The impact listing Lebanon on the FATF GREY List

Bachir El Nakib Founder Compliance Alert LLC 

Lebanon’s measures to fight illicit finance and escape FATF grey list

As risk of money laundering is amplified by a growing cash economy to disguise illicitly obtained assets, Lebanon’s Central Bank introduces needless amendments towards strengthening AML/CFT regulations

Despite new measures taken by the Banque du Liban (BDL), the listing of Lebanon on the Middle East and North Africa Financial Action Task Force (MENAFATF) grey list seems imminent, experts in close contacts with the issue told NOW. The MENAFATF wants to adopt and implement 40 recommendations on combating money laundering and financing of terrorism and proliferation. Growing concerns have surfaced that Lebanon’s cash-based economy is facilitating money launderers in concealing the origins of funds for the Palestinian group Hamas’ and the Hezbollah activities. Furthermore, the increasing reliance on cash transactions poses a threat to reverse the progress Lebanon made before 2019, making the economy more susceptible to financial crime vulnerabilities. Experts warn that the risk of money laundering is amplified by the use of cash to disguise illicitly obtained assets, and cash transactions could undo the efforts made prior to the crisis to bolster Lebanon’s financial integrity and establish comprehensive anti-financial crime measures.

"Lebanon’s addition comes just under a year after FATF’s Mutual Evaluation Report, released in December, that specifically commented on the risks from Hezbollah, although it wasn’t named and, instead, referenced as a “major local paramilitary organization”.

The report also noted high-level corruption, tax evasion, trade based money laundering risks, illicit trafficking, and smuggling, among others that are intimately connected with the terror financing risks associated with Hezbollah. Indeed, I discussed exactly this during my recent presentation alongside Baker Regulatory in the Channel Island of Jersey.

It further listed various gaps in Lebanon’s regulatory framework.

This includes the scope of coverage of money laundering predicate crimes, a lack of regulatory independence, poor monitoring for financial crimes, a commercial registry with no requirement for criminal records checks on company founders, and a lack of disciplinary measures against Designated Non-Financial Businesses and Professionals.

The report addressed deficiencies in enforcing existing AML/CFT laws due to a lack of resources, as well as ineffective beneficial ownership identification and poor international cooperation, especially with regards to terror finance and other financial crimes.

Lebanon also faces systemic issues arising from banking secrecy, which is in turn facilitated by the cash-driven economy.

This is not to say that the FATF hasn’t acknowledged the efforts made by Lebanon to address the above and also the significant challenges faced as a result of the ongoing armed conflict with Israel.Indeed, it granted Lebanon two years, instead of one, in order to address the issues raised during the grey listing.

While all such listings impact a country’s financial sector through various means, including damaging its reputation and investment prospects, raising transaction costs due to additional compliance requirements, and causing losses in correspondent banking relationships, among others, we anticipate that the impact on Lebanon will be particularly strong. This is in light of the financial crisis that the country has been facing since 2019, which already impacted its global reputation, reliability, ease of doing business, and other metrics. Furthermore, the conflict with Israel, as well as the high risk for terror financing exposure when conducting business with Lebanon, has served to deter foreign investment.

This, along with the political stalemate and lack of resources, indicates that there is a high risk that Lebanon will struggle in addressing its shortcomings, something well recognized by the global financial sector and demonstrated by FATF granting Lebanon that additional year to address its gaps. Despite this leniency, the international community will likely see Lebanon’s prospects as too low and begin even further reducing business and investments there."

The financial crisis has led many Lebanese citizens to invest in precious metals and stones as a safe haven. As a result, there is a need to update risk assessments for this sector, making them more comprehensive to address risks associated with precious metals trading. Competent authorities have access to financial and related data during investigations of ML and TF cases, either directly or indirectly. In TF cases, authorities rely heavily on financial intelligence, often requesting it from the Cassation Public Prosecutor. However, in ML cases, there is limited reliance on financial intelligence. There are gaps in the implementation of freezing assets and reporting to the Special Investigation Commission (SIC) concerning accused individuals and entities.

Key measures needed

Lebanon must assess and mitigate the risks associated with the activities of the main local paramilitary group as well as significant efforts should be made to train and develop the skills of key competent authorities, especially within the Customs & Tax Directorates, so they can effectively utilize financial intelligence to proactively trace money laundering (ML) evidence, the MENAFATF recommends. Accordingly Lebanon lacks law enforcement agencies and the Cassation Public Prosecutor should maintain reliable, consistent, and centralized data that can be regularly reviewed to build strong ML cases. The law establishing the “National Fund for the Management and Investment of Assets under Recovery or Recovered Related to Crimes and Proceeds during the Freezing or Seizure phase” should be enacted promptly, the evaluation quoted.

Also timely international cooperation should be pursued, proportional to the size of the predicate offences and ML/TF crimes. The watchdog also wants to see a comprehensive mechanism established to combat narcotic drug trafficking, ensuring timely and effective international cooperation. Efforts should be made to allow the General Intelligence Directorate and the Information Division timely access to all financial intelligence to strengthen financial investigations. Also supervisory authorities must regularly remind financial institutions (FIs) and DNFBPs of the national mechanism requirements related to updates in UN sanctions lists to ensure immediate freezing of assets. They should also monitor compliance with Targeted Financial Sanctions (TFS) requirements and enforce sanctions for violations.

The recommendations highlighted that notaries public, precious metals and stones traders, exchange houses, and real estate agents must be adequately informed about the ML/TF risks associated with their activities. The Ministry of Justice and SIC, as the entities responsible for these sectors, should ensure this information is disseminated. Lebanon lacks unified definition of beneficial owners should be established to clarify the handling of bank accounts held by notaries public. Regulators of financial institutions should continue their efforts to monitor unlicensed activities. Additionally, FIs and DNFBPs should be well-informed about the requirements of UNSCRs 1718 and 2231 concerning North Korea and Iran.

Also the activities of accountants should be supervised and reassessed to ensure compliance with AML/CFT requirements under Article 5 of Law No. 44 on money laundering. Similarly, the Ministry of Justice should supervise lawyers’ activities, as is done with notaries public. Non-profit organizations (NPOs) should be subject to supervision due to their receipt of foreign support, the report said.

Lebanese authorities across all institutions and entities must intensify their efforts to enhance and update their actions, addressing key findings to avoid being placed on the FATF grey list. For example the General Directorate of Customs must improve its technological and technical capabilities to effectively seize prohibited goods at borders and detect sanctions evasion.

What’s new in the circular?

As per BDL, this circular is in accordance with Law 44 of November 24, 2015 regarding fighting money laundering and terrorist financings Basic decision 12147 of December 22, 2015 concerning the implementation of UN Security Council resolutions No 1267 (1999), No 1988 (2011) and No 1989 (2011), in addition to any related successor resolutions and Basic decision 12253 of May 3, 2016 on dealing with the US Act of December 18, 2015.

The BDL wants details of all shareholders and stockholders that own more than 5% of shares and stocks. Beneficial owners who own and/or exercise effective control over more than 5% of shares and stocks through direct ownership, indirect ownership through a legal person, or through other means including chairman and members of the Board of Directors and also senior executive management members. The BDL recommendations are falling short of the needed action of money laundering, a source who asked for anonymity said. BDL may request the above-mentioned details for shareholders, stockholders or beneficial owners owning less than 5% if the bank, company or institution is not listed on the stock exchange and those owning more than 2% in banks, companies or institutions listed on the stock exchange.

FATF grey list countries have a strategic deficiency in their AML/CFT regime, and depending on the risk-based approach taken by an entity, grey list countries are treated as high-risk countries, Bachir El-Nakib,  a regulatory supervision consultant and founder of compliancealert.org told NOW.

Both the FATF grey List and Blacklist serve as a guiding light for businesses to assess the risks associated with jurisdictions and customers. The regulated entities take a risk-based approach and decide if the risks posed by a customer are within its risk appetite. The FATF lists for jurisdictions subject to a call for action, and jurisdictions under increased monitoring, he said.

Did Lebanon ever satisfy MENAFATF requirements?  “More to do in the legislative”, El-Nakib believes.

Seemingly more actions are needed from Lebanon’s legislative bodies. By early September Lebanon final evaluation is expected to come out , there’s more concern that the outcome will be negative, he added. Lebanon is estimated to be classified on the grey list, he said. If it happens, such classification could impact Lebanon severely with its fragile economy not to mention it’s non performing banking sector, leading to move isolation from the Global financial system, knowing for over two years the G7 considered placing Lebanon on the grey list due to unsatisfactory practices in relation to weaknesses establishing the ultimate beneficial ownership in non financial services.

The issue of illicit finance

US Treasury officials have expressed concerns about Lebanon’s large illicit financial service companies and a cash economy that accounts for around 46% of the country’s GDP, according to World Bank estimates. This unregulated cash flow is feared to potentially finance groups like Hamas and Hezbollah, both of which are blacklisted and sanctioned by the US Treasury Department.

The BDL’s Circular 165,

with speculations that the US Treasury official is questioning whether this circular could facilitate money laundering and terrorism financing. For context, Circular 165 was issued by BDL on April 19, 2023, and pertains to electronic settlement operations related to “banknotes” or “cash money.” Specifically, it requires all banks to open new accounts for cash (in US dollars and Lebanese pounds) to be used exclusively for settling electronic bank transfers for cash money and for clearing checks traded with cash money.

This circular has not only drawn attention from Lebanese media and legal experts but has also sparked interest in the international media. For instance, the Washington Institute for Near East Policy published a policy analysis paper on June 22, 2024, titled “Cash Cabal.” The paper discusses the origins of Lebanon’s financial crisis, which began with the government’s decision to default on $32 billion in sovereign foreign debt. It also analyses Circular 165, noting that when transfers are made between clients at different banks (e.g., a client at Bank A transferring to a client at Bank B), BDL directly handles the transaction by debiting Bank A’s Fresh dollar account and crediting Bank B’s account at BDL, bypassing the correspondent banks abroad. This process leaves the receiving bank (Bank B) unaware of the money’s origin, especially if the transferring bank (Bank A) is a small institution without a correspondent bank. The publication concludes that if the US Treasury approves this mechanism, it could lead to issues that the cash-dollar economy cannot manage.

According to El-Nakib the World Bank described the USD cash economy as the total USD in circulation, largely encompassing legal transactions within a heavily dollarized Lebanese economy. The cash economy’s size in Lebanon, calculated by comparing  “GDP from the expenditures side” to Gross National Disposable Income (GNDI) as published by the Central Administration of Statistics (CAS), reached a peak of $2.8 billion (5.6% of GDP) in 2015, escalating to $4.5 billion (14.20% of GDP) by 2020. Due to the lack of updated data from the CAS’ national accounts, the World Bank employed a tailored approach to estimate the cash economy for 2021 and 2022. This approach considered several USD cash circulation sources: withdrawals of pre-crisis foreign currency deposits, BDL’s foreign exchange interventions, USD remittances from the Lebanese diaspora, USD cash stored in homes since the crisis onset, USD cash entering Lebanon through both legal and illicit means, humanitarian and development cash assistance, and post-crisis USD bank deposits not affected by informal bank-imposed capital controls. The World Bank made several assumptions for its estimation, including the immediate conversion of LBP cash to USD at market rates to preserve purchasing power and the calculation of banking sector deleveraging by deducting foreign currency loans from deposits.

Moreover, it assumed that the net foreign currency deposits, after loan deductions, were withdrawn in compliance with BDL circular 158, either in cash or through discounted checks, contributing to the cash economy. Consequently, the World Bank estimated Lebanon’s cash economy at $6.05 billion in 2021, equating to 26.2% of nominal GDP, and $9.86 billion in 2022, accounting for 45.7% of GDP. The significant increase in the cash economy’s size in 2022 was attributed to a near halt in capital flight, largely due to stricter informal capital controls, and the relative increase in cash economy size as a percentage of GDP resulted from a drop in nominal GDP from $23.13 billion in 2021 to $21.55 billion in 2022.

The World Bank also noted that the prevalence of cash transactions heightens the risk of money laundering and creates more opportunities for tax evasion. The report cautioned that the growing reliance on cash transactions risks undermining Lebanon’s progress in enhancing the country’s financial integrity through robust anti-money laundering measures in the banking sector prior to the current crisis. Moreover, it observed that cash economies aid in obscuring the origins of funds used in illicit and illegal activities. Finally, the World Bank remarked that cash economies encourage informality among small and micro businesses and reduce productivity due to the lack of economies of scale, further exacerbating weaknesses in Lebanon’s tax code.

Lebanese Prime Minister Najib Mikati said the gray-listing was “expected, considering the known circumstances which hindered the establishment of the required legislation and financial reforms.”

Lebanon since late 2019 has been enduring a crushing economic collapse that the World Bank has called one of the worst in recent history, and which has hampered the work of public services and institutions.

Political deadlock

Lebanon’s relations with correspondent banks will not be impacted” by the classification, Mikati said, according to a statement issued by his office.

“Lebanon will continue to cooperate” with the FATF and will follow up on the move “in order to have it reversed,” he added.