The central bank and banking sector in Lebanon are progressively reformed

Limit the role of Government to efficient policy making and regulation in order to improve the performance of Lebanon’s main macroeconomic indicators

A Prosperous Economy That Creates Jobs For All and Reduces Inequalities

1.Banks ideally provide a safe place to store extra cash and credit. They offer savings accounts, certificates of deposit, and checking accounts. Banks use these deposits to make loans. These loans include home mortgages, business loans, and personal loans

2.Banking is one of the key drivers of economies. It provides the liquidity needed for families and businesses to invest in the future. Bank loans and credit mean families don't have to save up before going to college or buying a house. Companies use loans to start hiring immediately to build for future demand and expansion

3.The Central Bank is responsible for two main targets: the currency stability and the financial standing of the banking industry

1.Number of Lebanese banks

2.Banks capital adequacy ratios

3.Bank assets / GDP

4.Interest rates on LBP

5.Interest rates on USD

6.Banks loans to businesses

7.Banks non performing loans ratio 

8.Liquidity ratio

9.Consumer Price Index (CPI) inflation

10.Money in circulation

11.LBP/USD Exchange rate

12.Banks Net Foreign Assets Position

13.BDL Net Foreign Asset Position

1.Before the crises, with assets close to four times GDP, the financial sector was considered very large, but was relying on the expatriate Lebanese deposits in local banks

2.The financial engineering operations of the BDL, where banks convert customers’ cash into local currency and deposit the dollars at BDL which, a number of complex operations later, gives the banks very attractive returns

3.By January 2021, local currency in circulation outside the central bank increased by 487% since September 2019, as BDL is regularly printing LBP

4.Commercial banks have lost roughly 49 trillion LBP in deposits in the past two years, equivalent to around 22% of current total assets

5.The banking sector, which informally adopted severe capital controls, has ceased lending and does not attract deposits. Instead, it endures in a segmented payment system that distinguishes between older (pre-October 2019) dollar deposits and minimum new inflows of “fresh dollars”

6.Business activity is falling along with prices in a real estate sector that was once a pillar of the economy

7.The banking sector, having lent three-quarters of deposits to the government, has become functionally bankrupt and increasingly illiquid

8.After Hariri Cabinet resigned following people’s protest in October 2019, capital inflows came to a sudden halt; Banks, already insolvent, experienced a sharp liquidity crunch, forcing them to declare a “bank holiday” and institute severe restrictions on bank withdrawals

9.A foreign exchange black market emerged and the national currency, sharply depreciated. In turn, inflation soared and people’s real wages and purchasing power collapsed

10.Commercial banks’ net foreign assets position has continued to deteriorate. As of August 2020, the banking sector, as a whole, had US$ 4.4 billion in placements at non-resident financial institutions (FIs), while its liabilities to non-resident FIs amounted to US$ 7.5 billion, a net foreign asset position of US$ –3.1 billion (compared to a net foreign asset position of US$ –2.1 billion end-2019).

11.The credit portfolio of the banking sector has substantially deteriorated during recent months. Wholesale and retail trade and processing industries, among other economic sectors were severely affected, causing business closing and job losses/reduced salaries. Non-performing loan (NPL) ratio (gross NPLs including unearned interests as a percentage to total loans) stood at 28.3% as of June 2020, compared to 13.3% at end-June 2019 and 16.8% at the beginning of the crisis in October 2019.

12.The sudden stop in capital inflows has implied a steady depletion of FX reserves at BdL. As of end-September, 2020, BdL’s gross foreign asset position (excluding gold reserves) reached $25.9 billion, declining by $11.3 billion since end-2019. The gross position, however, differs widely from its net reserves (i.e., FX reserves at the central bank net of FX liabilities to others); BdL, contrary to other central banks, does not publish net reserves. BdL’s gross position includes US$ 5 billion in Lebanese Eurobonds and an unpublished amount lent out to banks since October 2019, leaving much of the remainder as required reserves on banks’ customer FX deposits, which is estimated at US$ 17.5 billion

13.A high import ratio for the consumption basket, along with the shortage of dollars in the market suggest an implicit tradeoff between (i) importation of goods and services and (ii) BdL’s stock of foreign exchange reserves. This compelled authorities to prioritize imports. First, and early on in the crisis, BdL identified a list of highly critical goods, namely, fuel, medicine and wheat—to be backed by its stock of foreign exchange reserves at the official exchange rate

14.A key shortcoming of current applications of informal capital controls is the lack of accountability on non-compliance, and the large discretionary space for banks to pursue ad hoc applications. Whereas most customers are subject to severe (and increasing) restrictions on dollar withdrawals and transfers, some have managed to transfer large sums of money out of the country since controls have been in place (October 2019)

15.The burden of the ongoing adjustment in the financial sector is highly regressive, concentrated on smaller depositors, the local labor force that is paid in LL and smaller businesses. De facto lirafication and haircuts on dollar deposits are ongoing despite BdL’s and banks’ official commitment to safeguarding deposits. When paying out dollar deposits to customers—other than a minimal (and diminishing) amount paid out in dollar bank notes—banks are exchanging at rates lower than the black-market rate and paying it out in LL, thereby effecting lirafication. Haircuts occur to the extent that the LL amount is being used to either purchase goods and services, whose prices are rising, or exchange for dollars bank notes, both lead by the black-market rate

1.Of its 20 biggest commercial banks, 18 are wholly or partly owned by politicians or well-connected families, and other Politically Exposed Persons (PEPs)

2.Loss of trust in the banking sector, in BdL’s governor, in the Banking Control Commission (BCC), and in all other financial authorities

3.Informal capital controls to prevent the outflow of USD are in place but are applied unequally, with influent and PEPs able to transfer money

4.Pretending to abide by the banking secrecy law prevented all efforts to discover identity of those who transferred money abroad since 2017

5.Lebanon is in a state of insolvency (both sovereign and banking system)

6.Lebanon lacks adequate foreign exchange reserves, while being an import-based economy, and while most of correspondent banks refuse to deal with Lebanese counterparts

7.An extreme form of wealth destruction is taking place with the Lebanese de facto losing the majority of their bank savings. A year into the economic crisis, there have been limited policy responses by the authorities as Lebanon faces a dangerous destruction of wealth and a depletion of resources, including human capital with brain drain an increasingly desperate option

8.Efforts to form a successor government having failed so far, progress awaits the formation of new Government. Meanwhile, the economy keeps shrinking and the social cost of the crisis rises and widens

9.The probability of the worst-case scenario, a continuation of the path of “malign neglect” is reasonably high. This scenario assumes that political parties would continue to block measures required to put the economy on a sustainable path, allowing for a continuation of the ongoing but extremely insidious process of “auto-adjustment” of macroeconomic imbalances, although in a very sub-optimal and regressive manner, and with a long-term negative impact on growth and the social fabric of the country. Left to its own devices, the economy will generate an alarming acceleration of youth and skilled labor emigration, and enterprise closures. The currency will become further un-anchored, hyperinflation will wipe out incomes and wealth, and food and medical shortages will escalate, requiring rising levels of humanitarian support

10.The financial sector is badly governed and regulated:

• The monetary authorities, as per the Code of Money and Credit, are responsible for two main targets: the currency stability and the financial standing of the banking industry. The focus has almost exclusively been on the first target, at the expense of the second
• The Banking Control Commission (BCC), the watchdog supervising banks and setting rules and regulations has accommodated too many things and did not fully achieve its oversight role; BCC consistently overlooked the yearly bank auditors’ reports which repetitively highlighted the duration mismatch between banks assets and liabilities, just to accommodate the financial policy by the state, to acquire treasury bills and Eurobonds, which have much longer maturities than the average life of deposits
• BDL has not published its income statements for over 15 years, and has used creative accounting to conceal the true position of its Net FX reserves
• The MoF’s commissioner at BDL did not effectively carry-out its supervisory responsibilities over BDL

11.Disagreement between BdL and the banking sector with the Government’s plan (Lazar) and analysis has brought the negotiations with the IMF to a stop. In particular, the identified losses in the financial sector, is a critical component as it determines the extent and modality of restructuring that would be needed in the financial sector (banks plus BdL). A key motivation for this disagreement has been the need for public debt restructuring, which would result in heavy losses in the financial system, given the large holdings of public debt by BdL and banks

12.The banking sector is advocating for mechanisms that incorporate state owned assets (SOEs), gold reserves, and public real estate in order to overhaul their impaired balance sheets. This constitutes a bailout of the financial sector and is inconsistent with best practice restructuring principles. These principles include bail in solutions based on a hierarchy of creditors, starting with banks shareholders. Government also has the prerogative and legal jurisdiction to apply a wealth tax on deposits as a tool to restructure the financial sector. A wealth tax applied on financial and real assets can be very progressive tool for needed macro-financial restructuring

13.Inability to tap international markets for foreign financing, and an impaired domestic banking system. As a result, capital controls will continue to be needed, but are also expected to become less effective over time, in line with international evidence

14.A steady depletion in Forex (FX) reserves at BdL presents a realistic downside risk of an inflationary-depreciation spiral. BdL officials have made statements to the effect that FX reserves levels will reach required reserves on banks’ customer FX deposits in the next few months, at which point they will be unable to back up critical imports at lower exchange rates. When BdL arrests its back up of critical goods, especially, energy products, medicine and food essentials, importers will fully revert to the black market for the needed hard currency. This would exacerbate inflationary pressures. The inflation rate rises as prices for critical products will immediately reflect the full black-market exchange rate. Additionally, the increased demand for dollars in the black market further worsens the exchange rate, fueling inflation

15.Inflation is a highly regressive tax, and disproportionally affects the poor and vulnerable, and more generally, people living on fixed income

16.Although the parliament issued a law that imposes a forensic audit of the central bank, BdL has consistently failed to supply the auditors with the requested information and succeeded in delaying the process

1.Banking secrecy law promulgated on September 3, 1956

2.Law authorizing the opening of joint account promulgated on December 19, 1961

3.The Code of money and credit promulgated by decree n°13513 of 8/1/1963

4.The Banking Control Commission of Lebanon (BCCL) was established in 1967 by Law Nº. 28/67

5.Law by decree n°14/1977: Establishment of the housing Bank “Banque de l’Habitat SAL”

6.Law n°42/1986: Prohibiting the sale of all Bank of Lebanon gold reserve

7.Law n°99/1991: The Central Bank of Lebanon (BDL) determines the required minimal capital for any Lebanese or foreign bank

8.Law n°192/1993: Facilitating the mergers and acquisition of banks

9.Law n°430/2002: Public Debt Account Creation

10.Law no. 81 dated 10/10/2018 : on electronic transactions and personal data

11.2016: BDL’s financial engineering

12.Since the end of 2019: informal capital controls

13.Circular 536 (December 4, 2019): New regulation on local and forex currency interest rates ceilings

14.circular 149 (April 3, 2020), BdL established a special unit that exchanges foreign currencies  comprising BdL, banks and exchange bureaus

15.2020: Circulars 148, 151, 549, 565 allow the withdrawal of pre-crisis deposits at exchange rates higher than the official rate, but lower than the black-market

16.Circular 568 (August 26) instructs banks to accept repayments by resident clients of their dollar retail loans—with limits of $US 800,000 for housing loans and $US 100,000 for retail loans— in LL at the official exchange rate

17.In circular 535 (November 26, 2019) and 561 (July 8 2020), BdL formalized its backup of critical imports; specifically, BdL’s provision of foreign currency at the official exchange rate for 90 % of the import bill for fuel products and 85 % for wheat, medicine, medical equipment and baby milk imports

18.Circular 556 (May 27, 2020): banks allowed to solicit foreign currency from BdL for 90 % of the value of raw materials imported by the industrial sector

19.Circular 557 (May 27) further targeted this scheme to agribusinesses, removing the limits

20.Circular 564 (July 8, 2020) allowed for foreign currency back up at the e-board rate for another list of essential goods’ imports identified by the Ministry of Economy and Trade (MoET)

21.Circular 547, 552 (23 March and April 22, 2020) permitted the rollover of private sector loans in LL and dollars that were coming due between March–June 2020, at zero interest rate and 5-year maturity

22.Circular 152, 569 (August 6, August 26, 2020) allowed banks to extend loans at zero interest rates and 5-year maturity to those affected by the Port explosion

23.Circular 153 (August 19) permitted the transfer of up to US$ 10,000 of pre-crisis deposits to students abroad

24.Circular 567 (August 26): Banks and financial institutions: (1) Must apply a statutory Expected Credit Loss (ECL) of 1.89 % on foreign currency placements with BdL. (2) Must not downgrade delinquent loans (between February 1, 2020 and December 31, 2020) for borrowers affected by the COVID-19 pandemic. (3) Refrain from distributing profits to shareholders for the years 2019 and 2020, and increase by December 31, 2020 their common equity tier one capital by 20 % from the 2018 level. (4) Must apply the minimum capital adequacy ratios. (5) Each bank must prepare a comprehensive plan to conform to the minimum capital requirements set forth by the regulator

25.Circular 154 (September 14): BDL required banks: (1) To complete a fair value assessment of their assets and liabilities and set a plan that helps in complying with all applicable regulations. (2) Boost their liquidity with their foreign correspondent banks, by incentivizing clients who have transferred more than $0.5 million abroad since July 1, 2017 to channel back 15 % of said amount to Lebanon, 30 % for banks’ Chairmen, members of Board of Directors, large shareholders and top management, and 30 % for Politically Exposed Persons (PEPs). (3) Constitute by end of February 2021, an external account at their correspondent banks equivalent to 3 % of the size of foreign currency deposits as of July 31, 2020. (4) Reconstitute/raise their capital to the required levels by the end of the first quarter of the year 2021

26.2020: Law lifting banking secrecy for a duration of 1 year

Policy Action

1.Form a credible and independent government with emergency legislative powers that adopts and implements a credible, comprehensive and coordinated macro-financial stability strategy, within a medium term macro-fiscal framework

2.Immediately resume negotiations with the IMF

3.Proceed with the forensic audit of BDL, and lift banking secrecy without restrictions, conditions, and any time limits, for the purpose of conducting the forensic audit of BdL

4.Hold executive officials accountable for wrong monetary and investment policies in the previous period

5.Start with a short-term stabilization program:

• Involving tightening of liquidity
• Officializing capital controls
• And obtaining an urgent bridge loan under the umbrella of an IMF Stand-By agreement

6.Commit to a three-year program

• Restructure the debt and bring it to sustainable levels
• Determine the losses at BdL, overhaul BdL, and redirect it’s focus back to its core mission of maintaining currency stability and financial soundness in the banking sector
• Pass a Banking Resolution Act that regulates and implements a comprehensive restructuring of the financial sector toward regaining solvency of the banking sector, so it gradually resumes its role in financing the economy, while evenly distributing the losses across the various segments of the economy and population, and while respecting the official hierarchy of creditors (shareholders equity, followed by capital increases, then by equitable bail-in through interest earned after 2016 on large deposits…)
• Adopt a new monetary policy framework aimed at regaining confidence and stability in a unified exchange rate
• Endorse and implement a phased fiscal adjustment aimed at regaining confidence in fiscal policy that streamlines the public sector, cuts government spending and raises taxes, replace products subsidies with direct global cash transfers
• Enact “real economy” growth enhancing reforms that would put the country on a recovery path, and enhance social protection; Encourage investment in the productive sectors by limiting lending in to the public sector, and set up specialized investment

7.Over the medium term, prioritize building better institutions, good governance, and a better business environment alongside physical reconstruction

8.However, given Lebanon’s state of insolvency (sovereign, banking system) and its lack of adequate foreign exchange reserves, international aid and private investment will be essential for comprehensive recovery and reconstruction

• The extent and speed to which aid and investments are mobilized will depend on whether the authorities and the Parliament can swiftly act on much needed fiscal, financial, social, and governance reforms
• Without reforms, there can be no sustainable recovery and reconstruction, and the social and economic situation will continue to worsen