Lebanon’s Central Bank under IMF pressure

Source: Nidaa al Watan

The dispute between Lebanon and the International Monetary Fund (IMF) has recently moved to the forefront, dominating discussions both in social circles and in the country’s decision-making centers. The disagreements cover multiple points; all related to reaching consensus on a rescue plan to address the economic collapse that has afflicted Lebanon since the end of 2019.

The IMF claims that its insistence on liquidating bank capital and assets, even if this leads to severe losses for depositors, who will only recover their funds if the banking sector remains viable, is aimed at applying internationally recognized standards in crisis management.

However, despite acknowledging that the central bank faces a financial gap, the Fund negotiates with the Lebanese government using standards for banking crises rather than the internationally established guidelines for addressing central bank losses. When asked why international central bank standards were not being applied in Lebanon as usual, a Lebanese official involved in the talks gave a vague and unconvincing answer, raising questions about the true objectives behind this approach.

To clarify the matter, monitoring authorities reviewed IMF-recommended international standards for handling central bank losses. They found a 2005 working paper published by the Fund’s Monetary and Financial Systems and Statistics Departments, which contains detailed recommendations and approved guidelines.

The paper notes that, under normal circumstances, a central bank is expected to operate profitably and generate basic income from currency issuance. Yet, many central banks around the world have suffered losses from a range of activities, including open market operations, restrictions on foreign currency flows, domestic and foreign investments, credit and guarantees, financial sector restructuring costs, direct or indirect interest rate support, and non-core financial or quasi-financial activities.

Failing to address ongoing losses, or allowing resulting negative net worth, can have adverse effects on monetary management and may threaten the independence and credibility of the central bank.

State responsibility in recapitalization

Transparency and accounting standards require that net losses be recorded in the income statement and deducted from capital. Net losses should not appear as assets on the balance sheet unless officially covered by the government.

When central bank losses lead to negative net worth, the IMF recommends that the government recapitalize the bank by injecting cash or government securities through transparent budget allocations.

Causes of Central Bank losses

Historical central bank losses in Africa, Europe, Latin America, and the Asia-Pacific region during the 1980s and 1990s reflect multiple factors, including operational and valuation losses as well as financial support. In many cases, central banks incurred losses from activities far beyond their traditional functions. Specific causes included converting government or private debt at inflated exchange rates, acquiring distressed assets through development banks or failing financial institutions, depreciation of the local currency when foreign liabilities exceeded foreign assets, losses on domestic or foreign securities, improperly priced emergency obligations such as foreign exchange guarantees, interest rate support for favoured borrowers, financial support for exporters, foreign exchange risks in re-lending borrowed funds, subsidized foreign exchange transactions, operational costs linked to open market operations, uncontrolled administrative spending, and transfers by the central bank.

In many cases, these accumulated losses became extremely large before being addressed and represented a significant share of national GDP.

Lessons and recommendations

Key lessons from these experiences indicate that central banks should not be burdened with responsibilities beyond monetary policy and exchange rate management. Governments must take responsibility for quasi-financial losses, accumulated losses must be resolved, and measures should be taken to reduce or eliminate the risk of future losses. Addressing these losses typically requires measures to tackle their underlying causes and to refinance the central bank, often by formalizing its claims on the government and converting these claims into appropriately yielding debt instruments.

Central banks in many countries have extended credit beyond their normal short-term secured facilities, including support during crises, explicit or implicit deposit guarantee plans, and bank restructuring arrangements. Extended credit to entities outside the usual financial institutions exposes central banks to broader commercial risks, including default risk or insufficient collateral. In such cases, central banks must carefully evaluate the quality of claims and set adequate provisions to cover potential loan losses, as any commercial institution would.

Costs related to bank restructuring can also contribute to central bank losses, including loan write-offs, lost interest, acquisition of low-yield assets, transferring failed banks to the central bank, purchasing long-term low-interest government bonds, and additional operational expenses associated with implementing or managing a restructuring plan. Guarantees provided to weak banks have similar effects.

Loss recognition

It is essential that losses be reflected in financial accounts as soon as they are discovered, a principle that applies equally to central banks and other institutions. Accounting standards require recognizing all operational losses or reductions in asset values below their historical cost in the income statement. According to international financial reporting standards, losses cannot be recognized or accumulated as assets on the balance sheet if they do not meet the criteria for asset recognition. Once a loss is recorded in the income statement, it must be deducted from capital and reserves.

In practice, for central banks, losses may be deducted from capital and reserves or covered by government expenditures or securities issued to the central bank. A central bank asset can only be recognized if the government formally acknowledges covering the losses, effectively recapitalizing the bank, or if the central bank law mandates the automatic issuance of such securities. When losses result in negative net worth, IMF guidance recommends covering them with government securities issued at market interest rates.

It is clear that international standards recommended by the IMF for addressing central bank losses differ significantly from the approach applied in Lebanon. In this case, the Fund appears primarily focused on avoiding any financial burden on the state, even if this comes at the expense of depositors, the banking sector, and the national economy as a whole.