A  Reform Proposal To Exit Lebanon’s Financial Crisis

I. Over six years of inaction and hypothetical rescue plans

The crisis

Lebanon’s financial crisis that has permeated the economy since 2019 was caused by the accumulation of misguided and improper policies over two decades adopted by the government and the central bank (BDL). Both institutions should carry the burden of compensation and the cost of deposit recovery, distribution of responsibilities shouldn’t be a debatable issue, it is the state. These policies included primarily a fixed exchange rate, mounting fiscal deficits and debt, a poorly managed public enterprise sector, weak overall governance and political paralysis.

The crisis prompted a rapid depreciation of the currency, capital flight, triple digit inflation, substantial drop in GDP and real incomes with the poverty rate rising to over 70%.

 In spite of these discouraging indicators and the ongoing crisis, Lebanon continues to maintain a high level of reserves thanks to the sizable gold appreciation and blocked dollar cash reserves at the BDL (bank’s foreign exchange assets).

Response to the crisis

Political disarray and frequent government changes prevented Lebanon from undertaking a quick and appropriate response to the crisis until today.  Improper ad-hoc actions further derailed the economy.

These included multiple fixed exchange rates reduced recently to two rates (LBP 15000 for dollar deposits before October 2019and LBP 89500 for fresh dollar deposits after October 2019 and cash), debt default, blocked clients’ deposits at banks and banks’ deposits at BDL and discretionary capital controls.   Only limited unified deposit withdrawal has been permitted (less than $ 800 per month) benefiting primarily small depositors.

Rather than negotiating with creditors, the authorities took the one sided decision to stop honoring Lebanon’s  euro-bond debt service in early 2020,  for the first time in the history of Lebanon, which contributed to a further down grading of Lebanon’s risk  to a “default” level cutting off access to international financial markets. The government in collaboration with the BDL initiated a massive subsidy scheme to smooth the crisis impact but its implication were dramatic.

Public enterprises (PEs) mismanagement continued and through the crisis.  Urgently needed reforms were not addressed. Rapid currency depreciation and continued underpricing of PEs services led to a sharp decline in their revenues, resulting in accumulation of losses and deterioration of public finances.  

 II. The recovery plans proposed by successive governments (2020-2025) further derailed the economy and reinforced distrust.

The plans that were initiated since mid-2020 (by the governments of Prime Ministers Diab, Mikati, and Nawaf Salam), focused on deleting most of the deposits and writing off bank’s capital  (presumed losses) instead of reviving the economy and introducing proper reforms. They assumed the crisis as a bankruptcy rather than an insolvency/liquidity case. All plans claimed protection of small depositors as a pretext to delete deposits.

The plans rejected using any state assets ( in a bail out scheme) to recapitalize the BDL and banks and to compensate depositors claiming that state assets belong to all citizens and not only to depositors, a naïve argument.

In sum, the successive plans aimed at writing off most dollar deposits, and liquidating most of the banking sector.

The proposed plans ultimately undermined the foundations of the Lebanese financial system based on a free exchange rate, free capital movement, and a solid and viable banking system.

Furthermore, the plans violated a fundamental constitutional law that safeguards financial and private property (law 15) as well as the Money and credit code of the BDL.

The IMF considered that the crisis is a bankruptcy case whereby banks and citizens should carry most of the burden of the unfolding cost by deleting most deposits and capital of banks. The IMF position was clearly stated in its last Board of Directors Article IV report (item 17 of the June 2023 IMF article IV report):

The report noted that the proposed roadmap of the IMF team for the rehabilitation of Lebanon’s financial sector could include:

 writing off banks’ capital, subordinated debt instruments, and related-party deposits.

 Internal recapitalization through a reduction of the overall deposits by a combination of: (i) write-offs ;( ii) conversion into equity or long-term bonds in banks; and (iii) lirafication of deposits at non-market rates.

 Protection of small FX depositors up to a certain amount in viable banks that will undergo restructuring and recapitalization.

 Inject fresh capital from current and/or new shareholders for viable banks to recapitalize and restructure these banks under credible and time-bound plans for each bank.

 The exit of unviable banks (by liquidation or a merger with stronger banks).”

The banks’ problems is simply that the BDL (that was supposed to safeguard banks) has confiscated their reserves and excess reserves of their accounts at the BDL. Releasing these deposits will resolve the liquidity issue for almost all banks. The problem did not originate in banks but they fell victim to an “official Ponzi” scheme that current BDL authorities assume it  cannot be solved except at the expense of depositors.

III: An alternative Reform Plan

It is, therefore, imperative to devise an alternative plan that resolves the insolvency issue without depriving depositors of their legitimate financial savings. Furthermore, deleting deposits cannot be undertaken without the consent of a majority of depositors under a “collective action clause-CAC” requiring a single aggregated vote of consent of about 70 to 75%. A massive bail in is an aberration and departs from good practices as noted by some members of the IMF Executive Board.

The government and the IMF staff should urgently start a genuine constructive and sequential reform. A “wait and see” game, hoping that the public will eventually accept their writing off their deposits is not prudent and will eventually aggravate the crisis, and reinforce public mistrust.

The current crisis represents a government and BDL default schemes to banks and correspondingly to private depositors, and cannot (legally and ethically) be resolved unitarily by the state at the expense of depositors.

The Bank for International Settlements did not endorse in a financial crises deletion of a central bank losses, and pari-passu deposits of banks and  clients.  The BIS endorses the view that losses and negative equity do not directly inhibit  the ability of central banks to operate effectively (BIS bulletin 68 of February 7, 2023).

The solution is neither to delete nor to refund all deposits; to the contrary, creating trust and liquidity are the indispensable elements of resolving banking crises. Creating conditions to enable the government and the BDL to service their respective debt is the appropriate solution.

To achieve these goals, it is essential to implement the following:

1- Safeguard all individual and institutional (national and international) deposits in the banking system. Assure that deposits are protected and maintained as banks’ liabilities, with complete free access.  The State Executive Council , having a prime function of respecting the constitutions  by all, has reaffirmed that the unlawful deprivation of  financial and real property is a stark violation of the constitution. Protecting Property right is a fundamental foundation of Lebanon’s decomocracy.

The government and parliament should declare adherence to item 15 of the constitution safeguarding all individual and institutional financial and real assets. Assure that this law could not be violated or altered. Attempts to dilute deposits over decades is a flagrant violation of the constitution.

2. Adopt a free market determined exchange rate: Unify and free the exchange rate (including terminating the unlawful distinction between the old dollar rate of LBP 15000/US$ and the fresh dollar free rate (LBP/US$ 89500) for all official and private real and financial transactions.

Remove all restrictions on banks transactions in foreign exchange.  The BDL may intervene in the FX market as part of its stabilization monetary policy to avert unexpected market turbulence.

A free FX market creates trust in banks and allows depositors and banks to freely make transactions in their FX accounts in either LBP or dollars at the market rate. In a unified market determined rate, depositors and traders will be indifferent whether payments are made in Lebanese pounds or in dollars.

The virtual and digital role of money can be resumed with the use of checks, credit cards and other digital schemes- such as PayPal and e wallets. With all banks accessing the FX market, the market will become larger and more competitive and will eliminate the capacity of few traders to manipulate FX transactions.

A free rate  has an equilibrating impact on  the financial markets and the balance of payments by promoting production of  substitutes and exports of goods and services,  restores the real value of financial assets and liabilities, (including FX bank accounts values), promotes  saving and investment, attracts foreign investments, and promotes growth.

A FREE exchange rate system does not create inflation. Inflation is caused by inappropriate fiscal and monetary policies that result in injection of domestic currency liquidity beyond the absorptive capacity of the economy.

Given that the government and the BDL are hesitant to free the foreign exchange market a main cause of the crisis and an urgent demand by donors) in violation of the fundamentals that built the Lebanese economy, the parliament can propose a legislative law to free the exchange rate and free deposits.  The code of money and banking does not stipulate that the BDL is required to fix the exchange rate. The BDL may intervene by buying or selling gold and foreign exchange in collaboration with the Ministry of Finance in case it desires to stabilize the exchange rate at an adequate real effective rate.

3.  Free (Unblock) deposits in bank accounts:  By creating two tier accounts, current accounts and saving accounts will allow regaining trust and liquidity in the banking system: The current accounts can be withdrawn in dollars or liras at the free market rate. The weights of each account can determined by the combined liquidity of banks and BDL. Depositors can have cash or digital access to their deposits at the market rate.  The saving accounts’ deposits maturity can be staggered over a period of 1 to 4 years, and should be compensated with a rate of return that allows maintaining the real value of such monetary savings.  Multi-tier checkbooks can be issued to depositors in addition to their digital access.

Banks have to play an important role in advancing virtual and digital use of money in either currency, especially with debit cards, e wallets and checks.

Freeing deposits can generate its own inertia through the multiplier effect of the normal operations of banks’ intermediation role. When saving accounts become due, they can, as well, be withdrawn in dollars or Liras at the free market rate or used in digital transactions.

 All client liabilities at banks and bank liabilities at BDL should be revalued to compensate their real losses since the beginning of 2020, as banks and BDL froze interest payments on these deposits since the beginning of the financial crisis.

4. Create Liquidity in the banking system: Liquidity by the BDL in LBP or dollars can be provided to commercial banks client deposits in either currency at the free market rate of exchange. The BDL can reimburse depositors on a pro rata basis. The current practice of reimbursing depositors an absolute equal minimal amounts based on circulars 158 and 166 regardless of the level of their deposits is neither just nor effective. It is an attempt to delete the real value of deposits.

 More than 50% of BDL reserves can be released to depositors current accounts. This will create enough liquidity in the banking system to resume normal operations. Hoarding excess reserves by BDL did not prevent the crisis but projected concealed confidence.

Transactions using saving accounts are possible in banks and secondary markets at discounted rates.

Interest cost remuneration of saving deposits can be generated from BDL banking and seigniorage operations in providing liquidity to the economy. The government cost contribution can be assured from a targeted fiscal primary surplus.   

5. Achieving a Balanced budget: With revenues at par with expenditure, comprising in addition to current and capital spending, a sufficient allocation for rescheduled debt service cost (abudget with a primary surplus) is a key ingredient in generating stability in the FX market and reaching a sustainable balance of payments outlook. A balanced budget will eliminate fiscal injection of liquidity into the market preventing recurring depreciation of the Lira. The BDL can determine liquidity needs of the economy guided by its growth potential and inflation target. A balanced budget with a primary surplus sufficient to compensate rescheduled debt service cost, will allow the government to service its Eurobond debt, gradually recapitalize BDL, and reach a sustainable debt level.

Additional fiscal measures to improve fiscal performance should be considered including enhancing revenue collection, adopting an appropriate tax structure combined with an efficient spending programs.

6. Reschedule all sovereign liabilities: Reschedule all state debt financial liabilities in FX (Eurobonds) and LBP accounts for short, medium, and longer-term periods. Public debt can be rescheduled along the pre-crisis period designed to ease the initial strain the banking system may face when a free/ floating exchange rate is adopted. It is prudent to implement in a manner to quell a burst of speculation.  

Sovereign Public LBP debt mostly held by BDL and banks has diminished in dollar value by 98% due to the exchange rate depreciation, and now constitutes a marginal debt burden.

Euro bond debt held mostly by International financial institutions could be rescheduled through a London Club type arrangement consistent with a debt sustainability target. In rescheduling Euro bond debt consideration could be taken to the fact that a significant amount was acquired at a discounted rate in the secondary market.

7.  Reform of commercial banks should be undertaken in a sequential and efficient manner:   Banks’ troubles stem from the default of both the BDL and the government in servicing their debt obligations to banks.  Their non-performing assets can be resolved as part of rescheduling BDL liabilities and bank deposits as noted. Banks’ reform can be supervised by an independent ad hoc agency in collaboration with the Association of Banks of Lebanon.

Exchange rate reform should precede any resolution or liquidation of banks. Commercial banks NET losses from their lending operations with the private sector should take into account banks’ collateralized assets. Their actual losses stem mostly from currency mismatches and BDL deleveraging policy (repayment of foreign currency credit at an artificially low exchange rate).

 8. Liquidation of banks: Any bank resolution attempt should be dealt with through the proper legal channels (liquidation law 110) and not through ad-hoc discretionary decisions and laws. The bank resolution law should be applied following the implementation of the financial reform plan. Most banks’ financial stress can be resolved when their deposits at BDL are freed.

The current draft resolution law under consideration in the parliament is an attempt to legalize liquidation of banks preceding reform. It should be draft along best international practices aiming at improving banks’ performance and the underlying prudential regulations, including providing protection to banks from both the BDL and the government “trespassing”.

 9.  BDL recapitalization and reform: BDL capital can be replenished gradually from government sources as Article 113 of the code of money and banking stipulates. BDL mandate should be aligned with best practices. Its reform should reduce its centralization of power, enhance its accountability and financial autonomy, grant independence to its supervision function and the banking control commission and enforce its prudential regulations (refer to IMF diagnostic report of BDL).

10. Corporatize state owned enterprises (SOEs): The public enterprise sector has been a major burden and drain on state finances with nearly most of the dollar debt burden has emerged from financing public sector enterprises’ financial gaps, prominently the power sector. The power sector alone received a transfer support of $50 billion over the past two decades (including interest cost estimated at $ 26 billion).

A practical solution envisaged could adopt the following strategy:

 First, improve the governance of the public enterprise sector through privatization of its management on a case- by- case basis starting with key enterprises: The mobile phone, the power sector, MEA, port and airport services, and the Casino Du Liban. The privatization of management should follow international procurement standards through open bids offered by domestic and international prequalified specialized agencies in each sector. The mandate (terms of reference) should focus on assuring the return of these enterprises to a state of profitability within a specified period of time (1 to 2 years).

Second, following this preliminary stage, conditions should allow for a full or partial corporatization of SOEs and can be listed at Beirut Stock Exchange. Limits will be set on individual holdings (not to exceed 0.5% of total equity) to adhere to competitiveness practices.

The repeated argument that SOEs are for all citizens and should not be disposed of is a void argument, as they have been a major cause of the crisis and impoverishment of a large segment of the population. Recovering SOEs profitability is expected to have a significant impact on growth, employment, and competitiveness of the economy that will benefit the whole economy.

Corporatization of SOEs will create an opportunity for depositors to invest in the equity of  privatized sectors, and reduce the liabilities of banks.

11. New currency and Compensation of real losses of National Social Security Fund (NSSF) and syndicate funds: Compensating government LBP treasury bills and deposits in LBP held by residents and non-residents is a very challenging task. It can enable the BDL to provide the necessary liquidity to banking system to allow the depositors to access fully their deposits at the market exchange rate, and help banks reestablish their financial intermediation role.

 Losses incurred from the massive depreciation of the Lebanese pound and can be compensated through the process of adopting a currency reform scheme involving the introduction of a new Lebanese pound. Such a reform can enable the BDL to provide the necessary liquidity to the banking system and to allow depositors to access fully their deposits at the market exchange rate, and helping banks reestablish their intermediation role. (Dr. Saleh Nsouli elaborated the process in a statement dated June 24, 2025)

12.   A “Pay -As-You Go” social security scheme

:  Introducing retirement and health compensation schemes on “pay-as –you-go” basis can be financed by a social security tax designed to provide a monthly pension and a capped health coverage.

IV. Concluding remarks.

Other longer-term structural measures covering the legal sector, the real and financial sector, and government institutions are needed to set the Lebanese economy on a solid economic recovery path. This document describes key broad measures that need to be addressed immediately to revive the financial sector.  Reform should not be delayed until a full plan is ready, or a program with the IMF is concluded. In all cases, reform takes a sequential path with prioritizing implementable measures at first, and work through time on demanding longer-term reforms.

Of utmost importance, the government should revise its reform strategy and negotiate effectively with the IMF, other donors, depositors and creditors a sound and viable program. Based on its current thinking, an agreement on an IMF program is almost an illusion. The IMF should also be very transparent with the public and clearly define the objective of its proposed policy of liquidating banks, writing off most deposits, protecting small depositors, and limiting recourse to public resources. Such policies do not provide a viable solution. To the contrary, trust and confidence in the system and government will vanish preventing economic recovery.

In the absence of a plausible reform plan along the above path that preserves the rights of depositors and creditors, eventually legal process may become the only course of action.