What is a Haircut and Why you took one as a Lebanese Resident or Depositor in its Banks

You probably are familiar with the concept of “Haircuts” already since it’s the word we are hearing most since the beginning of the collapse of the Lebanese economy back in 2019.

But in case you are not, here’s a quick explanation on what “Haircuts” are.

In the above picture, on the upper left part we see Lars. Lars was forced by his school to cut his hair, which he did. Lars is still happy because he knows his hair is going to grow back. However, Francoise (who plays the role of the banks in this example), the lovely lady next to Lars, is not as happy. Francoise took a haircut on her money, which unlike Lars’ hair is not going to grow back.

In the above example, we assume that Francoise has bought Greek Bonds worth €280 billion on which she receives an assumed 3% yield. By definition, a bond is a debt instrument meaning that in this example, the Greek government took a loan from Francoise, through the bank, and agreed to give her back the whole amount plus a premium of 3%.

But due to unfortunate reasons, the Greek Government declares that it cannot pay Francoise all her money back. Instead, she will get half of her money back, the sum of €140 billion which represents a 50% haircut. In this scenario, Francoise is not the only one affected, for the money the lady has invested on Greek bonds isn’t solely hers, it’s the money people deposited with her. So technically, all the fellow depositors took a 50% haircut on their money.

A more serious definition of haircuts proposed by the European Central Bank is the following: In financial markets, a haircut refers to a reduction applied to the value of an asset. It is expressed as a percentage. For example, if an asset — such as holdings of a particular government bond — is worth €1 million but is given a haircut of 20%, it means it is treated as though it has a value of €0.8 million.

Back to Lebanon, Eurobond holders are BDL, local banks and international investors. About two thirds of the Eurobonds are held by local banks and the BDL. So if we were to go back to our visual representation, local banks and the BDL are represented by Francoise and the depositors in local banks are represented by the investors who deposited with Francoise. Since the Lebanese Bonds took a haircut, BDL and local banks got affected mainly and subsequently Lebanese depositors suffered big losses.

A haircut is a double edge sword because it facilitates restructuring, however it cripples the banking system and the losses are felt locally. Further, with the devaluation of the lebanese lira even non-depositors took a haircut (and continue to take one) on the local currency they hold.

Long story short, Naiiman!

We took a haircut on our hard-earned money. Thanks thanks thanks dawle.

Ps: for a more technical and detailed definition of haircuts, you can check this video by Paddy Hirsch of which I took the snip and the example above.