Bank Restructuring: What the Diab Government Wants to Enact

Bail-in, recovery funds, gradual de-dollarization... A review of the government's plan

Protected by metal plates, the façade of the Beirut headquarters of the Association of Banks of Lebanon. AFP / PATRICK BAZ

In the last few weeks, the Association of Banks of Lebanon (ABL) mobilized strongly against the economic recovery plan adopted at the end of April by Prime Minister Hassan Diab's govern-ment. The cabinet, which has estimated the banking sector's accumulated losses at tens of bil-lions of dollars, has put the restructuring of the banking sector at the top of its priorities list.

The banks, on their part, refuse to consider themselves responsible for losses related to their investments in Lebanon's sovereign debt – Eurobonds worth $11 billion (debt in foreign curren-cies) and the equivalent of $14 billion in Treasury Bills (debt in the national currency) – or their investments in the Bank of Lebanon (BOL) – $74 billion in foreign currencies and $36 billion in Lebanese pounds. The estimates are according to an ABL plan, which calculated debt in the pound at the official exchange rate of LL1507.5 per dollar, compared to more than LL4,300 at the black market.

For most banks, as well as for part of the private sector, the state is primarily responsible for the severe economic and financial crisis in which Lebanon finds itself today, as well as for its colossal debt, which stood at the end of February at $92.2 billion. This situation now forces the government, which announced that it was defaulting on its debt in foreign currencies in March, to negotiate an aid plan with the International Monetary Fund (IMF).

However, this line of defense advocated by the banking sector is deemed inadmissible by some of the experts who follow the matter and believe that banks must bear the responsibility for their bad choices, namely the fact that they invested depositors' money massively to finance the state and the BOL rather than the real economy. The limitations of this strategy came to light with the dollar and the Covid-19 crises.

The main objectives set by the Finance Ministry with regard to the restructuring of the banking sector include halving the number of commercial banks (49 of the total of 63 ABL members, the others being investment banks) because the size of the Lebanese banking sector is "four times that of the country's economy" according to Diab. Another measure envisioned by the cabinet is to ensure that the banking sector regains its role in financing the real economy, rather than fo-cusing primarily on financing the government. Thus far, Treasury Bills and Eurobonds offered high interest rates, to the disadvantage of the private sector, which had to pay high interest rates in order to offset the opportunity cost of the banks.

Use of Equity

But how does the government, which estimates the total losses of the banking sector at LL186 trillion, plan to do so?

First, to reduce the sector's losses, the plan calls for the use of banks' equity of LL31 trillion, bringing the sector's net losses to LL154 trillion. The cabinet, therefore, wishes to involve the shareholders and holders of the banks' preferred stocks. As the losses remain high, the gov-ernment also wants to recover dividends paid since 2016 by banks to shareholders, as well as "illegally obtained" funds, particularly from politically exposed persons, and funds "illegally tak-en out of the country." All this money will be put into a "deposit recovery fund."

Then, the government divided the debt of this sector into two categories: deposits and the rest. This second category, which may contain notes payable (money the bank owes to other credi-tors), is simply erased. Regarding the first category, which is a subject of debate within the Lebanese society, the cabinet has emphasized its willingness to protect "the vast majority of depositors, if not all." But it will still have to draw on bank deposits in order to reduce the debts of banks and hence relieve their balance sheets. However, the plan does not specify the bracket of depositors or deposits that may be targeted.

However, it is known that "major depositors" will be given the choice of converting part of their deposits either into shares in their banks (bail-in), or into shares in the "recovery fund" or even into bank bonds with small or even zero interest rates. On the other hand, the deposits of the National Social Security Fund (NSSF) and professional organizations, such as trade unions, uni-versities and associations, will be "preserved."

Regarding halving the banking sector's size, the Finance Ministry said 10 days ago, it is the banks themselves that will have to propose a restructuring and recapitalization plan, notably through mergers and acquisitions.

In addition, the government will allow five new players to enter the market by issuing five new banking licenses, which may also be allocated to development banks and specialized funds. These institutions must have a minimum capital of $200 million, half of which must be made up of "fresh" money through foreign currency funds, either from abroad or placed in cash directly into an account. This new capital will have to finance "exclusively" the real economy.

The BOL and the Finance Ministry will furthermore undertake gradual de-dollarization to re-duce credit in foreign currencies. The dollarization rate for loans to the private sector was es-timated at 66.3% at the end of March, compared with 69.7% a year earlier, while the dollariza-tion rate for deposits was 77.9% in the first quarter of 2020, compared with 70.6% in the same period in 2019, according to figures reported by Byblos Bank's Lebanon this Week. Interbank lending will therefore be limited to providing liquidity in foreign currencies to banks, provided by the central bank.

Source of Losses

It should be noted that losses in the banking sector may be revised downwards or upwards to more accurately assess losses, depending on the results of the BOL audit (conducted by three international firms: Kroll, Oliver Wyman and KPMG), the quality of assets held by banks (Asset Quality Review- AQR), and, more specifically, questionable loans. Losses in question, to the tune of LL186 trillion, include those of the BOL, those of restructuring the Lebanese debt and bad debts. The latter are loans taken out by private sector players that can no longer repay. Bad debts are expected to grow by 30%, according to the government, due to the economic crisis.

Moreover, the central bank collects obligatory reserves from the banks to mitigate the risk of a bank defaulting on a customer. The BOL also holds certificates of deposit issued by the banks on which it repays when mature. Hence, any restructuring of the BOL, with losses of LL177 trillion (net losses of LL121 trillion calculated at a pound/dollar exchange rate of LL3,500) necessarily implies repercussions on the country's banks. However, the banking sector and the BOL have invested heavily in Treasury Bills and Eurobonds, and Lebanon officially defaulted on its debt in foreign currencies in March (which stood at $34.1 billion at the end of February), and is likely to do so for the debt in Lebanese pounds. This default has a double impact on the Lebanese banks: the first time directly, when they did not receive the principal or interest on maturing debt se-curities; the second time indirectly, when the BOL did not receive them, hence failing to repay the banks their maturing certificates of deposits.

As part of the BOL restructuring , the cabinet also plan to reduce its debt to banks by $10.4 bil-lion, or LL36,400 billion, calculated at a rate of LL3,500 per dollar. This will also weigh on the sector.

(This article was originally published in French in L'Orient-Le Jour on the 26th of May)

In the last few weeks, the Association of Banks of Lebanon (ABL) mobilized strongly against the economic recovery plan adopted at the end of April by Prime Minister Hassan Diab's govern-ment. The cabinet, which has estimated the banking sector's accumulated losses at tens of bil-lions of dollars, has put the restructuring of the banking sector at the top of its priorities list.The banks, on...