Financial Recovery in Lebanon: Power to the Rich or a Pathway to Prosperity?

Balsam Gharib

15 December 2022

The banking sector in Lebanon has shifted from being perceived as the bastion of the country’s economy to becoming a prime culprit in the crumbling of the financial system. Ever since the protests erupted against the political establishment in 2019, local commercial banks have been consistently blamed for Lebanon’s economic collapse, and in many instances physically attacked, vandalised and damaged.

The country is currently enduring a “worse-than-wartime” economic crisis, manifested through high inflation rates, a huge devaluation of the Lebanese Lira and a deteriorating financial system. While many people, including politicians, attribute the financial collapse to the start of protests back in 2019, a look into the financial engineering operations of Lebanon’s Central Bank (BDL) following the end of the 15-year civil war (1990) can accentuate the root causes of the current economic collapse.

A Socially and Economically Bankrupt Model in Disguise (1990-present)

Historically, the banking industry in Lebanon has been commended for being robust, with a strict banking secrecy law adopted in 1956, high interest rates to attract foreign currency deposits and a laissez-faire economy which helped attract petrodollars from neighbouring Arab countries and Gulf states.

After passing through a detrimental civil war, Lebanon needed huge funding and a new economic model to cause an upturn in the economy and finance the “reconstruction period”. Commercial banks started lending the state money at unprecedented interest rates, allowing the public sector to thrive and, in parallel, the government’s debt to increase. The large returns and profits that banks were making from loans to the government via the Central Bank allowed them to deviate from investing in the private sector in a way that boosts economic development. At the time of writing, 75% of deposits are invested in the state, making commercial banks the biggest holders of Lebanon’s debt.

There was also a need to stabilise the Lebanese Lira after it reached its lowest rate in 1992 (LBP 2825 to the dollar). The newly reigning political-financial governors intervened to appreciate the Lira at very high costs, leading to a currency peg in 1997. While the newly instituted peg (1507.5 L.L against USD) encouraged capital inflow that helped to partially cover deficits and foreign debt, its overvaluation led to an increasing dependency on importation and decreased incentive to produce locally (a currency peg gives comparative trading advantages). The peg eroded Lebanon’s trade competitiveness, increased unemployment and created a rentier economy. In addition, sustaining the peg required permanent inflows of dollars which made the Central Bank set consistently high interest rates, leading to an ever-increasing dependency on remittances and an unsustainable debt increase.

Hence, the orchestrated socioeconomic model suffocated the productive sectors in Lebanon and encouraged importation that compensated neither for the deficits faced in the trade balance, nor for the current account deficit. In fact, the system was on the edge of bankruptcy in 1998, emphasising the need to unpeg the Lira, decrease loans for a state with accumulated debt, and initiate financial engineering schemes that would trigger real growth, such as lower interest rates for investment purposes. But what happened instead was a call for international assistance to help the economy remain operational. Economics Professor Atif A. Kubrusi described the financial schemes of 1999 as having an “unjustified bias towards monetarism, a debt bias, and a bias in favour of regressive taxation and therefore in favour of the rich and against the poor.” This is to say that despite the unsustainable monetary and fiscal policies mentioned above, the developed model continued to enjoy major political backing, which some experts claim to be a result of the close relations between the political and financial businessmen who have a grip over the state’s resources.

The Illusion of Growth

The scheme that kept Lebanon’s economy going and, in a sense, gave a boost to the disastrous policies and the corrupt system of power-sharing, was foreign assistance. The Paris I, Paris II and Paris III donor conferences in 2001, 2002, and 2007 respectively have provided Lebanon with exogenous shocks that ultimately allowed the flow of foreign reserves leading to short-term growth and the economy’s sustenance.

This illusion of stability has incentivized investments, promoted the existing financial system and further encouraged Lebanon’s huge diaspora to deposit their money locally. In 2009, the banking sector received new deposits that were equivalent to 59 percent of the country’s GDP, giving the government a massive opportunity to upgrade the infrastructure, restructure its financial schemes and improve safety nets. However, the system continued to operate in the same pattern with little to no concern about investing in productive sectors and schemes for social protection that ensure a sustainable quality of life. The image of stability was purchased at the cost of deepening economic disparities, which in turn ignited a series of protests in 2015 and played a major role in the 2019 popular uprising. Those in power, however, failed to make any substantial commitment to reducing inequality and investing in quality of life; instead relied on GDP figures and on the confidence of people to defend the 1990s rentier economic model.

At the present time, the political-banking establishment has lost the trust of the public, as well as of foreign depositors and the international community. They capitalised on the semblance of economic success, while neglecting to undertake reforms that could have generated real capital, especially concerning the livelihoods of small depositors and the most vulnerable.

How can the Banking Sector Survive and the Most Vulnerable Be Saved?

Calls for redistributing the losses and restructuring the banking sector have been at the forefront of every economic recovery plan recommended for Lebanon's compounded crises. It is also one of the main prerequisites for unlocking the IMF deal that is currently being negotiated. The dilemma remains, however, in the choice of recovery strategies. Global best-practice principles endorse a strategy that starts by addressing the losses incurred and subsequently proceeds with the equitable distribution of losses through a framework that manages liabilities and induces real growth and prosperity. This includes protecting small depositors and safeguarding the rights of the most vulnerable through sufficient safety nets. In Lebanon however, almost three years into the crisis the central bank still denies the existence of major losses and the need to tap into an auditing of all banks internally. Some have even accused BDL’s governor of wanting to keep bankers mobilised by his side and is therefore preventing the auditing process. No economic recovery plan can be done on underestimated or unclear figures, such as those in the so-called “financial recovery plan” prepared by the Council of Ministers and proposed to parliament.

Bankers are currently suggesting a “bail-out” strategy in which public assets get privatised and transferred to the banking sector and all future government revenues are taken over to cover up financial losses. They also recommend freezing large deposits in the long term to limit “haircuts” (meaning reductions of an asset’s value), although in reality freezing deposits risks larger haircuts due to the continual scarcity of foreign reserves. The bail-out strategy implies that the poor ought to pay back the rich through direct taxation after the wealthy political/economic businessmen caused the crisis in the first place. Nevertheless, even if one turns a blind eye to how inequitable and unfair this strategy would be, the value of governmental assets and public real estate constitutes a fraction of Lebanon’s financial losses (greater than $72 billion) which is estimated to be three times the size of the national GDP for 2021. Therefore, the financial losses are too big to bail out, leaving us with the only equitable option which is the bail-in strategy.

According to the World Bank, redistribution ought to take place on the basis of a creditors’ hierarchy (starting with the shareholders of banks) as a mechanism for protecting the public from bearing the brunt of the ‘deliberate depression’. This is known as the bail-in strategy. The strategy should also be coupled with comprehensive reforms – such as unifying the exchange rates and instituting the capital control law – to be able to turn the page on Lebanon's flawed post-war rentier model.

A bail-in would mean that the banks’ shareholders and large creditors would have to recapitalize their institutions from their savings if they want to remain shareholders or prevent the merging (or closing) of their banks. Bail-in will require cancelling, writing down or converting liabilities into equity, and this seems to be – in reference to the World Bank’s report – the only viable option for regaining a solvent banking system that ensures the protection of small depositors. Now, in response to the neoliberal discourse of “why should the rich bear the brunt of the current crisis in Lebanon?”, it is worth noting that 50 % of deposits in Lebanon’s banking system were owned by 1% of depositors. This means that the 1% percent of depositors were offered the higher interest rates in LBP and USD, which benefitted them disproportionately, and contributed largely to the current financial losses. A bail-in strategy is not about asking wealthy depositors to bear the brunt of the crisis, but about instituting some accountability for the unsustainable economic model that has now pushed millions of people into poverty since 2019.

The reality is that banks need to be recapitalized and this time neither donor states nor international organisations will be coming to the rescue, unless those in power decide to implement structural socio-economic reforms. Nevertheless, with the dollar becoming scarcer by the day, the need for equitable-burden sharing ought to remain a priority to protect small depositors and middle-to-low income families that suffered the most from the orchestrated post-war economic model.

Balsam Gharib is a research assistant at the RELIEF Centre in Beirut with a specialisation in policy development. She holds a BA in Political Science/International Affairs along with a minor in Multimedia Journalism from the Lebanese American University (LAU). Her current research endeavours include studying the relationship between livelihood strategies, experiences of governance, and social and political identity in Lebanon.

Photo credit: Christelle Hayek on Unsplash