Complex Made Simple

Is Lebanon’s once highly touted financial sector rescuable?

Lebanon's banking system is almost defunct , or at least gaining a bad reputation stemming from a number of socio-economic factors in the country. Is there any hope of a financial sector resurgence amidst unprecedented turmoil and economic crisis ravaging the country?

An economic rescue plan will form the basis of Lebanon’s talks with the International Monetary Fund (IMF) Banks intend to regain this trust and are opposed to a haircut on any deposit account to protect the money of depositors The responsibility lies squarely on the shoulders of the executive branch to take the appropriate decisions to restore confidence

Lebanese depositors are expressing their frustrations at their inability to withdraw dollars from their accounts, by sometimes burning ATMs and other times the banks themselves.

The international financial community has all but burned bridges with Lebanon’s frail, if not failed banking sector.

Lebanon defaulted on $31 billion in Eurobonds in March.

Lebanese protesters wearing Central Bank Governor Riad Salame’ masksThe flight of dollar-denominated capital, often labeled as stolen monies, estimated between $7 billion and $8 billion, according to Finance Minister Ghazi Wazni, and the country’s growing $100bn debt with a globally third highest debt to GDP ratio at 152%, is making things much worse.  

So let’s paint a more complete picture before we get answers from Nassib Ghobril, Chief Economist, Head of the Economic Research & Analysis Department, Byblos Bank Group, an authority on the matter.

Read: “It’s a catastrophe”: Lebanon’s travel and tourism sector is on its last legs

Exchange rate dead?

According to Euromoney, the Lebanese pound’s (LP) exchange-rate system and which has been pegged to the dollar since 1997, has lost 50% of its value since October, causing food and essential goods prices to soar.  

Last April 30, Prime Minister Hassan Diab published a 53-page financial recovery plan that, alongside structural reforms and changes to the banking system and central bank, includes allowing the Lebanese pound to adjust to market rates, estimated to be LP 3,500 to the dollar.  

While the official rate of LP1,507.5 to the dollar continues to be used by the Banque du Liban (BDL) to import fuel, medicine and basic food stuffs, around 70% of transactions are now conducted at a parallel rate of around LP 4,300-4,400. 

Read: S&P Global Ratings: Several Lebanon Bonds Downgraded To ‘D’- Outlook Negative

Rescue plan

Earlier in May, an economic rescue plan that will form the basis of Lebanon’s talks with the International Monetary Fund (IMF) was panned by banks as one that would “further destroy confidence” in the country, quoting Reuters.

The rescue plan, approved by Diab’s government, sets out tens of billions of dollars in financial sector losses and tough measures to claw out of a crisis that has seen the currency crash, unemployment soar, Lebanon default on its sovereign debt and street protests.

The government is hoping that with an IMF program in hand, foreign donors will release about $11 billion pledged at a Paris conference, aka CEDRE, in 2018 which was tied to long-stalled reforms.

The plan calls for an additional $10 billion in external support over five years. 

A central plank of the plan rests on covering financial sector losses of roughly $70 billion in part by a bank shareholder bail-in that would wipe out their capital and cash (haircut) from large depositors that would be restored later.

Read: Lebanon downgraded to Selective Default on suspended Eurobond payments

Steve Hanke

Steve H. Hanke | Professor | Economist | Author | Currency Expert | White House Alum. and a professor of applied economics at The Johns Hopkins University, said late last year that with massive gov’t corruption & incompetent economic policies, Lebanon is bankrupt and a devaluation of the Lebanese pound (which he later called garbage) is all but certain.  “Millions have lost their savings & salaries,” he subsequently said last April 30 2020.
 “The Lebanese “Government Reform Program” is fatally flawed because it includes no means by which to fix the Lebanese pound, which is, after all, the epicenter of the current crisis,” he added.

Detailed interview with Nassib Ghobril

In an exclusive with Ghobril, we asked several pertinent questions related to Lebanon’s banking sector.

1-How confident are global financial institutions, rating agencies, governments, and the Lebanese diaspora with the banking sector?

Ghobril: Global financial institutions, such as correspondent banks, have had long and fruitful relations with Lebanese commercial banks and are familiar with the know-how and professionalism of the banks. 

But these institutions had to take certain measures when rating agencies downgraded Lebanon’s sovereign ratings. So the problem is with the lack of confidence in the ability of the executive branch to implement reforms and reduce public finance imbalances. 

The methodology of rating agencies stipulates that banks cannot be rated above the sovereign, even though banks are well managed and profitable.  

The Lebanese Diaspora is a good example of long lasting confidence in Lebanese banks, as expatriates have entrusted banks with their savings and various diaspora organizations have been calling for structural reforms. But now expatriates cannot use their deposits and the government wants a haircut on these deposits, so there is a trust issue with the government and with banks. 

But banks intend to regain this trust and are opposed to a haircut on any deposit account as their mission is to protect the money of depositors.

Read: Lebanon to not pay $1.2 billion Eurobond debt

2- Have Lebanese residents lost confidence in their banks?

Ghobril: Lebanese citizens lost confidence in the ability and willingness of the executive branch and of political parties in power to deliver public services and to improve their standards of living, as reflected by the Byblos Bank/AUB Consumer Confidence Index.

The most recent results show that the Index averaged 38.7 in the first quarter of 2020, constituting a decrease of 19.1% from 47.8 in the fourth quarter of 2019, following a drop of 30% in the fourth quarter of 2019.  

Most of the decrease in the Index in the first quarter of the year was driven by the March reading of the Index, which registered a decline of 34.2% from the preceding month and a drop of 62.3% from the same month of 2019. Also, the Index decreased by 39% annually in January 2020 and by 44.2% in February. 

In addition, the average monthly score of the Index in the first quarter of 2020 was 63.4% lower than the quarterly peak score of 105.8 registered in the fourth quarter of 2008, and remained 60% below the annual peak of 96.7 reached in full year 2009.

Household sentiment plunged to its lowest level since the fourth quarter of 2016, as the mounting frustrations of Lebanese citizens at the deteriorating socio-economic conditions led to the eruption of nationwide protests on October 17. 

Also, the accumulation of grievances over worsening economic conditions, as well as the increased dissatisfaction at the failure of the political class to address the long-standing socio-economic challenges in the country negatively affected confidence in the fourth quarter of 2019. 

The downward trend in sentiment in the first quarter of this year is due to mounting socioeconomic uncertainties for households following the outbreak of the coronavirus in the country and the lockdown measures that added to the prevailing financial uncertainties. 

In addition, the substantial increase in consumer prices and the government’s inability to contain the hikes further weighed negatively on confidence. Moreover, the government’s emerging intention to implement a haircut on deposits shook the confidence of depositors and contributed to the steep drop of the Index in March.

Amid these developments, it is normal that confidence in the banking sector gets affected, as banks are a key part of the Lebanese economy and are the most affected stakeholder of the Lebanese economy by developments, due to the fact that it is the only sector that lends to the entire economy. so it was expected that banks will be impacted by the crisis more than other sectors. 

Read: Time to buy the March 2020 Lebanon Eurobond at a 175% yield to maturity windfall?

3- What steps are needed by the Central bank to install new confidence in the sector, both internally and externally?

Ghobril: For the past 25 years, Banque du Liban (BDL) and commercial banks have maintained monetary and economic stability and, therefore, social stability. So it is long overdue for the executive branch and the political parties in power to assume part of this responsibility. If this responsibility was shared as it should have been, Lebanon would have avoided the current crisis.

More specifically, BDL has issued a series of circulars since December 2019 to fill part of the vacuum left by the absence of measures and decisions by the executive branch. 

But these circulars do not intend to replace a government reform plan with sequenced priorities that would create a positive shock in the market, restore confidence and address the liquidity shortages. The plan that the government issued recently has faced significant criticism from various stakeholders, and did not result in the positive shock that citizens, the private sector and the Diapsora have been waiting for.          

Read: Thinking the unthinkable: Lebanon’s sovereign debt default?

4- Where is the Lebanese pound headed? Will be see a decoupling from the Dollar or new pegs to other currencies?

The exchange rate of the Lebanese pound depends on confidence, which has been in short supply in recent months.

But monetary policy alone, amid a massive increase in public spending, widening fiscal deficits, and the absence of reforms, could not sustain the currency stability indefinitely. So now the responsibility lies squarely on the shoulders of the executive branch to take the appropriate decisions to restore confidence.     

5- What are the regional implications of Lebanon losing its place as a major financial player 

The current government’s decision to default on the foreign obligations of the Lebanese State in March relegated Lebanon to the sidelines of the international financial and banking system. 

Indeed, prior to March of this year, Lebanon always met its foreign obligations regardless of the prevailing circumstances. But this unblemished record was compromised earlier this year, especially that the government announced its default without a funded program with the International Monetary Fund in place, given that about 90% of countries that default on their foreign obligations either have an IMF program in place or are in negotiations with the IMF for such a program.