Banking secrecy, introduced in 1956, has largely contributed to Lebanon’s reputation as a banking center in the Middle East. It has, through the years, attracted a lot of criticism, and envy, for various reasons. But it remains, to this day, one of the pillars of the Lebanese banking sector, and there is a widespread conviction among the Lebanese that it should be maintained and safeguarded. This, however, does not rule out an appraisal of the overall experience, particularly where its impact has not been exclusively positive, such as in private entrepreneurship.
Middle East Strategic Perspectives has met Simon Kachar, who has previously written on the subject, and asked him about the impact of banking secrecy policies on private entrepreneurship projects. Kachar holds an MA in Public Administration and is currently preparing his doctoral thesis. He is the founder of CIPRIL, the Civil Initiative for Public Reform in Lebanon. His work focuses on public policy and decentralization. Here is his paper addressing banking secrecy and private entrepreneurship:
The banking system in Lebanon prospered since the independence of the country in 1943 and a great improvement occurred in 1964 with the establishment of the Central Bank “Banque du Liban”. Then, banking secrecy law was enacted in 1956, but it is with the ratification of the Code of Money and Credit that regulations, supervision and control were set. The Lebanese banking system is considered to be “brilliant” with its several characteristics that promote the role of Beirut as a regional financial center, in terms of ensuring protection for foreign capitals and earnings.
The Banking Secrecy Law:
On September 3, 1956 and during the era of President Camille Chamoun, the Lebanese Parliament passed the banking secrecy law subjecting all national as well as foreign banks operating in Lebanon to the “secret of profession”. The law says that all bank managers and employees who are exposed in a way or another to banking activities cannot reveal any of the information they have concerning their clients’ names, assets or holdings to any other party whether individuals or public authority. Such information can be released only under three conditions: when granted written authorization by the client, in case of bankruptcy and in case of any litigation between the bank and its client. In order to ensure the security of banks’ investments, the law permitted for joint communication between banks; and under the provision of bank secrecy, the law allowed ensuring information related to the debtor accounts of their clients.
The Actual Banking System:
Besides the banking secrecy law and the Code of Money and Credit that are considered to be two major pillars in the Lebanese banking system, this system also has many characteristics that made it unique in the Middle East.
Five main characteristics of the Lebanese Banking System:
• Free exchange system and the free movement of capital and earnings
• Tax exemptions that offer exemptions from income tax on all interest and revenues earned on all types of accounts opened in Lebanese banks
• The free banking zone – decree no. 29, April 1, 1975 giving the Lebanese Government the right to exempt non residents’ deposits and liabilities in foreign currency from income tax on interests earned
• The provision to open joint accounts
• The continuous focus on fighting money laundering since the banking secrecy law could be used as a means for such illegal operations.
Given this overview of the Lebanese Banking System, the questions that need to be asked are, to what extent the banking secrecy law can be a positive point in the daily operations of the banking system and what are the consequences of such a law? How private entrepreneurship projects are affected by banking secrecy and by the banking system in Lebanon in general? Does this banking system hinder private entrepreneurship projects? Essential questions that will lead us, at the end of this series, to consider the need for a financial reform in Lebanon.
Central Credit Reporting:
A worldwide Perspective:
It is very well known that the lack of credit information hinders banks from widely offering financial services. Credit reporting can increase financial services for businesses in general. The centralized credit reporting is a very important factor to the growth of private projects in terms of getting more financial services and when it comes to credits and term loans. And because the current issue is an important part of good corporate governance, central banks and bank supervisors can provide an important mechanism for the implementation of good governance and ensuring transparency and disclosure in financial statements and other material information.
A Comparative Perspective to Lebanon:
The absence of the central risk for stocks and the fact non-obliging the private companies to release its financial statements to the public, because of the banking secrecy law and because of the absence of centralized credit reporting, is resulting in hindering private entrepreneurship projects indirectly – by the banking secrecy law or by the Lebanese banking system – which in its turn is allowing the two major reasons that are considered direct causes. To clarify, the absence of centralized credit reporting in addition to many other issues that we will discuss later on, are affecting directly, and indirectly through the banking secrecy law, the financing and development of the private entrepreneurship projects in Lebanon.
“Centrale Des bilans” in France Compared to Lebanon:
The “Centrale des Bilans” has been created by the Bank of France in 1968. It is since an important element of the statistical observation of French companies. More specifically, it is constituted of a base of given information from companies which will allow the analysis of such information contained in individual and sectoral levels and to study the successive states and major trends of the national productive system. Its main task and responsibilities is data collection and data processing.
Compared to Lebanon, this system is very different because of the banking secrecy. We mentioned in the introduction that information concerning clients’ names, assets or holdings cannot be revealed according to the banking secrecy law. This aspect is not allowing our banking system to have a unit like the “Centrale des Bilans” in France, which is forcing Lebanese banks to depend on private “espionage” companies to provide them with needed information on clients and potential clients who are looking for credits from those banks. Moreover, the exchange of information about clients between banks is also not allowed by law. This again shows how private entrepreneurship projects are hindered indirectly because of the Lebanese banking system
Companies House in London Compared to Lebanon:
Companies House is the United Kingdom registrar of companies and is an executive agency of the United Kingdom Government Department of Business, Innovation and Skills – BIS. As the “Centrale des Bilans” in France, one of the main functions of the Companies House is to examine and store company information delivered under the Companies Act, and related registration and make this information available to the public, who in turn can find and file any information on a company.
If we compare it to Lebanon, this is also very different from the actual system because of the banking secrecy and the codes, rules and regulations under it. If an entrepreneur’s credit ceiling in bank X is one million US Dollars for example, and he goes to bank Y to get some finance to one of his projects, bank Y will not give him any credit or financial services unless it is allowed for him to know about his potential client’s financial status in other banks. Bank Y will be able to know such information only if the client gives him a written authorization. The result of this operation will create something called “transaction cost” which will increase the cost of bank Y. It is a very complicated procedure which will lead to hindrance in some way or the other for the new project of the entrepreneur.
Till now we were talking about some general causes and we were examining an international perspective of some organizations in Europe along with a comparative study with Lebanon and we found that the absence of what is being followed in France and England in addition to the central Credit Reporting is playing a very negative role directly and indirectly on the private entrepreneurship projects in Lebanon. In addition to the causes, we have the problems. With the problems, we will enter deeply into the Lebanese banking system, the way of doing business and many other reasons and factors to examine how it negatively affects private entrepreneurship projects.
The Absence of Term Finance:
Most of the loans in the Lebanese banks depend on the personal relationship between the banks’ senior executives and the borrowers, resulting in insufficient project finance and term lending. Project finance is a kind of loan for the long term for industrial and infrastructural projects. Project finance involves a corporate sponsor investing in and owning a single-purpose industrial asset, usually with a limited life, through a legally independent entity financed with nonrecourse debt. In the Lebanese banks everything is taken from a personal perspective, something that I call “personal relationship banking”. So it is very clear that there is neither a structure nor an index for the term finance: a very serious problem that stops the development of private entrepreneurship projects and moreover will lead us to consider that Lebanese banks are for elite people and selected citizens when it comes to term finance, project finance and term lending.
The “Shy” Stock Market (Almost Absent):
Another major problem in the Lebanese banking system is that most of the private companies were not able to expand their business and direct themselves to the stock market, which resulted in their dependency on banks to expand their projects. It is internationally known that the source of finance in any market is divided equally into three categories: one third of the profits, one third of the banking finance and one third of the market bonds and stocks. In the Middle East, instead of one third (33.33%) we only have 6% from the market bonds and stocks source and in Lebanon; the rate is much less than 6%. This dependency on the banking sector is the second major problem after the absence of term finance or what we called “personal relationship banking” which is hindering and affecting directly the private entrepreneurship projects in Lebanon.
The Commercial Bankruptcy Issue:
Commercial bankruptcy in Lebanon takes place under the civil judicial system and it is never considered a criminal/penal act. So the bankrupted entrepreneur will not be assigned for any penalty. For a bank to know about the bankruptcy of any person or entrepreneur, it will take around 700 days. When a problem occurs with any Lebanese entrepreneur or businessman, he will announce unofficially his commercial bankruptcy; his case will go to courts. The courts will pronounce that this person is financially bankrupt, only after a long time. And because this kind of bankruptcy is not considered as a criminal/penal act as we mentioned before, the information will not be publicly announced, which will have a negative effect on banks because they will face a lack of information. For the banks, lack of information plays negatively in financing private projects. We can consider the non-announcement of commercial bankruptcy a third major problem that hinders private entrepreneurship projects in Lebanon.
Old & Classical Way of Doing Business:
The lack of term finance, the absence of stock market and the commercial bankruptcy issue are three major problems causing a “stand still” situation in the Lebanese banking system. In the year 2000 and for a long period of time, there was a trial from the Lebanese Central Bank with the Lebanese Chamber of Commerce and Industry and with private banks to have a unified goal and to coordinate and cooperate to reach desired goals for everyone in terms of encouraging SME finance and in terms of encouraging the involvement of every sector. However, the chamber of commerce and industry along with the private banks were not cooperative in this matter, which resulted in no change in the system.
As a first impression, and after a quick review of what we have passed through, we can say that the first finding is that the banking system in Lebanon is not flexible as everyone perceives. The main characteristic of the Lebanese banking system is the banking secrecy law. This law is excellent from one single perspective. On the other hand, this law is imposing a lot of negative points that are affecting the Lebanese banking system and are hindering private entrepreneurship projects. It is very important to say that the Lebanese banking system is a safe system. But is it enough?
Another finding is that Lebanese banking is still far from being professional when it comes to dealing with entrepreneurs, because most of the credits and loans are decided based on the relationship between the banks’ senior managers and the borrower, a fact that is taking it very far from investment banking and its tools (private equity and venture capital). In other terms, it is the absence of term finance.
The shy participation in the stock market is also a disadvantage for private businesses in Lebanon, because they are becoming so dependent on the banking sector to expand their businesses; and here we can see how the cycle is being repeated again and again.
We can say that banking secrecy does not hinder private entrepreneurship projects directly, but those projects are indirectly affected by the problems that we stated, and by the lack of access to information; facts that are considered to be indirect results of the banking secrecy law or act.
At this point, we can state that the Lebanese banking system is not that flexible as earlier perceived and that everything is interconnected and that the banking secrecy law is a good thing at times and a threat otherwise, because as a law, banking secrecy is imposing many direct and indirect things on the banking system, which, at the end, is considered to be hindering private entrepreneurship projects even indirectly.
Investment Banking (Banquesd’Affaire):
Investment banking is different from commercial and retail banking. The main difference is that investment banking doesn’t take deposits. Investment banking is a field of banking that aids companies in acquiring funds. In addition to the acquisition of new funds, investment banking also offers advice for a wide range of transactions a company might engage in. Usually the main lines of business of investment banks in Lebanon are asset management, wealth management, corporate finance and brokerage. Most of the banks in Lebanon do have a license for investment banking and investment banking could be an efficient solution to the problems that we examined before.
Unfortunately, investment banks in Lebanon are restricting their activities in taking capital from commercial banks and investing them in bonds. In my opinion, by doing this, investment banks are losing the chance of participating in the growth of private entrepreneurship projects in Lebanon.
As a tool to the major solutions – investment banking – which is considered to be a good solution for the Lebanese banking system, private equity is an investment vehicle used to make investments in various equity. Private equity funds play an increasingly important role in addition to their significant day to day involvement as board members and advisers.
Venture capital is a type of private equity and a tool of investment banking. Venture capital funds are pools of assets that are created by the involvement of multiple investors. Generally, a venture capital fund is created for the purpose of engaging in a specific business-related project or enterprise.
Venture capital and private equity as major tools of investment banking if used properly and professionally could be another solution to the problem that we called before “personal relationship banking”.
Encouraging Stock Exchange:
We mentioned before that the stock market is something uncommon in Lebanon which resulted in the dependence of private companies on banks because they were not able to expand their businesses to reach the stock market. A public policy along with public awareness on the importance of stock markets is highly required and will be considered as a solution.
Is it the right time for a financial reform in Lebanon? Let’s not answer now and let’s state what can be good recommendations to our problem.
Lebanon is globally ranked 87 in terms of getting credit!
• An official agency to provide information for banks about borrowers is highly recommended. Credit registries, institutions that collect and distribute information on borrowers, can greatly expand access to credit. By sharing credit information, they help lenders assess risk and allocate credit more efficiently. They also free entrepreneurs to rely on personal connections alone when trying to obtain credit.
• The commercial bankruptcy issue should be reconsidered in a way that its inefficiency will no more be a deterrent to investment.
• Investment banking should be operating on the right track and not only in taking money from commercial banks and investing them in treasury bonds because of the high interest rates.
• Stock market should also, in its turn, be considered by the businesses, because it will decrease the dependency of those businesses on the banking sector to expand.
• Banking secrecy law in itself is a good characteristic for the Lebanese banking system. But this should have a “full stop”, a strict limitation because it is related to many other things and it is stopping or curbing many other potentially positive things. By doing that, banking secrecy is hindering, in a way or another, directly or indirectly through the related and interconnected issues, the private entrepreneurship projects in Lebanon.
It is the right time to answer on the question raised, and in my opinion it is the right time for a financial reform in Lebanon!
Based on the findings, and considering that Lebanon is ranked 87 overall for getting credit, and based on the fact that Lebanon doesn’t have any official agency for providing information, and based on the absence of term finance, stock market, private equity and venture capital; based on all those facts and on the fact that Lebanese banking system is so interconnected and interrelated in a negative way, I think that we reached a point where the Lebanese Government should interfere in a way or another, in cooperation with the Lebanese Central Bank and the Lebanese Banks Association and with the help of the civil society, hoping that they will play the role of agents for change and reform. I hope that everyone will join those stakeholders in advocating good governance, in fighting all the stated problems. It is a strategic venture and an investment that the Lebanese Government, along with all the concerned individuals and associations, owe the Lebanese private entrepreneurs specifically and the Lebanese community as a whole.