On September 14, Sali Hafiz held up a branch of BLOM Bank with a toy gun in one hand, forcing $13,000 out of her sister’s bank account. The 28-year-old interior designer carried out this bank heist with one goal in mind: to retrieve funds for her sister’s life-saving cancer surgery. Sali’s heist has been hailed as a resistance act against decades-long economic violence orchestrated by the country’s political and banking elites. Since late 2019, and against the backdrop of a financial meltdown considered amongst the most severe since the 1850s, commercial banks, fearing insolvency, illegally imposed withdrawal limits on bank accounts, largely restricting residents’ access to their own foreign currency deposits.
The financial collapse has been deliberately left to simmer by government and financial authorities, pushing more than 80 percent of the population into multidimensional poverty. The Lebanese pound has lost more than 95 percent of its value today, at a time when the country is expected to record the second highest inflation rate in the world. Today, only around 3 percent of those employed earn in foreign currency—US dollars or otherwise—according to estimates by Lebanon’s Central Administration of Statistics released in January 2022. The average resident earning in Lebanese pounds would need at least nine times more money today to afford the same level of consumption they had prior to the economic collapse. Amid dearth in local policies, the picture could not get any grimmer. In this vein, the International Monetary Fund (IMF), the world’s financial firefighter, has been quickly portrayed as a lifeline, the one and only way to counter Lebanon’s descent into economic catastrophe. This article aims to bring to light the cracks in the recent IMF deal and discuss how it ballooned the illusion of conducting reform in Lebanon.
The cost of lost time and ambiguous conditionality
On April 7, 2022, right before parliamentary elections, Lebanon reached a staff-level agreement with the IMF that would potentially help reinvigorate the economy and set it on a sustainable path toward recovery. This long-awaited agreement will be supported by an Extended Fund Arrangement (EFF) that would unlock $3 billion for four years upon the implementation of key governance and economic reforms. Some of these reforms include: 1) a bank restructuring strategy that tackles the large losses in the financial sector, 2) the reform of the banking secrecy law, 3) the approval of the 2022 budget, and 4) the implementation of a formal capital controls law. Unsurprisingly, six months later, Lebanese authorities have not been able to meet any of the conditions and have engaged in a blame game against one another to justify the delay in enacting reforms. The IMF, following a recent staff visit to Lebanon, expressed worry over how these delays are “increasing the costs to the country and its population.”
The IMF, when conditioning for governance reforms, has relaxed foundational assumptions about the ways through which the Lebanese political system survived for decades. The shift toward a more transparent, accountable, and socially just regime—as requested by the IMF—requires crucial political reform which in practice entails replacing the current class of lawmakers. This can possibly take place via general elections, a step that will not materialize before 2026.
Second, the collusion between the country’s political elites and the banking sector is another binding constraint to structural reform and economic growth in Lebanon. It was through such a relationship that political and banking officials benefited from exploiting and splitting “public” spoils amongst themselves, their supporters, and cronies, at the expense of social welfare. Indeed, this system was in place at a time when the country’s various economic sectors from transportation, construction, and energy to education and healthcare were in noticeably frail conditions. According to numbers released in 2016, members of the political class have built a network for themselves with 18 of the country’s 20 largest banks, which indicates that both political factions and banking officials similarly benefit from the country’s system of governance. The more they colluded and the more public resources they co-opted, the higher were the payoffs.
The IMF agreement assumes that reforms will be enacted regardless of the position taken by monetary and banking authorities on the subject matter. For example, the Fund requested that officials conduct a deep restructuring of banks—which would be a direct acknowledgment of commercial banks’ own losses—as well as an audit of the central bank’s foreign assets. Under current circumstances, this reform, while crucial, is far from feasible. Lebanon’s central bank has dodged a full-fledged audit for more than two years now to avoid, as well as to shield, its political and business networks from any exposure to losses in the financial sector.
Central to the survival of the Lebanese political-financial system is illusory reform. For decades, the political class has promoted its intention to conduct necessary economic and social reforms to increase welfare and improve the livelihood of many. Such a strategy aided authorities in containing their own constituencies and entrenched networks, solidifying allegiance for years. As matters stand now, the current IMF deal might as well be perpetuating the illusion of reform in Lebanon, by prolonging the life of the country’s oligarchy and by default, extending the social and economic anguish of the population. The deal is marred with overgeneralizations and a significant degree of ambiguity, which has further capacitated authorities to externalize the country’s financial and economic losses.
A necessary reform of the banking secrecy law
To curb the endemic tax evasion, money laundering, and financial corruption, the IMF requested that the Lebanese parliament amends the country’s 60-year-old banking secrecy law.
Established in 1956, the law currently proscribes access to any banking information or any data pertaining to depositors. Article 2 of Law No. 1/1956 prohibits any and all banks in Lebanon from sharing information about depositors’ accounts, including their name or their financial statements, with anyone regardless if it is an ordinary/private resident or a government authority. This enabled wealthy individuals and investors to transfer assets and financial deposits to banks anonymously and in an unregulated manner. That said, the law has been historically criticized for enabling money laundering, financial corruption, and rent-seeking on the backs of the smallest and most vulnerable of depositors. Concretely, the law has positioned itself as a tenet of the Lebanese postwar economic model which has enabled wealth accumulation at the expense of social welfare and productive economic activity.
Banking secrecy made it possible for foreign capital to pile up in the banking sector for years, helped by a wide space for tax evasion and untraditionally high interest rates which averaged at around 7 percent in late 2019 alone. Consequently, the high volume of foreign currency—a property of depositors—that reached the banking sector was lent to the government to spend on unproductive activities such as debt servicing, public sector employee compensations, and an inadequate electricity sector. In comparison, there was less spending on social protection programming or tradable economic sectors such as agriculture and manufacturing.
Calls for repealing this outdated law have been consistently avoided by the political class, especially since the onset of the October 2019 protests.
The IMF’s condition to reform the banking secrecy law, instead of removing it altogether, lacks specificity and in fact prolongs authorities’ mismanagement of the banking crisis. Last July, lawmakers designed a law which again aimed to provide the country’s political and banking elites further amnesty. Particularly, the law had provided them with a continued opportunity to cover up financial losses that would indict many of them. The veil on banking information can be lifted by just a handful of public entities that are either unequipped or not reliable. This includes judicial bodies, the Special Investigation Commission (SIC), and the National Anti-Corruption Commission (NACC).
A quick look at their function is very telling starting with the SIC, Lebanon’s key financial intelligence unit chaired by central bank Governor Riad Salameh. Theoretically, the commission is entitled to conduct financial investigations, lift banking secrecy, as well as freeze suspicious accounts when needed. However, the role of the SIC was largely limited in practice. Between 2018 and 2020, it processed and approved only a third of local requests from “foreign or local sources” to lift banking secrecy as well as just a handful of tax evasion cases.
The NACC, formally established in February 2022, is another entity that can lift banking secrecy under the most recent draft law. However, the effectiveness of the commission in combating financial corruption is questionable. First, the commission’s funding sources are not entirely clear seeing as the government is in debt and struggling to make basic ends meet. Second, it is unclear how the NACC will retain its objectivity, especially since some of its members are recommended by political and banking elites such as the Banking Control Commission which is directly tied to the central bank.
More importantly, the absence of an independent judiciary that functions outside political pressures and sectarian rule might completely nullify the work of the NACC and other anti-corruption entities, in the context of banking secrecy.
Expectedly, shortly after the law was approved by parliament, the IMF declared it as insufficient. While the amendment of the 1956 law has been broadly characterized by the IMF as a positive development, it must be called what it really is: an illusory reform, as the law in practice shields the political and banking elites from prosecution and exempts their wealth from any direct cuts. Six months later, the law was brought back to parliament for further amendments that would make lifting banking secrecy more feasible and transparent. However, the parliament is currently working toward its second session for electing a new president, which could further delay the lawmaking process. This is not surprising given the country’s rich history of political vacuum and deadlock.
Undefined bank restructuring and administration of losses
Another IMF condition is for authorities to put forward a bank restructuring strategy that would shield smaller depositors from further financial losses and social vulnerability. But this condition itself is not specific and leaves a lot of room for policy maneuver in a manner that could harm most residents. The IMF condition does not specify how a potential bail-in would look like for the banking sector as a whole, and for small-to-medium depositors in particular. In an ideal scenario, bank shareholders and large creditors should be among the first to internalize losses. A bail-in would then ensure the survival of the banking sector, helped by both shareholders and creditors, all while ensuring the protection of smaller depositors. But the country’s opaque and unregulated banking sector might oppose such a restructuring which, in essence, will delay IMF funding. In the context of a banking crisis such as Lebanon’s, recapitalization and bail-ins are necessary—not doing so would be catastrophic.
The devil lies in Lebanese banks’ balance sheets, which are financial statements highlighting their revenues and liabilities. Those are highly dependent on both shareholders and depositors, and would almost immediately expose small depositors to the high losses in the banking sector. In other words, depositors will likely continue to see immediate discounting of their savings (often referred to as a “haircut”) due to liquidity shortages in the banking sector. Look no further than the night of October 2019, when the central bank imposed informal “haircuts” on small deposits. These cuts took place as politically connected and wealthy depositors managed to transfer billions of dollars around the time protests erupted and thereafter, marking the collapse of the country’s financial sector. Some estimates, such as those reported by the former Director General of Lebanon’s finance ministry, indicate that at least $5.5 billion were funneled out of the country. This implies that political and banking elites were well aware of the likelihood of a crisis of this magnitude, but have nonetheless prioritized capital flight over shielding the rest of society from impending collapse and economic loss.
Today, residents are forced to withdraw their discounted savings with a loss ranging between 70 and 80 percent. This is, in practice, the outcome of illegal financial practices in the presence of multiple exchange rates in the banking sector. In other words, this protects wealthy investors and bankers from financial loss, at a time when the majority of the society continues to absorb the crisis’ effects.
Long overdue capital controls law
Between late 2019 and 2022, foreign currency reserves, which are foreign capital held in the central bank with the aim of stabilizing the currency and supporting the country’s balance of payments, dropped from around $33 billion to less than $10 billion, amid flight of capital abroad. In response, the IMF, in its staff level agreement with Lebanon, requested that authorities pass a formal capital controls law that would limit the drainage of public finances.
In the last few months, several capital controls law drafts were studied by parliament, but no consensus was reached. This comes at a time when the World Bank released a report identifying how the country’ Ponzi finance schemes as well as their policy inaction has caused immense economic pain to people in Lebanon.
Last August, a draft capital controls law that aimed to formalize a writing off for all deposits made prior to October 2019 at discounted rates in Lebanese pounds was discussed. This draft would have allowed stark inequalities between depositors who can properly access their foreign currency deposits in banks and those who are cut off from them. By doing so, elites aimed to absolve themselves from legal and economic crimes as they try securing a “win-win” scenario for all. First, the law would protect banks from any prosecution or lawsuits in Lebanon and abroad as it would legalize foreign capital smuggling that took place in late 2019, spearheaded by banking and political elites. Second, it would further zombify the sector by preventing banks from properly funding economic activities and private sector investment, stunting development further. The Lebanese economy, which is now largely cash-based and import-dependent, cannot begin to realize its export potential, a necessary condition for recovery by way of increased liquidity or foreign investment.
It is worth noting that the much-needed capital control law remains in a limbo, with no draft passed yet. The IMF should be particularly critical of any potential capital control legislation for the simple reason that it might as well affect their very own transferred funds if a deal is passed. Through a sound capital control law, foreign currency inflows via an IMF package, or other forms of international aid schemes, can be regulated to ensure they are not made devoid of their purpose. Furthermore, formal capital controls will ensure that what remains in foreign assets largely located in the central bank are shielded and preserved to stop the hemorrhage of public funds . The broader aim of all of this is to freeze Balance of Payment deficits, i.e. when imports of goods and services are significantly higher than exports. This is also a necessary condition to stabilize the exchange rate. With increased foreign currency inflows, comes a stronger and more reliable financial market and a stable currency.
Finally, the most recent capital control draft law annuls a key IMF condition, namely the unification of the exchange rate. As mentioned earlier, the banking sector in Lebanon currently applies different exchange rates depending on when a deposit was made—prior to 2019 and afterwards. The bill formalizes the “Sayrafa” exchange platform, developed by the central bank to record all Lebanese pounds foreign exchange transactions. This foreign exchange platform has a daily rate that exceeds the official exchange rate of 1,500 LBP/USD, but below the parallel market rate of 38,000 LBP/USD. The continued presence of multiple exchange rates births an informal “crisis economy.” For example, one can withdraw foreign currency deposits at a below-parallel-market-rate (“Sayrafa”), and then buy Lebanese pounds at a higher parallel market rate, generating sizable profits throughout the process. Eventually, this increases pressures on the foreign exchange market, exacerbates the devaluation of the Lebanese pound, and triggers inflation.
What’s next?
The current IMF deal has inflated the illusion of conducting reform in Lebanon. It has offered the political and banking elites more time and wider opportunity to maneuver around proposed reforms to protect one another. But the larger society cannot afford lost time anymore.
The fact of the matter is that economic gains from any potential IMF funding will not be equitably distributed. It is very likely that funding, under current circumstances, will inflate wealth and power and further sideline groups that do not belong to traditional social structures.
What the IMF puts forth next is crucial for society at large. The Fund should provide more clarity on the criteria and indicators upon which it will release its funds during the upcoming three years. To do so, IMF staff should work closely with local civil society groups, local economists, and social workers to ensure its program and funds will drive accountable behavior and good governance to avoid recasting the spell of corruption once again.
As a way forward, the IMF should be crystal clear on who “small depositors” are and should ensure that banking losses are allocated in a manner that does not compromise their livelihood and welfare. It should also stress on the importance of a wealth tax, as opposed to regressive taxation as reflected in the most recent budget passed for the year 2022, alongside the complete annulling of banking secrecy in Lebanon. Furthermore, the IMF should be clear on the abolishment of multiple exchange rates and on the importance of setting a rate based on economic logics, that goes in line with a broader recovery plan.
If history is any guide, the IMF needs more tangible and society-tailored reforms when addressing developing countries in debt crises. A one-size-fits-all approach that does not take into account a successive integration of vulnerable economies into the global market will only further delay growth and push more people into poverty. Concurrently, the IMF should stray away from privatization policy, as this will only exacerbate inflation via price gouging by wealthy businesses and cartels, comparable to what we saw in Latin America.
The IMF deal should not be paving the way for austerity of harmful proportions. Cutting back on public expenditure, such as through laying off public sector employees will only increase poverty, inequality, and push society further into the trenches of vulnerability. Finally, the IMF should assign a technical monitoring and evaluation team with access to the central bank and government to ensure officials are in check and are not plotting to generate further rents.
Until the Fund takes on these responsibilities, any and all reforms put forth in Lebanon will remain illusory and band-aid, with immense social costs.
Hussein Cheaito is a Nonresident Fellow at TIMEP focusing on governance and economic development in Lebanon.