In May 2016, rumors circulated that the largest banking group in Lebanon, Audi, had engaged in an exercise of tinkering with the possibility of relocating its corporate holding to a foreign jurisdiction. More tangibly, the bank released its results for the first quarter in 2016, showing lower assets and deposits when compared with the end of 2015 but a 10 percent year-on-year gain in profits. Executive sat down with Freddie Baz, the group’s chief strategist, to inquire about the group’s numbers, strategies and exercises in planning.

E  One reason why we felt the necessity to sit down with you at this time was to seek ultimate clarification of the rumors that Audi Group was considering a move of its holding.

I am not going to expand on this point. Everything needed as clarification was stated in our press release [see page 64]. It was very clear.

E   Looking at the results, there was a noticeable downturn in numbers at the end of the first quarter in 2016 when compared with the end of 2015. Can you explain?

A big chunk, albeit not all of [this drop] was due to currency movements, because we have a material presence in Turkey and Egypt. Sometimes there is some [foreign exchange] impact when we translate [all figures] into the national currency, which is the Lebanese pound, because the parent [company] is in Lebanon, but we express it in US dollar because of the currency peg.

E   But the Turkish lira did not drop much in the first quarter, or are we mistaken?

No, it was almost stagnant. What shows is that we have adopted a wait-and-see attitude in Turkey not only in Q1 but even in Q4 of 2015. We decelerated a bit. The prospects are still good. Turkey is an atypical case whereby the fundamentals are good, as seen by the improvement of the real sectors last year. They achieved 4 percent real growth, which is a very good performance as it represents more than two times the average GDP growth of emerging markets last year, excluding India and China. The very good performance does not only relate to growth. If you look at the debt profile, the fiscal balance to GDP is at a mere 1.5 or 2 percent – and the total debt to GDP [ratio] is within the Maastricht criteria (for EU economies). The concerns are only about the current account – which have also improved significantly, going down by almost 50 percent. So when you look at fundamentals, the country is doing well, but Turkey has a paradox. Its major weakness is [that they possess] zero oil and gas, so they have to import all their energy needs and [at the same time} it is an exports-driven economy. Thus they need to import the major inputs in exports, which is the most important driver of GDP growth. So there is some kind of dependence on the oil bill. This is a weakness which makes Turkey vulnerable from time to time, especially when the international environment is not supportive, such as the current one, which has been pervading for the last two years.

E   What pressures or non-supportive elements are you referring to?

The tapering and the Fed[eral Reserve’s] policy towards emerging markets which have led to many investments to exit emerging markets and return mainly to US markets. Turkey is very vulnerable. This, as I often say, is a weakness that is coming from a strength. Because it is an industrial country and Turkey’s exports are a major GDP growth driver, they need to import energy and are suffering from a structural current account deficit, which needs to be covered by short-term portfolio investments or longer-term foreign direct investments. If the international markets are not supportive, [Turkish economic players] can suffer some pressures on the real exchange rate, which happens from time to time – but they are wise enough to have implemented all kinds of hedge accounting.

[pullquote]The economic performance wasn’t achieved randomly. The GDP growth of 4 percent [in 2015] was supportedby more accommodating Fed policies.[/pullquote]

E   Does the Turkish scenario contain other specific challenges?

There are many pluses and minuses which are translating into a real sector which is performing well within the context of a currency which is drifting, in my opinion, with no fundamental reasons. I have to mention also the second vulnerability besides the capital account in an efficient market which translates into capital inflows and outflows and ultimately the exchange rate. But Turkey is also a very politicized country that is undergoing major structural political changes under [President Recep Tayyip] Erdogan as he wants to change from a parliamentary system to a presidential one. This is generating some domestic political tensions which are impacting the psychological dimension of the exchange rate. It is true that the exchange rate was at 1.70 (Turkish lira per USD) when we did our investment but the fair value at that time was [better than] the market rate. After the change in the international environment and the slight deterioration in the domestic political environment, the market rate closed the gap to the fair value and went beyond that. Today most knowledgeable market analysts put the fair value of the Turkish lira at 2.4 while the [exchange rate] is at 2.9. This means there is a markup of close to 20 percent because of the political volatility and that is too much.

E   How much of the political volatility and markup of the exchange rate vis-à-vis the fair value is in your opinion domestic and how much is related to international issues?

In my opinion it is today almost 100 percent domestic. The economic performance wasn’t achieved randomly. The GDP growth of 4 percent [in 2015] was supported by more accommodating Fed policies and the oil prices were at a level which was supportive for Turkey to significantly reduce its current account deficit, and, more importantly, the improvement in the eurozone, which remains one of the most important trade partners for Turkey, has all together supported the economic performances. What remains is the domestic political scene where there were two very sensitive points at the beginning of the year that were creating [political] volatility. One of [the challenges] was mostly solved through the nomination of the [relatively independent, experienced and well-liked] central bank governor. Also the renewal of positions of all the members of the monetary policy committee was carried out with people [who were accepted by the markets] and provided comfort and confidence to the market. What remains now is the regime change [and the questions related to the ambition of Mr. Erdogan].

E   Aren’t there also international issues, such as the row with Germany over a satirist’s words?

That is all part of the game. But in my opinion, 20 percent markup is excessive. One has to go to Istanbul and see the situation on the ground. People love to talk politics but at the end of the day there is a socioeconomic issue which is so large and so dense that there is some power of inertia in Turkey. I am telling you this because in the full year 2015, the [banking] sector achieved growth rates of major aggregates in two-digit territory, on US dollar adjusted basis.

E   So how did Odeabank perform in this context?

We have outperformed the industry by adding four to five bips market share in assets, loans and deposits. That means that our growth rate was higher than the average. These are five basis points, but it is a $700 million market. But in Q4 [of 2015] we said [to go slower] and we kept [that approach] in Q1 [2016].

[pullquote]You shouldn’t relate deposits to profits. You should relate deposits to spreads, which is the top line, not the bottom line.[/pullquote]

E   But as you said, the currency fluctuations cannot explain all the drops in your aggregates of Audi Group.

This brings us back to the first argument that we have been in consolidation mode in Turkey versus our traditional growth mode. In Egypt, we did grow but this was impacted by the heavy depreciation of the currency, and Lebanon did not achieve any significant performance. The end result was those slightly decreasing figures but it is not meaningful [to review performances] on a quarter to quarter basis. We have a budget to add $3 to 4 billion in the full year 2016 and we are confident that we will achieve it. Having said that, however, we have been able to increase our profits by ten percent.

E   Is it then naïve to think that growth in profits is correlated to growth in deposits?

You shouldn’t relate deposits to profits. You should relate deposits to spreads, which is the top line, not the bottom line. If you want to buy market share, it is at the detriment of your spread. It will ultimately impact your bottom line but it starts by looking at the top line. Our spreads have been improving and we haven’t been competing to get deposits. This explains to a certain extent this consolidation mode versus the growth mode, but is as strategic as growing your deposits base. We are very happy about our overall performance; it is true that we haven’t shown in Q1 important increases on the major aggregates on the group level, but when you look at the key performance metrics of the group, they all improved in terms of spreads, non-interest income generation and decreasing cost to income; and also you need to know that the 10 percent increase in consolidated profits do translate into similar trends in the positions of individual entities. The breakdown of consolidated profits over major development pillars – Lebanon, Turkey, Egypt, and private banking and other entities – shows a balanced contribution to the increase from all those pillars.

Although 2015 was a trying year for the Lebanese economy and tested many economic players beyond what they experienced in the already challenging year of 2014, the results of Lebanese banks were remarkably stable. It is notable that the consolidated market shares of alpha and beta banks maintained high concentration on the domestic side. Their domestic assets increased by 13.2 trillion Lebanese lira, accounting for over 95 percent of the growth in total assets.

The same is true for domestic deposits, which edged up 5.1 percent to over $151 billion, with the highest growth in percentage terms in lira-denominated deposits at 7.1 percent, down only 30 basis points when compared with 2014. Growth rates in foreign deposits, due to foreign currency developments, were down a multiple versus 2014, namely at 1.7 percent from 22.8 percent in 2014. This was reflected in the aggregate figures where the share of domestic deposits of overall alpha and beta deposits moved up by 50 basis points, in opposition of trends seen in previous years.

Lebanese banks in the two main size segments by deposits, the alpha banks with more than $2 billion and the beta banks with $500 million to $2 billion, account for over 95 percent of the sector. Bankdata, the consulting and analysis company covering the Lebanese financial sector, has consolidated the results of alpha and beta banks (14 alpha and 12 beta) for the past two years, illuminating their performance in a new and sharper light.

Overseas operations of alpha banks were stronger than those of beta banks as only two beta banks are active in markets outside of Lebanon. But the consolidated results reveal that alpha and beta groups together reached stable portions of approximately 82 percent of assets and deposits, 72 percent of loans and 82 percent of their profits in the domestic Lebanese market.

The profit growth rate of alpha and beta banks in 2015 was 7.5 percent, down 2.4 percentage points from the 9.9 percent growth achieved the year before. However, the growth rates of profits remained strong when compared with all other aggregates; growth in assets, deposits and loans were halved from the growth rates seen in 2014.

Beta banks, whose overall contribution to the consolidated aggregates revolves around 8 percent, saw an increase in their operating expenses that amounted to twice the increase in their operating income.

Of the total workforce of alpha and beta banks, 24,000 or about 70 percent, are active in the domestic market, compared with 10,000 employed overseas. Domestic recruitment was increased versus 2014. The concentration of bank branches is still in a wide range of less than 20 branches per 100,000 residents in outlying provinces to more than 80 branches per 100,000 persons in the Greater Beirut conurbation.

The overall bankerization rate of the Lebanese population is estimated by Bankdata to have reached above 70 percent. In terms of the outlook for network developments, we believe that there are still unused potentials for domestic rollouts, especially using advanced, diversified and innovative methods.

In review of the ratios reported by alpha and beta banks, liquidity is maintained at a high level in both the Lebanese currency and foreign currencies, mainly US dollar. Total net primary liquidity over deposits stood at 31.03 percent at end 2015, compared with 32.38 percent at end 2014. Portfolio securities over deposits increased to 40.97 percent. Collective provisions over net loans and operating expenses over average assets remained in the same ranges as 2014, registering 1.11 percent and 1.41 percent respectively.

Yield ratios on earning assets increased 7 basis points from 5.68 percent in 2014 to 5.75 percent in 2015, reflecting in stable interest margins of 1.97 percent and spreads of 1.89 percent. Asset utilization rates and net operating margins moved in narrow ranges, registering 2.83 percent and 35.08 percent respectively. The closely observed ratio for return on average assets (ROAA) remained unchanged at 0.99 percent while the return on average equity saw a marginal weakening from 11.35 percent in 2014 to 11.19 percent in 2015.

Bankdata notes that the stability of performance ratios and asset quality ratios is remarkable, given the overall market conditions and disruptive developments seen in 2015, and provide proof that Lebanese banks are resilient, run by bankers who are experts at what they do.

The introduction to this interview has been updated in response to the June 12 bombing of the Blom Bank headquarter branch in the Verdun district of Beirut. The original introduction began by noting the ire of Hezbollah party leaders in their reaction to the central bank’s early May decision (circular 137) ordering local banks to comply with a United States law aiming to isolate Hezbollah from the global financial system. The ire conveyed was that of political rhetoric and its acknowledgement is in no way an accusation of complicity at any level for the June 12 bombing. The views expressed in the interview, conducted in late May, also made no accusations of wrongdoing of any sort by Hezbollah in regards to American allegations or, to be clear, the recent targeting of Blom Bank. To better understand the nuances of compliance regulations at the technical level, Executive asked Chahdan Jebeyli, chair of the compliance committee at the Association of Lebanese Banks (ABL), who also doubles as head of compliance at Bank Audi, of the implications to banking of the US law, of institutional investments in compliance infrastructures and on the importance of maintaining partnerships with correspondent banks – those banks that facilitate a local bank’s transactions in the former’s jurisdiction.

E   Lebanon as we know it cannot exist without the banks, and the banks effectively cannot operate without connections to correspondent banks worldwide. In this sense, do you see compliance with the US law as a choice or as a must?

We, as Audi and we as banks, have committed to following international standards. We are living in a dollarized economy – the bulk of our transactions are in US dollars and cleared through the United States. When a transaction crosses a border and [is transacted in] the US, we become subject to their laws. This is the reality because the dollar is a key currency and because transactions in the world are in US dollars and they touch US correspondent banks. So because we are keen to maintain a position as a sophisticated and fair player in the global financial market, we respect the applicable laws. The key applicable laws, because of these reasons, are US laws – we are not talking about politics, this is a business and legal reality.

E   When you speak with other compliance executives at committee meetings of the ABL, is there concern in applying circular 137 or concern that there’s an impending disaster on the way akin to the forced closure of the Lebanese Canadian Bank in 2011?

Yes there are some questions and requests for clarification of some aspects of the implementation and because of the importance of the law and its implications, yes there is an increased focus on the subject – not at the level of the compliance officer but at the level of the banks’ management. This is a very important piece of legislation in the US with an important impact on us and on our customers and we care to preserve our image with the rest of the world and we care about protecting our customers without compromising our obligation to comply with the laws [and] do it in a way that is systematic with our local rules.

E   You word it as increased focus but does that mean executives in the banking community are worried?

No, I’m not losing sleep over this. I’m paying attention to the issue, of course. It is an important subject because we’re in the business of managing risk and when you have an item with such importance and implication for the bank and to the clients of the bank, of course we give it more attention than other things. I’m not trying to minimize the [issue] but I’m saying it is important to the US, it’s important to us, and it’s important to our clients.

E   The rules that the US Treasury Department published to implement its law say it is looking at major transactions and that the Americans are not targeting Lebanon’s economy or the banking sector. But at the same time when the Treasury sanctions an individual or entity they do not provide the evidence justifying their action. You don’t necessarily know why the Americans say this entity is bad but that one isn’t.

To me, I think we don’t need to know the why. I follow the law, the official process. I read the Simpson designation which said they had reason to believe that Lebanese Canadian Bank was a primary money laundering concern. To me, I would differentiate between the fact (and I don’t know exactly the facts) and the lesson you learn out of stuff like this. In the Lebanese Canadian Bank case they raised two issues: one being management complicity – and of course I’m not saying there was management complicity – but in terms of what I need to pay attention to as a prudent banker; and then they spoke of insufficient controls.

And you always ask yourself whether you have sufficient control, and I think our response to all of this is to continue to strengthen our compliance program, that we continue to give assurances to ourselves – our boards, our management, to our shareholders, our employees – that we are managing our compliance program efficiently and prudently so we can continue to maintain partnership with our correspondent bank. Not only do I need to pay attention to my standards but to comply with the standards of the correspondent bank. That means a successful continuation of correspondent banking relationships, which in turn means that we’ll continue to exist and prosper and continue to support our clients in their dealings with the world.

E   KYC (know your client) due diligence might be especially important to the correspondent banks in New York. Have those institutions reached out or been in contact for reassurance that Lebanon has the compliance structure in place and that all applicable rules and legislation are implemented?

They are dealing with our client, who they don’t know, and they rely on us to make sure that the transaction passing through their channel is in compliance with our rules and with their own. That’s why our central bank issued circular 126 [in 2012] which says that we need to respect the foreign laws of the countries where we do business or have transactions. And actually circular 137 refers to [circular 126]. So it means that if I’m doing business with a European client, I have to clear with a European bank paying attention to European laws. If I’m doing a business transaction in dollars, because those clear through the US, they touch the US and become, consequently, subject to US laws and I have to comply with and observe those laws.

E   In terms of opportunity cost, the individuals or entities that may come into contact with, may be linked to or may be directly connected to Hezbollah, might be blocked from accessing whatever banking service, product or financing. In aggregate, can this segment of the economy be quantified to say that this amount of business cannot be facilitated by our banks because the risk is too great?

I don’t have a view on the quantity [or] on quantification of income. All I can tell you is that we apply the law to the extent that is needed for the purpose of meeting our commitment to ourselves, our shareholders, our regulators, and to the global community.

E   Central bank rules and the anti-money laundering legislation passed by the parliament, as well as the latest circular, have added additional layers of compliance reporting requirements. Do you see the cost of compliance becoming prohibitive for Lebanese banks?

If it is a cost that is required by legislation and it’s a cost that you need to invest in for the purpose of continuing business successfully, or if you want to invest in systems for the purpose of improving your control environment, you must do this. With the investment in compliance, in human resources or otherwise, we’ll continue to make money. The challenge, however, is not to make money but to make durable income – income that you make and keep and don’t pay back as a matter of penalties or litigation. It is a cost and a necessary investment that we need to engage, and have, for the purpose of our continuity.

E   For Bank Audi, as Lebanon’s largest bank, these kind of costs can be absorbed. But are there concerns, maybe from a smaller bank, that might say ‘listen we can’t do it on our own, the investment threshold is simply too high’?

Yes, it’s manageable [for Bank Audi]. But providing compliance services is just not doable. This is a commitment of the management of each bank, and also there are regulations that prohibit banks from outsourcing main functions. There are discussions on the increasing costs of compliance, not just in Lebanon but across the world. Of course it is a bigger challenge for smaller banks than for bigger banks but it seems that the situation is still manageable. You cannot really compromise on [compliance] requirements for the purpose of saving money because you may end up paying a more expensive price. Compliance failure, if it is serious enough, could affect the franchise – it depends on the situation. That’s why this is essential spending, this is money well spent.

E   Can you point out how much investment this has required?

There has been an important cost increase but we never question if we should or should not spend. We spend as much as we need for the purpose of continuing to preserve our standing as a compliant banking industry. In compliance there are two risks. There is the risk of making a mistake and there is the other risk in missing legitimate opportunities because of being too conservative or because of insufficient knowledge. I don’t have exact numbers to give you, but is [investment in compliance] significant? I think so, and necessary.

Executive sat with the governor of Banque du Liban (BDL), Lebanon’s central bank, Riad Salameh, for updates on the banking sector, the results of the central bank’s monetary policy, the stimulus of the knowledge economy – known as Circular 331 – and the response to latest foreign initiatives, namely compliance with the United States’ Hezbollah International Financing Prevention Act.

All indicators, Salameh says, point to a continuation of slow economic growth in the country. One challenge to the economy is the low demand of consumption and credit, weakness offset by the central bank’s stimulus plans and incentives that directly contributed to growth rates in the targeted sectors. He tells Executive that the central bank will issue two new circulars to complement its May 2016 decision compelling local banks to comply with a US law meant to isolate Hezbollah from the global financial system. The Special Investigations Commission (SIC) will issue a circular requiring banks to detail justifications for the closure of any account. The Banking Control Commission (BCC), meanwhile, will also issue a circular concerning debtor’s accounts [i.e. those with a negative balance]. The balance of any forcibly closed account – whether positive or negative – must be addressed.

E   In all your statements you point out that Lebanon’s banking industry is still very healthy. What are the major developments, if there are any, relating to the growth of the sector and what would be the policies in order to amend or improve these ratios?

The growth of deposits is an important indicator as the Lebanese economy relies on remittances to fund the private and public sector. The central bank monitors closely this development and we can, in our assessment, look at the underlying base. That underlying base has been constantly increasing and therefore the percentage of increase is not really meaningful, it’s the amount that is being added to the liquidity of the country that is more important. Obviously, the remittances were affected by the low oil prices in 2015, and by the decline in commodities in general, as most of the remittances come from either the oil producing countries or from Africa. The increases last year were around $8 billion, which is lower than the previous year but enough to fund the public and private sector, especially since we saw a decline in the demand for credit from the private sector. For 2016 we expect the same amount and so far it is progressing in that sense. The country is liquid and today banks have excess liquidity. The issue is that we don’t have demand on credit, meaning enough to offset this liquidity.

E   But commercial banks’ lending opportunities to the private sector seem subdued. Why is that in your opinion?

The credit policies of the banks, and you see it from advertising, is still in force with the same energy. But today you have to recognize there is less demand for consumption and for investment.

E   Several circulars have been particularly impactful to the economy: the limit on borrowing by necessitating consumers to downpay 25 percent (from 2015), and those circulars seeking to inspire economic growth in areas ranging from renewable energies to creative industries and the arts, not to mention the stimulus package. How are these developing in 2016?

The general guideline and the target of the central bank is to increase local demand. We are in an environment where there is a slowdown in all the countries around us, and the reliance on external input to the economy has decreased. This is due to the political and security conditions in the area but also, again, due to lower liquidity because of lower oil prices. The incentives we are putting in place, we believe, are yielding results because today 67 percent of the growth rates of the country are directly linked to these incentives. Therefore, as long as we can increase the local demand without creating inflation or threatening the stability of the currency, the central bank will pursue these policies.

[pullquote]We have shown that the monetary initiatives, although non-conventional, have had results.[/pullquote]

On consumer debt, preemptively, we wanted to have more equity involved when there is a consumer debt and that is to protect from excesses or bubbles. Today, [households are] dedicating almost 44 percent of income to servicing their debt and we believe that we are close to a ceiling after which there will be social problems in that debt. The consumer debt in general represents 20 percent of the total portfolio of credit in the banks, and it is important to also be prudent so that we don’t have, in the future, failures in that sector that could affect the sustainability of our banking sector.

E   In the absence of fiscal policy in Lebanon and knowing that medium to long term monetary policy takes time to have effect, to what extent does the central bank have a margin of maneuvering in impacting the Lebanese economy with its monetary policy?

We have shown that the monetary initiatives, although non-conventional, have had results. Financial inclusion has developed and also the number of accounts dealing with banks exceeds today [one million accounts]. Credit has been spread to the community and you have today whole sectors relying on these credits that we initiated. Since 2008 most of the world’s central banks have been trying to stimulate their economies through monetary policy and they undertook non-conventional initiatives. The [European Central Bank] is buying all types of papers just to inject liquidity, even corporate papers. The [United States’ Federal Reserve Bank] has done it before, and they even bought companies. The Bank of Japan is buying shares. Of course adequate fiscal policy is helpful for the economy but the role of the central bank as of today is to try to avoid collapsing into a crisis.

E   Is it correct that the transformation of the Beirut Stock Exchange into a joint stock company is imminent, and does the central bank have a specific view of measures that are in support of developing capital markets in Lebanon, such as the drafting of a Private Equity Funds law?

The government under the recommendation of the minister of finance has asked the [Capital Markets Authority (CMA)] to prepare the first step changing it into a joint stock operation, which we are in the process of finalizing and then it will be up to the government to see how they’re going to do that privatization.

The CMA, on another course, had prepared an electronic platform for trading and it is intended that that platform be operated by the private sector. The advantage is that this platform will be accessible worldwide [so that] all the Lebanese diaspora can invest in the Lebanese markets. Both markets, the stock exchange and the electronic platform, will be monitored as per the law by the CMA which will guarantee transparency and good governance. The final package is not yet clear but ideally what we will try to do is a joint privatization for both entities in a way that the stock exchange in Lebanon will be under one umbrella and not have two exchanges competing.

[pullquote]The central bank by law does not interfere in business decisions or business activities. We provided an engineering approach that is a legal one to create funding for this sector[/pullquote]

E   Critics of circular 331 say that the equity guarantee initiative should only be used for investments in very high-risk seed investing into idea-stage startups. Some say fund managers cannot identify promising entrepreneurs in this category and are therefore not using the guarantee as intended. Also, some argue too much 331 money is being spent in London, here specifically talking about the UK Lebanon Tech Hub. What is your response to criticism directed at 331?

The central bank by law does not interfere in business decisions or business activities. We provided an engineering approach that is a legal one to create funding for this sector. The markets will decide how they invest. But what we have seen so far is that the banks have already committed and invested around $300 million in various funds and companies. The accelerators are needed in order to make this a success and that’s why we give a guarantee. Whether the companies will sell into London or the US is not an issue for us as long as the company that is profiting from the funding engineered by [the central bank] is a Lebanese company. If they are not taking funds from 331, we cannot oblige people to be in any place. We’re trying to create jobs, this is the only aim we have, by creating a new sector that would enrich all Lebanon, so one should not ask the central bank to go and organize that sector – it’s not our role.

E   Stepping back to the beginning of May just after circular 137 was published, there were reports in the media that some banks had closed the accounts of several Hezbollah MPs as well as affiliated organizations. Your mid-May statement clarified that banks will need to justify why an account was closed. Are reports accurate then that a new circular will complement 137, and, if so, what will the clarifications be?

The central board [of the central bank] dictates the policies that the banks have to follow based on [its] prerogative as determined by law. The board cannot ask to look at names because of the bank secrecy law, so the SIC will complement that circular by asking the banks prior to closing accounts to submit a file to the SIC – which has the right to look at names and cannot be opposed by banking secrecy. That file has to be documented by the activity in the account and the [know your client (KYC), due diligence] of the account. The SIC will look into that matter – there is a timespan of 30 days. If there is no answer [from the SIC], the bank will act on its own responsibility.

The BCC will also issue a circular on how to treat the debtor’s account that could be closed. If there is a dispute, the higher banking court will take the final decision – its decisions cannot be challenged. The aim is first, as we stated, to implement [the US] law locally. Two, is to be fair and don’t commit, without study and justification, financial exclusions.

Of course there are protests about [complying with the US law], but our concern is to protect the interests of Lebanon and to keep the integrity of our dealings with external banks.

“Should I be worried?” wondered one Beirut Souks restaurant owner. During a lunch at the local establishment the restaurateur passed by the table to inquire about the meal and service, casually mentioning concern over an American law – one targeting Hezbollah’s alleged money laundering through financial institutions worldwide.

Local business owners outside the banking industry should hardly be worried. It is the banks that are responsible for complying with the Hezbollah International Financing Prevention Act,  Lebanon’s central bank circular 137 stipulates, and in so doing must carry out client due diligence when opening accounts or facilitating transactions. To the banks this is just another chapter in the book of risk management, where compliance with the laws of foreign jurisdictions in which they do business is not a choice, because the banks must comply and have long invested in the tools to do so.

Compliance costs

This is money well spent, says Chahdan Jebeyli, the chair of the compliance committee at the Association of Lebanese Banks (ABL), who also heads compliance at Bank Audi. Referring to investments in compliance infrastructures to satisfy reporting requirements, he tells Executive that rules first started to surface following the terrorist attacks on the United States on September 11, 2001, with harsher rules introduced in the aftermath of the global financial crisis. In the years since, the costs of compliance have increasingly become a topic of boardroom conversations, not only of local banks but those worldwide as well.

For risk managers the question has never been whether to comply or not, but rather how much investment is necessary to satisfy regulators while not being overly cautious in a way that jeopardizes legitimate opportunities. Compliance costs have certainly increased and are significant, Jebeyli says, noting that its rise has become increasingly more challenging for smaller banks to meet, but one that is still manageable. “You cannot really compromise on [compliance] requirements for the purpose of saving money because you may end up paying a more expensive price. Compliance failure, if it is serious enough, could affect the franchise. That’s why this is essential spending,” he adds. Industry wide figures on investments into compliance structures in Lebanon are not available because they are difficult to determine – they are intermingled with other expenditures such as IT investments or otherwise enmeshed in human capital costs spread across departments. On the other hand, the proprietary nature of those investments, such as for sophisticated software, discourages disclosure of those figures.

[pullquote]For risk managers the question has never been whether to comply or not, but rather how much investment is necessaryto satisfy regulators[/pullquote]

The structure of a bank’s compliance department has varied looks, says chief economist at Byblos Bank, Nassib Ghobril. Foremost, it is a mesh of human resources and technology, a combination of interfacing with the client plus sophisticated software tracking transactions and managing clients’ identities.

Compliance is no joke

That the cost of compliance is looked at as an institutional investment is telling: it is an intangible deposit in the bank’s reputation, lending credibility and assurance to correspondent banks – those banks that facilitate a local bank’s transactions in the former’s jurisdiction. Non-compliance with the US law, or Lebanon’s central bank failure to regulate compliance, would jeopardize partnerships, cutting Lebanese banks off from correspondent banks in the United States. That Lebanon is a dollarized economy, and that the bulk of transactions are in US dollars, also fuel the existential necessity of complying.

Of course investing in compliance is no guarantee that a correspondent bank will continue the relationship; the risk of severance is only decreased by proof of compliance. But the cost of a cut off can be far greater than the investment. When a bank is accused of being non-compliant a number of cost factors come into play: the difficult to quantify losses in opportunity resulting from suspended relations with a correspondent bank, and the more easily measurable financial penalties from regulatory action or litigation.

Were a correspondent bank to cut relations with an accused financial institution, the ability to conduct transactions in US dollars would no longer be possible, affecting not only the bank but its clients too – local businesses trading internationally and Lebanese abroad transferring dollar-denominated remittances back home. What’s more, the mere hint of non-compliance may cost the bank – damaging its reputation, an accusation might push clients to migrate to a competitor for any number of reasons.

[pullquote]Were a correspondent bank to cut relations with an accused financial institution, the ability to conduct transa ctions in US dollars would no longer be possible[/pullquote]

By size of infractions, Lebanon, in the years since 2002, has not really been on the radar of anti-money laundering concerns. But when terrorism finance is factored, where very small amounts can actually finance a bomb, then Lebanon is on the map. In 2015, the subsidiary of Bank of Beirut in the United Kingdom was fined £2.1 million for intentionally misleading regulators with false information concerning its financial crime systems and controls. Lebanon’s biggest case in money laundering – the forced closure of the Lebanese Canadian Bank (LCB) in 2011, settled for $102 million in 2013 – pales in comparison to bank penalties in Europe or New York. Take, for example, the 2015 case of French bank BNP Paribas (BNPP), at the time the fourth largest in the world by total assets. BNPP was accused of laundering upwards of $100 billion for several sanctioned countries, including Iran and Sudan. The bank was convicted of violating US economic sanctions and forced to pay a total financial penalty of just under $9 billion.

Lessons learned

To say that Lebanese banks are panicked that their compliance investments might not satisfy American standards may be an overstatement, but it certainly is an issue that compliance executives and banks’ management are following closely. “I’m not trying to minimize the [issue] but I’m saying it is important to the US, it’s important to us and it’s important to our clients,” Jebeyli says. Lebanese banking officials and executives are acutely aware of the seriousness of the American legislation, a notion that Jebeyli and others that Executive spoke with pointed out. And the lessons learned from the case of LCB – of alleged management complicity in money laundering and that of insufficient controls – are now core considerations in assessing compliance programs.

But smaller banks, perhaps in acknowledgement of the high investment threshold of compliance, do recognize that client due diligence, coined KYC for “know your client,” is a challenge. “It’s not written on their face and you don’t ask them to fill a document asking ‘Are you Hezbollah? – click yes or no.’ We investigate and do our homework on due diligence but at the end of the day we cannot do anything if someone is Hezbollah and we don’t know that. There is an element of uncertainty that we are worried about, definitely,” says Raed Khoury, chairman and general manager of Cedrus Invest Bank.

As Lebanon’s largest bank, Bank Audi may be less concerned than smaller financial institutions because it can more easily absorb the costs and may be able to incorporate more sophisticated compliance solutions. That continued availability of its banking products or services in parts of the country where clients may come into contact with, may be linked to or directly connected to Hezbollah, is a non-issue for the bank, Jebeyli says. “It is clear which individuals are listed or designated [sanctioned by the Americans], and there are the proper diligence rules that are driven by risk classification,” he says before confidently telling Executive, “We treat our clients fairly and properly. At the same time we’ll apply the law as and when we should and to the extent that we need to.”