An alternative to ineffective banking reforms and recovery plans
The latest version of the bank resolution law has the same pitfalls as the previous ones.
Mainly, the law proposed the creation of a committee entitled to determine which banks to be resolved and which to be restructured. The committee is composed of the central bank’s governor and vice governors as the main decision makers, which implies that Banque du Liban (BDL), the debtor, is determining the destiny of banks, the creditors. It is an absurd situation. The decision-making process should be in the hands of an independent committee.
It has other pitfalls such as the discretionary classification of deposits into qualified and nonqualified deposits. The proposed reforms would also require depositors to provide evidence of how they earned all deposits exceeding $500 thousand dollars and confirmation from the ministry of finance of the respective country where the deposits originated. This is impossible, especially in cases where earnings originate from Arab oil countries that don’t impose a tax regime.
An alternative reform plan
It is, therefore, imperative to devise an alternative plan that resolves the insolvency issue without depriving depositors of their legitimate financial savings. Furthermore, deleting deposits can’t be undertaken without the consent of the majority of depositors under a “collective action clause-CAC” requiring a single aggregated vote of consent of 75 percent. A massive bail in is an aberration and departs from good practices as noted by some member of the IMF Executive Board. Deposits of banks at BDL are liabilities and should not be classified as losses under any circumstances. The solution is neither to delete nor to refund deposits, but to safeguard them in banks’ balance sheets and create liquidity and trust in the financial system.
Creating trust and liquidity are the indispensable elements of resolving any banking crisis. To achieve these goals, it is essential to implement the following:
1. Protect all deposits: First, assure that deposits are protected and maintained as banks’ liabilities. Any emerging losses incurred from liquidated banks should be dealt with through the proper legal liquidation channels (liquidation law 110) and not through ad-hoc discretionary measures. The government should declare adherence to the constitution safeguarding all financial and real assets. Safeguarding personal (national and foreign) and institutional savings is necessary to regain trust.
2. Adopt a free market-determined exchange rate: Unify and free the exchange rate for all public and private transactions and remove all restrictions on bank transactions in foreign exchange. The central bank may intervene in the foreign exchange market as part of its stabilization monetary policy and to avert unexpected market pressure. A free foreign exchange market will diminish the role of the BDL in hoarding significant amounts of reserves. Required reserves ratios can be significantly reduced, thus generating foreign exchange liquidity in the banking sector.
A free foreign exchange market creates trust as it allows depositors and banks to freely make transactions from their foreign exchange accounts in either Lebanese pounds (LBP) or dollars at the market rate. With a unified market determined rate, the depositors will be unconcerned about whether they are reimbursed in Lebanese pounds or in dollars from their accounts. The virtual and digital role of money can be resumed with the use of checks and credit cards and other digital schemes such as PayPal and e-wallets. With all banks accessing the foreign exchange market, the market will become larger and more competitive, limiting opportunities for manipulation by single foreign exchange traders.
A free rate can equilibrate financial markets and the balance of payments by promoting production of import substitutes and exports of goods and services. It restores the real value of financial assets and liabilities, promotes savings and investments, attracts foreign investments, and promotes growth.
3. Reschedule financial assets and liabilities: Reschedule all public and private financial assets and liabilities in foreign exchange and LBP accounts including deposits and public debt for short, medium, and longer-term periods not to exceed 5 years. This measure can be designed to ease the initial strain the banking system may face when a free/ floating exchange rate is adopted. The BDL can initially allocate a portion of its reserves to reduce a possible initial turbulence in the foreign exchange market. Rescheduling of financial assets and liabilities may be guided by the term-structure that prevailed in 2017-2018 before the crisis. The BDL could supervise the process to ensure its adequacy according to the prevailing conditions in banks. The rescheduling should include all client deposits at banks and the liabilities of the BDL toward the banking sector. Any write-off proposals to reduce liabilities of banks has to be acceptable to depositors individually or in the context of a Collaborative Action Clause (CAC). The government cannot devise a plan that reduces deposits without acceptable and appropriate compensation, which requires the participation of creditors and legal transparency.
Foreign currency debt consisting of $33 billion (composed mostly Eurobonds) is being held by foreign financial institutions and private holders (approximately 50 percent), Lebanese commercial banks (7 percent), the BDL (15 percent), and by bilateral and multilateral obligation (3 percent), with the remainder being held by Lebanese banks and private holders. A large part of the portion held by international financial institutions (IFIs) was acquired at a discounted price during the crisis. Netting out BDL-held Eurobond debt and the discounted value of IFI-held Eurobond debt could entail a reduction in foreign currency debt of nearly 20 to 25 percent. The government may be able to reschedule dollar debt on terms consistent with debt sustainability with the consent of creditor.
Public debt in LBP mostly held by BDL and banks has been diminished in dollar value by 98 percent, or the exchange rate depreciation rate.
4. Balance the budget: Pursuing fiscal reform with the objective of achieving a balanced budget with a primary surplus is a key ingredient in generating stability in the foreign exchange market and improving external transactions outlook. A free rate enhances government revenues from trade taxes, VAT and income taxes. It can allow the government to adjust its expenditure including wages, investment spending and, at the same time, contribute to a balanced budget target.
In addition to the impact of adopting a free market-determined rate, several additional fiscal measures should be considered that can improve budget performance and debt sustainability by enhancing revenue collection, such as adopting an appropriate tax structure combined with an efficient- spending programs.
5. Efficiently reform the banks: Banks’ troubles stem from the default of both the BDL and the government in servicing their obligations. Their non-performing assets can be resolved as part of rescheduling their liabilities. Bank reform can be supervised by the relevant financial agency at the BDL in collaboration with the Association of Banks of Lebanon. Exchange rate reform should precede any resolution or liquidation of banks. Commercial bank losses could be limited as most bank assets are collateralized except for sovereign public debt.
The BDL recapitalization could be replenished gradually from government sources as Article 113 of the code of money and banking stipulates that BDL losses have to be borne by the government. The rescheduling of BDL assets and liabilities combined with freeing the currency market could be sufficient to allow the BDL to resume its normal operations. However, the BDL is indeed in need of implementing an administrative restructuring plan in order to reduce the centralization of its current structure.
6. Corporatize public enterprises: The public enterprise sector has been a major burden on state finances with most of the dollar debt burden emerging from financing their financial gap, prominently within the power sector. The power sector alone received transfers of $50 billion over the past two decades including interest cost estimated at $26 billion.
Corporatization of state-owned enterprises will create an opportunity for depositors to invest in the private sector, and reduce the liabilities of banks. The emergence of a new corporate class will be a fertile ground for allowing banks to play their proper intermediation role and grow again instead of relying on the state for their livelihood.
A salvage plan for whom?
All recovery plans that have been presented since mid-2020 by the governments of Prime Ministers Diab and Mikati, respectively, continued to focus on writing off presumed losses and diluting them rather than on reviving the economy. They presumed the crisis as a bankruptcy rather than an insolvency or liquidity case.
These plans, endorsed by the International Monetary Fund (IMF), assumed losses equivalent to over 90 percent of deposits and concluded that the burden of losses should be borne by the depositors, as they falsely claimed that both banks and the government are bankrupt. Residents and non-residents alike have already assumed large losses from restricted and undervalued dollar withdrawals. As noted at the onset of this comment, no version of the bank resolution law has resolved this fundamental flaw. Any new recovery plans must not further penalize the people.
This article reiterates and expands on a similar argument from this same author published by Executive in February 2023.
