The proposals introduced in the Draft Law Governing the Resolution of Banks in Lebanon, and the Draft Law Aiming to Rebalance the Financial System in Lebanon entail a rescue plan – broadly achieved through bank resolution and deposit recovery – for Lebanon’s broken financial sector. Both laws nonetheless contain inherent ambiguities that cultivate space for loopholes, haphazard implementation, and, most significantly, pervasive conflicts of interest. On a grander scale, these draft laws lack a vision of root-and-branch reform necessary to earn the claim of fully re-structuring Lebanon’s financial system and restoring both domestic and international confidence in the viability of Lebanon’s financial sector.
INTRODUCTION
The Draft Law Governing the Resolution of Banks in Lebanon (henceforth referred to as Draft Law 1) attempts to resolve the present banking sector crisis through a comprehensive restructuring programme implemented through the Higher Banking Commission (HBC). The HBC was established at the Banque du Liban (BDL) in 1967 pursuant to Article 10 of Law No 28/67. Draft Law 1 outlines the powers entrusted to the HBC in light of its new role in the Resolution Process, through which it decides whether the banking institution under investigation is subject either to a Resolution Decision or a Strike Off Decision. The Draft Law subsequently offers information on the processes, entities, and frameworks implemented following such a decision.
Meanwhile, The Draft Law Aiming to Rebalance the Financial System in Lebanon (subsequently referred to as Draft Law 2) takes a broader focus, attempting to address faults in Lebanon’s financial system in a way that protects depositors in the allocation of losses. It simultaneously aims to restore confidence in the Lebanese financial system through a restructuring process that serves the “interests of the national economy” and the necessary recapitalisation of the Banque du Liban.
This position paper firstly outlines the reforms introduced, and entities established, by the separate draft laws. It subsequently discusses issues in the drafts, whilst suggesting recommended adjustments and necessary clarifications. In doing so it aims to ensure that any leeway for loopholes is closed and that small depositors are protected in the distribution of losses. More broadly, this paper highlights the need to mandate the build-up of the Total Loss Absorption Capacity standard for distributing losses and requirements for future crisis which would simultaneously bring Lebanon’s financial system in line with internationally recognised standards established in Basel III, the international financial regulation standard.
I. LEGAL & POLICY ANALYSIS
The below points detail the most significant entities established and processes outlined in the Law Governing the Resolution of the Banks in Lebanon and The Draft Law Aiming to Rebalance the Financial System in Lebanon. The draft laws are complimentary and as such will be addressed in tandem.
A. Initiation of the Resolution or Liquidation Process
Draft Law 1 outlines the powers entrusted to the HBC in light of its role in the Resolution Process as the Resolution Authority for the implementation of the law at hand. Most central to such a role is the power allocated to the Commission to decide whether a banking institution under investigation is subject to either a Resolution Decision or a Strike Off Decision. Whilst the designation of a Resolution Decision involves the allocation of the necessary “Resolution Tools” to be implemented, the Strike Off Decision initiates the liquidation process of the specific bank. This is followed up by the appointment of a Liquidator/Liquidation Committee.
Notification of the status of a concerned bank as placed under either Resolution or Liquidation is to be published in the Official Gazette, in a newspaper of general circulation in the country, and on Banque du Liban’s website.
B. The Valuation Process
Part 6 of Draft Law 1 details the Valuation Process by which the Net Asset Value of a bank is calculated by Independent , The eligibility criteria of these Independent Valuers is extensive. It includes the clarification that they should have no relationship which could result in a conflict of interest and the “requisite qualifications”. The Independent Valuers are, furthermore, bound by professional and banking secrecy regulations. The draft law does not detail which law such “banking secrecy regulations” are based on. Subsequent clarification must establish that the law is referencing the standards and penalties established in the 2022 version of the 1956 Lebanese Banking Secrecy Law.
C. The Business Plan
Following the outcome of the HBC’s Valuation Process, banks will respond within a specific number of days with a Business Plan detailing how the institution aims to undertake phased recapitalisation in successive periods of 6 months, 9 months, and 12 months from the date of the law’s publication in the Official Gazette. This Business Plan is submitted to the Banking Control Commission (BCC), a Supervisory Authority established by law 28/67 dated 9/5/1967.
The necessary information in such a business plan includes the source of funds to meet minimum capital requirements, the source of funds for meeting minimum liquidity requirements, and the measures aimed at restoring long-term viability to the institution. The BCC will, in turn, assess the viability of such a business plan according to a “failing or likely to fail” criterion. Such criterion includes the likelihood of a bank to fail to comply with minimum capital or liquidity requirements, “fundamental shortcomings” in the bank’s business activities, or the bank is operated in a “imprudent, unsafe or unsound manner”. Such language is markedly ambiguous, not least due a consequent lack of any elaboration regarding who or what entity defines indicators of such “shortcomings” or ill-governance. An assessment report is subsequently submitted to the HBC who shall decide whether the bank will be resolved by a Resolution Decision or liquidated following a Strike Off decision.
D. The Resolution
Draft 1 subsequently details the core principles underpinning the Resolution Process including, most importantly, the order by which equity shall absorb losses first whilst no loss is imposed on creditors until equity has been written down completely. The draft outlines that this shall occur according to the “Equity and Creditor Hierarchy in Resolution”, through which the first to shoulder losses are shareholders, then subordinated debts, followed by unsecured claims, and finally customers’ deposits in foreign currencies (See Appendix 1). These shall be followed in order until the losses are covered to the extent that the Net Asset Value is zero or positive. The liabilities in such a process include, amongst others, National Social Security Deposits.
Resolution tools are detailed at length in the draft. The right to apply specific tools belongs to the HBC. These include the conversion of liabilities into equity instruments (Debt-to-Equity) and the conversion of Customers Deposits in foreign currencies to the Lebanese Pound (Lirafication) at an unspecified “pre-defined exchange rate”, as set by the HBC. The funding of the entire Resolution Process is to be borne by the bank in question.
Draft law 2 goes further into detail of the resolution process by governing eligible and ineligible deposits.
The law references that in order to determine the impact of the financial crisis on deposits, banks will be addressed through the Resolution Process (outlined above). The deposits within banks are divided according to “ineligible deposits”, or those converted into foreign currencies post October 17, 2019 (in reference to the protests that began in Lebanon on the 17 October 2019), and “eligible deposits”, the rest of the deposits in foreign currencies. Banks must respond in one month with the necessary information on both such deposits in their system. Deposits are consequently processed in accordance with payment of specific amounts of “eligible deposits” in “viable banks” as established in the Draft Law 1 and calculated at the level of the banking sector as a whole.
“Eligible deposits” and “ineligible deposits” in “non-viable banks” are subject to the provisions of Draft Law 1. Namely that following consideration by a Liquidator or Liquidation Committee (appointed by the HBC), the order of reimbursement for creditors outlined in Appendix 2.
Draft Law 2 finally details exceptions to the law that include fresh funds, i.e., those received by the concerned bank after 30/10/2019, and any other exceptions provided in Draft Law 1.
E. The Deposit Recovery Fund
Draft Law 2 subsequently establishes a Deposit Recovery Fund (DRF) aiming to secure the recovery of “eligible deposits” and to allocate funds for this process. The management and structure of the Fund will be determined by the Council of Ministers on the proposal of the Minister of Finance. The Council of Ministers will appoint a so-called independent body of specialists for the management of assets of the Fund. These “assets” in the Fund include the assets of the bank in question, a financial contribution from banks equivalent to a percentage of their profits, and any assets in BdL with a potential basis in revenues from stolen, smuggled or illegal funds.
The state will allocate certain future revenues (of which there lacks any elaboration on their source) to the benefit of the Fund if specific conditions are met. These conditions include and completion of the economic and financial reform programme. Finally, the Fund will be able to issue securities or bonds representing shareholding to banks.
F. The Powers of the HBC and BCC
The law details at length the far-reaching powers entrusted to the HBC as a Resolution Authority. This includes, but is not confined to, the imposition of the Resolution Tools even without the consent of shareholders, creditors, board of directors or senior management. It also includes instructing the clawback of variable renumeration from individuals in high managerial positions in the Bank under Resolution and requiring structural changes within the Bank to remove impediments to the resolvability of the bank including requiring a bank to divest assets, cease or limit existing operations, or reorganise its ownership structure. It may remove or replace members of the board of directors, senior management, and shareholders for the banking institution following a Fit and Proper Assessment (conducted by the BCC upon BdL’s prior approval). The contents of the Assessment are to be defined at a later stage in a circular.
The HBC can also establish a uniform mechanism and criteria for the. The HBC can deduct surplus since 2015 on “Eligible Deposits” above $100,000. The Central Board of the BDL determines the surplus interest mentioned above according to the annual interest rate. Most significantly, the HBC may take “necessary action” to order individuals who transferred any “eligible deposits” abroad or used them to pay for real estate, or other investments, since 2015 to repay equivalent to the interest they since accrued on these deposits.
The BCC acts as a supervising body throughout the Resolution Process, overseeing the implementation of Resolution Tools and submitting reports on non-compliance to the HBC.
G. The Special Administrator
Part 13 of Draft law 1 details the role of the Special Administrator, designated by and answerable to the HBC, and charged with managing the affairs of the Bank under Resolution. It subsequently details the necessary qualifications and authorities of such a role. Notably lacking is elaboration on the appointment process for such an individual, apart from the designation based on the “criteria of integrity, independence, competence and professional experience”. The Special Administrator’s authorities include unrestricted access to the properties, offices, assets and records of the concerned bank and the authority to remove any or all directors and appoint their replacements (with written approval from the HBC).
H. Liquidation Process
The initiation of the Liquidation Process is triggered when a bank does not comply with the prerequisite minimum capital requirements and must consequently be struck off from Banque du Liban’s list of banks. Following such a decision the HBC appoints one Liquidator or a Liquidation Committee (depending on the quantity of transactions of the Bank undergoing Liquidation), and subsequently notifies the Minister of Finance of such a decision. Particularly significant is the ability of the relevant Resolution Authority to pursue in the Lebanese Competent Courts, and impose the interim seizure of assets of, any entities or individuals who have been in their function for the past five years in the Bank under Liquidation as accountable for criminal offence.
The Special Court is established by Court serves the purpose of resolving disputes between a creditor (including depositors) and the. The Special Court is not subject to any legal or judicial recourse. The Special Court is not subject to any legal or judicial recourse. The Special Court is not subject to any legal or judicial recourse.
I. Miscellaneous Information
Part 15, titled ‘Miscellaneous’, contains several key articles regarding the application of the law and the scope of the various entities involved in Resolution Processes. Firstly, it details that the HBC’s decisions are “irrevocable and not subject to appeal” or judicial recourse. Furthermore, the Lebanese Banking Secrecy Law of 1956, is lifted towards the HBC, the BCC, the Special Administrator, the Liquidator or Liquidation Committee, the Independent Valuers, and any auditor working for the BCC in relation to the implementation of the law. This is, however, a reference to a law that has since been amended by the Banking Secrecy Law of 03/11/2022. This Draft Law should eventually reference this change.
J. Recapitalisation of Banque du Liban
Draft law 2 aims to establish a legal framework to address the present faults of Lebanon’s banking system in a way that ensures that the depositors are protected in the allocation of losses. It does not, however, contain any reference to placing Lebanon’s financial system in line with international requirements of TLAC.
Section I proceeds to detail the recapitalisation process of the BDL. This process commences with an accounting audit of BDL that complies with “international standards”. The law does not elaborate on what specific international standards it is referring to. It proceeds to describe the three means by which depositors, especially “small ones”, will be protected in such a process. Firstly, recapitalisation with $2.5 billion through means determined by the Council of Ministers The “means” – from where these funds shall be taken and how the Council of Ministers can access them – are not elaborated. Thirdly, the draft law seeks to address the obligations of BDL to other banks regarding the coverage of debts. Article IV references that the deficit capital remaining in BDL in LBP will be tackled over a period of five years, whilst the debts resulting from the application of the ‘Seigniorage principle’ will be cancelled. ‘Seigniorage’ is the difference between the face value of money and the cost to produce it. In Lebanon’s context it conveys the fact that the cost to produce the Lebanese Pound is higher than its actual exchange value, in turn resulting a loss for the government. This loss would be cancelled by this draft law.
II. POLICY RECOMMENDATIONS
A. Conflicts of Interest
The most glaring issue at the heart of the bank restructuring process is the politically bias governance makeup of the various entities central to the implementation of the law itself. This is most evident in the unparalleled authority allocated to the Higher Banking Commission (HBC) in shaping the process of bank resolution. Not only does the HBC decide whether a banking institution under investigation is subject to either a Resolution Decision or a Strike Off Decision, all other entities and individuals referenced in the law – the Liquidation Committee/Liquidators, Banking Control Commission, the Special Administrator, and Independent Valuers – are appointed by and answerable to the HBC. Furthermore, the law highlights that the HBC’s decisions are “irrevocable and not subject to appeal” or judicial recourse.
The effectiveness of the HBC, as the judicial arm of the Banque du Liban, is, however, compromised by undue political influence, conflicts of interest among Commission members, and gaps that allow its Chairman (also Governor of the BDL) to dominate decision making. Members of the HBC include, amongst others, the Governor of the BDL, a position currently held by Riad Salameh, and the Director General of Finance at the Ministry of Finance, the incumbent being Georges Maarawi. The entity therefore includes members with known political affiliations. Maarawi, for example, previously worked for Suleiman Frangieh, President of the Marada Movement, prior to his appointment as the Director General of Finance.
Having the Governor of the BDL as the HBC’s Chairman with overarching veto rights, creates a complex web of conflicting interests. Riad Salameh currently heads the three BDL oversight bodies: the Higher Banking Commission, the Special Investigation Commission, and the Capital Markets Authority (CMA). By placing the application of this law in the remit of the HBC, an entity chaired by the Governor of the BDL, the law perpetuates the systemic issue of double hatting, where chairs of boards also serve as an institution’s general manager (CEO). Double Hatting is prohibited by the Basel Committee on Banking Supervision not least because it minimises internal accountability procedures and was seen to have partly contributed to the GFC in 2008. By perpetuating this systemic issue, Draft Law 1 directly counters its self-professed objectives for “the protection and enhancement of public confidence”, “the protection and enhancement of the stability of the financial system”, and “maintaining the sustainability of public finances”. Such a complex web of compromised figures on the chief resolution authority of the Draft Law works directly against regulations put in place by the international financial community and compromises the independence of decision making in the HBC.
Rather than placing such authority in the hands of the HBC, a politically independent entity without conflicts of interest should be tasked with implementing the processes outlined in the Law at hand. This would ensure that the resolution process was not subject to undue influence from politically compromised implementers. Including independent experts would send a signal to the international community that Lebanon is serious about banking reforms. Such an oversight body would be required to report to parliamentary scrutiny. Whilst the Lebanese Parliament is far from perfect in the present clientelist context, this oversight body would ensure a more open and publicly accessible space than BDL’s committees, and individual MPs and committees would be able to scrutinise and/or address regulatory updates on the public record.
B. Bail in Objectives
Draft Law 1 should reference in its ‘Objectives’ that it aims to bring Lebanese banking sector in line with international regulations. These encompass the revised regulations of TLAC and Basel III regulations, developed by the Financial Stability Board (FSB) and Basel Committee on Banking Supervision (BCBS) which respectively promoted conditions for facilitating a “bail-in” following the 2008 Global Financial Crisis (GFC). Notably, the BDL did not sign up to the Basel III reforms and most other global regulatory developments following the GFC. In not doing so, BDL was able to maintain claims to prudent financial management despite a lack of regulation which in 2019 was shown to be a façade. By committing to these principles in the law at hand, it reiterates the commitment to avoid repeating the past.
C. The DRF
Draft Law 2 measures deposit inclusion in the DRF according to an eligibility criterion. It does not, however, include a highly necessary focus on investigating the legality of sources of wealth in influencing the allocation of “eligible” or “ineligible”. There consequently remains a risk that funds based in ill-gotten gains will be bailed out by the DRF.
Draft Law 2 should, therefore, require that the depositors themselves (specifically, those with deposits above $250,000) to apply to be included in the DRF. This application should be submitted to an independent body of legal specialists who can consider evidence (documentary paperwork) provided by depositors to prove the sources of these funds are ‘legal’. This investigation will be enforced under the terms of the 2022 amended Banking Secrecy Act (of 1956). If any deposits are found to be based in profits from illegal, smuggled, or stolen sources of wealth, they must not be covered in the DRF.
The Council of Ministers (upon the proposal of the Ministry of Finance) is allocated the legal authority to establish and determine the makeup of the governing body of the DRF. There remains a cryptic lack of information regarding this body, only that it will “include specialists to manage the assets of the Fund”. The Financial Recovery Plan explicitly states that the DRF will be run by an independent private sector entity, yet this has not been codified in the draft laws. This lack of specificity, and that, most crucially, such an entity is ring fenced from outside interests provides greater leeway for political influence in the makeup of the Fund. In its place, a joint international board should be established to ensure the highest level of transparency and independence. There must be a rigorous list of criteria to be met in order to be in such a body including extensive specialist knowledge, no connections to any Lebanese political parties or interests, and no ties to any of the banks, their management, or employees, currently under investigation.
D. Relationship between the DRF and bail-in
The Draft Laws do not explain the relationship between a bail-in and the DRF in relation to deposit recovery. Specifically, that the deposit recovery is the sum of bail-in shares, a bank’s future profits and/or dividends, and clawback. The Draft Law should explain the proportion of each. Namely that the first to foot the bill in the bail-in (according to TLAC) are the bank shareholders, although these stakes will likely be insufficient to absorb all losses.[1] Given the lack of sufficient subordinated debt in the system, the second tier of loss responsibility will comprise a balancing act between BDL and large depositors. BDL’s mopping up of the on-paper losses will have to be significant enough so that a haircut on large depositors alone will suffice to cover the remainder of losses. Large depositors’ contribution to covering the losses will come by converting a part of their deposits into preferential shares in restructured banks. At the same time, this share conversion will form the primary component of their compensation, as they will receive preferential dividend payments once the banks start making profits. Secondary forms of compensation – primarily clawbacks – should be pursued through legal processes (see below).
E. Clarify ambiguous language
The use of ambiguous language leaves space for haphazard implementation and confused, possibly conflicting, interpretations of the clauses of Draft Law 1. The draft therefore requires greater precision in its wording to ensure that this is avoided, and clear elaboration on information introduced in the law.
The use of such funds in the recapitalisation of the BDL must then be ratified by the wider Lebanese Parliament so as not to leave the matter up to the executive.
A recapitalization plan is outlined in Saade Chami’s Financial Recovery Plan. The plan stipulates that the government of Lebanon will issue perpetual bonds to BDL valued at 2.5 billion USD, however there is no mention of this detail in the draft laws. Raising 2.5 billion USD through sovereign debt issuance for the purpose of recapitalization would risk further loss in confidence of Lebanese public debt and presents a fiscal policy of kicking the debt can further down the road.
Lirafication, the conversion of dollar deposits in banks undergoing liquidation into Lebanese pounds, is a core tenet of both the draft laws at hand. Article VII of Draft Law 2 details that $100,000 of specific “eligible deposits” (those equal to or exceeding $100,000) will be converted to Lebanese Pounds based on the Sayrafa exchange rate “that will become the market rate upon unification of exchange rates”.
The process of Lirafication, imposed without the consent of the depositors themselves, would significantly devalue the deposits in question. Salameh, Governor of BDL, recently announced that BDL will adopt an exchange rate closer to Lebanese Pound’s real market value (approximately 15,000 LBP to $1). Given Salameh also acts as the Chairman of the HBC it is likely that the exchange rate for Lirafication will correspond to that established by his recent announcement. This exchange rate remains markedly lower that the real market value of the Lebanese Pound (hovering at around 40,000 LBP to $1 as of 29/11/22). Furthermore, the promise that the Sayrafa rate will become the market rate upon a “unification of exchange rates” appears to be wishful thinking in light of the current gridlock over unification of the multiple exchange rates.
Finally, the level at which deposits are protected, or the equivalent of $100,000, is too low to fall in line with international standards and the ongoing bailout of the banks by depositors. Effectively, setting the level at $100,000 absolves the banks of much of their liability for the crisis. That is because the $100,000 level lowers the chances of both ordinary Lebanese to recover financial after three years, especially in relation to the ability of ordinary citizens to start/(re)start business operations. Instead, the $100,000 protection level should be raised to $250,000 as the level corresponds to the standard deposit insurance per depositor set by the Federal Deposits Insurance Corporation in the United States.
F. Conversion of liabilities of equities
The conversion of liabilities to equity is mentioned only once in the law at hand. The Draft Law needs to be clearer on which liabilities are in scope for bail-in given subordinated debt, or debt that ranks below other debt with respect to claims, is almost non-existent in the current banking system.
G. Recapitalization
The draft outlines that recapitalisation will occur with $2.5 billion through means to be decided upon by the Council of Ministers. The law must elaborate where these funds will come from. The use of such funds in the recapitalisation of the BDL must then be ratified by the wider Lebanese Parliament so as not to leave the matter up to the executive.
A recapitalization plan is outlined in Saade Chami’s Financial Recovery Plan. The plan stipulates that the government of Lebanon will issue perpetual bonds to BDL valued at 2.5 billion USD, however there is no mention of this detail in the draft laws. Raising 2.5 billion USD through sovereign debt issuance for the purpose of recapitalization would risk further loss in confidence of Lebanese public debt and presents a fiscal policy of kicking the debt can further down the road.
H. Lirafication and Protection Ceiling
Lirafication, the conversion of dollar deposits in banks undergoing liquidation into Lebanese pounds, is a core tenet of both the draft laws at hand. Most notable is the authority allocated to the HBC to convert both ”eligible” and “ineligible” deposits in foreign currencies currently in “viable banks” (those deemed eligible for resolution as opposed to liquidation) into Lebanese Pounds. Article VII of Draft Law 2 details that $100,000 of specific “eligible deposits” (those equal to or exceeding $100,000) will be converted to Lebanese Pounds based on the Sayrafa exchange rate “that will become the market rate upon unification of exchange rates”.
The process of Lirafication, imposed without the consent of the depositors themselves, would significantly devalue the deposits in question. Salameh, Governor of BDL, recently announced that BDL will adopt an exchange rate closer to Lebanese Pound’s real market value (approximately 15,000 LBP to $1). Given Salameh also acts as the Chairman of the HBC it is likely that the exchange rate for Lirafication will correspond to that established by his recent announcement. This exchange rate remains markedly lower that the real market value of the Lebanese Pound (hovering at around 40,000 LBP to $1 as of 29/11/22). Furthermore, the promise that the Sayrafa rate will become the market rate upon a “unification of exchange rates” appears to be wishful thinking in light of the current gridlock over unification of the multiple exchange rates.
Finally, the level at which deposits are protected, or the equivalent of $100,000, is too low to fall in line with international standards and the ongoing bailout of the banks by depositors. Effectively, setting the level at $100,000 absolves the banks of much of their liability for the crisis. That is because the $100,000 level lowers the chances of both ordinary Lebanese to recover financial after three years, especially in relation to the ability of ordinary citizens to start/(re)start business operations. Instead, the $100,000 protection level should be raised to $250,000 as the level corresponds to the standard deposit insurance per depositor set by the Federal Deposits Insurance Corporation in the United States.
I. Clawback, Bankruptcy, and Asset Recovery
Draft 1 only once mentions clawback, the recovery (under certain circumstances) of renumeration already paid to a bank employee, in reference to the process of variable renumeration from “persons in high managerial positions.” Whilst Draft Law 2, describes in greater a process for clawback, neither of these draft laws describes the procedures for an implementation of clawback in enough detail. The Draft Law at hand should push for an Independent Clawback Body (ICB) outside the HBC where clawback in the Lebanese context is implemented. Clawback must be implemented in line with the bail-in framework established by TLAC and clawback provisions of the Basel Commission on Banking Supervision (BCBS) rules. Furthermore, clawback provisions should extend beyond variable remuneration, (including, for example, non-salary payments such as bonuses) in the case of blatant wrongdoing. Indeed, if the triggering of clawback provisions is limited only to blatant wrongdoing as outlined by the Draft Law, variable compensation (such as bonuses) will almost certainly not be enough to fully compensate depositors or other parties, such as preferred shared owners, who will be also wiped out.
Clawback provisions should, therefore, extend to all assets of the executives in question and include, at a minimum, funds which were siphoned outside the country before the capital controls were introduced and deposits of the executives in the bank itself. If not, there remains a risk that such managers will return as shareholders under the bail-in.
More broadly, clawback provisions, in line with BCBS rules, must be more effectively woven into the underlying fabric of the Lebanese banking sector. The draft law at hand details immediate clawback provisions in the present attempt to resolve the banking crisis. It also provides an invaluable opportunity to establish long-term frameworks for clawback with the aim to diversify the Lebanese banking sector’s liability structure.
Legislatively enshrining a mandatory requirement that all Lebanese banking institutions and the BDL include internationally established clawback provisions in their management and oversight structure would ensure that bank leaders avoided reckless or illegal behaviour or otherwise face severe financial penalties. Equally, effective use of clawback would offer an additional stream of capital to meet a bank’s losses upon possible failure in the future. Leaving clawback provisions to voluntary implementation would prove risky, particularly given the context of Lebanon’s financial collapse, whilst research shows that very few among the S&P 500 firms have voluntarily adopted clawback policy when not required to do so by law.[2]
Clawback will need to be applied retroactively against decision makers who set up financial engineering, bank management figures that facilitated participation in financial engineering, and bankers who broke the law in applying capital controls.
the banking sector have claimed that there are insufficient resources to accommodate for a higher deposit protection. However, these claims are unfounded given the enormous profits banks and their management have made pre-crisis.
Dubiously, both Draft 1 and Draft 2 of the present laws do not mention the need for banks to declare official bankruptcy before resolution or liquidation takes place. This obvious omission is most likely rooted in the fact that the bankruptcy law, or Law 2/67, which already outlines a process of resolution for bankrupt banks. Under this law, managers of the banks become personally liable to the extent of their personal assets, which would include foreign assets. As such, the position of MPs should be that: (1) the laws in question do not supersede the Law 2/67, (2) that the process of Law 2/67 becomes integral to the resolution process, and (3) clawback provisions encompass asset recover operations and international cooperation to liquidate and return funds to Lebanon’s banking sector.
J. Time frame for legislative applicability
The Draft Laws should include a requirement for the laws not to solely renew after five years, but to undergo a required “review” after five years. This would involve a special committee of elected representatives and relevant specialists to reconsider the relevance, implementation, and progress of the processes and bodies initiated in the Draft Law.
References:
Lebanese Banking Secrecy Law of 1956
Accessible at: https://drive.google.com/file/d/1i_E9vf2WT_gDl7-1GTrWr3S7Hmd-Ijlx/view?usp=sharing
Banking Secrecy Law Amendments of 2022
Accessible at: https://drive.google.com/file/d/1h2nInY8LEzM-F5idL-B7sErEz4JUnvSy/view?usp=sharing
Law 28/67 of 09/05/2021
Accessible at: https://docs.google.com/document/d/1cnOOvpj42gycOSMjzf1wxM9OnEDbI188ACWqjUcqZ30/edit?usp=sharing
Lebanese Code of Money and Credit of 1963
Accessible at: https://drive.google.com/file/d/106HSpJqAP22zSdyCXUdX2q3M0M4tExIf/view?usp=sharing
- Article 208 was amended with Law 28/67 of May 9, 1967.
Accessible at: https://drive.google.com/file/d/1FvIfoAVS5LGwrSEsJozRcx6g-41RIF9X/view?usp=sharing
- Article 209 was deleted in 1970 and replaced by the following text: ‘The penalties provided for in the previous article are decided by the supreme banking commission established under Article 10 of Law No. 28/67 of May 9, 1967. The decisions of this body do not accept any method of ordinary or extraordinary administrative or judicial review. The committee’s decisions are not subject to appeal.’
Law No. 214 of 08/04/2021
Accessible at: https://drive.google.com/file/d/1uBB9RKHbxKp5E2yRHmSFVHsF86-CWu5e/view?usp=sharing
Law No. 110 of 7/11/1991
Accessible at: https://drive.google.com/file/d/1ZNxX4LXszBEdebl9PpDVrSwl_NcxrmGW/view?usp=sharing
Law No. 2/67 of 1/17/1967
Accessible at: law-2-67 (1).pdf
Appendix 1: Equity and Creditor Hierarchy in Resolution
As outlined in Appendix 1 of The Draft Law Governing the Resolution of Banks in Lebanon
| Component
|
Rank in terms of Loss Absorption | |
| 1. Equity in all currencies | ||
| Retained earnings, reserves and other comprehensive income as per the International Financial Reporting Standards | 1 | |
| Common shares and other capital instruments included in Common Equity Tier 1 Capital. | 2 | |
| Cash contribution included in Common Equity Tier 1 Capital. | 2 | |
| Cash contributions included in additional Tier 1 Capital | 3 | |
| Preferred Shares and other capital instruments included in Additional Tier 1 Capital | 3 | |
| Preferred shares and other capital instruments included in Tier 2 Capital. | 4 | |
| Subordinated Debts included in Tier 2 Capital | 4 | |
| 2. Liabilities in Foreign Currencies | ||
| Subordinated Debts (not eligible as part of Equity) | 5 | |
|
Unsecured Claims other than Customers Deposits |
Bonds issued by the bank and held by individuals and financial and non-financial sector entities | 6 |
| Related and unrelated financial sector entities claims | 6 | |
| On balance sheet deposits of financial sector entities originating from fiduciary contracts between such entities acting as financial intermediary and their client | 6 | |
| Customers’ Deposits | 7 | |
Appendix 2: Equity and Creditor Hierarchy in Liquidation
As outlined in Appendix 3 of The Draft Law Governing the Resolution of Banks in Lebanon
| Component
|
Rank in terms of Reimbursement | |
| 1. Liabilities in all currencies | ||
| Liquidator/Liquidation Committee fees | 1 | |
| Tax Payable | 1 | |
| Payable Amounts to the Bank Employees | 1 | |
| National Social Security Deposits and National Institute for the Guarantee of Deposits | 2 | |
| Customers’ Deposits (including exempted liabilities in resolution) | 2 | |
|
Unsecured Claims other than Customers Deposits (including exempted liabilities in resolution) |
Bonds issued by the bank and held by individuals and financial and non-financial sector entities | 2 |
| Related and unrelated financial sector entities claims | 3 | |
| On balance sheet deposits of financial sector entities originating from fiduciary contracts between such entities actings as financial intermediary and their client | 3 | |
| Subordinated debts | 4 | |
| 2. Equity | ||
| Subordinated Debts included in Tier 2 Capital | 5 | |
| Preferred shares and other capital instruments included in Tier 2 Capital | 5 | |
| Preferred shares and other capital instruments included in Tier 1 Capital | 6 | |
| Cash Contributions included in Additional Tier 1 Capital | 6 | |
| Cash Contributions included in Common equity Tier 1 Capital | 7 | |
| Common shares and other capital instruments included in common equity tier 1 capital | 7 | |
[1] It is to be noted that within Lebanon’s banks there are clear differences between banks’ major shareholders many of whom are politically exposed, and “preferred shareholders”. The latter would normally be considered as part of the liability structure of a bank, however, in Lebanon many of these parties are depositors who were duped into converting their deposits and savings into preferred shares. Under a bail-in, these parties would have to incur a loss. It is, however, highly likely that banks broke the law in convincing depositors into agreeing to these conversions (see Azar G, 2021). As such, compensation mechanisms should be detailed to allow those parties to recoup some of their losses.
[2] J.M. Fried, N. Shilon ‘Excess-Pay Clawbacks’ Journal of Corporation Law 36 (2011), pp. 722-751.
