When it comes to the question of what Lebanese commercial banks should and could do differently in 2015, the short answer is ‘almost everything’. However, as far as what one can realistically expect them to do differently, from the damaging ways they have trodden for more than two decades, the answer is ‘very little’.
As vexing as this is, our banking system’s emergence into the modern economic era would depend on an awakening and adoption of new policies by the central bank. For the past 22 years, since embarking on reconstruction in 1992, Lebanon has been relying on a simplistic currency mechanism of fixity.
In 1972, the countries of the world replaced the post World War II fixity with a system whereby the currency, as a mirror of the economy, moves under the influence of factors such as domestic interest rates, job creation and employment, balance of trade and fiscal balance.
Lebanon’s central bank, however, has been focused on maintaining the Lebanese lira independently of the economy
Since then, when the previous model of fixity known as Bretton Woods was abandoned, monetary policy has incorporated flexibility, which helps any national economy to position and correct itself. Lebanon’s current currency regime, on the other hand, is still stuck in the era of fixity defined by Bretton Woods and it lacks a real monetary policy — its greatest failing.
By definition, monetary policy aims at supplying enough money to the economy to cover the needs of producers and consumers, to control inflation and to contribute efficiently to better economic growth. Lebanon’s central bank, however, has been focused on maintaining the Lebanese lira independently of the economy. Thus, what we have seen is a contractionary central monetary policy under which money supply in Lebanon since 1993 has never been sufficient to cover the real needs of companies, farmers, individuals and private households.
In August 2014, our commercial banks surpassed $150 billion in deposits. How are they utilizing these savings? Of this $150 billion, $60.9 billion was deposited in the central bank as of September 2014, according to data from the Association of Banks in Lebanon. This sum entails the required reserves, which are among the highest in the world in terms of percentages mandated, at 15 percent for deposits in foreign currency and 25 percent for lira denominated deposits.
The required reserves amount to approximately $25–$30 billion, which means that we have $30–$35 billion held at the central bank in excess of the required reserves. These amounts lie dormant, meaning they are paralyzed and inactive when it comes to economic usage.
But, even if we assume for argument’s sake that the $60 billion in the vaults of the central bank is held to support fixity and the lira’s peg to the US dollar, what about the remaining $90 billion in deposits? How is it used? Between $37 and $38 billion are committed to funding the public deficit via subscriptions in treasury bills and eurobonds. The rest amounts to a bit more than $50 billion, out of which $44.2 billion have been granted by commercial banks as loans to the whole resident private sector in Lebanon, to all companies and private households.
We are contradicting the basic equation of macroeconomic equilibrium
This fashion of managing our financial resources contradicts a basic macroeconomic equilibrium equation, which says that savings in the national economy are supposed to mainly finance domestic investments and foreign trade. Given that less than one third of our savings are dedicated to lending to the private sector, do our savings sufficiently finance our domestic investments and foreign trade? The answer is obviously no. We are thus contradicting the basic equation of macroeconomic equilibrium.
The way out of this violation of macroeconomic fundamentals will open up only if a real monetary policy is established and diligently applied, including flexibility in the management of our currency. If you allow your currency to depreciate when you have a growing deficit in the balance of trade or in your budget, this depreciation will help you export more, and by exporting more, you can correct the anomalies in your domestic economy. Rigidity of the currency regime, on the other hand, will only exacerbate any anomaly in your economic results, as you are not allowing the economy to correct itself.
Our economy is of a very humble dimension compared to a huge quantity of debt, the result of the contractionary monetary approach of the past 22 years. Also, resulting from this approach of the central bank, our interest rate returns on deposits since 1992 have always been higher than international rates. These high returns have been linked to that approach because in the mind of the central bank, the assumption has been that the higher the return on deposits, the higher the demand for the lira will be, irrespective of the state of the Lebanese economy.
What these high interest rates have neither linkage to, nor influence on, though, is inflation. In the minds of our central bankers, the course of keeping liquidity scarce under a contractionary monetary approach may have aimed at warding off inflation — but that has not been so. Despite a very controlled money supply, inflation has not been controlled or mastered. Reasons for this inability to control inflation stem from huge structural deficiencies, such as the presence of monopolies paired with anarchy and a lack of controls in our markets.
As the high returns on deposits have been linked only to the currency peg and to nothing else, the presence of high interest rates has lowered both domestic investment and consumption, and we all know that you cannot grow an economy without sufficient domestic investments and domestic consumption. For this reason, the entire banking system in Lebanon, including the central bank and the commercial banks, is suffering from anomalies and deficiencies.
The profit trap
Yet nobody can deny that the Lebanese banking sector is flourishing, generating high profits for both owners and shareholders in our commercial banks. There are three reasons for this, despite the financial sector’s violations of a basic macroeconomic equation.
The first is that the majority of the $45 billion in domestic lending is given by the banks to the private sector’s strongest constituents. Only 5 to 10 percent of private sector participants are benefiting from 80 percent of loans, which means that our banks are not playing their role of fairly supporting all stakeholders, sectors and producers. Even with the very moderate amounts of money that are loaned to the private sector, banks are very selective in choosing their debtors.
Lebanon’s economic model is therefore an elitist growth model — only the elite in such a system are supposed to grow and progress, while in Lebanon’s case it is comprised of people from the political class and those in governmental positions, plus the financial oligarchy. Besides being restrictive against the needs of small producers and burdening consumers with excessive costs of credit, the elitist growth model allows banks to reduce their overall lending risk to very low levels — nearly nil — because their borrowers are overwhelmingly very solvent people and have enough assets to cover their loans.
The whole practice is as if the central bank is transforming itself into a commercial bank
Secondly, the commercial banks benefit from interest payments by the central bank on their excess deposits — those billions sitting in the central bank beyond the required reserves. Even if the banks’ margins are very low on each deposited lira or dollar, they reap these interest incomes on large deposits, risk free and without any input of labor. Apart from awarding banks with unjustifiable interest earnings, the whole practice is as if the central bank is transforming itself into a commercial bank. It accepts deposits and pays interest, which is contrary to the mission of a central bank.
The third reason is, when commercial banks subscribe to public debt instruments, they are assured that they will be paid their interest rates. I think that at least $40 billion of the $65 billion in bank funding of the public debt comes from deposits, meaning that the principal of the lent funds actually belongs to the depositors. But it’s the banks, not the owners of the principal, who obtain high profits from lending to the public sector — and these profits are assured by whom? By all tax payers because the government collects their taxes and pays the interest it owes to the banks through the treasury.
With these three sources of profit — from the wealthy and solvent, from interests paid by the central bank and from the high interest rates on public borrowing — banks are in a very comfortable position and may see no reason to push the government and central bank towards a real monetary policy. But have banks succeeded in meeting their fundamental obligation, which is to guarantee the safety of deposits to the depositors, given that they have granted all these funds to a corrupted government? Likely not.
Managing money right
What the banking sector, led by the central bank, should do in 2015 is take steps to gauge the real state of financial markets in order to at least begin moving toward a monetary approach that supports the macroeconomic equation. The way to do this would be regular weekly meetings with the three parties involved in financial market supply and demand: the central bank governor, the commercial bankers and the economic producers.
In order to invest and consume, the private sector demands money. By viewing this demand on a weekly basis, we can determine how much money the central bank is supposed to supply. The creation of money is warranted, as long as this created money is distributed equitably and fairly between investing and consuming. If all newly created money goes to consumption, it will be inflationary. If it goes to production alone, there will be an excess of supply and a decrease in prices. The money should be supplied based on an understanding of the existing demand and it must be distributed equitably. Both these measures would be within much greater reach if the three parties were to sit down at the same table and review the demand and supply of money on a weekly basis in 2015 and in all other years.