The Tripoli-based Arab-Foreign Investment Bank paid 3bn drachmas ( pounds 10m) to raise its holding in Arab Hellenic Bank (AHB) from 20 per cent to 72 per cent.
Under the second banking directive, which came into force on 1 January, banks authorised in one EC state can set up branches in other member countries with a 'single passport', without interference from local banking supervisors.
Branches in the main financial centres, such as London, Paris and Frankfurt, could help Libya overcome the effects of United Nations-imposed sanctions.
The Bank of England would not be able to object to a London branch except under a let-out clause in the directive covering the 'public good'. The precise meaning of this clause has yet to be tested.
As there are currently no financial sanctions operating against Libya in the UK, any action on these grounds is likely to be difficult to justify.
The suggestion to Colonel Gaddafi came from his Libyan finance adviser, Saddik Hijjaji, a former chairman and general manager of AHB. He said Libya should not miss an opportunity to control a European bank that would enable him to open prestigious branches in important cities while remaining accountable only to the Bank of Greece, the Greek central bank.
The move reduced the National Bank of Greece's holding in AHB from 51 per cent before the cash injection to 18 per cent. The third partner, the Kuwait Investment Office, had its holding reduced from 20 per cent to 10 per cent.
Operating from a front shop and two-storey office building in Athens, AHB was founded in 1979 on an initiative of the then economics minister, Constantine Mitsotakis, to invite foreign investors into the country.
Last year, the Greek government instructed the bank to increase its capital. Michalis Vranopoulos, the bank president, first approached the Kuwaiti partners, without success.
Mr Hijjaji, who was also elected in May 1990 to the board of UBAF Arab American Bank, the Arab- controlled New York consortium bank, was deported from Greece early in January 1991 alongside Iraqis, Palestinians and Jordanians as part of EC security measures before the start of operation Desert Storm.
According to Middle Eastern and Greek sources, the British are not amused at the prospect of Colonel Gaddafi's bank opening branches in London. Nor do they welcome the idea of the Libyans having a foothold inside the EC banking system. Several Western intelligence sources warned last year that the UN economic sanctions imposed on Colonel Gaddafi for refusing to hand over two suspects in the Lockerbie bombing case were likely to be less effective because of a network of Libyan investment in Europe, especially in the down- stream petroleum products sector and in banking and financial services.
Although the Libyans have holdings in banks such as UBAF, and Aresbank in Spain, as well as smaller stakes in banks in Italy and the Netherlands, this is the first time they have taken a majority holding in a European bank.
A Greek banking source said Greece had full rights to supervise AHB, audit its books and direct its conduct. But one British official said the Libyans could turn the Bank of Greece's supervision into 'Europe's Achilles heel', citing the bank's poor record in auditing and supervising foreign banking activities.
Displeased by such criticism, one Greek banker replied: 'And how long did it take the Bank of England to uncover the BCCI fraud?'
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