World Bank report says
bank sector too big to bail

Recommends conversion

of large deposits to equity

A bail-in solution is the only realistic option to address the financial crisis because the financial sector is too big for a bailout and its losses exceed $72 billion and represent 311 percent of GDP, according to the World Bank’s Lebanon Economic Monitor (LEM) for the fall of 2022.

“Lebanon’s financial sector is simply too big to bail due to the magnitude of the losses in an oversized balance sheet,” said the LEM which is titled ‘Time for an Equitable Banking Resolution’.

A bailout involves using taxpayers’ money to rescue a failing financial institution while a bail-in involves the cancellation or conversion into equity of liabilities owed by a financial institution to large creditors including shareholders and depositors.

“The magnitude of the holes in the intertwined balances sheets of the Central Bank (BDL), the banking sector and the Sovereign, dwarfs the current and future assets that the sovereign could realistically mobilize for a bailout,” the LEM said. State-owned assets including real estate and any potential future revenues from oil and gas are worth only a fraction of the estimated financial losses. “Given the uncertain valuation of both assets, any crisis resolution plan that relies on these would lack credibility and fail,” the World Bank said.

A bail-in allows viable banks to regain solvency. It is based on a hierarchy of creditors which starts with banks’ shareholders. Under a bail-in, large creditors and bank shareholders bear the main cost of bank restructuring. This is done by writing down, canceling, or converting liabilities owed by the banks into equity. The bail-in aims to protect small depositors and it is accompanied by comprehensive reforms.

A bailout is unviable and inconsistent with the restructuring principles that protect taxpayers and small depositors, according to the LEM. “A bailout of the financial sector by taxpayers would redistribute wealth from poorer to richer households, as the public would be asked to compensate bank equity holders and wealthy depositors,” the World Bank said.

“BDL has $60 billion (259 percent of GDP) in negative net foreign exchange reserves—by far the largest negative reserves of all central banks across the world,” according to the LEM. The oversized banking sector has incurred substantial losses in its credit to the private sector which have made it insolvent against its pre-crisis equity of $22 billion.

“Delays in the day of reckoning with the magnitude and viable distribution of financial losses will only compound human and social capital losses,” the World Bank said.