Why Lebanon’s exchange rate change just cost banks about $8bn

On Wednesday the local currency was devalued by 90 per cent but remained far below the commonly used rate on the parallel market

Riad Salameh, the governor of Lebanon's Central Bank, speaks during a press conference, in Beirut, Lebanon. AP

The move by Lebanon's central bank on Wednesday to adopt a new official exchange rate and effectively devalue the currency by 90 per cent has left experts and bankers with more questions than answers.

But one thing is clear ― banks rather than depositors will be most immediately affected.

Riad Salameh, governor of Banque Du Liban, has painted the shift from about 1,507 Lebanese pounds to the dollar to the new rate of 15,000 as a move aimed at unifying Lebanon’s multiple exchange rates.

Such a step is a condition that has been set by the International Monetary Fund for a $3 billion bailout that is part of a tentative agreement with Lebanon.

The country is experiencing one of the worst economic crises in modern times, according to the World Bank, with the local currency having lost about 97 per cent of its value against the US dollar on the parallel market — the most commonly used rate.

However, experts and industry insiders said, rather than removing confusion and streamlining rates, the move would simply add another value to the mix of exchange rates.

Lebanon already had the official 1,507 rate, a rate for withdrawals from bank deposits set at 8,000 to the dollar, the Sayrafa rate – an official platform managed by the Central Bank – that is currently trading at 38,000 to the dollar and an informal rate fluctuating daily on the parallel market – which is the most commonly used – currently sitting at 60,000 to the dollar.

The official 1,507 rate has been redundant for years and the value on the parallel market accounts for the bulk of transactions.

What does the devaluation entail for banks, their clients, and the central bank?

In essence, the new rate will not significantly affect depositors, who have been locked out of their life savings since the start of the liquidity crisis.

But they should now be able to withdraw their deposits at the 15,000 rate instead of the previously offered rate of 8,000, which is still far from the actual rate on the parallel market.

The biggest impact will be on banks as it means that, for the first time since the Lebanese pound started its rapid decline in 2019, a new rate will apply to their balance sheets.

The country's banks have more foreign currency liabilities than they have foreign currency assets, so the devaluation of the local currency means acknowledging huge foreign exchange losses.

Until now, they've been allowed to continue to list liabilities at the 1,507 rate in their accounting.

The latest measure “was inevitable” said one financial executive.

“Banks' equity has already been slashed with the current currency collapse. Reality is not impacted by accounting tricks; the 1,500 rate had since early 2020 become totally irrelevant anyway," he said.

How are banks going to recover from these foreign exchange losses?

“This is going to have a major impact for banks, which will have to recognise between $7 billion-$8 billion in losses due to foreign exchange rate”, Jean Riachi, Chairman of FFA Private Bank Dubai Limited told the National.

“The central bank gave banks five years to close foreign exchange losses, but how will they manage to do that and will they be able to avoid the losses?” he added.

However, it is unclear at this stage if the devaluation will also apply to the central bank itself.

“It is not clear whether BDL will adopt the new rate for its balance sheet and admit its owns losses due to its negative foreign exchange position [negative net reserves] or if it will be the only one exempted,” said Mr Riachi.

If yes, this will further impact the banks’ balance sheets as "the bulk of the bank losses will come from provisions on their deposits with BDL — where banks have 80 per cent of their assets and not only from their foreign exchange positions.”

The central bank has been accused of using accounting tricks to obscure its balance sheet losses since 2015 by recording them under “other assets” — in a bid to amortise or gradually write them off against future revenue.

A move towards an IMF deal?

Lebanese banking expert Mike Azar, referring to the staff-level agreement with the IMF, said the currency devaluation “actually cuts against the philosophy of the deal — recognising all losses upfront and not dragging it”.

“How much FX losses do banks actually have, how will they plausibly be closed over 5 years and why use a fake 15,000 rate. Why drag on this misery,” he asked.

The financial executive agreed that the 15,000 rate was also far from where the currency's true value.

“The reality is now far from 15,000 and closer to 60,000,” he said.

Experts also stressed the need for a recovery plan to fairly allocate the estimated $72 billion in financial losses between the state, the financial sector and depositors.

“Financial sector losses should be resolved through a comprehensive bank resolution framework, not piecemeal circulars,” Mr Azar wrote.

The situation comes as Lebanon finds itself in an unprecedented governance vacuum.

MPs have failed to elect a new president despite 11 attempts, three months after Michel Aoun departed office.

Meanwhile, the cabinet of Prime Minister Najib Mikati is in caretaker status since last year's election and is severely stripped of its powers.