Restoring Lebanon's depositors' frozen funds needs an international court, not the IMF

Domestic efforts at reform will hit a brick wall, given the nature of Lebanon’s banking system and its cosy relations with regulators and politicians.

Al Majalla

Billions deposited by the Lebanese people haven’t disappeared but won’t be found simply by asking.

Restoring Lebanon's depositors' frozen funds needs an international court, not the IMF

Toufic Chanbour

last update on 29 Dec 2023

A draft law on the reform and reorganisation of banks, prepared by the Banking Control Commission (BCC) and the Bank of Lebanon, was recently unveiled in Lebanon.

It drew criticism from the banks, represented by the Association of Banks in Lebanon (ABL), which objected to much of its content. Those objections are worth analysis since they highlight the financial disaster that befell the country.

For a start, the ABL lays blame elsewhere. It is an issue with the draft law because it holds banks responsible for the systemic financial crisis. The ABL says this was, in fact, “caused by the erroneous policies of the State and the Bank of Lebanon (BoL)”.

The ABL says this is because the BoL “used banks’ dollar-denominated investments with them to stabilise the Lebanese pound’s exchange rate against the dollar and cover public expenses while defaulting on repayment of these investments”.

This, it said inaccurately, “prevented banks from returning deposits to their owners”. Not true. People know that banks are primarily responsible for the current crisis and its exacerbation by violating laws in collaboration with the BoL.

Indulging in adventures

Commercial banks’ main business, as specified in law, is the investment of deposits with the private sector to develop the economy. They deviated from this and invested more than 75% of deposits in bonds issued by the Treasury and the BoL.

Their activities were more akin to those of medium- and long-term credit banks. It contradicts the rules prohibiting a commercial bank from crediting (directly and indirectly) one entity with more than 30% of its funds.

It also violates several precautionary rules. These require banks to harmonise deposits and loan maturities and sustain high liquidity ratios in the event of it handling deposits in foreign currencies due to the lack of a “lender of last resort” that can secure liquidity in foreign currency when necessary.

Commercial banks are required to invest deposits with the private sector to develop the economy, but they invested more than 75% of deposits in bonds issued by the Treasury.

The International Monetary Fund (IMF) has cautioned against this, as did former ABL president Dr François Bassil, who warned in 2014 against banks financing a corrupt political class.

Indeed, the warning signs were manifest in other areas, including many years ago, when most branches of foreign banks left the Lebanese banking market, rather than indulge in the deadly adventures of its banks.

Many banks also participated in the financial engineering of the BoL. This was designed to attract banks' deposits, contrary to the legal provisions that prevent it (as a merchant entity) from borrowing when it loses capital.

As the crisis hit, banks illegally facilitated the transfer abroad of large sums of money owned by politicians and the elites

The economist Tawfiq Kasbar estimated the revenues from this financial wizardry topped $30bn, none of which appeared in banks' balance sheets.

Guillotining depositors' funds

At the request of the BoL, and without any objection, banks also made mandatory foreign currency investments in it, in exchange for lucrative interest. This is contrary to the law, which says mandatory reserves should be without any returns. These investments are currently worth about $8bn.

At the outbreak of the crisis, banks applied a discretionary "guillotine." They illegally facilitated the transfer abroad of large sums of money owned by politicians and influential people, which is punishable under the Penal Code.

The BoL governor explicitly referred to this discretion in one of his letters to the Minister of Finance months after the outbreak of the crisis in October 2019, but no action was taken to stop it.

The warning signs were there. Most branches of foreign banks left the Lebanese banking market years ago rather than indulge in its deadly adventures.

Deputy Parliament Speaker Elias Bou Saab, in a recent speech at the legislature, averred that "a large number of influential people in Lebanon are still sending their money abroad, including politicians, businessmen, officers, and judges".

No official figures put a value on these transfers, including credit transfers, but some studies point to at least $8bn.

On the other hand, many banks skewed a BoL circular whose legality is contested to begin with.

It required them to accept, under certain conditions, the payment of instalments from retail loans granted in foreign currencies for personal or residential purposes on the basis of LBP 1,500 per dollar (currently at about LBP 90,000 Lebanese pounds).

They illegally applied this circular to the repayment of commercial loans and loans due to politicians and people of influence. This resulted in a sharp $30bn decrease in the volume of loans to the private sector.

This sum is close to the gap in the BoL's accounts and exceeds 80% of the total deposits recorded in the banks' balance sheets.

A second ABL argument against the draft law is that "banks may not be subjected… to short periods to reconstitute their financial positions under the penalty of liquidation". It adds that "banks are trying to absorb losses they didn't cause and need to be helped, not punished".

This is not true. Basic Circular No. 154 required them to relaunch their activities and services to their customers as of mid-2020.

Passing the blame

The ABL also stressed that "it is not permissible to hold bank managements, key shareholders, authorised signatories, and control commissioners responsible for the crisis and seize their funds".

This statement is inconsistent with the calls of many officials that bankers who violated the law, or acted in a negligent manner, should be punished. They have stressed the importance of this in any banking reform process.

Christine Lagarde, the current president of the European Central Bank (ECB), stated during a Federal Reserve seminar in 2015 (when she was the IMF's managing director) that it is "necessary to hold bankers fully responsible, whether in terms of civil or penal responsibility, for their actions in the event of legal violations".

Lebanon's banks say they should not be punished, but in 2015, Christine Lagarde said banks should be held fully responsible for legal violations.

She added that they "should not be able to evade penalties by paying fines alone, as such a measure has proven to be of limited effect".

Daniel Tarullo, professor of law at Harvard Law School and a former member of the Federal Reserve, reiterated the importance of ethical conduct from banks' leaders.

"Proper banking regularity isn't only based on the need to meet traditional objective criteria such as capital, liquidity, solvency, and stress tests, and to ensure the separation among the activities of commercial, investment and other banking," he said.

"It also entails ensuring the presence of banking leaders who aren't blemished in their professional conduct in bank managements, and who, when they make violations, must be publicly banned from practicing banking and be prosecuted and imprisoned similar to other people."

This is what Iceland did, according to its former president, Olafur Ragnar Grímsson. He told delegates at Davos that his country's plan to overcome its financial crisis sought to punish the perpetrators and the negligent, confiscate their property and money (even if hidden in tax havens), and declare his country a "state of law".

The formula worked wonders and facilitated Iceland's quick return to the financial markets, where it soon regained the confidence of creditors. Eight years after its crisis, Iceland had the highest and fastest GDP growth (at 7.2%) in the world.

Meanwhile, and in contrast, as Lebanon's crisis enters its fifth year, there are no judicial investigations, no arrests, no confiscations, and no laws to pave the way out.

So, more pain seems likely to follow. Garbis Iradian, chief economist at the International Finance Corporation, estimates a negative forecast for Lebanon's 2023 GDP (at -7%).

Partners in crime

The ABL adds that responsibility for negligence "must extend to all those involved in decisions affecting the fate of banks". By this, it means political authorities (including deputies and ministers) and banking authorities (including the BoL and the BCC).

True, but to gain a complete picture, this responsibility needs to lie alongside that of bankers.

Laws were violated by all of the above, both individually and jointly, which led to the transfer of depositors' wealth to others, including politicians, elites, and bankers.

After Iceland's crisis, perpetrators were punished, and their assets were confiscated. In Lebanon, five years after its own crisis, there have been no investigations, no arrests, no confiscations, and no new laws.

As per the famous French proverb: nothing is lost or evaporated. Rather, it is transformed from one state to another.

As it is with depositors' money. This did not evaporate. It still exists, but in the pockets, accounts, and assets of those who benefited from the crisis and its exacerbation.

The recovery of these deposits does not require the adoption of draft laws described as reformative and agreed upon with the IMF (while, in fact, they are meant to cover up the abuses and the historic theft).

The first move should be to introduce amendments to the Banking Secrecy Law. This was originally designed to protect deposits, but it has become a means of obstructing any investigation to uncover the real looters.

Most branches of foreign banks left the Lebanese banking market years ago

In an article published on 21 October 2021, The Washington Post outlined the tripartite political, administrative, and banking entanglement that exists in Lebanon.

It said that of the 54 commercial banks operating in the country, "only 20 have total deposits above $1bn... and hold 99% of consolidated commercial banks' assets, a sign of high market concentration".

Research, it said, shows that "18 of these 20 have major shareholders linked to political elites, and 43% of the sector's assets could be attributed to individuals and families closely linked to politicians".

A system all sewn up

As if that weren't damning enough, it added that "only eight political families control 32% of the commercial banking sector's total assets". In a subheading, it said that "Lebanon's central bank ran a scheme to enrich politicians".

This should have been expected. The BoL board is appointed after consultation with politicians. Its members, therefore, usually take account of the banking interests of the politicians who nominate them, in the hope of winning second terms.

Furthermore, the Central Bank and the BCC take into consideration the interests of bankers alongside those of politicians.

As of 2021, just eight of Lebanon's political families controlled 32% of its commercial banking sector's total assets.

Peter Kunz, professor of economic law at the University of Bern, says appointees to banking watchdogs aspire to higher salaries at the end of their terms, such as to senior positions in major banks. As a result, they are softer with any potential future employers.

This is indeed the case. Despite a ban on them joining banks or financial institutions within two years of leaving the regulator, the majority of former BoL deputy governors and BCC members join once their terms expired, first as advisers, then as senior managers and board members.

Due to the tripartite political, administrative, and banking entanglement discussed by The Washington Post, it is hard — indeed, impossible — to pass any reform law.

This would require the reimbursement of funds accrued illicitly, such as the discretionary transfers abroad, the repayment of loans at a dollar exchange rate much lower than the real one, the illegal financial engineering launched by the BoL, among others.

All of this was done to benefit those who make the laws, so these same people will not vote for a law that forces the restitution of what they accrued.

Rigged from the start

Moreover, and contrary to the norms in many other countries, regulations governing Lebanon's Council of Ministers and Parliament do not require the absence of any conflict of interests for a vote on an institution in which the lawmaker is conflicted.

Furthermore, plans are currently being circulated to camouflage and obscure illegal operations, such as imposing an a posteriori tax on dollar loans repaid at exchange rates lower than actual ones. The goal is to give such repayments legitimacy.

As it might in other countries, hope of wresting this tripartite grip on Lebanon does not rest with the judiciary, which is unable to address the irregularities.

In Lebanon, there is no rule that a lawmaker must excuse themselves in a vote on which they have a conflict of interests.

Even the justice minister described the judiciary as "unwell". Tellingly, Parliament Speaker Nabih Berri said "only the weak seeks justice from the judiciary in Lebanon".

The Lebanese are therefore left with no choice but to press the international community to establish an international tribunal to investigate the crisis and its causes, and issue judgments against those found responsible for this crime against humanity.

In this regard, it is useful to press the IMF to cease any discussions with Lebanese authorities, since its intervention is subject to economic and financial shocks, not violations punishable by law.

IMF pressure towards the establishment of an international tribunal may even exempt it from blame for its failure to act after discovering that Lebanon was on the edge of the abyss, as its representative Alvaro Piris informed the former BoL governor in April 2016.

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