Financial wherewithal was not a quality Lebanese poet Khalil Gibran naturally inherited; his father was a gambling addict who was imprisoned for embezzlement. But given his penchant for priceless wisdom, perhaps the Lebanese banking system would be sage to heed of one of Gibran’s most famous sayings: “If you reveal your secrets to the wind you should not blame the wind for revealing them to the trees.”
Lebanon’s financial sector has long relied on the country’s banking secrecy laws, some of the toughest in the Middle East, and the country has, for decades, encouraged the powerful and affluent from across the region to use it as a safe house for capital. Yet, despite Gibran’s warning, word has gotten out and awoken some altogether more powerful beasts, with Western countries claiming Lebanon’s secrecy laws help their citizens avoid tax. Recent events, both in Lebanon and internationally, suggest those countries will look the other way no more and Lebanon’s secretive system is under threat.
Near the beginning of 2011 it emerged that the United States Department of the Treasury had designated Lebanese Canadian Bank as a money laundering concern, claiming it was acting as a washing machine for Hezbollah cash. To prevent a catastrophic collapse in confidence in the sector, Bank du Liban (BDL), Lebanon’s central bank, intervened, eventually facilitating LCB — minus the suspect accounts — being bought out by Société Générale de Banque au Liban. The LCB crisis proved seminal for the industry, with a December article in The New York Times alleging pervasive cooperation between LCB and Hezbollah in laundering money, bringing the crisis back into the international consciousness.
While the banking sector tried hard to regain confidence some of the mud stuck, and it has struggled to regain its international reputation. A compliance officer of a major Lebanese bank, talking on condition of anonymity because he was not officially permitted to speak to the press, admitted it signalled change in the industry.
“After the LCB it has become much more important for banks to have the backing of the international community. It has made all the Lebanese banks more concerned,” he said.
Fighting the FATCA
The crisis in confidence comes amid increasingly tough attitudes towards banking secrecy globally. In particular, the US has indicated that it going to go tough on those countries that act as havens for tax avoidance through the new Foreign Account Tax Compliance Act (FATCA).
Under the law, which comes into force in July 2013, non-US banking institutions will have to provide transaction details of all customers with American citizenship and a balance of more than $50,000 in their accounts, to the US Internal Revenue Service (IRS) annually. If they fail to do so they will have to pay 30 percent of the interest, dividend and investment payments due to those clients to the IRS. More worryingly for the banks, they could be deemed ‘non-compliant,’ making it difficult for US institutions to continue working with them, or for them to continue to trade in dollars — the same issue that saw the closure of LCB.
The compliance officer, however, admits that there may still be loopholes. If a client, for example, spreads his money between banks he can avoid hitting the limit. “If you have $45,000 in our bank and $45,000 in five others it is not reportable,” he said.
Camille Barkho, manager of money laundering advice firm Amerab Business Solutions, explains that the law transforms the role of banks, particularly in a secretive financial system like Lebanon. “Let’s say I am a Lebanese-American, at any time my account hits the threshold the banks I work with are obliged every January to report directly to the IRS every transaction I have made,” he says. “FATCA changes the rules so that foreign banks have to take part in identifying US citizens, assessing who is eligible to be investigated and reporting it to the IRS.”
This is clearly incompatible with the banking secrecy rules in the country, based around the 1956 law which was amended in 2001 in the form of Law 318. Within that legal framework banking secrecy can only be terminated in a small number of circumstances, including if a client files for bankruptcy, becomes subject to legal proceedings or dies.
For this reason the Lebanese central bank initially sought to preserve banking secrecy by urging banks to just pay the fees on their clients accounts to the IRS.
“Our recommendation to the banks is going to be to go for the 30 percent option because the other option is legally difficult,” he said. “It would involve the IRS auditing their banks, which is not in line with Lebanese laws and would also create much litigation, which, reputation wise, is not recommendable.”
However it appears attitudes have softened in the past year, with banks coming to the conclusion that they can no longer fight the tide of pressure from the US Treasury. Asked if his bank would abide by the FATCA law, the compliance officer said: “We are forced to. We live in a world where the US is the dominant force and the dollar is the global currency, we can’t just ignore that.”
He admitted that this could mean an end to banking secrecy, for Americans at least.
Outside the law?
However, the current legal framework in Lebanon may prevent banks from complying with FATCA even if they want to. Lebanese anti-money laundering legislation revolves around Law 318, which explicitly does not mention tax avoidance. The most common way to lift banking secrecy currently is through raising suspicion under Law 318; therefore, for the banks to supply the IRS with the information without a waiver from the customer could be a breach of the law.
Barkhro says he believes that for any Lebanese institution to comply with FATCA it would require Law 318 to be amended to include tax avoidance. Paul Morcos, founder of the law firm, Justicia Beirut Consult, and an adviser who works closely with the BDL, is less certain but said that an amendment has been discussed by the central bank. The BDL did not respond to repeated requests for confirmation.
But if reforms are needed, perhaps somebody should tell the parliamentarians. The head of the parliamentary finance and budget committee, Member of Parliament Ibrahim Kanaan, admitted he was not familiar with the intricacies of the FATCA law and said he hoped the BDL could deal with the issue without needing to change the law.
“Money laundering is an issue that is of concern to us and the central bank and the government,” he said. “It should be dealt with by different measures but these measures could be decisions taken, initiatives to control the cash flow, to try to see any way regulations could be more effective. I don’t know if it needs an amendment to the law.”
The downside of any such change to the law would be the effect it could have on remittances. In February, the World Bank estimated that money sent from the Diaspora had remained constant at around $7.6 billion in 2011, despite overall financial inflows falling 18 percent. In an economy with a gross domestic product of around $40 billion, that equates to around 20 percent of the country’s economy.
Adding tax evasion in foreign countries to the items recognized under Law 318 would mean that all remittances would have to have been taxed before they entered the country. If, for example, a dual British-Lebanese citizen brings money into Lebanon without paying tax in the UK and puts it in a Lebanese bank, currently there is no legislation under which he can be prosecuted. If the amendment were passed then these accounts would be open to scrutiny under Law 318, not just for Americans but all remittances.
“You have diaspora who transfer their money to Lebanon and the source of money might be considered tax evasion in American law, especially in the US where they have to pay high taxation rates,” said Morcos. “It is not in the interests of the Lebanese economy to classify tax evasion as a money laundering crime. It could prevent Lebanon from benefiting from huge amounts of transfers coming from abroad; it would have a very negative effect.”
According to Byblos Bank, at least 45 percent of households in Lebanon have at least one family member abroad who sends home some form of remittance. Some send more than others, but Nassib Ghobril, head of research and analysis at the bank, estimated that on average Lebanese emigrants are worth about $1,400 per capita every year to their home country.
The compliance manager admits that the changes would “certainly” have negative consequence for trade: “It is going to affect the business but it’s is not easy to know the full impact yet.”
These difficulties with estimating the effect are even more pronounced as the $7.6 billion does not include the remittances that are brought into the country in cash. According to Morcos, Barkho and the compliance officer, if Lebanon wanted to comply with FATCA and change its laws accordingly, effectively cash deposits would have to be justified by the depositor to see if they are taxable — thus ending the days of ‘no questions’ over where cash comes from, and the consequent attractiveness of the Lebanese banking sector.
The government and the banking sector are caught in a bind. If they carry out the reforms, they risk undercutting the remittances that keep the economy alive, if they fail to do so, they risk irking the international community and undermining confidence in the sector.
The Secretary-General of the Association of Banks in Lebanon (ABL) Makram Sader admits they are concerned about the effect FATCA could have on the sector, but denies that Lebanon's secretive system is more susceptible than any other country’s. “We are as concerned as any other bank in Asia, Europe or emerging [economies],” he said.
The third way?
Karlheinz Moll, founder of the German firm SPIROCO Consulting, which focuses on FATCA, equates Lebanon’s two potential paths to being a choice between the two tax-havens of Switzerland and Singapore. Switzerland has announced concessions to its banking secrecy laws in recent years in an attempt to tame the anger of the international community, while Singapore has remained hostile to any reform of its banking system.
“Switzerland is in very strong dialogue with the US Treasury and the IRS and I expect they will reach an agreement [on FATCA] at some point, whereas Singapore is not yet actively approaching them,” he says.
There may yet be a way to square the circle. The most recent draft of the FATCA law, released in early February, contained a surprise for many bankers. Previously the assumption had been that the only agreements that would be signed were between the IRS and individual banks. However, the new draft contained a direct agreement with five European countries: France, Germany, Italy, Spain and Britain. The deal commits both sides to helping each other target tax evasion, but requires the US to work with these states to find their tax-dodging nationals in the US as well.
Given that Lebanon does not have any sort of global income tax, however, the country may not have equal bargaining power with the IRS, though Moll believes that if Lebanon approaches the IRS with other countries in the region, it could achieve a similar agreement.
“They will have to go to the IRS to get a deal. This is what the European governments are doing: they are going government to government,” he said. “Everyone in the region should sit together and say ‘let’s write to the IRS and enter a bilateral agreement that banks don’t need a contract and full disclosure, but we will supply you with some information’.”
Moll also pointed out that the Organization for Economic Cooperation and Development-led initiative TRACE aims to make information exchange agreements the standard method of fighting tax evasion, and thinks Lebanon could benefit from this: “You can get a special agreement but you have to approach the IRS. You have to go to them as they are not going to come to you.” Executive queried BDL officials regarding whether they were considering such agreements, but they failed to comment.
If such a deal is not stuck, the omens are not good. Without the correct planning the Lebanese banking system faces an unenviable choice: between opening up and potentially scaring away remittances that fuel the economy, or staying secretive but risking American censure. Whatever changes the government makes, the decision will be weighty, and the financial sector and remittances are too important to the economy to get it wrong.