The Banking Executive Magazine - March 2021

The Conduct of Lebanese Banks Leading to the 2020 Financial Crisis Lebanon walked out of Paris II in No- vember of 2002 with US$4.5 billion in soft loans from countries friends of Lebanon. This represented, at the time, 25% of the country’s Gross Do- mestic Product (GDP). It must’ve been a much needed fund but it was not properly utilized. After that, po- litical class’s appetite to spend grew stronger with little to no reforms to report or claim. The nature and mag- nitude of the debt problem couldn’t be made clearer with the statement of, then the chairman of the Board or Directors of the Association of Banks in Lebanon (ABL), in February of 2012, Dr. Francois Bassil, came out strong against banks continuing on the path of lending the government. It was utterly clear that Lebanon’s public debt is getting out of hands, and it is no longer sustainable. With banks operating in Lebanon bearing half of the public debt in foreign cur- rencies, and over two-third of the debt denominated in domestic cur- rency, that put them in the eye of the storm! The government’s disorderly default in early March 2020 turned Bassil’s legitimate fear into a horrible reality. The nature of the crisis and its magnitude make a government res- cue and recovery plan very complex, and it will most definitely fall short of dealing with the causes of the crisis. THE BANKING LANDSCAPE Banks under-estimated the risks asso- ciated with buying in Lebanese gov- ernment debt instruments, and over-invested in these securities. Isn’t it time to ask if the state of banking in Lebanon, the way it’s been, is healthy and sustainable? I doubt it is. I can think of a few areas that banks need to revisit, look long and hard to identify weaknesses, and effectively deal with them. a) The Banking Model. The excessive reliance on deposits as the only source of fund for banks makes managing liability more chal- lenging relative to a banking sector with more diversified sources of funds. Banks, in recent years, spread their wings very thin knowing the volatility of their sources of funds. Banks’ uses of funds have been ef- fortlessly allocated as follows: • Required Reserves (25% on Lebanese Pound - LBP, and 15% on Foreign Currency – FC, which comes in the form of Mandatory Placements with Banque Du Liban, BDL, the country’s central bank) are balances held at the central bank earning no explicit return. However, what was supposed to be ready reserves failed in 70% of it when that much turned into long-term subsidized loans as a part of an expansionary monetary policy initiative which turned sour because, in pursuit of explicit re- turns, banks failed to match the high quality of this reserve with high quality loans! Banks utilized every penny in regulation, and, by doing so, the mandatory reserves effectively dropped from 25% to less than 18% leaving banks ex- posed. • Excess Reserves which, to date, re- mained as ready reserves in the purest sense of liquidity. Banks al- locate this liquidity between cash in Automated Teller Machines (ATMs) and with tellers. • Loans to private sector. Retail (car, personal, housing, … loans to in- dividuals), commercial (overdraft facility, term-loans, project fi- nance, … to business enterprises). For most banks in Lebanon, the loan-to-deposit ratio jumped over 65%. Not all banks followed best practices in lending. The problems of adverse selection and moral hazard became obvious when at the first sign of deteriorating eco- nomic conditions in late 2017, non-performing loans jumped up with little impact on bankers’ ap- petite to lend more; lending con- tinued until up mid-2019, right before the ‘big bang’ – the uprising of October 2019. On the other hand, in order to avoid being pe- nalized through provisions for loan loss reserves, banks practiced a worrisome rigidity in downgrading the quality of their loans; a practice the Board of Directors and the ex- ternal auditors found no harm in it. Finally, since loan sales is not a vi- able option here in Lebanon, loans are, by far, the most illiquid form of uses of funds even a simple delin- quency in settling a payment on a loan is easily felt in the bank’s re- alization of ready liquidity derived from the settlement of debt. • Placements with non-resident banks, mostly correspondent banks. These placements are used [as a cushion] to facilitate the fi- nancing of international trade. Al- ISSUE 147 MARCH 2021 the BANKING EXECUTIVE 35