311 SANCTIONS CASTING A SHADOW ON THE CBS'S FUTURE

C O N F I D E N T I A L SECTION 01 OF 02 DAMASCUS 000173 SIPDIS SIPDIS NEA/ELA; NSC FOR MARCHESE; TREASURY FOR LEBENSON/GLASER E.O. 12958: DECL: 02/14/2017 TAGS: ECON EFIN SANC ETTC PREL KTFN SY SUBJECT: 311 SANCTIONS CASTING A SHADOW ON THE CBS'S FUTURE REF: A. 06 DAMASCUS 02063 ¶B. 06 DAMASCUS 05285 ¶C. DAMASCUS 00127 Classified By: Charge d'Affaires Michael Corbin, reasons 1.4 b/d ¶1. (C) Summary. Financial sanctions under USAPATRIOT Act Section 311 continue to put pressure on the Commercial Bank of Syria (CBS) nearly a year after the final ruling was imposed. Nonetheless, the CBS, up till now, is managing to maintain its central role in Syria's banking sector. While some international banks and financial institutions have terminated their relationships with the CBS, the SARG is trying to counter sanctions on the CBS by using envoys to Europe, financial conferences in Syria, and efforts to influence the local diplomatic corps. Yet, regardless of the CBS's continued dominance of Syria's banking sector, 311 sanctions have created difficulties for the CBS that could hasten its demise in the longer term. End Summary. ¶2. (SBU) OVERVIEW OF 311 SANCTIONS AGAINST THE CBS: The CBS is the largest of six state-owned banks in Syria with more than 65 branches. The CBS continues to control more than 80 percent of Syria's banking market, as well as a majority of the SARG's foreign currency reserves, which total USD 12 billion or more. Since the nationalization of the banking sector in the 1960's the regime has empowered the CBS to perform many functions normally executed by a central bank to help centralize financial authority. The CBS's power also derives from its role as primary banker for corrupt business deals that put money in the pockets of regime members -- from non-performing loans for questionable public enterprises to kickbacks during the oil-for-food scandal. In March 2006, the U.S. Department of Treasury issued a final ruling that imposed a special measure against the CBS pursuant to USA PATRIOT Act Section 311, and its subsidiary, the Syrian Lebanese Commercial Bank, as a financial institution of "primary money laundering concern," due to a reasonable belief that it had been and may still be exploited by criminal and terrorist enterprises. Of all the USG sanctions on it, the SARG has demonstrated the greatest concern about the Section 311 sanctions. In the first year the sanction was threatened (2004 - 2005),the SARG expended considerable energy to avoid its imposition by implementing a number of requested reforms. The SARG is currently continuing to campaign on CBS's behalf to limit the impact of the sanction. ¶3. (C) HOW SANCTIONS HAVE AFFECTED THE CBS: The CBS claims its profits are growing, but at the same time has publicly complained that sanctions have impeded its operations. (Note: Local banking contacts state that the CBS's lack of regard for internationally accepted banking and accounting standards brings the bank's profit numbers into question. End Note). On January 7, 2007, the Chairman of the CBS, Dureid Dergham, publicly stated that 20 international banks terminated correspondent accounts with the CBS. Local banking contacts agree that third-country banks are continuing to terminate their correspondent relationships with the CBS, and at a rate higher than what the CBS has publicly admitted. Additionally, the CBS has historically held significant portions of its assets in dollar accounts, but as foreign banks have refused transactions involving dollars with the CBS, the CBS has been forced to assume the transaction costs of converting these dollars into other currencies. Businessmen, especially private importers and foreign companies, are also deserting the CBS because of its difficulties with dollar transactions and because private banks are now offering better, and more timely, services. ¶4. (C) CBS RETAINS PLACE IN SARG POWER STRUCTURE: Despite sanctions, Dergham appears to be holding his own against his likely competitors, the Minister of Finance, Mohammed Hussein, and the Governor of the Central Bank, Adib Mayaleh. Moreover, the CBS is still carrying out the functions it has performed over the past forty years. For example, there is no indication that the SARG has shifted large, hard currency reserves from the CBS to the Central Bank, as was expected. The CBS also continues to maintain exclusive control of public sector contracts (ref A). Riad Obegi, Chairman of Banque Bemo Saudi Fransi, stated that his foreign clients cannot directly receive funds into their private bank accounts from Syria's public sector oil company, but instead are forced to receive these funds through the CBS. Local banking contacts also state that the CBS has developed DAMASCUS 00000173 002 OF 002 alternative methods of operation to evade the difficulties created by the sanctions. This includes reaching out to smaller European banks still willing to conduct business with them and the SARG's 2006 decision to switch half of its foreign currency reserves from USD to Euros. Local banking contacts report that many European banks have indicated a willingness to do business with the CBS in Euros, but not in dollars which need to pass through the U.S. banking system. ¶5. (C) SARG ATTEMPTS TO MANAGE 311 SANCTIONS: The SARG has sent Deputy Prime Minister for Economic Affairs, Abdullah Dardari, and other SARG officials to various European capitals to encourage European governments and banks to maintain accounts at the CBS. Dardari and others have also worked to enlist Europeans' support against the USG sanctions, which the SARG claims are politically motivated and responsible for hindering the SARG's economic reform efforts. The SARG has also engaged the resident diplomatic community and used SARG-sponsored regional financial conferences attended by the IMF and other financial institutions to assert that the USG is wrongly and unfairly punishing the CBS (ref B). In addition, the SARG has toasted the results of the recent peer review of Syria's anti-money laundering systems conducted by the Financial Action Task Force of the Middle East and North Africa (MENA-FATF), claiming it proves the sanctions against the CBS for money laundering are unfounded. The SARG recently announced the CBS will conduct an audit to prove its financial practices are sound. The SARG's propaganda appears to be moderately successful, at least with members of the resident diplomatic community, who point to the EU Parliament's recently restarted debate over the EU Association Agreement as a sign that the EU may be considering breaking with the USG on linking economic issues to their opposition to objectionable SARG political policies. ¶6. (C) 311 SANCTIONS ALSO HAVE A LONGER-TERM EFFECT: Despite the SARG's best effort at damage control, 311 sanctions are exploiting some of the CBS's existing vulnerabilities. While expending significant effort to condemn the 311 sanctions internationally and develop alternative operating methods, the CBS has neglected critical internal reforms. The pressure to streamline overhead costs is growing because of the CBS's increasing need to compete with the nascent, but growing private banks (ref C). (Note: The CBS has a ratio of nearly 70 workers per bank branch, as opposed to a ratio of 20 workers per bank branch in the private sector. End Note). In late 2006, the Dutch Bank ING even stopped providing technical assistance to the Ministry of Finance for a banking reform project due to concerns of involving itself with the CBS - contributing to the project's delay. Furthermore, while the SARG is protecting the CBS, the sanctions have also spurred the SARG to develop alternative financing mechanisms that could erode the centrality of the anachronistic CBS. This includes SARG efforts to develop a Syrian stock exchange, expand its ties to international financial markets, and build capacity within the increasingly assertive Central Bank so that it can fulfill the traditional central bank role of managing monetary policy. ¶7. (C) Comment: While the CBS has managed to overcome some of the technical hurdles presented by the 311 sanctions and maintain its position in Syria's banking sector, the sanctions are hampering the CBS's operations. The SARG's vigorous campaign against the 311 sanctions reflects the value it currently places in the CBS - as a central financing mechanism for its questionable business ventures - and its concern that the sanctions are both damaging the CBS and the "reformist" image the SARG is trying to project externally. Nevertheless, the sanctions are exacerbating the CBS's internal vulnerabilities - speeding the trend of Syrian and foreign investors moving their business to the growing private banking sector and encouraging the development of other Syrian financial institutions that can fulfill functions previously dominated by the CBS. These pressures are undercutting the CBS's previous monopoly on banking issues and undermining the CBS's ability to maintain power in the longer term. CORBIN