A Reading of the Future of the Lebanese Banking Sector
Prepared by Retired Administrative Brigadier General Ghazi Mahmoud, January 30, 2023
The banking sector in Lebanon has long stood out among its peers in the Arab countries looking for investment opportunities in Beirut and, through it, in global markets. The prosperity of Lebanese banks reached a point where they earned the trust of capital holders, became one of the pillars of the national economy, and drew the attention of international financial institutions.
Lebanese banks had long affirmed their commitment to applying the Basel I and Basel II rules with respect to capital adequacy and the development of risk management systems, which spared them the repercussions of the 2008 financial sector collapse that brought down numerous financial institutions around the world. Lebanon was among the very few countries whose banks continued to record growth despite the economic crisis that accompanied that collapse, encouraging many expatriates to make large remittances to Lebanon that led to a marked reduction in the balance-of-payments deficit during that period.
The sector attracted deposits almost continuously until the end of 2018, with deposits rising from $43.3 billion in 2002 to $178.5 billion in 2018, an increase of $135.2 billion, or 312%, at an annual average of $8 billion. Deposits then began to decline noticeably at the beginning of 2019, ending that year down to $167.8 billion from where they had stood at the end of 2018, a drop of 6%, which constituted the clearest expression of the worsening banking sector crisis.
Net expatriate remittances to Lebanese banks had begun to decline from 2015 onward due to the sharp fall in oil prices, especially since, on the one hand, a large share of remittances came from Lebanese working in the Arab Gulf states and in African countries exposed to the risks of fluctuations in the prices of oil and its derivatives. On the other hand, the cumulative value of imported goods and services and remittances by foreign workers residing in Lebanon exceeded the cumulative value of export revenues and remittances to the country from Lebanese living abroad.
Continued political conflict among the parties holding the reins of political and economic decision-making prevented agreement on an economic vision that would strengthen the comparative advantages of the national economy and develop its productive sectors, while worsening poor governance, a lack of transparency, the persistent squandering of public funds, and widespread corruption. At the same time, state revenues were confined to taxes and fees levied on an economy shrinking day by day, until these revenues were no longer enough to service the public debt, prompting the government to issue treasury bonds on a regular basis to finance the budget deficit and driving up interest rates to attract deposits. Interest rates reached their highest levels by 2019, hitting 8 percent on dollar deposits and more than 12 percent on deposits in Lebanese pounds.
High interest rates and the policies of Banque du Liban gave banks an incentive to invest in treasury bonds, while they steadily reduced the loans granted to the private sector. The outcome of financial engineering operations proved costly for Banque du Liban and raised its liabilities toward the banks at a time when it was difficult for Lebanon to obtain financing from international debt markets, leading to a growing share of public debt denominated in Lebanese pounds and mounting pressure on the domestic market.
The popular uprising on October 17, 2019, exposed the fragility of the banking sector and the banks' failure to abide by the principle of diversifying their risks in accordance with the Basel rules they had boasted of applying. The reasons for ignoring the most basic rules of good governance ranged from the lure of high interest rates on treasury bonds to the pressures exerted by Banque du Liban, acting jointly and in solidarity with the parties holding the reins of political and economic decision-making, to secure the continued financing of public spending.
Making matters worse was the ability of those actors (the parties holding the reins of political and economic decision-making) to transfer their foreign-currency savings abroad, unlike all other depositors, who suffer from restrictions on cash withdrawals from deposits in the national currency and deductions (Hair Cut) on withdrawals from foreign-currency deposits without any legal justification to date. Banks fell from their pioneering position in the breadth and diversity of banking services to a role confined to money-market intermediation, offering services far removed from the functions and modern services of contemporary banks.
The collapse of the banking sector on the one hand, and the collapse in the value of the national currency on the other, produced catastrophic social repercussions. To grasp their scale, it suffices to note that total resident deposits, particularly those of small depositors and salaried employees, stood at roughly 54 trillion pounds in Lebanese banks at the end of 2019, and their value fell from roughly $35.8 billion at that time to less than $1 billion today, and is set to fall further with every additional depreciation of the national currency.
Added to Lebanese-pound deposits are roughly $105 billion in foreign-currency deposits, amid growing fears that they cannot be recovered, while Banque du Liban circulars regulating withdrawals from these deposits come at the expense of depositors. This means depositors are losing a large share of their savings, which formed a major part of the wealth accumulated by both resident and expatriate Lebanese, alongside a continuous deterioration in the pound's exchange rate and rising prices.
The economic repercussions of the banking sector's collapse are no less grave than the social repercussions, especially since the size of Lebanese banks swelled abnormally relative to the size of the national economy, with the value of their assets exceeding more than four times gross domestic product, a very high ratio disproportionate to an economy lacking productive sectors capable of borrowing this liquidity and investing it in suitable projects.
The economic repercussions of this collapse also lie in the end of the banks' primary role in financing economic activity, shifting Lebanon from a credit economy in which banks play a pivotal role in the movement of financial flows to a cash economy fraught with risks and difficulties that prevent the expansion and development of economic activities. While some industrial and commercial enterprises have managed to find solutions for their cash flows, the role of banks remains suspended pending the adoption of appropriate solutions for deposits and the restructuring of banks within a comprehensive plan for economic recovery.
Responsibility for the state to which depositors' rights and the banking sector have been reduced is shared by the Lebanese state and Banque du Liban as well as the banks. Even if the state, through its legislative and executive branches, must find appropriate solutions regardless of the responsibility of its institutions for squandering the bulk of deposits, direct responsibility rests with the banks that attracted those deposits and failed to take appropriate precautions to ward off the risks of deploying them.
While personal and electoral interests pull those in charge of the legislative and executive branches in competing directions, banks must realize that their own interest lies in taking the initiative to ensure the continuity of the banking sector, whose survival is an urgent necessity for the regular functioning of the national economy. Lebanese banks must adopt a roadmap that restores confidence in the banking sector, accelerates putting the problem on the path to resolution, and helps restore the banks' pivotal role in reviving the national economy, without waiting for the state and the comprehensive solutions that will remain its responsibility.
The banking sector will not emerge from the impasse in which it is mired unless those running it possess the firm will to overcome the crisis and the forward-looking vision to devise solutions that lay the groundwork for resuming banking operations with a new mindset, and not merely in a new guise (restructuring/merger). This is particularly important because bailing out the banking sector by drawing on public revenues would redistribute wealth from poorer households to wealthier ones. The required initiative must aim in essence to restore the confidence of depositors, especially small depositors, in the banks, bearing in mind that finding solutions for small depositors and protecting them must form the cornerstone for banking activity to regain its momentum and sustainability.
Any banking sector initiative ought to adopt the principles of fairness and justice and align with global best practices in banking sector restructuring strategies, which call for recognizing large losses and addressing them upfront, respecting the hierarchy of claims, protecting small depositors who have hitherto borne the brunt of this crisis, and refraining from resorting to public resources.
A bail-in solution ordering creditors' claims, alongside comprehensive reforms, is considered the only realistic option available to banks to turn the page on the fiscal and monetary policies that led them into ruin and squandered their pioneering and distinguished experience.
An initiative by the banking sector to adopt a realistic self-rescue plan is inevitable given the divergent views among political parties over how to distribute financial losses, which represents the main obstacle to reaching agreement on a comprehensive reform plan aimed at restoring financial sector stability and achieving economic recovery.
Translated from Arabic with AI. Read it in Arabic