebanon came in to lay the grounds for procedures. The Lebanese banks stepped up their controls, systems, human resources and budgets, trying hard to quicken implementation. However, that wasn’t a stress-free transition.
Big Lebanese banks each count 4000+ employees, dozens of branches and several subsidiaries. Large institutions are typically slow to respond to fast-paced changes, but Lebanese banks did not have the luxury of time.
Clashes between profitability concerns and compliance needs arose, but the banks’ senior managers were firm in their priorities. First came compliance. Managers concerned with meeting sales targets or bringing new business found compliance to be standing in the way of their performance. People in front-office positions also complained because their own clients were annoyed. However, with patience, education, awareness, and management support, as both Messrs. Costa and Jebeily agree, the middle ground between conforming to laws, facilitating clients’ needs, and maintaining business profitability was preserved. That took a lot of training, workshops, meetings and discussions, and considerable budgets.
It takes delicate understanding and full knowledge of regulations to execute banking operations in Lebanon without accidentally breaching laws. Mr. Costa mentioned several cases where banks succeeded in carving windows into rigid rules to allow the real economy to breathe. For example, “instead of enforcing systematic blocks that were aimed at countering financing of terrorism by banning a whole segment, such as prohibiting all imports of car sales, efforts were made to distinguish the car sales destined to the local market, from the ones used to launder money from/to Africa. To be able to win that window, Lebanese banks gave proofs of full knowledge of their clients and their operations, and had clear rules and procedures for monitoring breaches.”
Another difficult element in the equation of proper compliance is the client himself. Understandably, when rules and controls were first enforced, clients were baffled by the requests, papers to sign, and the required disclosures. So they resisted. In the earliest stages, some even called it bad service; others changed banks or attempted to counter the procedures. It was not out of ill intentions, but out of lack of understanding of the new culture. The proof is that, eventually, no flight of deposits was recorded as a result of compliance procedures.
Mr. Karim Daher, a managing partner at HBD-T Law firm which specializes in private and public laws, and the General coordinator of the NGO ALDIC (The Lebanese Association for Taxpayers’ Rights), defends wholeheartedly the Lebanese clients who suffered the consequences of the confusion accompanying the implementation of every new regulation. The lawyer’s top concerns are threefold: the protection of clients from being misled or unknowingly signing new clauses waiving secrecy; the ways some banks are communicating the clients’ rights and duties to them; and the extent of explanation and follow up offered for clients. Indeed, the Central Bank had recently issued a circular stipulating the necessity of having an independent compliance officer in each branch to cater for the clients’ requests and needs.
Among the major compliance topics, FATCA was probably the hardest to achieve. For the readers who may have not heard of FATCA (the Foreign Account Tax Compliance Act), FATCA is a U.S. law enforcing the reporting of foreign financial assets by all U.S. taxpayers, at the cost of withholding and fining the breaching party. It required all non-U.S. financial institutions to search their records to identify clients who are U.S. persons and to report their assets and identities to the U.S. Department of the Treasury.
FATCA application was an untested territory and needed delicate care. In this regard, Mr. Daher explains that banks were required to monitor not only holders of U.S. passports (i.e. U.S. Citizens) or holders of Green Card, but also people to whom applies the criterion of U.S. Person. This can be a person holding a proxy and acting for the account of a U.S. resident, or someone having a U.S. postcode or address or who bought an American SIM card, or people sending money on regular basis for their kids who are studying in the US, to name a few. This means a good percentage of the Lebanese population.
However, being a U.S. person does not not necessarily entail tax declarations or liabilities as other conditions apply in order to be considered a U.S. taxpayer, especially if you are a foreigner who does not have revenues from a U.S. source (whether trading activities or real estate).
Laws aimed at countering and criminalizing tax evasions are multiplying. The Europeans have also embraced the new era of financial transparency. Since 2013, more than 80 countries agreed to conform to the common reporting standards of the OECD countries, in which they agree to exchange tax information on their citizens. Lebanon will be applying this treaty as of September 2018. With all the global tax-cooperation gaining thrust, bank secrecy is looking more and more like a product of the past.
Mr. Jebeily notes: “Banking secrecy is not eliminated in Lebanon, but the exceptions multiplied. The classical definition of banking secrecy has now changed. It is no longer a mean of protection for outlaws or individuals breaking the law.” Mr. Daher converges to the same point, preferring to focus on “professional secrecy rather than banking secrecy, which is the clients’ right of having their information and account details safeguarded, unless called for by a solid and legal authority.”
The world is heading toward more cooperation on the informational level, and this is not without benefits. Although the costs of implementing FATCA were deemed extraordinary, tax proceeds for the U.S. have added $13.5 billion since 2010, equivalent to $843 million per year. Those figures come from an estimate of 6 million Americans living abroad, according to the U.S. State Department. There is a lot to gain in Lebanon too. More transparency in reporting and business disclosures will probably bring back a lot of money that is now going under the radar.
The role of legal compliance will only continue to increase from here. The levels reached on strict application of laws cannot deescalate. Investments in this segment will rise, human needs will multiply. The role of the regulator is enormous. The Association of Banks in Lebanon has worked hard to spread and develop the guidelines for the regulations. The sector is always anticipating alterations, striving to stay flexible and dynamic enough to move through the changes towards the end of keeping the reputation and the interests of all stakeholders as sound and as best as possible.
This monthly editorial is brought to you by the Research Department of BLOMINVEST BANK.