IRAQ-ITALY: REPERCUSSIONS OF THE BNL-ATLANTA SCANDAL

Created: 11/6/1989

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DIRECTORATE OF INTELLIGENCE

69 Iraq-Italy: Repercussions of the BNL-Atlanta Scandal

Summary

The revelationS branch of an Italian bank. Banco Nazionale del Lavororanted more than S3 billion in unauthorized letters of credit to Iraq has hadwide-ranging repercussions for Iraq and Italy. For Iraq, public disclosure that it used some of the credits to acquire military-related technology has impeded procurement efforts, and the suspension of BNL credits has slowed civilian reconstruction and development projects. For Italy, the BNL scandal has cast atemporary shadow on Prime Minister Andreotti's new government, raised questions about public-sector enterprises, and reopened the issue of privatization.

The affair is unlikely toajor impact on Iraqi military procurement efforts, but cash-short Bagfidad probably will nave to postpone plans for some civilian projects. The loss of BNL financing and, more important, any reduction in US agricultural credit guarantees because of negative publicity about the scandal probably would damage US-Iraqi commercial ties. For Iraq's part, however, the strain in political relations is likely to be short-lived, particularly if Baghdad believes US credit guarantees will be forthcoming. Iraq is eager to maintain good ties to the Unaed States, an attitude intensified by improved relations between Iran and the USSR |

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BNL-Atlanta Financing for Iraq

iTiwt<iforP* bran?'SiS* state-owned Banca Nazionale del Lavoroargestillionnauthorized letters of credit

?SS authori?ies haveinvestigating the scandal since Jury for violations of banking regulations and lax and customs laws.

BNL-Atlanta's unusual activities included:

Exceeding the branch's allowable debt0 per customer.

Charging Baghdad anercent commission instead of the usualercentoor credil risk.

f credit borrowing from other banks ISO days but allowing Iraq up to five years to repay.

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eadquarters in New York and the bank's directors in

alS ftH theJSlena BNL official in

Chicago claims he notified New York and Rome several times about the unusual

JflKS accJrdmgrCSS Tcp?m-also indicatcbranch in IJdinc Italy referred customers exporting to Iraq to the Atlanta branch. Iraqi

vkTn.in the'sSndalkjlw,cdse^arguing that Baghdad is a

used some BNL crcdiis-al0 million, according to British press-to firrns inWe^raSggfi ^nous front companies and legiWa.c

snri8NL-by far Baghdad's largest source of credits-

SISSS!? PS* ,hcilitary-related

technology has almost cenainly complicated Baghdad's procurement efforts. We

easItemporarily impairedbdity to acquire such technology. Press coverageon's

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pryggfoa to Iraq's conlro!ompany possessing sensitive technology, for example, led SRC Composites to divest its advanced composites factory, according toome other firms in the networks have gone out of business, I

The loss of BNL financing has almost certainly slowed civilian reconstruction and development in Iraq. ManylJS and West European firms supplying Roods and services to projects in Iraq were being paid through BNL, I

of these firms have probably suspended misanesswun iraq unt SsSfSSSS of payment-cash, other loans, or barter-are arranged. Financially strapped Baghdad, however, is unable to meet demands by some of these firms for

Iraqi Procurement Networks

caicd complex procurement networks of holding companies in Western Europe to acquire technology for its chemical, biological nuclear and

'According to Britishjl^p^

sucn network begins Jxfflagnaauwnri

the London-based Technology and

Development Group, Ltd. (TDG) and another UK firm, TMGits Brussels-based partner, Space Research Corporation, own theTechnical Corporation, Ltd. Canira in March established

SRC Composites, which acquired access to advanced composite and carbon fiber technology used in aircraft and missile production.7 TMG gained control of Matrix-Churchill,he United Kingdom's leading producer of computer-controlled machine tools that can be used in the production of sophisticated armaments.

Forany reduction in bilateral commerdal ties because of the BNLon political significance, which Baghdad-ever paranoid-tends to exaggeratefrom the scandal has strained US-Iraqi relations. Baghdad isthat the affair is adversely affecting its economic ties to the Unitedbackbone of the bilateral relationship. Iraq is particularly upset that thesignificantly less credit guarantees forhan Baghdad requestednegative publicity about the scandal. Iraq fears that any lar^reduction inguarantees would make it more costly and difficult to import agriculturaldamage its international credit rating.

Several US firms have already been affected by the scandal, press reporting indicate BNL was financing at least SI billion inirms, including agricultural goods, an automobile plant, an ethylene plant, indl

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machinery, construction materials, and irrigation equipment. Some US suppliers arc worried that they will not receive payment on letters of credit that they have not vet submitted to BNL-Atlanta. Many US firms are trying to arrange other means of payment to avoid losing lucrative contracts. I

The scandal has contributed to Iraq's perception that the United States is trying to hamstringfforts to promote better politicalenior Iraqi official told his US counterpart in early October that Baghdad was unhappy that Washington's decision on CCC credits is linked to the scandal, with which he maintained Iraq had no pan. The ottoahndicatcd this wasign that the United States wants to improve relations.

m Baghdad is eager to resolve the BNL crisis because harmonious bilateral relations are important to its strategic planning. Iraq believes that the Iranians have not abandoned plans to oust the regime in Baghdad and wants to assure that the superpowers would back Iraq or at least remain neutral during any future hostilities Inc Iraqis seek to prevent Washington from favoring Iran so much that Baghdad's interests are threatened- In Iraq's view, the superpowers regard Iran to be of greater importance in the region, and Baghdad is therefore trying to enhance Iraq's political and economic importance to the United States. I

Impact on Italy

L ^air-in combination with other scandals-hashadow on Prime Ministerhree-month-old government. Partly to divert attention from the unl attair, the Socialists and some Christian Democrats are playing up other scandals SwSr5llegations that the Italian military covered up evidence concerning'0 crash of an Italian airliner north of Sicily. None of the governing political parties or their factions, however .appears now to believe it can strengthen its relative positions by exploiting the issue. I

The scandal has also spotlighted the cost of Italy's longstanding and entrenched spoils system in the state-owned enterprises. Traditionally, appointments to key positions in public-sector companies have been allocatedeasure of party and even factional influence. Under this system, the president and several directors of BNL are members of the Italian Socialist Party, while the executive director usually comes from the Christian Democratic Party. Several backbenchers in parliament quickly denounced the spoils system for not allowing the most competent people to fill public-sector jobs. The attacks, however, have been discounted as political sour grapes, and the system shows no signs of collapse. |

In light of the BNL affair, Treasury Minister Carli-has renewed his efforts-against admittedly long odds-to enlist support for privatizing state-owned banks and other public-sector corporations. Carli believes the breakdown in supervision at BNL is all too typical of the quality of Italian public-sector banking. In his opinion, privatization would force Italian banks to narrow theercentage-point spread between interest paid to depositors and that charged torerequisite if Italian banks are to do well after the EC dismantles capital controls next year. |

The discovery of BNL's exposure in Iraq forced the bank to seek funds to boost its capital, which the Bank of Italy already considered too low. If Iraq defaulted BNL technically would have been bankrupt because the amount of its loans to Iraq exceeded

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the bank's capital. In that event, the Bank of Italy and the Treasury Ministrybeen compelled to bail out the bank. Rome was stymied in finding ainstitution to recapitalize the bank by itself, and the government incobbled7 billion package from the Treasury, acompany, and the Social Security Fund, thusocialistthe BNL board of

We believe the revelations of BNL's dealings with Iraq-along with otherin counterpoint tu growing Italian self-confidence on thein recent years. After more than three decades of international diffidence,Italian leaders have beeniplomatic profile moretheir country's international economic role. Italians have felt particular

Italian troops in tbe Beirut peacekeeping forces had fulfilled their mission as defined by Rome.

The Italian decision to accept US cruise missilesecisive role in swinging West Germany behind deployment

Their country's GDP had surpassed that of the United Kingdom and possibly France.

In the opinion of almost all Italian press commentators, tbe BNL affairegative impact on Italy's credibility throughout the West. We believe, however, that the setback to Rome's international standing has been substantially less than that portrayed in the Italian press, and we expect the scandal will gradually fade from public view within Italy and will have little lasting impact on the country's perception of its international role

Outlook

We believe Iraq will work hard to establish new military procurement networks to replace those disclosed by the press and by the US and Italian investigations as part of the fallout from the BNL affair. Baghdad highly values these networks to obtain technology that might otherwise be denied to it if the end user or purpose were revealed. Because of renewed Iraqi efforts and the likely existence of other networks that remain undetected, we do not believe that Iraq's covert procurement efforts will be set back seriously. |

The drying up of this major financial source-at least for the next several years-will probably force Iraq to scale back ambitious civilian reconstruction and development plans. Baghdad probably formulated some economic plans under the assumption that BNL-Atlanta would continue to issue letters of credit on its behalf. Iraq will be unable, however, to replace BNL financing any time soon. Most commercial banks and foreign governments are likely to remain unwilling to grant or

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arantee significant new credits to Baghdad until it repays more ofillion non-ab foreignow priority to Iraq. Furthermore, Iraq has overextended its barter commitments and will probably be reluctant to engage in many more such deals. I

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The BNL affair will probably haveinimal impact on Italian-Iraqi relations. The scandal is unlikely to cause more than short-term political friction unless BNL fails to disburse the remaining letters of credit. Even then, Baghdad would probably employ economic-not political-means to punish Rome, Continued Iraqi threats to suspend payment to Italian firms if Rome fails to release the promised BNL credits will almost certainly be effective against the Italians, who have already agreed to release some of the undisbursed credits and have backed down in the past in the face of threats from other countries.

We have detected no sign of flagging Italian interest in Iraq, although we expect that Italian banks will scrutinize export financinc and other credits for Baghdad more carefully. The Italians are maintaining existing levels of oil imports from Iraq while still trying to boost exports. Italian-Iraqi relations will continue to be strained, however, by the dispute over the delivery of Italian warships to Iraq, which is unlikely to be resolved any time soon because of Iraqi demands for additional financing for the ships and Iranian threats of retaliation against Italy if the ships are delivered. I

Implications for the United States

Tbe BNL scandal is likely to leadeduction in US-Iraqi commercial relations, particularly if CCC credit guarantees are decreased. Any loss of CCC credits probably would reduce Iraq's food imports from the United States because Baghdad prefers to buy on credit. Iraq probably would turn to Australia and EC countnes-which lost sales when the United States became Iraq's top Western agricultural supplieras well as traditional suppliers Turkey and Brazil. Many of these suppliers are already trying to profit from the BNL scandal by boosting agricultural sales to Iraq at US expense. Furthermore, the bank's continued refusal to disburse remaining credits probably would prevent some US firms from implementing contracts with Iraq, ^

The strain in US-Iraqi political relations caused by the BNL scandal will probably be short-lived, particularly if Baghdad believes additional US credits will be forthcoming after the dust of the investigation settles. Iraq is eager to maintain good ties to the United States, an attitude intensified by improved relations between Iran and the USSR that make Baghdad uneasy. Iraq probably also believes that strained political relations would complicate its efforts to acquire US technology and credits in the future. We anticipate that Iraq will work hard to overcome the current frictions by offering commercial opportunities to the United States and lobbying US business and government officials.

Although the BNL affair embarrassed the Italian Government and sector, we do not believe it will notajor impact on Italian relations with United States. Rome appears satisfied to date with the cooperation of the US investigating agencies and appreciates tbe low-key manner in which Washington has reacted. BNL will probably close its Atlanta office and mayoss of business in financing exports for US companies. I

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