Contentious Path for Lebanon’s Forensic Audit

Thursday, November 5, 2020
Opinion by Jean AbiNader
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Lebanon built its reputation as a regional financial center on its weakly-regulated, well-run banking system, flows of capital from international investors and expatriates, and secrecy laws which have been both beneficial and a source of controversy. Over the past decade, Lebanon rushed headlong into becoming the third-worst indebted country in the world, importing more than 80% of its consumption and using “financial engineering” to prop up the currency. A collapse was inevitable. Maintaining an artificial exchange rate value of approximately 1500 lira, the local currency, to the dollar, as capital inflows decreased and wealthy bank depositors started transferring funds abroad, the once vaunted financial system eroded and became bankrupt.

The demands for widespread economic, financial, political, and social reforms are an intrinsic part of any international rescue effort, along with accountability for public sector spending and the outflow of capital. Whether the demand is coming from the International Monetary Fund (IMF) or international donors grouped under the 2018 CEDRE program including the International Support Group, the list of mandatory steps for external fiscal support include two key provisions: a forensic audit of the Central Bank by an external firm to track funds within the system and those that have been allowed to leave; and a restructuring of the banking system to show credible balance sheets, adequate capital liquidity, and protection of all deposits.

Despite many promises made by the government, it has been challenging to move forward with banking reform and the forensic audit. First, the Ministry of Finance put a number of restrictions on the scope of the audit to exempt transactions allegedly tied to influential individuals and institutions. Then the Central Bank, the target of the audit, sought to further restrict the investigation by limiting the types of transactions it would submit for review. This latest move so upset the Caretaker Prime Minister Hassan Diab, who had resigned along with his government because of systematic blocking of reform measures by the oligarchy, that he called out the Central Bank in a public statement.

“I warn against trying to overthrow the forensic audit to prevent the Lebanese from knowing the truth about the reasons behind the disappearance of their deposits, the causes of the financial collapse, and the deliberate manipulation of the national currency,” Diab said. “Any attempt to obstruct the forensic audit constitutes a shared responsibility for the suffering of the Lebanese people on the financial, economic, and living levels,” he added.

Diab pointed out that the Central Bank of Lebanon (BDL) has only delivered 42% of the documents requested by the auditing firm Alvarez & Marsal. The BDL responded that it could not submit the documents and that function should be done by the government, which signed the contract to conduct forensic auditing of the accounts of the Central Bank to determine whether there were clear violations or financial irregularities. Diab noted that “that the forensic auditing contract signed by the Lebanese state is consistent with the provisions of Banking Secrecy Law and the Monetary and Credit Law. Any reform that does not start with a forensic audit of BDL is a sham reform to cover up the continuation of the approach that led to the current financial collapse,” Diab added.

Resistance to banking reform is also evident in attempts to restructure the banking sector. Although the government has mandated a number of steps to clear up balance sheets, protect deposits, limit capital flight through implementation of capital control regulations, and pushing for individual banks to prepare to implement restructuring plans, most of these directives have been ignored.

The latest circular by the Banking Control Commission dealt with the recapitalization of banks, which has been a very controversial subject. It requires banks to specify how they will abide by the minimal capital ratio of equity required to do business. As explained by Byblos Bank Economic Research and Analysis Department, the requirement for recapitalization of the sector includes several factors: a five-year business plan to strengthen the bank financial position and profitability; a clear demonstration of how the bank will make provisions for its holdings of government debt including loans to the government; provisions for private sector loans; and that “each bank clearly specifies the options it has to increase its stock of capital, such as transferring profits to the capital account, reevaluating its real estate holdings,” and its options for reducing risk-weighted assets.

When asked about the chances for this latest directive to be implemented, several financial advisers responded that there is a very low chance since it mandates that banks raise their Tier 1 capital ratios(i), or sell assets to meet the ratio requirements. Another agreed saying “This is wishful thinking on many levels. First, it involves equity capital. Any takers? Existing owners will be severely diluted so the bank owners don’t like it. What the bankers want is a bailout which they’re not going to get.”

Without strong leadership from the government to reduce public expenses and a commitment by the private banking sector to take the steps needed to set the financial sector on the road to recovery, the suffering of Lebanon will only continue and the desperation becomes even more widespread.


i. Tier 1 capital is the core measure of a bank’s financial strength from a regulator’s point of view. It is composed of core capital, which consists primarily of common stock and disclosed reserves, but may also include non-redeemable non-cumulative preferred stock. In Lebanon’s situation, banks hold 80% of the country’s debt and are reluctant to downgrade the debt and therefore diminish equity on paper.

The views and opinions expressed here are those of the author and do not necessarily reflect the position of the American Task Force on Lebanon.