Why the Lebanese and American banking crises have almost nothing in common

Beirut could have benefited from being as responsive as Washington was to the latest difficulties encountered by the banking sector in the United States.

Why the Lebanese and American banking crises have almost nothing in common

Top: Depositors line up outside Silicon Valley Bank headquarters in Santa Clara, California. (Credit: AFP); Below: depositors gather in front of a burned down BBAC branch in Beirut. (Credit: PHB)

The turbulence in many stock markets around the world, notably the failure of several American banks almost two weeks ago — including Silicon Valley Bank (SVB), the 16th largest in the country — has reignited debate on the financial crisis in Lebanon.

Depositors in Beirut have been asking why clients of American banks received measures guaranteeing the totality of their deposits within a week of the banking disaster being identified, while those of Lebanese banks have seen their savings dwindle over the past three and a half years without the Lebanese state defending them.

On Tuesday, MP Ibrahim Kanaan (Free Patriotic Movement), chairman of the parliamentary Finance and Budget Committee, took to Twitter to contrast the American reaction to the banking crisis with Lebanon’s “solutions,” which consider deposits “as losses, write them off and stop paying them.”

Kanaan’s message sparked reactions from several financial experts on social media, including former Johns Hopkins University professor Mike Azar, who believes that the MP is not approaching the problem from the right angle.

Meanwhile, financial expert Nicolas Chikhani thinks that “the crisis of the SVB and that of the Lebanese sector may be different, but the damage incurred is of the same nature.”

Three fundamental differences

One notable difference between the two crises is the scale of the impact of the bank failure in their respective cases. In the US, a handful of medium sized banks failed; in Lebanon the entire financial system collapsed. However, the health of the US financial sector has a more significant impact on global markets than the state of Lebanese banks.

In the US, several medium-sized banks have failed, and authorities have responded swiftly to prevent the contagion from spreading to other regional banks.

“Even without government intervention, depositors would have been able to recover a substantial portion of their deposits that were not already insured by the default $250,000 cap established by the Deposit Insurance Corporation (DIC), given the level of losses incurred,” Azar told L’Orient-Le Jour.

The second difference between the two situations is that, unlike in the US, the Lebanese banking crisis is directly linked to the state’s and the Banque du Liban (BDL)’s bankruptcy.

“In Lebanon, the entire financial sector is facing losses equivalent to three or four times the size of the [country’s] GDP. This has been caused by the state’s bankruptcy (which has been in partial default since 2020) and the Banque du Liban’s insolvency (whose foreign exchange reserves have a deficit of several tens of billions of dollars),” he explained.

Mike Azar pointed out, “How can the bankrupt Lebanese government and BDL rescue the banks when they are the ones responsible for the banking sector’s insolvency? If Lebanese institutions had the capacity to save the banking sector, there wouldn’t have been a crisis in the first place.”

The third fundamental difference is that while in both crises the beleaguered banking institutions owe their clients dollar denominated deposits, the US's Fed can print dollars while BDL cannot.

The problem in Lebanon is that the majority of the Lebanese financial sector’s liabilities, including deposits, are also denominated in US dollars in a highly dollarized economy.

At the end of 2019, when the crisis began, the deposits of banks and financial institutions at BDL amounted to $109 billion, while BDL’s reserves, including gold, amounted to just over $43 billion (according to BDL’s balance sheets).

The deposits held by banks were the depositors’ funds placed with BDL, which the banks could not repay in full.

Moreover, the National Institute for Deposit Insurance’s coverage ceiling of LL75 million, established by the 2020 budget law to replace the previous LL5 million ceiling, remains insufficient to protect depositors.

Under the previous official peg of LL1,507.5 to the dollar, the LL75 million ceiling was worth $50,000. However, with the parallel market exchange rate surpassing the LL100,000-mark since March 14, that LL75 million is now only worth approximately $700.

Preventing contagion

Despite differing circumstances, Lebanese authorities had the opportunity to respond as promptly as their US counterparts to prevent irreparable damage to confidence in the country’s financial sector.

“For the American economy, confidence is invaluable. This is why the US quickly decided to intervene to save the situation when it had decided not to do so — at least via a bailout — after the 2008 crisis,” Chikhani said.

The objective is to avoid a “bank run” (massive withdrawals by depositors), and the authorities have gone to great lengths to guarantee deposits for one year, extending protection beyond the automatic insurance of $250,000.

Chikhani emphasized a crucial point in understanding the measures implemented in the US: “The authorities did not urge all depositors to immediately withdraw their money. They guaranteed that, no matter what happens, the money will be returned to them at the value at which they deposited it in US dollars.”

The Bank Term Funding Program, which included a $25 billion backstop beyond what the Fed itself offered, was significant enough to be taken seriously.

On this basis, the primary risks for the US authorities are that they may have to print a significant amount of money if the measures do not prevent a bank run and that they may expose banks to moral hazard, which refers to changes in depositors’ behavior resulting from knowing they are protected against the risk of US bank failures.

Another critical detail is that the US authorities have refused to bail out shareholders, demonstrating a willingness to hold them accountable and ruling out imposing the bill for the bailout on taxpayers.

However, it remains to be seen whether this promise will endure.

“If the measures taken do not stop the contagion from spreading to other banks, the US authorities may ultimately resort to raising taxes to make the taxpayer pay for it. However, this tax increase should be seen as an additional guarantee for the deposits at risk,” Chikhani said.

Too late to save what had already been lost

Lebanon could have contained the financial crisis by implementing measures recommended by the International Monetary Fund (IMF), such as capital controls, bank auditing and restructuring of the banking sector.

The activation of these measures would have allowed the country to receive financial support from the international community, which has been mobilized since 2018 (via the CEDRE conference, held in April 2018), and possibly an assistance program from the IMF.

These actions could have compensated for the lack of financial means to guarantee deposits at stake and prevented a collapse by limiting losses.

However, Azar believes that it is not too late to take action, except for what has already been lost.

However, the political class and the managers of the Lebanese banks, at various levels of responsibility, have impeded the reorganization process by focusing on debating the estimation of the system’s losses (more than $70 billion) and their distribution among different actors, such as the state, BDL, the banks and the depositors.

This has led to a clash between two camps. The first camp, supported by the IMF, advocates for shareholders and large depositors relinquishing some of their rights to alleviate the liabilities of BDL, followed by restructuring the state and the economy. The second camp considers this solution unacceptable and proposes spreading out the repayment of deposits over time by privatizing all or some of the state’s assets or their management.

The crux of the matter, however, is that no action was taken, the “bank run” persisted, and banks limited deposit access without being held accountable for the imbalances in their balance sheets, ultimately leading them to a state of “technical bankruptcy.”

In the absence of a bailout, BDL implemented various measures that compelled depositors to withdraw their dollar deposits in Lebanese lira at a value lower than the market rate.

As a result, the government was left with no funds and resorted to a haphazard tax hike to generate revenue for civil servant salaries.

As the local currency continues to decline, the withdrawn deposits lose even more value compared to their original worth.

At present, a portion of the estimated $7-10 billion that Lebanon receives annually from formal and informal remittances is being used to compensate for the over $90 billion of frozen deposits that still exist, at the expense of printing billions of additional banknotes.

This article was originally published in French in L'Orient-Le Jour. Translation by Sahar Ghoussoub. 

The turbulence in many stock markets around the world, notably the failure of several American banks almost two weeks ago — including Silicon Valley Bank (SVB), the 16th largest in the country — has reignited debate on the financial crisis in Lebanon.Depositors in Beirut have been asking why clients of American banks received measures guaranteeing the totality of their deposits within a week...