A key driver of the Lebanese economic crisis has been the losses incurred by the public sector. These losses have impaired the banking sector and through it the deposits of many citizens. Banks had committed the bulk of client deposits in the central bank, Banque du Liban (BDL), which in turn had used them to finance the expenses of the government and public institutions. In relying on Lebanese citizens’ deposits to cover public deficits, Lebanese authorities have abused trust and failed to ensure the effective and transparent management of the economy. Prior to the meltdown, the government had tried to placate citizens with the help of subsidies. Since 2019, citizens have borne the brunt of the crisis, reflected in rising unemployment rates, increased poverty, inflation, and degradation of deposits. With the beginning of the crisis, the politically divisive debates raged over the right strategy to address the progressing degradation of deposits. Both the subsidy policies and attempts to stop the degradation by measures forced upon the banking sector have failed in fulfilling the hopes of citizens and wishes of the government. After two years of financial disarray, priority should be given to compensating for US dollar deposits that banks have placed in BDL, as these make up more than 60 percent of total deposits and are not backed up by any guarantees.
For citizens, freeing their deposits is the top concern. The current government statement of policy in September 2021 has responded to this issue by emphasizing that the reform plan for the banking sector will be “prioritizing the safeguarding of depositor rights and funds.” The public sector is responsible for depleting the citizens’ funds and must shoulder the consequences. The private sector has endured enough. A haircut on deposits or a distribution of losses between the private and the public sectors might be the simplest, but also the worst solution. It could be challenged constitutionally and judicially. Moreover, a haircut has already been applied on depositor withdrawals. It has cost citizens an estimated $5 billion in losses. In total, measures taken by the government and BDL since the beginning of the crisis have accelerated, rather than resolved, the economic and financial freefall. The government has not even shown interest in addressing the matter. Therefore, how can the State really commit to restoring citizens’ savings and rebuilding trust?
The first step to restoring trust is adopting monetary, financial, and structural reforms; namely the immediate unpegging and standardization of the exchange rate for all transactions, given the serious damage that multiple exchange rates can have on the economy.
It has been argued that unpegging of the exchange rate from the previous low rate of 1,500 Lebanese pounds on the dollar would further increase inflation. By that reasoning, if one believes that the added liquidity would be detrimental to the economy, one must first recognize that the damage from multiple exchange rates and the freezing of deposits has been and will be far more disastrous than the damage of adding liquidity. Unpegging the exchange rate and operating deposit withdrawals at the unpegged rate may alone provide an important solution to the deposit access dilemma.
Under this solution, depositors would be content with cashing their US dollar deposits in Lebanese pounds at the market rate. As such, they would cease making cash transactions that have flooded the economy with liquidity and accelerated the collapse of the Lebanese pound. Unpegging the exchange rate is inevitable. It is better to adopt it immediately rather than pay the far higher cost of delaying it.
Second: A self-bailout by BDL
As a second step, or simultaneously, the matter of deposits in US dollars in BDL must be addressed. These deposits, without backing of guarantees, amount to around $65 billion, out of a total of $106 billion of deposits as at end June 2021. The remaining 39 percent of deposits are invested in the private sector and bonds, and are backed by guarantees.
The $106 billion deposits were deployed by banks as follows:
* Deposits in BDL amounting to around $65 billion (an estimate, since BDL does not disclose this figure).
* Investments in Eurobonds payable by the Lebanese State ($8 billion).
* Lebanese pound and US dollar denominated loans to the resident and non-resident private sector in US dollars ($23 billion).
* Other bank assets in foreign currencies, including holdings of equity (shares) in branches abroad ($10 billion). These shares are considered foreign assets.
To compensate depositors for their deposits that have been invested by banks in BDL, the public sector’s real and monetary assets must be used. Deposits at BDL have been drained, are supposedly unavailable, marked as losses (in the electricity sector and other dossiers), and are not guaranteed. The public sector as a whole carries the blame of squandering these funds. This devastating practice has been facilitated by the indifference or inability of oversight bodies, namely the legislative and executive authorities, to ensure effective monitoring of banking sector performance, despite decades-long warnings by experts and international financial institutions about risks of exceeding the solvency.
The simplest and most effective method by which the public sector can take responsibility for restitution of squandered funds is first to restore depositors’ funds by using the remaining BDL cash assets in foreign currencies, similarly to when the private sector defaults on obligations. It is still possible to restore $14 billion in cash to banks from the remaining mandatory reserves.
Moreover, the government may reconsider liquidating part of the gold reserves and depositing the amount in banks in order to compensate depositors for the funds. Believing that gold is a bond of trust is indeed wrong. It gives false trust in economic performance. It is widely known that gold is considered worldwide as part of monetary reserves and is used as such.
Once the exchange rate is unpegged and BDL ceases to supply foreign currency to the market, management becomes more effective and will focus by default on the management of liquidity in the national currency.
Secondly, state-owned real assets should be used through privatization to compensate depositors for the remaining $51 billion. The total value of state institutions subject to privatization as a first stage (telecommunication-OGERO, aviation-Middle East Airlines, electricity, port operation contracts, real estate companies, airport and marine blocs – gas, oil, etc.) is estimated at no less than $50 billion, based on projected profit under private administration.
Filling the $51 billion gap
Establish individual joint stock companies for each basic public sector institution, place them under private management as soon as possible, and issue shares denominated in US dollars, similarly to other companies listed on the Beirut Stock Exchange (such as Solidere and others). This requires seeking out local and international expertise to form a commission in charge of achieving this goal and issuing new securities. These shares would be gradually offered through the Beirut Stock Exchange and be made available to those interested, including resident and non-resident depositors. A sizeable portion of these shares would be bought by depositors through their bank accounts. As a result, deposits would be replaced with real assets, thereby reducing bank balance sheets by the corresponding amount. A reminder, the 2003 government reform plan for the electricity sector was based on the privatization of the power company, Electricité du Liban (EDL).
Furthermore, shares in the privatized companies purchased through new accounts and international transfers would provide revenue in US dollars, which then would feed into the remaining bank deposits in US dollars. For depositors who do not wish to buy the new shares in the privatized companies, their deposits will remain in banks and these depositors will now have cash assets in foreign currency, proportionately to the level of subscription to these new shares by resident and non-resident investors.
In other words, the State would not be squandering public resources, but rather transferring ownership of public assets to citizens, while maintaining fair distribution by limiting individual ownership. Therefore, remaining non-liquid deposits will be exchanged for real shares from privatized state assets such as Middle East Airlines.
The resolution of state-owned assets would result in restoring the real monetary value of deposits that were dissipated in BDL. Deposits would either be in foreign currency, or consist of a mix of shares and deposits with long maturity dates of foreign currency and real assets. Part of the population who do not own bank deposits, would benefit from reforms, better management of the economy, and restoration of economic growth and job opportunities.
Those who oppose privatization, such as foreign consulting firms, aim at having Lebanon continue depending on foreign financing and depleting deposits, despite great risks.
Privatization and compensation for deposits are the optimal solution. Anti-privatization rationale argues that the public sector belongs to everyone, not only to depositors. This logic can be challenged by the very fact that the public sector’s administration has made everyone go bankrupt, the rich, the poor, people who own deposits and people who do not. The alternative to privatization is to let the State continue with poor management of public sector institutions or rob citizens’ deposits.
Moreover, privatization would enhance economic performance and improve the standard of living of Lebanese people of all classes. Thinking that selling state-owned institutions in the current situation would be selling them cheap is a flawed analysis because real assets are valued based on projected potential performance.
Accounts in banks and in BDL would be adjusted to reflect these transactions: bank deposits and the corresponding assets in BDL will decrease proportionately to the value of shares purchased in the new companies using frozen deposits. The BDL budget, meaning the BDL balance sheet, will be reduced by the parallel $14 billion, representing the reserves returned to depositors as well as by the extent of compensation for the remaining bank deposits in US dollars through privatization. To avoid bank runs on cash withdrawals from the remaining deposits, banks would restructure the deposits in a multi-term plan; over sequential short- to medium-term maturity.
There have been previous calls for the establishment of a sovereign fund for state institutions with the aim of using its profit to compensate for deposits. This is a futile proposition considering that the fund would still be managed by the incapable State, and compensation will take generations.
Finally, with regard to deposits in Lebanese pounds, these are guaranteed by secured loans and state bonds, and must be subject to a clear restructuring. Solving the dilemma of deposits and the availability of liquidity (in addition to other reforms) is necessary to restore trust and foster economic growth. Solving the overall deposit crisis will be the cornerstone of reforms and rebuilding trust.