The Lebanese State vs. The Banks: The "oil jug story"

Money, money, money

There is an ongoing if slow burning war of words, arguments and counter arguments, between Lebanon’s commercial banks and the State, which includes the State owned Banque du Liban. Run independently by a board and a governor, the extraordinary amount of power and independence allowed BDL’s governor makes him a central figure in the unfolding financial tragedy. This war of words is seeing ever rising levels of acrimony between former “partners”, in both politics and money, over who ultimately is responsible for the huge gaping hole in our financial system which deprived the Lebanese of their hard earned savings and institutions and private businesses of their liquid capital.

 

Each side has their truth to tell, each side’s tale differs wildly in their conclusions as to who has the legal and moral obligation to provide restitution. A recent ruling by the State Shura Council, while “inapplicable at present” as stated by the Association of Banks in Lebanon’s own counsel, Akram Azouri, does nonetheless seem to come out in favor of Lebanese banks, laying responsibility if not blame at the State’s door (and its bank) for paying back the money that supposedly they owe banks and banks owe depositors and that seemingly evaporated.

 

This war of words has been played out in a series of statements and published articles and analyses and studies issued by experts with loyalties to one side or the other over who benefit the most and by how much out of BDL’s notorious financial engineering? Who managed to squirrel away substantial funds abroad before the big crash? Who made the largest profits from ridiculously high interest rates? Who among the banks and in their hierarchies took the decision to proceed with placing what BDL termed banks’ “excess liquidity in foreign currency” with the central banker in exchange for lira funds. Many questions abound and remain unanswered.

 

I heard it once from a local bank boss “we were forced to place funds with BDL”, and this was not even a Lebanese bank boss talking! The same bank today charges on average $6 per ATM withdrawal from fresh dollar accounts. This conversation was early in the crisis and I couldn’t quite understand what he meant, why does he have $700 million stuck at BDL? How can a state bank force a privately owned bank to essentially give the state bank dollars?

 

Of course that’s an over simplification of a complicated and I would say parasitic relationship that existed for a long time between the State and Lebanon’s banks. The lackadaisical attitude of local banks meant they preferred easy money, high interest earned lending to the sovereign, instead of building a productive commercial banking environment that would actively seek out private sector businesses to lend to based on solid economic grounds and feasibility studies.

 

Banks preferred the high interest rates they were paid by a single borrower (the State) with which they could pad their profits at the end of each year to show shareholders growth in business when in fact it was growth in high risk lending. And among the financial engineering wizardry contrived by the state banker to gather as many dollars from the market as possible, was having banks exchange dollar denominated Eurobonds for lira denominated T-Bills, dollars for liras.

 

In a report on BDL published by AUB’s Issam Fares Institute, former senior adviser to the Ministry of Finance and the IMF, Toufic Gaspard, said the main culprit behind BDL’s $60 billion deficit by the end of 2019 was its costly financial engineering. This scheme attracted banks to shift their US dollar liquidity from foreign correspondent banks to BDL in return for “unusually high interest rates and bonuses”. This resulted in a dramatic drop in banks’ liquidity to around seven percent which was the critical element leading to the banking collapse, Gaspard’s report concludes.

 

“The banking collapse is the result of BDL’s toxic financial engineering policy, willingly joined by banks that mismanaged their US dollar liquidity and credit policy. The Lebanese Government’s responsibility stems from its systematic failure as a banking supervisory authority. The collapse of the Lebanese Lira is a separate event that resulted from Government’s fiscal irresponsibility and corrupt practices,” the report said.

 

Gaspard says that during the 2015-2019 period, analysis of BDL’s and the banks’ sources and uses of US dollar funds revealed an unaccounted-for residual of at least $25 billion believed to have been transferred by banks abroad to shareholders in the banks, as opposed to the banking institutions themselves.

 

The Association of Banks in Lebanon (ABL), refutes these claims and insists that banks’ income in lira from BDL’s financial engineering policy in the period 2015- 2019 came to LBP 7.3 trillion ($4.86 billion) according to the Alvarez and Marsal preliminary forensic audit report. The ABL insists that none of these funds in lira were converted to US dollars.

 

In his opening statement to ABL’s January report, Fadi Khalaf, ABL secretary general, said that it was in the same period that BDL asked commercial banks to increase their liquidity in lira, raising the capital adequacy ratio. “BDL forbade profit distribution by banks of any profits realized through financial engineering. In compliance with BDL circulars, banks added net profits realized in lira to their capital thereby increasing their reserves in lira,” Khalaf said.

 

He added that the financial engineering carried out by BDL aimed at raising dollar interest rates in order to draw in dollars from the market with the purpose of financing the state and fixing the lira/US dollar rate artificially high. This aim, he said, was stated in the introduction to government’s plan to develop the financial sector, that states: “The huge losses incurred by BDL are the result of its financial operations aimed at attracting capital flows to maintain the overvalued exchange rate and to finance the budget deficit.”

 

Khalaf said that banks only keep the difference between the interest they receive on their deposits at BDL and the interest paid to depositors, as such, the largest returns from financial engineering went to everyone who benefited from the high interest rates and not to the banks themselves.

 

Just before the crisis, many banks did try to use their excess lira, by trying to convince their customers to convert at least some of their dollar savings into lira deposits, citing lucratively high interest rates paid on Lira.

 

I recall quite vividly, as a bank costumer myself, my own banker urging me in late 2018 and early 2019 to transfer at least some of my dollar funds to lira as interest rates paid out on lira deposits was at a record high. I was nervous and reluctant and in the end I never did as he recommended. I wonder if that bank employee knew what was coming and what such a decision would mean for the value of my deposits.

 

Human tragedies abound sadly. These are not mere names and numbers on a statement of account. Banks aren’t supposed to be gambling casinos! I know of at least one example in which a depositor converted all her dollars to lira just before September 2019, a former colleague of my mother’s in fact, now a widow in her 90s. Her nest egg on which she was supposed to live for the rest of her life is now all but worthless having lost 98% of its value. This is but a single example of the human cost that bankers and financiers often fail to tally or quantify or even mention, not even as a footnote to their sanitized reports.

 

Regardless, this analysis is not an exercise in finger pointing and blame-laying, it’s just a way to clarify matters so as to create a solid basis on which to build.

 

Gaspard’s report said that the state banker’s “unconventional policies” led to the illiquidity of the banks that deposited their dollar funds with BDL. Gaspard said this “dangerous process” was not stopped by any of those with oversight powers over the then BDL governor Riad Salameh, namely BDL’s central council, in which the current acting governor, Wassim Mansouri, was a member, the Banking Control Commission, the Ministry of Finance and the government. Instead, all remained silent.

 

Gaspard said the banks were also responsible for what happened to them given the fact that they greedily chose quick and easy profits, placing at risk the survival of their own banking institutions and their depositors’ money.

 

BDL has regularly exchanged T-Bills for Eurobonds with the Ministry of Finance, Gaspard said, adding that the latter were then sold by BDL in the market for dollar funds, as such, he added, it was the government that was supplying BDL with dollars rather than the other way round. Indeed, through these operations and until 2019, around $17.5 billion were transferred to BDL. Gaspard adds in his report that had BDL not exchanged T-Bills for $17.5 billion in Eurobonds, the government’s dollar debt would have amounted, after accounting for interest, to only about five or six billion dollars instead of $31 billion prior to the collapse in September 2019.

 

Although the government’s indebtedness did not trigger the banking collapse, Gaspard said, it is the main reason for the Lira’s depreciation. The government debt was used to finance current

expenditures, interest on the public debt and public sector wages, rather than spending on capital expenditures, physical infrastructure and human development. The government’s capital expenditures between 1993 and 2019, Gaspard added, averaged only 8% of total government expenditures. Not a track record that should fill possible rescuers (IMF) with too much confidence!