The Banking Executive Magazine - March 2021

The Conduct of Lebanese Banks Leading to the 2020 Financial Crisis though these deposits are, in prin- ciple, ready liquid assets for the banks, today, most of them are held against off balance sheet facil- ities (e.g., letters of Credits, Bank Guarantees, etc.) extended by the correspondent banks (to the banks). The downgrading of the country’s credit risk rating eats away from the power of these placements in terms of their ability to support international trade. • Placements with resident banks, most of these are referred to as overnight placements but with an actual maturity of one week. This is settled quickly and it is used to manage short-lived surpluses and/or deficits in liquidity. Recent events rendered the overnight mar- ket to no use since all banks have been suffering from shortages in liquidity. • Investments in Treasury Securities and Eurobonds. The exposure that bears the higher risk is the one de- nominated in foreign currency. The latest awakening by the people of Lebanon over years of corruption and irresponsible spending by the fiscal government brought con- cerns over the interdependency between the availability of deposi- tors’ funds, the quality of Banks’ uses of fund, the extent of the Cen- tral Bank’s exposure to the public sector, and the health of the fiscal government and its ability to honor its commitments. That describes the nature and extent of complex- ity the financial system in Lebanon has been enduring since early 2020. These securities are mostly held till maturity where banks ben- efit from the coupon payments, and a small portion is held for trad- ing. However, recent years wit- nessed a noticeable conversion of Eurobonds into placements with BDL as an expression of the disap- proval of banks over the conduct of the fiscal government. These forms of investments suffered im- mensely with the disorderly sover- eign default in March of 2020. Best practices call on banks holding these types of investments to write these assets off completely and im- mediately! Instead, however, banks continue to consider, to date, these government securities as a part of their high quality assets in their cal- culations of the Liquidity Coverage Ratio (LCR), and Net Stable Fund- ing Ration (NSFR). That’s the kind of false sense of safety and security which I spoke of earlier. • Placement with the central bank of Lebanon. These placements are over and above both the manda- tory placements with BDL and the reserve requirements. They are dis- tributed between small clearing balances, and the rest in certifi- cates of deposit. These are, in prin- ciple, risk-free placements had the Central Bank kept them as liquid as they ought to be. But, in recent months, it became apparent that BDL used a large portion of these placements, in both domestic and foreign currencies, to bail out the government’s ailing public finance filling in the void that banks cre- ated by pulling away from lending the government. The banking model deployed by most banks has been rigid, and out- dated for being based on originate- to-hold with most of the assets. In addition, it strictly relies on short- to medium-term deposit funding; it’s very restricted with respect to banks’ ability to convert assets into cash; and weak in properly and effectively assessing the risks associated with the uses and sources of fund. I attrib- ute that to the false sense of safety and security that banks have re- ceived from the country’s regulatory authority. I recommend that every bank should intentionally differenti- ate between what is required for reg- ulatory compliance and effective risk management: • In fact, the data produced by most, if not all, banks is done just enough to satisfy BDL reporting require- ments. Banks’ MIS is guided by the data reporting templates provided by the central bank; these tem- plates that have never been chal- lenged not in form nor in content or substance. The figures in regula- tory reporting clearly understate the true risks since it is not risk-dri- ven. • However, the bank’s own identifi- cation and assessment of all risks is what matters to its solvency. These numbers show if the bank is ade- quately capitalized or not; and if more needs to be done to cushion the true risks. This is at the heart of what should be expected out of the risk management unit at a bank. Banks have not been paying close attention to risks because it is not a profit-generating activity. Instead, they feel content with just compli- ance. Compliance is definitely not the job of the Chief Risk Officer! The Board of Directors should intro- duce and enforce rules to remove in- centives for excessive profit-taking behavior, and ensure that the bank is adequately cushioned against true risks at all times. b) The rules of engagements between the banks and their clients. Banks ought not promise more than they can credibly, sustainably and profitably deliver. For most clients, what is possible today becomes mandatory tomorrow! This is the case in normal times, and crisis time should have its own rules of engage- ment. Unfortunately, banks failed to include “communication strategy” in their crisis management and business continuity plan. Ever since day one of the crisis and banks have been forcing all kind of controls on move- ments in clients’ accounts: • controls on withdrawals, • controls reaching the level of com- plete cancelation of credit and debit cards, • controls on fund transfers out of Lebanon • banks stopped opening new ac- counts, giving new loans, and cut working hours by half. the BANKING EXECUTIVE 36 ISSUE 147 MARCH 2021