Overview of the Lebanese Financial System Amid the Crisis 1. the Twin Deficit Phenomenon in Lebanon

General Secretariat – Research Department

March 2021

Overview of the Lebanese Financial System amid the Crisis

1. The twin deficit phenomenon in Lebanon: the root of the crisis Lebanon is one of the mostly indebted countries in the world, with a debt-to-GDP ratio reaching 171.7% by the end of 2020 according to the IMF. This mounting debt has resulted from decades of lack of planning, the adoption of failed economic and financial policies, the continuous budget deficit, the exceptionally high cost of borrowing, and the rampant corruption. In fact, the budget deficit may summarise the repercussions of all the above listed factors, where this deficit (Figure 1) in its turn contributed to boosting public debt to unsustainable levels.

Figure 1: Budget deficit in Lebanon as percentage of GDP 35

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: IMF, October 2020.

This large deficit in government balance was coupled with a similar – large and continuous – deficit in the current account of the balance of payments in Lebanon (Figure 2), which proves the prevalence of the Twin Deficit phenomenon in Lebanon. Despite the large remittance inflows Lebanon received from its diaspora, the economic and monetary policies adopted after the civil war that ended in 1990, have resulted in constant retreat in the productive sectors, provoking a decline in exports and increase in imports. Consequently, Lebanon recorded a constant deficit in its balance of payments, with very low levels of employment and economic growth. Therefore,

1 over three decades Lebanon witnessed internal and external imbalances resulting in a very weak and fragile economy, which collapsed after the eruption of October 17 (2019) demonstrations.

Figure 2: Current account deficit in Lebanon as percentage of GDP 70

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: IMF, October 2020.

Table 1: The development of the public debt in Lebanon 1993-2020 Gross local Foreign Total debt Total debt* currency debt currency debt (in LBP billion) (in USD billion) (in LBP billion) (in LBP billion) 1993 5,804 327 6,131 3.6 1994 9,348 772 10,120 6.1 1995 11,997 1,343 13,340 8.4 1996 17,229 1,908 19,136 12.3 1997 19,787 2,432 22,219 14.7 1998 21,686 4,176 25,862 17.2 1999 25,383 5,529 30,912 20.5 2000 27,161 7,183 34,344 22.8 2001 28,214 9,573 37,786 25.1 2002 25,302 14,581 39,883 26.5 2003 26,843 15,562 42,405 28.1 2004 26,371 18,382 44,753 29.7 2005 29,141 19,133 48,274 32.0 2006 30,204 20,334 50,538 33.5 2007 31,373 21,221 52,594 34.9 2008 39,007 21,183 60,190 39.9 2009 44,973 21,319 66,292 44.0 2010 48,255 20,592 68,847 45.7

2011 49,340 20,927 70,267 46.6 2012 50,198 24,385 74,583 49.5 2013 56,312 26,135 82,447 54.7 2014 61,752 25,608 87,360 58.0 2015 65,195 27,078 92,273 61.2 2016 70,528 28,115 98,643 65.4 2017 74,077 30,395 104,472 69.3 2018 77,852 33,490 111,342 73.9 2019 87,279 33,745 121,024 80.3 2020 (Nov.) 89,954 35,836 125,790 83.4 Source: Banque du Liban. * According to the official exchange rate (LBP1507.5/USD).

2. The exposure of Lebanese banks to the Lebanese sovereign debt During the past three decades, Lebanese banks have expanded largely, in terms of number or size, whether through internal growth or through mergers and acquisitions. Currently, the number of banks operating in Lebanon is 59, of which 44 are Lebanese and 15 are with Arab or foreign ownership. The local Lebanese banks are divided into 24 banking entities (8 groups and 16 individual banks). As for activity, the operating banks are divided into 38 conventional banks, 4 Islamic banks, 12 investment banks, 2 for private banking and 3 specialised banks. Accordingly, Lebanon is one of the most “crowded” banking sectors, and Lebanon can be describe as “overbanked”. Moreover, until end 2020, Lebanese banks operated in 26 countries in the form of subsidiaries or branches and 13 Lebanese banks owned 41 subsidiaries in 21 countries. Nonetheless, Lebanese banks have already begun to reconsider their presence abroad and liquidated their subsidiaries and branches in a number of Arab markets (e.g. Bank Audi and Blom Bank). The presence of a large number of banks, in parallel with the small size of the local market and the limited investment opportunities, have led Lebanese banks to invest extensively in the Lebanese Treasury securities and the central bank’s (Banque du Liban) certificates of deposit. This resulted in a very high exposure of banks to Lebanese sovereign debt, in terms of Treasury securities and certificates of deposit. The suspension of the Lebanese government of Eurobonds repayment in March 2020 resulted in serious doubts that banks will be subject to large haircuts in their holdings of Treasury securities and certificates of deposit, especially those dominated in foreign currency. Such haircut would lead to huge losses that may cause partial or total eradication of banks’ equity, depending on their exposure to Lebanese sovereign debt. Table 2 shows (according to the latest

3 available figures) the exposure of Lebanese banks to Treasury securities; Table 3 shows their exposure to Banque du Liban certificates of deposit; while Table 4 presents their exposure to both Treasury securities and certificates of deposit, with a comparison to their equity.

3. The eruption of the financial and banking crisis in Lebanon For about three decades, financial inflows (mainly in the form of remittances and non-resident deposit inflows to local banks) represented the lifeline for the Lebanese economy, because it suffers large and persistent trade, current account, and balance of payments deficits as stated above. In this regard, Banque du Liban adopted several measures to stimulate these financial inflows mainly by preserving high interest rates on both foreign currency and local currency deposits. However, starting end of 2017, the considerable deterioration in economic and fiscal conditions and the mounting corruption, started reversing these financial flows. It became obvious that the lack of confidence in the Lebanese economy started triggering large financial outflows, putting Banque du Liban foreign currency reserves under constant pressure, which have almost depleted now. Table 5 presents the monthly changes in the net foreign assets of the financial system in Lebanon (Banque du Liban and banks and financial institutions), and provides evidence on the drainage of foreign currency in the Lebanese financial system, which are coupled with a considerable decline in financial inflows as stated previously. Starting mid-1993, the Banque du Liban adopted the exchange rate targeting to stabilise the currency, until a full peg with the US dollar was adopted in December 1997 at LBP 1507.5 per US dollar. Nevertheless, in summer 2019, and with the mounting shortage in foreign currency, a black market emerged and it became obvious that Banque du Liban was not willing or able to interfere to stabilise the market due to continuous decline in its foreign reserves (Figure 3). The black market rate dominated and the value of LBP deteriorated gradually until the parallel market rate hit LBP 15,000/USD in March 2021 (versus an official rate of 1507.5). In October 17, 2019, huge demonstrations all over the country erupted, after the government announced the adoption of new tax on the Watsapp calls. The period following the demonstrations has clearly revealed the fragility of the Lebanese economy, and a new era emerged.

Table 2: Lebanese bank exposures to treasury securities (USD million) As of Equity LBP treasury Eurobonds Total treasury Total treasury securities securities securities/equity Fenicia Bank Dec-19 143.7 314.5 97.7 412.2 287% Lebanese Swiss Bank Jun-19 217.8 330.3 285.2 615.5 283% Cedrus Investment Bank Dec-18 354.6 627.3 257.9 885.2 250% First National Bank Sep-19 408.4 364.8 625.6 990.4 242% Federal Bank of Lebanon Dec-18 62.7 28.4 117.1 145.5 232% BankMed Dec-19 810.0 n.a. n.a. 1,818.8 225% BBAC Jun-19 651.7 859.2 529.0 1,388.2 213% IBL Bank Sep-19 653.3 497.2 876.9 1,374.1 210% BSL Bank Dec-18 121.5 74.5 163.1 237.5 195% BLC Dec-18 583.9 334.7 751.5 1,086.2 186% AM Bank Dec-18 31.3 39.9 10.1 50.1 160% Fransabank Jun-19 2,053.1 1,616.3 1,621.7 3,237.9 158% SGBL Sep-19 1,936.3 1,383.0 1,624.5 3,007.5 155% Bank of Beirut Jun-19 1,761.5 600.3 2,063.4 2,663.7 151% Credit Libanais Dec-19 993.0 853.1 551.9 1,405.0 142% Lebanon and Gulf Bank Sep-19 444.4 354.8 239.4 594.2 134% Byblos Bank Jun-19 1,865.7 951.6 1,335.0 2,286.6 123% Banque Libano-Francaise Jun-19 1,333.3 571.1 915.4 1,486.6 111% BEMO Bank Dec-18 189.9 107.3 102.8 210.0 111% Libank Dec-18 44.2 24.7 22.2 47.0 106% MEAB Dec-18 187.5 140.8 48.0 188.8 101% Banque de Credit National Dec-18 23.6 9.9 11.3 21.2 90% Saradar Sep-19 280.7 30.6 195.1 225.7 80% Blom Bank Jun-19 3,269.3 2,047.4 246.6 2,293.9 70% Bank Audi Jun-20 3,089.0 2,210.0 (259.0) 1,951.0 63% Lucid Dec-18 20.2 10.5 0 10.5 52% Creditbank Sep-19 425.0 87.6 29.5 117.1 28% FFA Dec-18 44.1 0.1 0 0.1 0% Source: Bank websites and BilanBanques. Remarks: n.a. not available. The value of exposures have been computed according to the official exchange rate.

Table 3: Lebanese bank exposures to Banque du Liban certificates of deposits (USD million) As of Equity LBP CDs USD CDs Total CDs Total CDs/equity AM Bank Dec-18 31.3 202.0 23.1 225.1 719% BankMed Dec-19 810.0 n.a. n.a. 4,567.5 564% IBL Bank Sep-19 653.3 1,132.8 527.4 1,660.2 254% BSL Bank Dec-18 121.5 189.0 57.0 246.0 202% First National Bank Sep-19 408.4 161.6 536.7 698.2 171% BBAC Jun-19 651.7 540.4 401.9 942.4 145% Bank Audi Jun-20 3,089.0 149.0 3,947.0 4,096.0 133% BLC Dec-18 583.9 524.0 184.1 708.2 121% Fransabank Jun-19 2,053.1 1,976.2 492.6 2,468.8 120% Bank of Beirut Jun-19 1,761.5 1,324.8 596.0 1,920.9 109% Byblos Bank Jun-19 1,865.7 1,109.9 902.0 2,011.8 108% Banque Libano-Francaise Jun-19 1,333.3 819.0 567.4 1,386.4 104% Credit Libanais Dec-19 993.0 773.5 250.1 1,023.5 103% SGBL Sep-19 1,936.3 224.9 1,658.9 1,883.8 97% BEMO Bank Dec-18 189.9 47.8 130.5 178.3 94% Libank Dec-18 44.2 2.4 32.4 34.8 79% Federal Bank of Lebanon Dec-18 62.7 32.6 12.8 45.4 73% Lebanese Swiss Bank Jun-19 217.8 17.5 126.4 143.9 66% Fenicia Bank Dec-19 143.7 29.2 60.6 89.8 62% MEAB Dec-18 187.5 29.5 69.7 99.2 53% Banque de Credit National Dec-18 23.6 0 10.5 10.5 45% Lebanon and Gulf Bank Sep-19 444.4 45.7 140.2 185.9 42% Blom Bank Jun-19 3,269.3 65.9 1,178.3 1,244.2 38% Creditbank Sep-19 425.0 0 79.7 79.7 19% Cedrus Investment Bank Dec-18 354.6 6.4 58.3 64.7 18% FFA Dec-18 44.1 0 7.8 7.8 18% Saradar Sep-19 280.7 17.8 10.6 28.4 10% Lucid Dec-18 20.2 00 0 0 0% Source: Bank websites and BilanBanques. Remarks: n.a. not available. The value of exposures have been computed according to the official exchange rate. These exposures do not include bank deposits at Banque du Liban.

Table 4: Lebanese bank exposures to total sovereign debt (USD million) As of Equity Treasury securities CDs Treasury (Treasury securities securities + CDs + CDs)/equity AM Bank Dec-18 31.3 50.1 225.1 275.2 878% BankMed Dec-19 810.0 1,818.8 4,567.5 6,386.4 788% IBL Bank Sep-19 653.3 1,374.1 1,660.2 3,034.3 464% First National Bank Sep-19 408.4 990.4 698.2 1,688.6 413% BSL Bank Dec-18 121.5 237.5 246.0 483.5 398% BBAC Jun-19 651.7 1,388.2 942.4 2,330.5 358% Fenicia Bank Dec-19 143.7 412.2 89.8 501.9 349% Lebanese Swiss Bank Jun-19 217.8 615.5 143.9 759.4 349% BLC Dec-18 583.9 1,086.2 708.2 1,794.4 307% Federal Bank of Lebanon Dec-18 62.7 145.5 45.4 191.0 305% Fransabank Jun-19 2,053.1 3,237.9 2,468.8 5,706.7 278% Cedrus Investment Bank Dec-18 354.6 885.2 64.7 949.9 268% Bank of Beirut Jun-19 1,761.5 2,663.7 1,920.9 4,584.5 260% SGBL Sep-19 1,936.3 3,007.5 1,883.8 4,891.3 253% Credit Libanais Dec-19 993.0 1,405.0 1,023.5 2,429.2 245% Byblos Bank Jun-19 1,865.7 2,286.6 2,011.8 4,298.4 230% Banque Libano-Francaise Jun-19 1,333.3 1,486.6 1,386.4 2,873.0 215% BEMO Bank Dec-18 189.9 210.0 178.3 388.3 204% Bank Audi Jun-20 3,089.0 1,951.0 4,096.0 6,047.0 196% Libank Dec-18 44.2 47.0 34.8 81.7 185% Lebanon and Gulf Bank Sep-19 444.4 594.2 185.9 780.0 176% MEAB Dec-18 187.5 188.8 99.2 288.0 154% Banque de Credit National Dec-18 23.6 21.2 10.5 31.8 134% Blom Bank Jun-19 3,269.3 2,293.9 1,244.2 3,538.2 108% Saradar Sep-19 280.7 225.7 28.4 254.1 91% Lucid Dec-18 20.2 10.5 0 10.5 52% Creditbank Sep-19 425.0 117.1 79.7 196.8 46% FFA Dec-18 44.1 0.1 7.8 7.9 18% Source: Bank websites and BilanBanques. Remark: the value of exposures have been computed according to the official exchange rate. These exposures do not include bank deposits at Banque du Liban.

Table 5: Monthly change in the net foreign assets in the financial system (USD million) Banque Du Liban Banks & Financial Total Institutions Jan-18 985.9 (749.0) 236.9 Feb-18 415.2 (486.9) (71.6) Mar-18 30.9 (394.4) (363.5) Apr-18 (271.8) (303.2) (575.0) May-18 2,157.9 (954.4) 1203.5 Jun-18 (1,113.4) 474.9 (638.5) Jul-18 258.5 (807.3) (548.9) Aug-18 (869.3) 461.2 (408.1) Sep-18 (26.6) (119.5) (146.1) Oct-18 (373.9) (1,436.5) (1,810.4) Nov-18 (2,270.2) 1316.3 (953.9) Dec-18 (1,212.7) 465.1 (747.5) Jan-19 (395.0) (984.6) (1,379.7) Feb-19 (391.2) (159.0) (550.1) Mar-19 (319.7) 244.6 (75.1) Apr-19 (589.3) (710.8) (1,300.0) May-19 (1,373.5) (508.2) (1,881.6) Jun-19 (209.9) 5.6 (204.3) Jul-19 691.1 (618.6) 72.5 Aug-19 86.3 (664.8) (578.5) Sep-19 (160.1) 101.6 (58.5) Oct-19 (583.7) 385.8 (197.9) Nov-19 167.0 975.8 1,142.8 Dec-19 (826.8) (14.0) (840.8) Jan-20 (612.8) 454.9 (157.9) Feb-20 (989.2) 641.7 (347.4) Mar-20 (551.1) (5.7) (556.8) Apr-20 (812.4) 571.8 (240.6) May-20 (908.1) 20.4 (887.7) Jun-20 (555.8) 260.1 (295.8) Jul-20 (2,779.9) (266.5) (3,046.4) Aug-20 (2,221.2) 253.2 (,1968.0) Sep-20 (2,531.9) 424.2 (2,107.7) Oct-20 (489.6) 109.6 (380.0) Nov-20 (629.9) 415.5 (214.4) Dec-20 (1,192.1) 844.0 (348.1) Jan-21 (630.8) 220.2 (410.6) Total (21,099.1) (536.9) (21,635.7) Source: Banque du Liban.

Figure 3: Banque du Liban foreign currency reserves (USD billion) 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 ‐ 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

2021 (January) Source: Banque du Liban.

4. The banking development in Lebanon in light of the crisis The impact of the crisis that emerged following the demonstrations was amplified by the outbreak of the COVID-19 pandemic in the beginning of 2020. The repeated lockdowns, the political deadlock that delayed forming new government (until now), and the August 4, 2020 Port of Beirut explosion, have all resulted in a collapse of the Lebanese economy. The IMF estimated that Lebanon’s GDP has shrunk by 25% in 2020, while the large depreciation in LBP has resulted in an inflation of 144.5%. Among the most affected economic sectors was the banking sector. Moreover, a de facto capital control by banks (mainly in foreign currencies) resulted in overwhelming mistrust in banks by the public. This was evident by the reluctance of dealing with banks, a further decline in transfers from abroad through banks, and a large wave of real estate purchases using bank checks. Banks encouraged the latter in order to reduce their foreign currency liabilities, and in parallel to reduce their dues from real estate developers. Additionally, Banque du Liban issued a circular allowing depositors to withdraw (at a specified ceiling) their foreign currency deposits from banks at the rate of LBP 3900 per USD. The considerable decline in banking activities especially in light of the crisis and COVID-19 pandemic, in addition to the decline in both assets and liabilities, have reduced the size of the Lebanese banking sector (Table 6).

Table 6: The decline in the size of the Lebanese banking sector (in USD billions)* Total Resident Non- Claims on Claims on Capital assets customers resident resident non- accounts deposits customers customers resident deposits customers 2018 249.5 135.5 37.7 51.8 7.1 20.2 2019 216.8 125.0 32.5 43.9 5.6 20.7 2020 188.0 110.2 27.4 31.8 4.1 19.9 Change (24.6%) (18.6%) (27.5%) (38.7%) (41.9%) (1.1%) between end 2018 and end 2020 Source: Banque du Liban. * According to the official exchange rate (LBP1507.5/USD).

Table 6 shows that the size of the Lebanese banking sector has declined by 61.4 billion USD (about 24.6%) over the past two years, while its total deposits (resident and non-resident) declined by 35.6 billion USD (about 20.6%), its total private sector claims by 39.0 billion USD (about 39.1%). In parallel, banks have recorded huge and unprecedented losses starting 2019, despite the unavailability of any official figures released by banks. However, the IMF estimated that the Lebanese financial system’s total losses (Banque du Liban and banks) exceeds 100 billion USD. Finally, note that Banque du Liban has requested from banks in August 2020 to boost their capitals by 20% (a total of 4 billion USD) in an attempt to recapitalise the banking sector, with a deadline ended in February 28, 2021.

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