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Lebanese central bank governor inflated assets as liabilities grew -audit

Credit: REUTERS/Mohamed Azakir

Lebanon's central bank governor inflated the institution's assets by over $6 billion in 2018, its audited annual accounts show, underlining the extent of financial engineering used to help prop up the country's economy.

 (Repeats story first published on July 23, text unchanged)
    By Samia Nakhoul and Tom Arnold
    BEIRUT/LONDON, July 23 (Reuters) - Lebanon's central bank
governor inflated the institution's assets by over $6 billion in
2018, its audited annual accounts show, underlining the extent
of financial engineering used to help prop up the country's
economy.
    The financial statements for 2018, a copy of which was seen
by Reuters, were signed off with qualifications by EY and
Deloitte just last month, and have not been made public. 
    The accounts show how the central bank managed to balance
its books while helping to fund an ever-widening government
deficit, including recording a 10.27 trillion Lebanese pound
($6.82 billion) asset described as "seigniorage on financial
stability".
    The accounts said governor Riad Salameh "determines on a
yearly basis the amount that should be allocated from the
liability balance from seigniorage to deferred interest expense
and other finance costs".
    Most central banks record seigniorage, usually defined as a
profit made from printing money, as an income stream. But
Lebanon's central bank was recording expected seigniorage
profits as an asset, according to the annual financial statement
for 2018, prepared by the central bank and reviewed by EY and
Deloitte.  
    "The item that deals with seigniorage is total fiction,"
said Steve H. Hanke, Professor of Applied Economics at the Johns
Hopkins University and a central banking expert.
    In an emailed response to Reuters, Salameh rejected the
notion that the central bank's accounting was used to make its
financial position appear stronger or to hide losses, saying it
was in line with accounting policies approved by its board, as
stated in the 2018 financial statements.
    "Several central banks adopt cost deferral in order to
achieve their objectives and deliver on their mandates," he
wrote, without identifying those banks. "Banque Du Liban had to
adopt it for relatively larger balances and for longer periods
compared to other central banks as Lebanon has been witnessing
exceptional circumstances for most of the past 15 years."
    He said "deferred costs" had been accumulated over that
period because of the central bank's intervention to support
government finances, pressured in the wake of public servants'
salary rises and the impact of an influx of Syrian refugees on
the economy since 2011.
    Deloitte declined to comment. EY did not respond to a
request for comment.
    The outlines of the central bank's accounting approach were
first reported by the Financial Times. 
    Explaining why they were signing off on the accounts with
qualifications, EY and Deloitte listed a number of factors
including being unable to confirm all deposit balances and being
unable to conduct an in-person inventory of the bank's gold
reserves.
    In addition, Deloitte and EY said the central bank used an
accounting and financial reporting framework adopted by its own
council, rather than International Financial Reporting Standards
(IFRS). They said their own audit was conducted in accordance
with International Standards on Auditing.
    The central bank's unusual approach is permissible because
there is no global standard for central bank accounting.  

    FINANCIAL ENGINEERING
    During Salameh's 27 years in charge, the governor has used
what he has described as "financial engineering" to keep
Lebanon's public finances afloat and defend the pound's peg to
the U.S. dollar, chiefly by attracting dollars from local banks
with high interest rates.
    The International Monetary Fund described Lebanon's central
bank as "the linchpin of financial stability" in an October 2019
report "but at the cost of intensifying sovereign-bank linkages,
which pose risks to banking sector stability, and weighing down
its balance sheet while protecting banks' profitability." 
    Salameh has publicly defended the strategy.
    "This engineering, we were forced to do it to buy time for
Lebanon, so Lebanon could reform," he said in a televised
address in April. [nL8N2CH0LA]
    But an economic crisis that has led Lebanon to default on
foreign currency debt and seen the currency plunge by 80% has
shaken his reputation as a pillar of stability, and Salameh has
become a focus of anger for street protesters. 
    Prime Minister Hassan Diab said on Tuesday that turnaround
specialist Alvarez & Marsal would conduct a forensic audit and
KPMG and Oliver Wyman a financial audit of the central bank amid
a dispute over the scale of the financial losses facing the
institution. [nL5N2ES4JI]
    The 2018 report shows a number of methods used to inflate
assets and minimise liabilities of the central bank, which the
government and the IMF, from which Lebanon is seeking support,
say is $50 billion in the red.
    As well as the unorthodox seigniorage accounting, the
central bank also booked supposed profits on lending to the
government. The cost of interest paid to banks at rates of
between 10% and 20% was meanwhile constantly deferred, building
up huge future debts, the statements show.
    The statements also refer to the central bank purchasing
treasury bills from the banks at a premium carried over
unamortized, meaning it should be treated as a liability on the
central bank's balance sheet. 
    "Central banks don't have strict rules like companies do,
IFRS or GAAP," said Mike Azar, a senior financial adviser based
in Lebanon, referring to international accounting standards.
    "But there are good practices they should follow. One is not
to show losses and resulting negative capital as fake assets."
    
    GOLD RESERVES
    Talks with the IMF that began in May are on hold while the
government and central bank argue over the scale of losses in
the financial system -- estimated at nearly $69 billion by Alain
Bifani, a former member of Lebanon's negotiating team with the
IMF -- and how they should be shared.
    The most recent central bank data show it had assets of $152
billion last month. According to research by Credit Libanais,
that included "other assets" valued at $48.2 billion in
mid-June, 61% higher than a year before, a rise the investment
bank attributed to seigniorage, open market operations and an
appreciation in gold reserves.
    The 2018 statements showed the central bank held gold worth
10.61 trillion pounds on which the auditors were unable to
perform a physical inventory due to a "policy which gives access
exclusivity to top executives of the bank". 
    One accountant, who spoke on condition of anonymity, said
that should have raised a red flag given the central bank's
asset position and credibility was under scrutiny. 
    In his email to Reuters, Salameh said he had recently
approved a physical count of the gold which the bank's external
auditors would be asked to attend, with the aim of completing it
before the 2019 audit is finalised. 
    The accountant also said it was not best practice for the
central bank's financial statements to be released so late. 
    A September 2018 paper by the IMF said more than half of
central banks publish their statements within nine months of
their financial year-ends.
    Salameh blamed delays to the 2018 audited statements on the
"unusual circumstances and social unrest" in Lebanon since
October 2019 and the lockdown caused by COVID-19. 
    Asked about the 2018 report, Bifani, the second member of
Lebanon's IMF team to quit last month, said:
    "The most glaring thing is how they're hiding the losses. He
is trying to inflate his assets as much as possible."

 (Editing by Catherine Evans and Carmel Crimmins)
 ((samia.nakhoul@thomsonreuters.com;))

Keywords: LEBANON CRISIS/CENTRALBANK (REPEAT, UPDATE 1, PIX, TV)

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