The Lebanese government recently ratified the financial sector recovery strategy whereby it pointed out that the recovery of the financial sector forms a cornerstone towards achieving a set of reforms that will aid in restoring confidence and stimulating economic recovery. The strategy considered that the financial sector needs recapitalization and restructuring that will lead to a downsizing of the sector. The strategy commented that the financial sector’s losses, estimated at $70 billion, emanate from its large exposure to financial engineering schemes structured by BDL in order to steady the level of an overpriced exchange rate and in order to finance the budget deficit. In this regard, the government’s plan assumed a conservative approach to estimate losses on the banking sector’s loan portfolio given the lack of available information at present, stating that said portfolio will be assessed at a later stage by the Banking Control Commission with the help of renowned international companies. The strategy document discussed during the government’s meeting last week revolves around three main pillars: untangling the interlinkage between the balance sheet of commercial banks, balance sheet of BDL and sovereign debt, the recapitalization of BDL & the improvement of its financial reporting process in order to restore confidence, and the recapitalization and restructuring of commercial banks via the attraction of new capital after absorbing existing losses. On the other hand, the strategy’s principles focus on transparency, respecting the priority of claims when allocating losses and the protection of small depositors to the maximum extent possible. As for the implementation of the strategy, the preliminary phase will involve the elimination of the multiple exchange rate phenomena whereby there will be only one official exchange rate published on the “Sayrafa” platform, preparing a set of assumptions concerning Eurobond restructuring and the amendment of the banking secrecy law. As a first step, the strategy revolves around the recapitalization of BDL, whereby estimates point out to an accumulated negative capital of $60 billion. In this regard, there is an ongoing special audit on BDL’s balance sheet that will be split across two phases, the first phase of which involves auditing the foreign currency reserves (projected to be completed by end of May), while phase two, the overall audit, is estimated to end by June. Then, and according to the results of said audit, a big chunk of BDL’s foreign currency liabilities to banks will be eliminated in order to reduce the negative equity and negative foreign exchange positions at BDL. The first step also involves a partial recapitalization of BDL via $2.5 billion of sovereign bonds, with a potential to increase this amount if circumstances permit, while the remaining capital losses will be extinguished over five years. The second step centers on the recapitalization of banks through a partial bail-in from large depositors. In details, the strategy document stated that a loss evaluation assessment will be conducted by the Banking Control Committee (BCC) on each of the largest 14 banks (representing 83% of total assets), with the exercise expected to be completed by September 2022. This will be followed by an internal recapitalization of banks, whereby part of foreign currency deposits will be either converted into equity or into LBP at rates not similar to the then prevailing official exchange rate. The document also highlighted that the BCC will then from banks to secure fresh capital injections from existing/new shareholders in such a manner that secures a minimum level of capital adequacy. The government’s plan calls for reimbursing the remaining deposits (whether in LBP or USD) after the bail-in to depositors and this within the limits allowed by the capital control law. The final step suggested by the plan revolves around conducting an enhancement to the banking sector’s overall regulatory framework by revising main banking sector regulations, decision-making frameworks and deposit guarantees.