Home Banking & Finance One path to survival with no forks in the road

One path to survival with no forks in the road

A new financial system is required to lift the nation from its bowels of misery

by Marwan Marshi

Lebanon’s socio-political-economic cancer has metastasized through critical levels of political corruption and nepotism, with flagrant economic and social exploitations, from politicians, their institutions, and the elitists who surround them. The country’s fiscal and monetary platforms need a thorough overhaul, which stand as the formal starting point to remedy the state’s inherent calamities.

Earlier this year, on June 22, Marshi & Partners (MAP) presented a comprehensive Reform Plan (RP) for Lebanon. MAP’s newly designed financial system is presented in Exhibit I (below). Its primary focus is simple – creating robust, independent divisions with the necessary knowledge, and checks and balances, legislated by a judicial infrastructure. Every successful nation across the globe employs similar processes.

The proposal provides executable solutions for the majority of the catastrophes that plagued Lebanon since its days of prosperity in the early 1970s. Lebanon’s self-inflicted problems resulted from actions and decisions bordering on deliberate and institutional fraud. They destroyed the moral identity, integrity, and dignity of the nation, disrespecting our citizens, while abandoning future generations with shameful legacies that require too long to heal.

MAP designed a restructuring of Lebanon’s financial system, consistent with best practices. The proposed new financial structure analyzes three pillars: (A) Ministry of Finance (MOF); (B) Banque du Liban (BDL); and (C) Commercial Banks. The primary emphasis is on BDL, as it is the most critical component of the system today, marred with a current convoluted and haphazard structure, compounded by irresponsible input from MOF and commercial banks (A and C). Once the state is serious about restructuring; we could see ripples of confidence and trust in nine months to a year.

Republic of Lebanon (ROL)
Bank Du Liban (BDL)
Commercial Banks

It is practically impossible to establish sustainable solutions for around 95 percent of Lebanon’s population – primarily middle-class and lower-class citizens, and those below poverty lines – unless fiscal and monetary financial discourse is fixed first. The approach must include fiscal control of governmental expenditures, efficient tax collection, along with monetary actions to inject confidence in the local currency, control inflation, lower unemployment, and expand GDP.

In developed, prosperous, and democratic countries, whenever political and financial problems collide, financial solutions usually out-trump politics towards reform. Political agendas ebb and flow and are often overly debated. What may be popular one year may become toxic in another. Alternately, the health of financial markets is always necessary, and it generates an atmosphere of productivity and efficiency.

Lebanon is a developing country, and over the past decades, our government’s political and monetary strategies grew in obstinate directions of sectarian divides, mired by exceptional fiscal embezzlement and corruptibility. Lebanon was robbed of its stature and wealth through domineering foreign affairs, mostly found on fraud, malfeasance, and exploitation, against a backdrop of impunity. Decades of financial carnage resulted in the collapse of the commercial banking sector and BDL, the central bank, just before the end of 2019. The civil uprising of October 2019 was the straw that broke the camel’s back, as frustrations and inequalities of the past near decade eventually erupted, in a somewhat peaceful, yet aggressive, nationwide manner, never witnessed before in Lebanon’s modern history. 

Ironically, the savior for politicians against the government’s compounded misfortunes arrived as a result of the outbreak of the global COVID-19 pandemic in January 2020, when protesting was banned for health reasons and became legally and practically prohibited – a significant win for the government to procrastinate, especially as no solutions were agreed to let alone contemplated. 

From the onset of 2020, two of several debacles sent Lebanon reeling further downwards. The first was the announcement of the government’s first-ever international debt moratorium in March 2020 by Prime Minister Hassan Diab, the short-lived replacement after the resignation of Prime Minister Saad Hariri. The second was the heinous Beirut Port explosion in August 2020, the combination of which led to Hassan Diab’s resignation. The country’s woes continue to disintegrate, as the World Bank defined the financial crisis as one of the worst in the world since the mid-19th century.

Let us not forget that since its independence from France in 1943, Lebanon has advanced with the most highly qualified educational, social, and medical institutions in the Arab world, with one of the highest literacy rates in the Middle East. It championed robust, westernized, international banking and commercial organizations, with a cosmopolitan, multi-lingual environment, under a democratic constitution, albeit one that needs restructuring, to appease current times. Lebanon commanded tourism, with a breathtaking, fertile landscape, a complete western Mediterranean coast, countless rivers, ski-high mountains, and deep tree-lined valleys, envied by most nations in the region. The country, with all its problems, has always been a beacon of hope, with resilience under any duress.

Lebanon’s character and history provide a unique opportunity to reengage in principles of fairness and morality, so long as the government abides by its mandate for integrity and fairness. If we fail with solutions in the now, our day of reckoning is around the corner. 

Fiscal Program

In the fiscal part, MAP designed a program to reduce the Ministry of Finance’s total debt outstanding. We investigated all our indentures, covenants, and our Fiscal Agency Agreement, and designed what we termed the Switch Exchange Offer (SEO).

SEO is a unique strategy that allows for the exercise of our Collective Action Clause (CAC), in a manner that applies to all Eurodebt. It allows MOF to restructure the liabilities by extending maturity, lowering interest expenses, and reducing principal outstanding. The restructuring of local debt is not as involved, particularly because it is governed by local law, and the Lebanese pound (LBP) depreciated significantly. In our fiscal phase, we reduce our debt from close to USD 104 billion pre-crisis to around USD 20 billion post-restructuring. The entire process could be completed in less than one year. 

Monetary Program

Since 1997, post the Taif Agreement that ended the Lebanese civil war, the Lebanese pound was pegged to the US dollar (USD) at a constant rate of LBP 1,500/USD 1.00. It was not until 2019 that the Lebanese pound collapsed and by early September, 2022 reached levels as high as LBP 35,000/USD 1.00.

For any return of confidence in our currency, a change in structure is required. A significant portion of problems arose from the careless printing of the pound and irresponsible acts of financial engineering. 

With this in mind, MAP has incorporated a new “benchmark currency” into the strategy, called the Republic of Lebanon Lira (RLL). RLL is not the central theme that restores confidence, but it nevertheless represents a vital ingredient.

MAP proposes the following scenario. RLL becomes the new and sole legal tender, the only currency accepted for any transaction inside Lebanon. Concurrently, LBP is confiscated in exchange for RLL. RLL bills for circulation will be newly minted, and RLL will enter the Fedwire system for electronic international transfers, post-conversion to USD, at then-prevailing exchange rates, as defined below. RLL will have two components, a pre-determined amount of USD and a Lebanese Lira-Indexed (LLI) Value. The stapled nature of RLL makes it a single unit that cannot be separated into individual elements and is “collateralized” by them. Cross-border transactions will be dealt with using RLL in local bank accounts, converted to foreign currencies, using reserves at BDL. To apply some level of consistency, RLL should be somehow related to the confiscated Lebanese pounds, and that may be accomplished, albeit at controlled levels of monitored “issuance.”

Assume the following exchange rate equation applies between RLL and USD:

• RLL [1.00] = USD [Y] + USD [1.00 – Y] * [X(0)/X(t)], where

• RLL = New Republic of Lebanon Lira

• USD = US Dollar

• Y = Pre-determined fixed USD amount, for an ‘initial parity condition,’ so RLL 1.00 = USD 1.00

• X(0) = Constant exchange rate, for the initial parity level of legacy LBP to USD 

• X(t) = “Monetary Variable” representing a Lebanon Lira-Index (LLI) to manage monetary policy, to control inflation, unemployment, and GDP. 

When RLL is introduced, at t = 0, RLL 1.00 will equal USD 1.00, by definition. X(0) will be the initial parity level of legacy LBP/USD. As an example, if Y is set at USD 0.70, which appears as a reasonable approximation of the current percentage of Lebanon’s GDP in USD; and X(0) equals legacy LBP 20,000/USD, Lebanon meets its preliminary parity objective, RLL 1.00 = USD 1.00.

If X(t) is changed to LBP 30,000/USD at a future period t, then RLL = USD 0.90. Alternately, if X(t) is changed to LBP 10,000/USD at a future period t, then RLL = USD 1.30.

It is difficult to set the equation parameters presently, without full knowledge of the existing data. Importantly, future BDL monetary changes are instituted through changes in X(t) at time intervals of t. The value of X(t) will be managed by a pre-determined percentage change by several institutions to ensure fairness and transparency. At the outset, and until Lebanon’s economic confidence is retrieved, the International Monetary Fund, the World Bank, BDL, and the MOF will be in charge of setting X(0) and the percentage range within which X(t) can alter periodically, based on extensive historical, economic, monetary, and statistical data, with appreciation of market dynamics and reactions. Eventually, after trust in BDL is achieved with the highest integrity, the value of X(t) will be determined by BDL, as shown on page XX.

Once Y, X(0), and the parameters influencing X(t) are established, RLL is produced. Legacy Lebanese pound, LBP, will be translated into RLL and confiscated. All commercial banking deposits will be translated into RLL, through systematic and transparent processes, not described in this article for simplicity. Local transactions will be performed in RLL as the sole currency, while cross border activity is executed through exchanging RLL into USD at prevailing exchange rates through BDL’s FX reserves.

The advantages of replacing the Lebanese pound are numerous. Firstly, any constant peg of LBP would be gone, and with it the outlandish mispricing opportunities in parallel and black markets. The exchange shops, or “sarrafs” would be outlawed, and a limited number of nationally regulated exchange rate entities would be established with offices all around Lebanon. 

BDL would be divided into independent Divisions I and II, with various, yet complementary functions to separate the flows of USD and RLL inside Lebanon. Division II will be tasked with exchanging all USD net transfers across Lebanon (such as proceeds and payments of foreign borrowings, internal remittances and external transfers, and financing current account deficits), in exchange for RLL from Division I at prevailing RLL/USD exchange rates. Division I will be tasked with exchanging all USD net transfers within Lebanon in exchange for RLL with Division II at prevailing RLL/USD exchange rates, and is the only entity allowed to print RLL. In such a manner, all Lebanese constituents, such as merchants, suppliers, and retail bank customers perform USD transactions under the checks and balances between Divisions I and II as follows: To the extent Lebanese constituents require USD transfers outside Lebanon, Division II withdraws RLL from the Lebanese constituents RLL commercial banks accounts and exchanges them into USD from Division I for such transfers. The reverse processes apply for Lebanese constituents’ RLL commercial bank accounts receiving USD from outside Lebanon. While we use USD here to explain the flows between Divisions, any other international currency may be substituted. We use USD as the primary example because a) Lebanon has a predominantly dollarized economy and b) the USD is the reserve currency of the world.

All RLL/USD exchanges between the two Divisions are pre-approved, recorded, and monitored. Divisions I and II, within BDL, operate under different management and are accounted for and monitored separately and independently. Both Divisions jointly establish monetary policy for inflation, labor, and current account stability, and intermediate with the MOF to assess fiscal policy.

The three charts in this comment are our exhibit I, which illustrates the proposal of our new financial system, with emphasis on Part (B), BDL’s operational restructuring. Exhibit I may appear complex, because it is a full and robust description of A, B and C.  In real life, it is simple to develop, given the advances in financial system speed and technology.

There are exceptional advantages to instituting RLL as the new currency. For purposes of illustration below, we set Y at USD 0.70; X(0) at LBP 20,000/USD; and use X to denote X(t).

1. RLL cannot be separated into its individual components; namely, USD 0.70 and the remaining LLI portion of the RLL, and the issuance of RLL is fully monitored and controlled by BDL’s Divisions I and II.

2. RLL will be the sole legal tender accepted in Lebanon, with judicial penalties against any violations. Further, all commercial bank deposits will be denominated in RLL, with fluent access to transact in foreign currencies outside Lebanon, through BDL’s Divisions.

3. RLL is neither a “peg” nor a “free-float” currency; its value can be adjusted based on changes in its variables with the USD: a fixed component, Y, and a tight range-bound variable component, X. 

4. X does not change daily or independently, rather it is altered periodically by BDL and its advisory committees, as and if needed by market conditions.

5. RLL will generally be similar in currency composition to Lebanon’s GDP composition, providing for more efficient stability in Lebanon’s current account.

6. RLL’s volatility is estimated to be less than one-fourth the volatility of the defunct legacy LBP, as a result of the stabilizing impact of a constant Y value, and the tight range-bound X value, offering consumers comfort and stability in valuations and inflation. 

7. RLL’s value for X is limited in reasonably stable markets, and will generally be calibrated such that RLL remains within USD 0.80 to USD 1.20, over a long time period, unless unmitigated conditions warrant otherwise. 

8. RLL’s downside limit is USD 0.70 plus the residual USD value from X’s LLI component. 

9. Unregulated “sarrafs” will be outlawed, and a limited number of nationally regulated exchange rate entities would be established to provide RLL in exchange for USD, for tourism and other small retail transactions.

MAP’s logic is based on history, using the two extremes of currency exchangeability. At one extreme would be the ‘peg concept,’ perhaps at LBP 20,000/USD, or whichever alternate constant figure. At the other extreme, the currency is allowed to ‘float freely’ against other currencies. History has proved that neither extreme would be successful for Lebanon. Hence, MAP applied a point in between, designed to calibrate the local financial environment, by X adjustments. The country can apply specific constraints on RLL allowing it to serve as the common nucleus needed to advance and confront the most critical problem we face. Taken holistically, we believe that along with MOF’s domestic and foreign debt reduction program, RLL’s stated advantages make it an ideal monetary product for Lebanon.

If Lebanon places belief solely behind the sanctity of politics or finance, independently, we will surely fail for several more years, perhaps decades, to come. Citizens are exhausted from their collective miseries, observing one of history’s worst brain drains, under a mere two hours of electricity per day. 

The will of the people must prevail. With that, the only way to stabilize the nation is by first revamping our financial system, outlawing corruption, and retrieving confidence. Once those are done, political problems and standoffs, whatever their genesis, will be resolved. The Lebanon of the past must retreat from its old processes and mannerisms if we are to save the nation.

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Marwan Marshi

The founder and chairman of Marshi & Partners, a financial innovation boutique specializing in the advice and execution of corporate and sovereign liability and risk management strategies.

Samer Marchi

A founding member and director of Marshi & Partners

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