Banque Du Liban's Financial Engineering: Background, Objectives, and Impact

Banque Du Liban’s
Financial Engineering:
Background, Objectives, and
Impact
Table of Contents
I. Background..............................................................................2
II. BDL’s Financial Engineering Mechanism ................................2
III. BDL’s Financial Engineering Objectives& Impact ...................3
IV. Conclusion..............................................................................4
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I. Background
The aftermath of the financial crisis is still bearing severe repercussions on

the global economic landscape; developed, emerging, and developing
economies alike. On the global level, the phenomenon of economic secular
stagnation has damaged the real economy, exhausted quantitative easing
leading to negative interest rates, and heightened uncertainties in the global
political economy. All of these factors have exacerbated economic slowdown
and socioeconomic inequities. Eventually, what once served as remedial
cash flow reserves from emerging markets in the period of the financial crisis
is now more or less paralyzed.
At the regional level, the political and security turmoil caused by various wars
and conflicts, the humanitarian refugee crisis, and the drop in oil prices have
led to severe macroeconomic and socioeconomic-developmental
drawbacks. This has been mostly evident in the deteriorating aggregate
demand and increasing deficits for many Arab countries, and in particular the
austerity measures of oil-producing countries.
At the local level, the past few years have strained the Lebanese economy
with political tensions, security challenges, and regional unrest, caused
particularly by the spillover risks from the Syrian crisis and its consequential
flow of over one million and a half refugees. The situation was also
exacerbated by the political paralysis which kept the country without a
president for more than two years. In effect, the main economic indicators,
namely foreign trade, tourism, investment, and consumption, have been
steadily decreasing since 2011. As a consequence, the debt-to-GDP ratio
has risen to around144 percent; fiscal deficit has reached 8 percent of GDP,
aggravated by the absence of a public budget for a decade now; GDP
growth has decreased from eight percent in 2010 to around 2 percent
currently; the deficit in the balance of payments has reached USD 3.3 billion
in the year 2015, mounting to USD 9 billion during the last four years; the
country rating and outlook by relevant international agencies have been
relatively unfavorable; the growth in bank deposits has been declining.
Despite all of these challenges, the Lebanese economy was able to achieve
real annual growth of around one percent in 2015 with inflation rate close to
0%. Much of this resilience is rooted in a history of monetary and financial
stability thanks to the prudent management by Banque du Liban (BDL). BDL
policies, mainly its stimulus packages since 2013, have played a central role
in fostering economic growth. Moreover, continuous increase in foreign
assets and persisting decrease in dollarization ratios have been proof of
confidence in the financial system and the Lebanese Pound.
II. BDL’s Financial Engineering Mechanism
Based on the aforementioned, and in light of the persisting global economic

stagnation and regional political-economic turmoil, BDL has resorted to
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additional financial engineering policies as part of its monetary policy
objectives.
The recent financial engineering mechanism was carried out on orders place
between May and August 2016 as follows:
First, BDL swapped Lebanese Pound (LBP) treasury bills (TBs) held in its
portfolio with equivalent Eurobonds issued by the Ministry of Finance,
amounting to USD 2 billion.
Second, BDL sold the recently acquired Eurobonds and issued USD
Certificates of Deposits (CDs) to commercial banks against fresh USD
inflows provided by banks.
Third, BDL discounted at 0% an amount equivalent to the previous

transaction (Eurobonds and USD CDs) of LBP denominated debt held by
commercial banks in their portfolio. This transaction was subject to voluntary
50% haircut on interest in favor of BDL.
III. BDL’s Financial Engineering Objectives& Impact
The objectives targeted by the financial engineering mechanism were

achieved. This is evident through highlighting the following facts:
First, strengthening BDL’s foreign currency assets from the standpoint that a
strong balance sheet is essential to maintain exchange rate and interest rate
stability, which is necessary to achieve sustainable economic development:
After the financial engineering, BDL foreign currency assets have reached a
historical record level of around USD 41 billion which confers stability to the
Lebanese Pound and to interest rates.
Second, beefing up the capital base of banks: BDL instructed banks to book
the proceeds from the financial mechanism in their Tier Two Capital, which
would enable them to constitute additional general reserves ahead of the
implementation of IFRS 9 in January 2018 (BDL is targeting a ratio of 2% of
general reserves to risk weighted assets). Moreover, banks would be able to
reach the BDL targeted capital adequacy ratio of 15% (end 2018), which is
above the international capitalization requirements (Basel III).
Third, increasing liquidity in local currency as a form of improving the status

of the Lebanese Pound and undertaking quantitative easing to secure the
financing needs of the public and private sectors at optimal costs: This year
and up to April 2016, deposits grew by 0.9%, compared with a growth of
2.5% after the financial engineering. On an annual basis, deposits grew by
5%, as compared to 2% annual growth before the financial engineering. With
this fresh liquidity in LBP, banks would be able to keep expanding their credit
portfolio, especially to SMEs, to back the economic activity, while complying
with the new international capital and risk requirements.
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Fourth, improving the government debt profile by reducing the cost of
borrowing: BDL’s financial engineering has led to a decrease in interest rates
for the 5–year TBs from 6.74% to 5%. BDL has also lowered the interest rate
on its long-term LBP denominated CDs and time deposits from 9% to
8.4%.Furthermore, and as a sign for improving the government debt profile,
it was noted that international financial institutions have encouraged their
customers (pension funds and asset managers) to invest in Lebanese
Eurobonds.
Fifth, improving the balance of payments status through setting the means
for increasing internal demand and productivity, hence bolstering growth and
development: The balance of payments became positive after the financial
engineering, turning a cumulative deficit of USD 1.7 billion in May 2016 into
a cumulative surplus of USD 555 million in September 2016.
Sixth, targeting positive inflation rate below 4%: Inflation rate has risen to 2%
in September 2016, which is in line with BDL’s objectives.
Seventh, improving the country’s rating and outlook: In September 2016 and
despite the political deadlock in the country, Standard & Poor’s revised
Lebanon’s outlook, from negative to stable.
IV. Conclusion
In conclusion, despite all downsides in the Lebanese scene, Lebanon is a

country that has the ability to fund internally both its public and private
sectors without resorting to any external funds or aid.
It is worth noting, this financial engineering was based on a win-win situation,

whereby it didn’t burden the Central Bank neither the Lebanese Government
with any costs. On the contrary, it enhanced both BDL’s balance sheet and
Lebanon’s credit profile.
Finally, amid these exceptionally harsh circumstances, the gains of this

financial engineering scheme were not limited to financial ones; it also
resulted in important social gains. The Lebanese society is the ultimate
winner: it will benefit from more financial inclusion, better economic
development, and a more stable social welfare.
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Banque Du Liban’s

The aftermath of the financial crisis is still bearing severe repercussions on

II. BDL’s Financial Engineering Mechanism

Based on the aforementioned, and in light of the persisting global economic

Third, BDL discounted at 0% an amount equivalent to the previous

III. BDL’s Financial Engineering Objectives& Impact

The objectives targeted by the financial engineering mechanism were

Third, increasing liquidity in local currency as a form of improving the status

In conclusion, despite all downsides in the Lebanese scene, Lebanon is a

It is worth noting, this financial engineering was based on a win-win situation,

Finally, amid these exceptionally harsh circumstances, the gains of this

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