A case for seizing Lebanon’s banks. A twitter thread published December 24, 2019
1. #Lebanon is undergoing a massive financial crisis on a scale that rivals that of Greece & Cyprus. Its worst manifestation is a banking crisis that has shut out depositors from accessing their paychecks. See @EHSANI22, @lebfinance, @AndyKhalil1 & @wael_atallah for background
2. I will attempt to make a case for the state seizing banks as a solution for the banking crisis. This is counter-intuitive – especially coming from someone who strongly believes in a smaller government and in free markets
3. In order for this to happen, 3 important conditions have to be met:
A-There is a legal case from a regulatory standpoint
B-Depositors will be better off
C-Chances of fresh recapitalization are greater than under status quo
4. To evaluate the regulatory standpoint, it is important to note that 3 of the biggest banks, for example, have an equity/assets ratio of less than 10% each. 7-8% to be more exact. That is based on financial statements before the latest uprising.
5.Taking assumption made by many that 60% of bank assets are at the Central Bank, BdL, any restructuring that results in a 15% haircut will wipe out bank equity. BUT, a BdL debt restructuring is NOT needed to wipe said equity. Not to mention deteriorating value of other assets.
6. Looking at banks’ balance sheets, without getting too technical, their debt securities at BdL are valued optimistically at or above cost. With IFRS9, banks have to “immediately recognize impairment losses on financial assets on the basis of expected credit losses.”
7. “the measurement of the impairment loss will differ depending on the financial asset’s credit risk at inception and changes in credit risk from inception, as well as the applicability of certain practical expedients”
8. Recall that in November S&P lowered Lebanon’s long-term and short-term foreign and local currency sovereign credit ratings to ‘CCC/C’ from ‘B-/B’, citing rising financial and monetary risks with the outlook being negative.
9. This is not to mention the increasingly likelihood of floating of the Lira -which will be the death knell of most banks. Rating agencies have recently already given a SD, selective default, rating to several large banks.
10. But you say that banks are raising their capital by 10% by Dec 31 as BdL requested. Yes. But, imagine a bank’s simple balance sheet: Assets = 100 made up of 60 in deposits and investments with BdL and 40 in everything else (property, consumer & commercial loans).
11. Those Assets are backed by 8 in capital. New capital requirement simply raises capital from 8 to 8.8. Good, but not very significant especially if it is not fresh outside capital. Emphasis being on fresh outside capital.
12. Banks have to prepare their audited 2019 annual reports soon. Is the government regulatory arm, the Banking Control Commission going to wait for a hired Auditor’s report to state the obvious or will the BCC take action before?
13. So, I reckon there is a legal case if the BCC does its supervisory job. Remember, there are 67 banks overseen by the BCC. Are they all in tip top shape? You know the answer to that. Not saying all are insolvent but some clearly are.
14. Another regulatory point to raise is the inherent conflict of interest between bank shareholders/management and depositors. This is magnified when a bank is in distress. In that case, banks try to buy time at the expense of depositors’ best interests.
15. This will create immense hardships for depositors and worsen the overall economy through personal and business bankruptcies, layoffs etc. Not to mention civil unrest. Lebanese government has dispatched the police to maintain order at all bank branches nationwide. Imagine!
16. Another practical issue that calls for immediate takeover of failing banks is the fact that they hold claims against BdL/Govt in terms of deposits/CDs/Eurobonds that are not yet due. BdL likely can’t meet those obligations anyway when due.
17. So timing becomes important. BdL defaulting will cause banks to have a legal claim against the government. Using the Lebanese proverb, if regulators don’t eat (seize) banks for lunch, banks will eat (sue) government for dinner. This is Machiavellian but with cause.
18. Banks have been acting primarily as intermediaries shipping customer deposits to BdL. Now that some are insolvent, eliminating the middle man also eliminates the markup charged by the banks, making BdL’s obligations to the ultimate beneficiaries – depositors- easier to meet.
19. Point of regulators seizing financial institutions is to protect depositors & minimize losses by tax payers. Will regulators seizing banks maximize recovery by depositors given the size of some banks & the poor financial situation of the government/BdL? Yes, if done properly.
20. Will taking banks over make way for an eventual quick path to raising new additional capital from the private sector and ultimately the state selling those banks? Yes, if done properly.
So what is the solution?
21. You have to start with the biggest problems first. In the banks’ case it is the financial engineering operations that entitled them to obscene interest rates from BdL which they in turn funded by promising depositors obscene interest rates on certain time deposits.
22. BdL can’t meet its obligations and so are banks with respect to their depositors. These financial engineering transactions are a tumor that must be extracted in order to save the banking industry AND BdL.
23. The first step is by taking over floundering banks and removing the FE & related transactions from both the Assets and Liabilities side of their balance sheet.
24. Specifically, for banks, all FE assets at BdL and the associated Liabilities (customer deposits above a certain promised interest rate) are transferred to a new national recovery entity (NRE).
25. Those high yielding deposit products sold to customers should be treated like high risk securities not guaranteed deposits. The result is that you’ll have trimmed down banks that are more able to emerge in the near future. But you still need additional capital cushions.
26. Above a certain threshold, large and very large depositors will contribute part of their deposits as a bail-in to capitalize the failed bank. BDL will contribute additional capital via a long term zero coupon or 1% coupon bond to round out the capital needed for the new bank.
27. In addition, BdL will provide USD daily liquidity to banks in receivership in certain amounts. It is easier to provide such a lifeline then compared to the current status quo.
28. In addition to the above, some macro steps need to be implemented:
-Formal capital controls for 1 year with prioritized withdrawals and transfers, to be renewed if needed
-No restrictions on new funds being transferred in from outside
-Many other reforms I will discuss later
29. Banks that are taken over will be merged as needed and sold to new buyers either directly or via an international and/or local exchange listing within the shortest possible time frame (likely 2 to 3 years)
30. So what happens to those depositors stuck in the FE related term deposits? They will be placed in the national recovery entity (NRE) and have the most to lose.
31. Their recovery will be based on annual principal payments over a number of years depending on BdL/Government finances. A small slice of equity from each of the banks taken over can be assigned to the (NRE).
32. So how are depositors better off under State seizure of Banks?
This will increase confidence in the banking system. Sounds counter-intuitive but right now the system is on fire. Depositors want to flee, Expats have stopped their badly needed foreign currency remittances,
33. ..and potential investors are waiting for the dust to clear to consider any potential investment. A state guarantee, even with its current credit rating, is better than the current situation.
34. This is not panacea; depositors will still want to flee but foreign remittances will start coming back via the banking system and not by travelers through the airport. Banks that are scaled down and cleaned up will be more attractive to potential new investors.
35. Plus, a more egalitarian & prioritized system of withdrawals by depositors will be put in place compared to the current totally arbitrary setup in place. There will still be limits on withdrawals but clarity and regained confidence in the system will make this a lot easier.
36. But why not reverse FE transactions & give banks 5 years to pay it back as @bteish_mansour suggested?
This may involve canceling the FE assets for banks but not their associated deposit liabilities which will make them more insolvent.
37. You need a more comprehensive State sponsored approach to cancel the deposit liabilities. Even for the widely circulated haircut; it can’t be practically implemented without a State sponsored approach.
38. In Summary, FE-related customer deposits transferred to a new entity, likely 20-30% of each side of the balance sheet
Large depositors (uninsured deposits) become shareholders
Capital provided by BDL via zero coupon long term bond. New equity injections as soon as practical
39. Key point here is that current banks’ managements have proven that they are terrible stewards of depositors’ assets. Keeping the current charade on & giving them more time will only hurt small depositors & complicate things further for the government when/if it defaults
40. *****Status quo gives banks’ mgmnt/shareholders a free long dated call option where they benefit from any reduction in their bank’s liabilities that are borne by current depositors and/or Lebanese tax payers. Any future upside SHOULD not belong to current shareholders/mgmnt
41. What happens when an insolvent bank is seized? Essentially, ownership changes to the government which also assumes the bank’s liabilities. Upper management is removed and key decision are made by a new management. All other employees stay the same. *See Postscript below
42. Now will any of this happen under current political system where a majority of banks are controlled by or under influence of political elites? You know the answer to that.
Will the new Prime Minister @Hassan_B_Diab push for anything bold like this?
43. I will end here for now. Now tell me why this is a bad idea and what is your solution instead.
Postscript: for 41. When an insolvent bank is seized, its liabilities are not liabilities of the government. Shareholders remain liable. The government basically takes over management and tries to maximize the bank’s assets and fairly distribute losses among depositors.