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April 18, 2020 Updated slides based on the original paper - February 2020 (https://lebanoneconomics.net/paper.html)

Prepared by Alia Moubayed, Gerard Zouein.

Unsustainable business model and required restructuring

The findings, interpretations, and conclusions expressed in this presentation are entirely those of the authors. They do not represent the views of their respective employers.

LEBANON

https://lebanoneconomics.net/paper.html

2

lebanoneconomics.net

3

Disclaimer

• This presentation focuses mainly on the need to tackle the debt overhang and BDLlosses through an equitable burden sharing as a priority towards an orderly fiscal andexchange rate adjustment.

• It suggests possible scenarios/options to discuss and assesses their feasibility.

• It DOES NOT address all aspects of Lebanon’s unfolding crisis and possible remedies(namely the details of required fiscal policy measures, the elements of a new growth andfinancing model for the Lebanese economy).

4

Outline

• Section 1: Snapshot of the current macroeconomic situation and how did we get here?

• Section 2: What happened in other crisis countries, and where is Lebanon heading?

• Section 3: Scenarios of debt restructuring and possible burden sharing

• Conclusions and Issues for further discussion

5

Key messages and conclusions

• Urgency is required. The cost of inaction is too high and will increase with time as lossesaccumulate endangering social stability and security.

• Debt restructuring should be deep and comprehensive in order to smooth the burdenof required fiscal consolidation, and provide fiscal space for expanding social safety netsand support growth. Dealing with BdL (>$30bn of net negative FX position) is crucial toavoid a disorderly devaluation and to restore confidence in the LBP.

• An equitable burden sharing is necessary for maintaining the social peace and shouldunderpin efforts at recapitalizing and restructuring the banking sector.

• Anchoring debt restructuring and banking sector recapitalization within acomprehensive macro-fiscal and growth recovery program is essential.

• The ultimate objective of the planned restructuring and recapitalization should be tobuild a new economic growth model for the Lebanese economy.

Snapshot of the current situation: How did we get here?

7

Current account deficit – Large, recurrent and unsustainable

Source: IMF, World Bank, Lebanon’s Ministry of Finance, Banque du Liban. Note: *Countries of similar GDP per capita and population >5m.

Relative to GDP vs. other countries (cum. since 2002)*Current account deficit over time

Relative to “trouble” countries at start of crisis

9% 3%

(1%) (1%) (1%) (1%) (3%) (5%) (5%)(8%)

(20%)

Mal

aysia

Thai

land

Kaza

khst

an

Turk

men

istan

Braz

il

Mex

ico

Dom

inic

anRe

publ

ic

Turk

ey

Bulg

aria

Serb

ia

Leba

non

(28%)

(23%)

(18%)

(13%)

(8%)

(3%)

(14)

(12)

(10)

(8)

(6)

(4)

(2)

0

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Current account balance ($ bn, lhs) Relative to GDP (%, rhs)

(3%)(6%) (6%)

(9%)(12%)

(14%) (14%) (15%) (16%)(18%)

(21%) (22%)

Italy

(200

8)Ire

land

(200

8)Eg

ypt

(201

6)Sp

ain

(200

7)Po

rtug

al(2

008)

Gree

ce(2

007)

Cypr

us(2

007)

Lith

uani

a(2

007)

Esto

nia

(200

7)Ic

elan

d('0

5-07

)La

tvia

(200

7)Le

bano

n(2

018)

Lebanon has one of the largest current account deficits in the world and compared to any other country at the onset of its crisis.

8

Current account deficit – Large, recurrent and unsustainable (cont’d)

Source: IMF, World Bank, Lebanon’s Ministry of Finance, Banque du Liban.

Breakdown of deficit relative to GDP (cum. since 2002)

Net remittances have been deteriorating since 2015 while a fixed exchange rate allowed the Lebanese to live above their means running a large deficit in the balance of goods and services.

Remittances relative to GDP over time

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

Remittances - Gross inflows Remittances - Net inflows

9

Current account deficit – Funded through debt creating flows

Source: IMF, World Bank, Lebanon’s Ministry of Finance, Banque du Liban. Note: *Based on Capital & Financial Account (ex. Net errors and omissions and Reserves).

Financing of the current account over time*Financing of the current account (cum. since 2002)*

Lebanon relied on debt creating flows to finance its large current account deficits, a large part of which were non-resident deposits of foreign institutions and the diaspora. Confidence and excessive returns were key drivers.

68%

23%

10%

Debt creating flows including non-resident deposits FDI Other

58%

28%

66%

78% 78% 75%

42%

42%

31%

19% 11%

12% 30%

3% 4% 11% 13%

20022004

20052007

20082010

20112013

20142016

20162018

Debt creating flows including non-resident deposits FDI Other

10

Fiscal deficit – Large, recurrent and unsustainable with increasing budget rigidityInterest payment as % expenditures relative to othersFiscal balance (cumulative since 2002)


Expenditures are rigid and vulnerable to changes in interest rates and oil prices. Debt service eats ~50% of revenue, wages ~50%, and EdL ~15%, leaving no room for Capex, critical for long-term productivity and growth.

69%

100%

35%

32%

11%

5%

18%

Reve

nue

Expe

nditu

res

Debt

inte

rest

Pers

onne

lco

st EdL

Cape

x

Oth

er

Fiscal balance as % of GDP relative to others

32%

24%

11% 11% 8% 6% 4% 4% 3% 2% 1% 1%

Leba

non

(201

8)Eg

ypt

(201

6)Ita

ly(2

008)

Gree

ce(2

007)

Cypr

us(2

007)

Port

ugal

(200

8)Ic

elan

d(2

006)

Spai

n(2

007)

Irela

nd(2

008)

Lith

uani

a(2

007)

Latv

ia(2

007)

Esto

nia

(200

7)

8% 7%

5% 5% 2% 2%

(2%) (3%) (4%) (5%)(8%)

(11%)

Icel

and

(200

6)Es

toni

a(2

007)

Cypr

us(2

007)

Spai

n(2

007)

Lith

uani

a(2

007)

Latv

ia(2

007)

Italy

(200

8)Ire

land

(200

8)Po

rtug

al(2

008)

Gree

ce(2

007)

Egyp

t(2

016)

Leba

non

(201

8)

11

Fiscal deficit – Large and recurrent, leading to rapid accumulation of public debtPublic debt to GDP since 1992


One of the worst public debt levels relative to GDP in the world. Most importantly Lebanon’s current debt position is substantially worse than other “trouble” countries ahead of their crisis

Highest public debt to GDP in the world (2018A)

Relative to “trouble” countries at start of crisis

52%

51

%

72%

80%

10

1%

100%

10

8%

130%

148%

163%

16

3%

171%

17

0%

179%

18

3%

169%

16

1%

144%

13

7%

134%

13

0%

135%

13

8%

141%

14

6%

149%

15

1%

157%

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

212% 198% 194%174%

157% 143% 131% 126% 125% 123%

Suda

n

Japa

n

Gre

ece

Eritr

ea

Leba

non

Cypr

us

Italy

Barb

ados

Cabo

Ver

de

Port

ugal

157%

103% 101% 92% 85%69%

45%30% 27%

15% 6% 1%

Leba

non

(201

9)G

reec

e(2

007)

Italy

(200

8)Eg

ypt

(201

6)Cy

prus

(200

7)Po

rtug

al(2

008)

Irela

nd(2

008)

Spai

n(2

007)

Icel

and

(200

6)Li

thua

nia

(200

7)La

tvia

(200

7)Es

toni

a(2

007)

12

Fiscal deficit – Increasingly funded through the central bank (debt monetisation)Public debt evolution since 2002 ($bn)


The USD share of public debt declined as government struggled to tap international market. ~50% of USD debt owned by local banks, another ~20% by BdL. The latter’s share of LBP debt increased over time (debt monetization)

Share of public debt (%)

37%

39%

38%

38%

39%

39%42%

43%

40%

40%

42%45

%51%

51%

50%

52%

47%

47%

18%21

%

23%

25%28

%31%31

%

31%

31%33

%36%34

%27%

27%

25%

23%

25%37

%

37%31

%

30%

27%

23%20%18

%

17%

20%

17%13

%12%

14%

15%

20%

19%

17%1%

8%9%9%10%

11%

11%

10%

9%10%

10%

10%8%9%7%6%7%

11%

16%

Dec-

19

Dec-

18

Dec-

17

Dec-

16

Dec-

15

Dec-

14

Dec-

13

Dec-

12

Dec-

11

Dec-

10

Dec-

09

Dec-

08

Dec-

07

Dec-

06

Dec-

05

Dec-

04

Dec-

03

Dec-

02USD debt LBP debt: Banks LBP debt: Central bank LBP debt: Other

Cent

ralb

ank

shar

e of

tota

l gov

ernm

ent d

ebt a

t 40-

45%

(55 -

60%

of L

BP d

ebt a

nd 2

0% o

f USD

deb

t) v

s. 2

0% 5

yea

rs a

go

34 33 30 28 27 26 26 24 21 21 21 21 21 20 19 18 16 15

17 18 18 19 19 20 19

18 16 17 18 16

11 11 9 8 8 11

34 26

24 20

16 13 11 10

11 9 7 6

6 6 7 7

6 0

7

8 7

7 7

7 6

5 5 5 5

4 4 3 2

2 4

5

Dec-

19

Dec-

18

Dec-

17

Dec-

16

Dec-

15

Dec-

14

Dec-

13

Dec-

12

Dec-

11

Dec-

10

Dec-

09

Dec-

08

Dec-

07

Dec-

06

Dec-

05

Dec-

04

Dec-

03

Dec-

02

USD debt LBP debt: Banks LBP debt: Central bank LBP debt: Other

13

Fiscal deficit – Banque du Liban has been the sole financier of the fiscal deficit


BdL share of government debt over time BdL share of incremental government LBP debt

BdL funded most the incremental LBP government borrowing over the last 10 yrs (debt monetization)

0%

10%

20%

30%

40%

50%

60%

70%De

c-02

Dec-

03

Dec-

04

Dec-

05

Dec-

06

Dec-

07

Dec-

08

Dec-

09

Dec-

10

Dec-

11

Dec-

12

Dec-

13

Dec-

14

Dec-

15

Dec-

16

Dec-

17

Dec-

18

Dec-

19

BdL share of total debt BdL share of LBP debt

98%

117%

80%

96%

% of total incremental debt % of LBP incremental debt

Last 5 years Last 10 years

14

Current account & fiscal deficits were funded by deposits into the banking sectorLebanese banking sector total deposits as % of GDP

Source: IMF, World Bank, Lebanon’s Ministry of Finance, Banque du Liban, OECD, individual countries central banks.

World’s highest banks deposit to GDP (2018A)

Total banks assets to GDP vs “trouble” countries

Strong deposit inflows, lured by excessive returns post 2015 led to an outsized banking sector relative to GDP.

133%

12

7%

135%

13

2%

146%

16

1%

177%

195%

218%

22

7%

222%

242%

25

8%

265%

27

5%

270%

26

5%

266%

27

4%

283%

27

6%

285%

29

2%

296%

30

9%

309%

30

0%

302%

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

400%353%

302%

221%160% 141% 135% 134% 126% 124%

Luxe

mbo

urg

Hong

Kon

g

Leba

non

Japa

n

Liby

a

Mal

ta

St. K

itts

Mac

ao

Thai

land

Kore

a

741% 709%

481% 416%

280% 235% 214% 166% 126% 123% 84% 82%

Icel

and

(200

8)Ire

land

(200

8)Cy

prus

(200

8)Le

bano

n(2

019)

Spai

n(2

007)

Port

ugal

(200

8)Ita

ly(2

008)

Gre

ece

(200

7)Es

toni

a(2

007)

Latv

ia(2

007)

Egyp

t(2

016)

Lith

uani

a(2

007)

15

Deposits inflows were driven by attractive interest rates differentials Lebanese banks rates on USD deposits vs 3M Libor (%)


Dollar deposits relative to total deposits (%)

Inflows driven by attractive interest rates differentials (~250bps premium to LIBOR), compounded by a sizeable diaspora, kept deposit dollarization elevated (70% of deposits in $).

72%

73

%

64%

64

%

58%

64

%

66%

62

% 67

% 73

%

70%

66

% 70

%

73%

76

%

77%

70

%

65%

64

%

67%

66

%

68%

67

%

67%

67

%

70%

72

% 76

%

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

(2.0%)

(1.0%)

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

Feb-

95Ja

n-96

Dec-

96N

ov-9

7O

ct-9

8Se

p-99

Aug-

00Ju

l-01

Jun-

02M

ay-0

3Ap

r-04

Mar

-05

Feb-

06Ja

n-07

Dec-

07N

ov-0

8O

ct-0

9Se

p-10

Aug-

11Ju

l-12

Jun-

13M

ay-1

4Ap

r-15

Mar

-16

Feb-

17Ja

n-18

Dec-

18N

ov-1

9

Weighted average interest on USD deposits USD 3M LIBOR Spread

16

62%

14%

24%

Deposits at CentralBank (BdL)

Loans toGovernment

Loans toprivate sector

~75% of risk assets exposed to Sovereign risk

Business model significantly weakened banks and put depositors’ money at riskBanks risk assets composition (%)


Banks risk exposure evolution over time (%)

The banks’ business model relied on lending to government and shifted to BdL as sovereign creditworthiness deteriorated. Banks became “brokerage houses” undermining their “underwriting expertise” to some extent.

Relative to other countries

Lebanon off the scale when accounting for BdL exposure

Housing loans 19%Construction 16%RE / rent services 5%RE exposure 40%Wholesale/retail trade 23%Industry / Ag. 12%Consumer loans 12%Other 13%Se

ctor

exp

osur

e

38%

37%

38%

34%

32%

35%

39%

39%

41%

42%

39%

42%

44%

49%

53%

59%

62%

28%

30%

32%

36%

35%

34%

32%

28%

25%

25%

27%

24%

23%

19%

16%

15%

14%

34%

33%

30%

30%

33%

32%

30%

33%

34%

34%

34%

34%

33%

32%

30%

26%

24%

2003

A

2004

A

2005

A

2006

A

2007

A

2008

A

2009

A

2010

A

2011

A

2012

A

2013

A

2014

A

2015

A

2016

A

2017

A

2018

A

2019

A

Deposits at Central Bank (BdL) Loans to Government Loans to private sector

17

Banque du Liban balance sheet increased significantly over time

Source: IMF, World Bank, Lebanon’s Ministry of Finance, Banque du Liban. Note: *Excluding the impact of BdL financial engineering on balance sheet.

BdL total assets relative to GDP* World’s largest CB balance sheet size relative to GDP*

Relative to “trouble” countries at start of crisis*BdL foreign assets relative to total assets*

BdL is one of the largest central banks in the world relative to the size of the economy. Size of BdL’s balance sheet and its deteriorating FX position will hinder its ability to intervene in a debt restructuring / bank bail-out scenario

0%10%20%30%40%50%60%70%

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

BdL foreign assets excluding Gold as % of total assets including Gold

68%

124%

124%

134%

139%

130%

137%

152%

163%

175%

173%

164%

177%

182%

200%

221%

248%

274%

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

274%

70% 36% 30% 27% 24% 21% 21% 18% 16% 16% 16%

Leba

non

(201

9)Li

thua

nia

(200

7)Cy

prus

(200

7)Ire

land

(200

7)Po

rtug

al(2

008)

Icel

and

(200

6)G

reec

e(2

007)

Latv

ia(2

007)

Spai

n(2

007)

Italy

(200

6)Es

toni

a(2

007)

Egyp

t(2

015)

369%

274% 238%

103% 90% 80% 74% 70% 69% 64% 59%

Luxe

mbo

urg

Leba

non

Nor

way

Japa

n

Taiw

an

Cypr

us

Port

ugal

Czec

h Re

p

Mal

ta

Saud

i Ara

bia

Spai

n

18

Banque du Liban net foreign reserves were brought into negative territory


BdL negative net foreign currency position ($ bn) – April 2020

BdL net foreign currency position (including gold) have been negative for many years, and estimated at ~60% of GDP (excluding haircuts on Lebanese government Eurobonds).

29.6 34.7

50.5

(80.0) (29.5)

5.0

15.8

Foreign currencies Lebanesegovernmenteurobonds

Foreign assetsex-Gold

Gold Foreign assetsincluding Gold

Banks USD depositsat BdL (estimated)

Net foreignassets

In the last round of financial engineering,BdL borrowed $ from banks at an effective

interest rate of ~16.5% (6.5% in $; 10% in LBP).

The $ payment is in a currency BdL cannot

create/print.

Subject to haircut as part of debt restructuring

Includes some loans to Lebanese banks. $22bn of

total is liquid

19

The currency overvaluation

Source: IMF, World Bank, Lebanon’s Ministry of Finance, Banque du Liban, Bruegel.

“The IMF’s EBA-light methodology suggests that thereal effective exchange rate is significantlyovervalued. The very high negative net foreign assetposition, with high levels of short-term debt suggeststhat the external sustainability approach is the mostrelevant measure for Lebanon. It suggests a 50 percentovervaluation if net foreign assets were to be stabilizedat the 2018 level of -128 percent of GDP. In turn, theexchange rate is overvalued by 66 percent if the netforeign assets were to be brought down to -100 percentof GDP by 2024. The current account approach suggestsa real exchange rate gap of 63 percent in 2018(compared to 45 percent estimated in 2017). As inprevious years, the IREER approach suggests a muchsmaller REER gap of 9.1 percent. The REER hasappreciated over 30 percent since the lows in 2008. Theappreciation trends are consistent with the higherdomestic inflation rates in Lebanon in the past year andappreciation of the nominal effective exchange rate.”

IMF view of the currency

The cost of the currency peg has been exorbitant, including high interest rates paid by BdL and an erosion of export competitiveness as the real effective exchange rate has significantly appreciated since 2007

Real / Nominal effective exchange rate (2007-2018)

Most overvalued FX ranking: Lebanon in top decile

90

100

110

120

130

140

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Real effective exchange rate Nominal effective exchange rate

25

11

REER ranking NEER ranking

LBP is the 11th and 25th most overvalued currency in the

world based on NEER and REER respectively

20

Lebanon Inc consolidated foreign currency balance sheet

Source: IMF, World Bank, Lebanon’s Ministry of Finance, Banque du Liban. Feb-2020 data for consolidated banks balance sheet; 15-Apr-2020 data for BdL.

Consolidated foreign currency balance sheet ($ bn)

Lebanon Inc net foreign currency position is negative and estimated at 115% of 2019 GDP (including gold). This position will deteriorate with time and should be addressed when looking at the different proposed solutions

Negative net foreign currency position

Government ($ bn) Banque du Liban ($ bn) Banks ($ bn)

USD assets USD assets USD assetsAsset sale ? Government Eurobond 5 Government Eurobond 12Other ? Loans to Banks 8 Holdings at Banque du Liban 80

Foreign currencies 22 Private sector USD loans 31Gold 16 Other foreign assets 11

Total foreign currency assets ? Total foreign currency assets 50 Total foreign currency assets 133

USD liabilities USD liabilities USD liabilitiesEurobond: Banks 12 Banks holdings at Banque du Liban 80 Loans from Banque du Liban 8Eurobond: Banque du Liban 5 Other ? Customers USD deposits 117Eurobond: Non-domestic held 13 Other foreign liabilities 9Total foreign currency liabilities 30 Total foreign currency liabilities 80 Total foreign currency liabilities 134

Net foreign currency position (30) Net foreign currency position (30) Net foreign currency position (1)

Assets ($ bn) CurrrentBdL: Foreign currencies - End of period 22BdL: Gold 16BdL: Total foreign currency assets 37

Government (including asset sale) 0

Banks: Private sector USD loans 31Banks: Other foreign currency assets 11Banks: Total foreign currency assets 42

Lebanon Inc: Foreign currency assets 79

Liabilities and Equity ($ bn)Government: Non-domestic held Eurobonds 13

Banks: USD deposits 117Banks: Other foreign liabilities 9Banks: Total 126

Lebanon Inc: Foreign currency liabilities 139Lebanon Inc: Equity = Net foreign currency position (60)

Snapshot of where are we heading: Lessons from crisis countries

22

Contraction in real GDP of select “crisis countries”Cumulative contraction in real GDP of select countries


Past experience in other crisis countries suggests a real GDP contraction of 15-25% over next few years (even more due to COVID-19). Recovery speed depends on policy makers’ actions including structural reforms and depth of debt restructuring.

Years from peak to trough GDP

(26%)

(21%)

(19%)

(15%)

(10%) (10%) (9%) (9%) (9%)(8%)

(14%)

Gre

ece

Latv

ia

Esto

nia

Lith

uani

a

Cypr

us

Icel

and

Irela

nd

Spai

n

Italy

Port

ugal

5 ye

ars

2 ye

ars

1 ye

ars

1 ye

ars

6 ye

ars

2 ye

ars

1 ye

ars

5 ye

ars

5 ye

ars

5 ye

ars

Gre

ece

Latv

ia

Esto

nia

Lith

uani

a

Cypr

us

Icel

and

Irela

nd

Spai

n

Italy

Port

ugal

23

Contraction in nominal GDP of select “crisis countries”Cumulative contraction in $ GDP of select countries


Sharp real GDP contraction and exchange rate overvaluation will likely result in more than 25-35% reduction in $ nominal GDP over next few years.

Years from peak to trough GDP

(45%)

(39%)

(33%)

(29%) (29%)(27%)

(24%) (23%) (22%)

(19%) (19%)

(28%)

Gre

ece

Icel

and

Latv

ia

Cypr

us

Egyp

t

Spai

n

Port

ugal

Italy

Lith

uani

a

Esto

nia

Irela

nd

8 ye

ars

2 ye

ars

2 ye

ars

7 ye

ars

2 ye

ars

7 ye

ars

7 ye

ars

7 ye

ars

2 ye

ars

2 ye

ars

2 ye

ars

Gre

ece

Icel

and

Latv

ia

Cypr

us

Egyp

t

Spai

n

Port

ugal

Italy

Lith

uani

a

Esto

nia

Irela

nd

24

Change in government revenues of select “crisis countries”Cumulative contraction of government revenues in $


Past experience in other countries suggests $ government revenues will likely shrink by 35-50% over the next few years as GDP contracts, and given the large contribution of the financial sector to total revenues

Years from peak to trough government revenues

(50%)

(35%)

(30%)

(25%)(24%) (23%) (23%)

(20%) (19%)

(13%)

(26%)

Icel

and

Gre

ece

Cypr

us

Latv

ia

Spai

n

Irela

nd

Lith

uani

a

Port

ugal

Italy

Esto

nia

2 ye

ars

7 ye

ars

7 ye

ars

2 ye

ars

7 ye

ars

2 ye

ars

2 ye

ars

7 ye

ars

7 ye

ars

2 ye

ars

Icel

and

Gre

ece

Cypr

us

Latv

ia

Spai

n

Irela

nd

Lith

uani

a

Port

ugal

Italy

Esto

nia

25

Change in banks’ non-performing loans of select “crisis countries”Cumulative percentage point change of banks’ NPLs


Past experience in other countries suggests an increase in banks’ NPLs of 20% over next few years. Recovery speed depends on willingness to quickly absorb the loss and recapitalize, as well as the sovereign’s ability to help

Years from trough to peak NPLs

45%

41%

25%

22%

18%

15% 14% 12%

8%

3%

20%

Cypr

us

Gree

ce

Irela

nd

Lithu

ania

Icel

and

Port

ugal

Latv

ia

Italy

Spai

n

Esto

nia

8 ye

ars 9

year

s

6 ye

ars

2 ye

ars

2 ye

ars

8 ye

ars

2 ye

ars

8 ye

ars

6 ye

ars

2 ye

ars

Cypr

us

Gree

ce

Irela

nd

Lithu

ania

Icel

and

Port

ugal

Latv

ia

Italy

Spai

n

Esto

nia

26

Change in banks deposits of select “crisis countries”Cumulative contraction of banks’ deposits in $ terms


Past experience in other countries suggests we should expect banks’ deposits to shrink by 25-35% over the next few years transforming the banking sector. Banking rely on trust and confidence: it will take a long time to regain confidence.

Length of deposit erosion period

(57%)

(36%) (35%)

(29%)(28%)

(23%)

(13%)(11%)

(4%) (3%)

(24%)

Gree

ce

Cypr

us

Icel

and

Irela

nd

Port

ugal

Spai

n

Italy

Latv

ia

Lithu

ania

Esto

nia

8 ye

ars

7 ye

ars

4 ye

ars

7 ye

ars

7 ye

ars

7 ye

ars

7 ye

ars

4 ye

ars

1 ye

ars

2 ye

ars

Gre

ece

Cypr

us

Icel

and

Irela

nd

Port

ugal

Spai

n

Italy

Latv

ia

Lith

uani

a

Esto

nia

27

Change in unemployment rate of select “crisis countries”Cumulative percent point change in unemployment


Past experience in other countries suggests we should expect the unemployment rate to increase by 10-20 percentage points over the next few years. Providing and expanding a targeted social safety net is critical.

Years from trough to peak unemployment

20%

18%

14% 13% 12% 12%

11%

9%

7% 5%

12%

Gre

ece

Spai

n

Lith

uani

a

Latv

ia

Cypr

us

Esto

nia

Irela

nd

Port

ugal

Italy

Icel

and

5 ye

ars

5 ye

ars

3 ye

ars

3 ye

ars

6 ye

ars

3 ye

ars

6 ye

ars

5 ye

ars

7 ye

ars

3 ye

ars

Gre

ece

Spai

n

Lith

uani

a

Latv

ia

Cypr

us

Esto

nia

Irela

nd

Port

ugal

Italy

Icel

and

28

The cost of inaction is high – Venezuela case study

The cost of inaction is high and only increases with time as demonstrated in Venezuela. Urgency to act is required.


Real GDP growth (%) Unemployment rate (%)

Households income below national poverty line (%)Inflation rate (%)

(3%) (2%)

4% 6%

1%

(4%)(6%)

(17%) (16%)(20%)

(10%)

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

-54% cumulative real GDP contraction

0%

50,000%

100,000%

150,000%

200,000%

250,000%

300,000%

350,000%

Jan-

2010

Jun-

2010

Nov

-201

0

Apr-

2011

Sep-

2011

Feb-

2012

Jul-2

012

Dec-

2012

May

-201

3

Oct

-201

3

Mar

-201

4

Aug-

2014

Jan-

2015

Jun-

2015

Nov

-201

5

Apr-

2016

Sep-

2016

Feb-

2017

Jul-2

017

Dec-

2017

May

-201

8

Oct

-201

8

Mar

-201

9

Aug-

2019

8% 9% 8% 8% 7% 7% 7%

21%

28%

35%

44%

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

27% 27% 27% 21%

27%

48%

73% 82%

87% 90% 90%

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

29

The cost of inaction is high


Key considerations Lebanon Inc foreign currency balance sheet ($ bn)• Balance of Payment: Further disruption in supply of

critical materials such a medical resources.• Currency: Further weakening of currency with risk of

spiralling potentially leading to hyperinflation.• Fiscal: Increasing deficits given weak economy (limits

tax collection) and the rigid cost structure. Fundedthrough money printing by BdL.

• Government debt stock: Increasing in LBP andsignificantly more relative to GDP.

• Banque du Liban: Deterioration in net negative FXreserves position. Further loss of credibility in abilityto manage LBP or save the banking sector.

• Banks restructuring: Recapitalization amount onlyincreases with time leading to higher amount of“haircuts” through forced partial conversion of USDdeposits and/or large depositors bail-in.

• Private sector: bankruptcies, non-performing loans,job losses, loss of competitiveness. Majorimplications for country’s long-term potential.

• Social: significant increase in unemployment, povertyrates, emigration. Major implications for country’slong-term potential.

Lebanon Inc net negative foreign currency position significantly deteriorates with time if no measures are taken.

Assets ($ bn) Currrent Projections 2020E 2021E 2022E

BdL: Foreign currencies - Beginning of period 22 12 6Interest income on foreign currencies 0 0 0Current account deficit (ex. interest) (5) (3) (3)Principal and interest on non-domestic held Eurobonds 0 0 0Capital outflows (5) (3) (3)BdL: Foreign currencies - End of period 22 12 6 0BdL: Gold 16 16 16 16BdL: Total foreign currency assets 37 28 22 16

Government (including asset sale) 0 0 0 0

Banks: Private sector USD loans 31 29 27 25Banks: Other foreign currency assets 11 11 11 11Banks: Total foreign currency assets 42 40 38 35

Lebanon Inc: Foreign currency assets 79 68 60 52

Liabilities and Equity ($ bn)Government: Non-domestic held Eurobon 13 13 13 13

Banks: USD deposits 117 116 116 116Banks: Other foreign liabilities 9 9 9 9Banks: Total 126 125 126 125

Lebanon Inc: Foreign currency liabilities 139 138 139 138

Leb Inc: Net foreign currency position (60) (71) (79) (86)Relative to GDP (115%) (183%) (220%) (247%)

Snapshot of potential solutions for the way forward

31

Devising a credible comprehensive economic plan to underpin debt restructuring

Immediately stop the bleeding


Implement in parallel a growth recovery plan

•Legalize comprehensive enforceable and transparent capital controls

•Adopt a strategic management of FX reserves

•Secure liquidity to arrest growth fall out

•Audit BDL and sovereign balance sheets

•Expand social safety nets

•Accelerate structural reforms

•Fiscal consolidation (medium-term framework)•Recapitalize BdL’s balance sheet•Debt restructuring – equitable burden sharing•Banks’ recapitalization•Orderly exchange rate adjustment•Continued expansion of social safety nets•Growth enhancing structural reforms •Governance and institutional reforms•Mobilization of external funding

Comprehensive approach is needed. Partial ad-hoc solutions are more harmful and unsustainable.

Key pillars of a comprehensive macro-fiscal and growth recovery planPillar 1 Pillar 2 Pillar 3 Pillar 4 Pillar 5 Pillar 6

Macro-Fiscal adjustment and

debt restructuring

Banking sector recapitalization and

restructuring

Exchange rate and monetary

management

Social protection and development

policies

Growth stabilization and transformation

(Private sector)

Governance and institutional

reforms

Donor Engagement and external financing mobilizationCommunication and Stakeholders engagement

32

Confirming Lebanon Inc net negative foreign currency position through audits

Confirming the size of Lebanon Inc losses is critical through a professional and independent audit as a first step towards greater accountability.

Consolidated foreign currency balance sheet ($ bn)

Negative net foreign currency position

Government ($ bn) Banque du Liban ($ bn) Banks ($ bn)

USD assets USD assets USD assetsAsset sale ? Government Eurobond 5 Government Eurobond 12Other ? Loans to Banks 8 Holdings at Banque du Liban 80

Foreign currencies 22 Private sector USD loans 31Gold 16 Other foreign assets 11

Total foreign currency assets ? Total foreign currency assets 50 Total foreign currency assets 133

USD liabilities USD liabilities USD liabilitiesEurobond: Banks 12 Banks holdings at Banque du Liban 80 Loans from Banque du Liban 8Eurobond: Banque du Liban 5 Other ? Customers USD deposits 117Eurobond: Non-domestic held 13 Other foreign liabilities 9Total foreign currency liabilities 30 Total foreign currency liabilities 80 Total foreign currency liabilities 134

Net foreign currency position (30) Net foreign currency position (30) Net foreign currency position (1)

Assets ($ bn) CurrrentBdL: Foreign currencies - End of period 22BdL: Gold 16BdL: Total foreign currency assets 37

Government (including asset sale) 0

Banks: Private sector USD loans 31Banks: Other foreign currency assets 11Banks: Total foreign currency assets 42

Lebanon Inc: Foreign currency assets 79

Liabilities and Equity ($ bn)Government: Non-domestic held Eurobonds 13

Banks: USD deposits 117Banks: Other foreign liabilities 9Banks: Total 126

Lebanon Inc: Foreign currency liabilities 139Lebanon Inc: Equity = Net foreign currency position (60)

Source: IMF, World Bank, Lebanon’s Ministry of Finance, Banque du Liban. Feb-2020 data for consolidated banks balance sheet; 15-Apr-2020 data for BdL.

33

Assessing the banking sector exposure to major risks

Source: IMF, World Bank, Lebanon’s Ministry of Finance, Banque du Liban.Note: * Estimated losses based on BdL estimated net foreign FX position of $33-41bn.

Deposits at Central Bank Loans to Government Loans to private sector

Lebanese banks will witness losses from three different buckets of exposure, each enough to require a full recapitalization of the banking sector as total losses could hover around $60 bn.

Expo

sure

si

ze ($

bn)

USD: $80bnLBP: $39bn



Loss

est

. (%

) USD: 20-45%*LBP: 0%

USD: ~70%LBP: ~30%

USD: 20% incrementalLBP: 20% incremental

Loss

est

. ($

bn) USD: $18-40bn*

LBP: N.A.USD: $8-9bnLBP: $4-5bn

USD: $6bnLBP: $3bn

Total potential losses: $40-60bnTotal bank equity: $21bn

34

Dealing with Banque du Liban’s balance sheet


Partial forced conversion of banks’ USD deposits at BdL ($ bn)

To close BdL’s net negative FX position, $33-41bn of banks deposits at BdL (~45%) could be either i) converted from USD to LBP at LBP1,500; or ii) subject to a haircut. Each will have different implications on banks’ losses, exchange rate, and inflation.

30 31

47

(80) (33)

33 0

2

16

Foreign assets Lebanesegovernmenteurobonds

Foreign assetsex-Gold

Gold Foreign assetsincluding Gold

Banks USDdeposits at BdL

(estimated)

Net foreignassets

Forced conversionor Haircut of

banks $ depositsat BdL

Proforma netforeign assets

To close BdL's net negative foreign asset position, ~45%

of banks deposits at BdL needs to be either:

i) converted from $ to LBPii) subject to haircut

Subject to haircut as part of debt restructuring

Includes some loans to Lebanese banks. $22bn of

total is liquid

35

Restructuring government debt: Potential scenarios and implicationsScenario: 60% haircut to government debt• LBP3,300*• No debt service holiday• 60% haircut to T-Bills (100% BdL + 6% non-BdL owned)• 60% haircut to Eurobond• BdL closes net negative FX position

• LBP3,300*• No debt service holiday• 70% haircut to T-Bills (100% BdL + 30% non-BdL owned)• 70% haircut to Eurobond• BdL closes net negative FX position

Scenario: 70% haircut to government debt

Lebanon needs to target 60-80% debt to GDP while addressing BdL negative FX reserves position. This would be critical to lift capital controls, anchor the exchange rate, recap banks & allow credit to flow back to the economy.

Gov

ernm

ent d

ebt

(as %

of G

DP)

Use

s ($b

n)

Source: IMF, World Bank, Lebanon’s Ministry of Finance, Banque du Liban. Note: * Based on current exchange rate of LBP in parallel market.

29%

29%

29%

28%

27%

24%

22%

20%

18%

16%

49%

54%

57%

58%

57%

55%

54%

53%

51%

50%

78% 83% 85% 86% 84% 80% 76% 72% 69% 65%

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030Foreign currency Local currency

37%

37%

37%

36%

34%

31%

28%

25%

22%

20%

56%

62%

65%

67%

67%

66%

66%

65%

65%

65%

93% 99% 102% 103% 101% 97% 94% 90% 87% 84%

2021 2022 2023 2024 2025 2026 2027 2028 2029 2030Foreign currency Local currency

Uses BDL balance sheetForced conversion Haircut

Required banks capital 35 49BdL net negative FX position 0 0Total 35 49Lebanon Inc net foreign assets position (25) (10)

Uses BDL balance sheetForced conversion Haircut

Required banks capital 38 52BdL net negative FX position 0 0Total 38 52Lebanon Inc net foreign assets position (21) (6)

36

Restructuring and recapitalizing banks: Funding sources (the waterfall of losses)


Internal capital generation (current year profits)

Banks existing equity

External capital injected

Internal capital generation (reduced interest on deposits)

Forced conversion of $ deposits to LBP

Mergers / Consolidation

First line of defense

Last line of defense

Given the expected size of the losses, depositors are likely to bear some part of the recapitalization cost in return for cleaner, leaner, smaller, better regulated and managed banks.

Second line of defense

Third line of defense

Fourth line of defense

Depositors bail-in (deposit to equity conversion) and potentially one-off tax

37

Restructuring and recapitalizing banks: A partial deposit bail in seems inevitable

Source: IMF, World Bank, Lebanon’s Ministry of Finance, Banque du Liban. Note: *Based on total deposits in the banking sector (USD + LBP).

Breakdown by number of accounts Amount by tranches ($bn)*

91%

7%2%

X< $100k

$100k <X

< $500k

$500k <X

~200k account

~50k account

Government plan:

Focus on these depositsfor banks

recapitalizationGovernment plan:

Focus on these depositsfor banks recapitalization

~$115bn total USD deposits = ~$62bn < $500k + $53bn > $500k

If an account has $1.2m then:- First $100k is counted here- Amount between $100k and $500k is counted here (i.e. $400k)- Amount above $1m is counted here (i.e. $700k)

1

2

31

2

3

~$31bn

~$31bn

~$53bn

The pool of money of the top 2% of depositors (> $500k) is potentially not “enough” to recap the banks as proposed by the government.

38

Banks/BdL restructuring: Assessing possible options for bridging the funding gaps• Forced conversion of banks USD deposits at BDL

• Negative implications on the exchange rate and inflation.• Massive increase in the money supply: ~80-100% increase in LBP monetary base.• Smaller losses vs. haircut to CDs/Depts as it preserves a residual value of banks’ assets in LBP.

• Internal capital generation through reduced interest rates on deposits• Effectively an NPV reduction for depositors but “psychologically” less painful.• 0% interest on USD deposits can generate ~$3bn of capital p.a. (i.e. ~ $6bn over two years).

• External capital injection• $5bn external capital injection saves large depositors (i.e. > $500k) ~10% of their principal.• Although small by market standards but requires confidence building measures and reforms.• Can encompass sale and monetization of bank assets.

• Recovered asset fund• Should be credibly pursued to recover stolen monies. Accountability is essential to regain

confidence and consolidate rule of law.• Lawsuits will take time. However, depositors can be promised compensation if / when stolen

money is recovered.• Contribution of state assets to recapitalize banks

• Subject to debate around fairness: reduces pain of large depositors in order to preserve capitalfor economic expansion later.

• However this could be at the expense of tax payers / broader population.• Risk of deepening capture in a weak State. Requires very credible and strong institutions and

independent judiciary.

39

Banks restructuring: The cost increases with time

Source: IMF, World Bank, Lebanon’s Ministry of Finance, Banque du Liban. Note: Assumes LBP at 5,000/6,000 given funding of fiscal deficit through BdL.

Delaying decisions will have a significantly bigger impact on depositors as the exchange rate weakens further. The cost of inaction is too high and increasing. Urgency is required.

70% haircut to government debt – assuming LBP 5,000 70% haircut to government debt – assuming LBP 6,000

Requ

ired

bank

s rec

apita

lizat

ion

($ b

n)

BDL:

For

ced

conv

ersi

onBD

L: H

airc

ut

$38bn

$57bn

2020E 2022E

$52bn

$73bn

2020E 2022E

$38bn

$61bn

2020E 2022E

$52bn

$74bn

2020E 2022E

40

How does our proposal differ from that of the Government?

Government – April 2020(advised by Lazard)

Moubayed & Zouei(www.lebanoneconomics.net)

Private sector NPLs 30% total 20% incremental losses (34% total)

Scope of losses at BdL LBP + Foreign currency Foreign currency focused

Dealing with BdL losses Haircut banks assets at BdL(CDs/deposits)

Two options:- Partial forced conversion- Haircut

Targeted BdL net asset position (equity)

-$5 bn net negative equity position in both local and foreign currency (15% of GDP)

- Zero net foreign currency asset position (foreign currency)- Assumes LBP negative equity can be managed/amortized overtime

Haircut on Eurobonds ~75% (estimated) 70%

Haircut on LBP debt ~50% (estimated) 70% (100% on BDL portfolioand 30% on non-BdL- excludes social security..)

Bank recapitalization No full bail-outDeposit bail-in (2% of top depositors)Asset fund recovery (lack of details)

No bail-outLimiting extent of bail-in by exploring range of possible funding sources

Important to explore a range of policy options/measures and assess pros and cons of each based on evidence/analysis.

http://www.lebanoneconomics.net/

41

Key conclusions and issues for further debateCONCLUSIONS:

• Urgency is required. The cost of inaction is too high and increasing.

• Deep and comprehensive restructuring is inevitable, anchored within a credible fiscalreform and growth recovery plan

• An equitable burden sharing is doable in a way to protect small depositors.-----------

ISSUES for FURTHER DEBATE:

1. There is a rationale for bail-in: how to strike the right balance between efficiencyand social equity?

2. The math does no add-up with only 2% of depositors: Is government’s proposedstate assets monetization a feasible option (politically, legally, etc.)?• What assurances and safeguards should an asset monetization process entail in

order to prevent state capture and distributing the spoils to cronies?• How do we ensure a fair valuation of these assets?• Who benefits from any future potential upside upon state assets monetization?

3. Whatever option we choose: how do we make the model sustainable?

42

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