Breaking down a Lebanese haircut

Talks of a Lebanese haircut or a forced decrease in deposits since the past year came With the looming financial failure in Lebanon, several new terms emerged in the average citizen’s daily conversation such as Haircut, Capital Control, Liralization, etc. Haircut, or a forced decrease in deposits, is widely debated and most dreaded by the public.

However, these debates come with little rigorous and scientific analysis. This is due to the absence of data on deposit concentration in different balance brackets (as a result of Lebanon’s Banking Secrecy Law), coupled with the lack of reliable information on the sizes of BDL monetary reserves. In short, we are in a crisis, but we have no idea when the curtain will drop.

An article by Dan Azzi on November 8th, 2019 suggested that a banking capital control (back then was still not widely imposed) would only stanch a bleeding while more drastic measures are needed such as a haircut on all accounts above 1 mill $. Others anticipate an immanent haircut affecting all deposits above 100K $.

In this article, I examine the different “discussed” haircut scenarios, using realistic approximations to overcome the problem of data shortage. It is worth mentioning that this is an effort to explore the different scenarios and their consequences and is by no means a suggestion that a deposit haircut is the best solution for banking recapitalization.

The International Monetary Fund (IMF), in its 2016 Article IV on Lebanon, showed Lebanese deposit concentration based on three bucket sizes: 100K $, 1 mill $ and 100 mill $. The numbers published by the IMF are utilized to calculate total haircut amount that can be generated to recapitalize banks under the three scenarios. The assumption is made that these different bucket sizes are still valid today.

The main scenarios analyzed here are haircut on deposits, haircut on net deposits, and indirect haircut through Liralization. Under each scenario, a fixed rate of haircut (30%) can be applied to all deposits, a progressive rate is simulated depending on deposit size (30%, 40%, 50%), and then a more aggressive rate (40%, 50%, 60%). 

Scenario 1 below assumes a haircut on deposits ($ and LBP) only independent of loan amounts. In the least case, this can generate 44bn$ (1A) and in the most progressive rate case, it generates 68bn$ (1C).

A less likely scenario, Scenario 2, assumes a haircut on deposits net of loans. An assumption here is that each depositor holds an equal loan-to-deposit ratio as the total in the banking sector (30%). This scenario can generate 30bn$ in the most progressive rate case (2C).

The third scenario is recently discussed on social media platforms and newly termed as tThe third scenario has been recently discussed on social media platforms and newly termed as the Liralization haircut. In this scenario, all dollar deposits (and loans) would be converted forcefully to LBP. This is therefore an indirect haircut of at least 40% (at current exchange rates) on all deposits across all buckets. This scenario can yield 35bn$.

Note that the shortage of physical dollars in the country is already forcing a Liralization haircut of this kind. This is where half of the interest on dollar accounts are being paid in Lebanese Lira (some banks are paying full in Liras) while other depositors with urgent liquidity needs are converting their accounts to Lebanese Lira to avoid the stricter limits on dollar accounts.

With an estimated 2bn$ outflow of total banking deposits per month, at least a ten-fold amount of banking recapitalization is needed to stop banks from moving from their current illiquidity status into insolvency. The source of this recapitalization will continue to be hotly debated in the coming months, as each solution will cause several grievous social, economic and financial consequences.

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