The Basel Bubble: BDL’s Illusion of Financial Health

2 March 2025

In the global financial framework, international principles and standards exist to ensure full transparency and sound fiscal and monetary policies, with the most prominent standard being the Basel Principles, a set of international banking regulations developed by the Basel Committee on Banking Supervision (BCBS). These principles aim to strengthen financial stability by ensuring that banks maintain adequate capital reserves, manage risks effectively, and operate with transparency. The framework has evolved through Basel I (1988), Basel II (2004), and Basel III (2010-2017).

Lebanon's banking sector has (on paper) aligned with Basel regulations through the directives of the Banque du Liban (BDL) and the Banking Control Commission of Lebanon (BCCL). 

Subsequent to shifts in administrative positions, the public perceived that a new approach to governance will enhance transparency; however, recent decisions by BDL do not align with such perception and directly contradict core provisions of Basel I and Basel II, presenting artificially positive economic and monetary indicators.

Firstly, following the election of President Joseph Aoun, the acting governor of BDL Wissam Mansouri has announced that the foreign reserves have increased by 300 million dollars within days of the election. However, this inflated increase in the foreign reserves is "Mansouri-made," since this increase was not driven by the inflow of hard currency from abroad, but rather by the increase of the market value of Eurobonds that BDL ultimately included within its foreign reserves. In addition, BDL has manipulated basic accounting principles by considering that the balance of payments is in a surplus of 6.4 billion dollars in 2024, despite the military conflict, political distress, and decrease in tourism; yet, the bubble surplus that BDL formed is due to the increase of the international market price of gold, which BDL has decided to include in its calculations of the balance of payments, a potential violation of accounting principles.

In Basel I, the requirement that only liquid, marketable, and freely available assets should be counted toward a bank’s capital base is reflected in the definition of Tier 1 and Tier 2 capital within the 1988 Basel Accord.

Specifically, Tier 1 capital (Core Capital) includes common equity, disclosed reserves, and retained earnings, as these are the most liquid and loss-absorbing forms of capital. Tier 2 capital (Supplementary Capital) includes subordinated debt, hybrid instruments, and revaluation reserves, but these must still meet conditions of being available to absorb losses if required.

Paragraph 18 states that "capital components must be fully paid, freely available to absorb losses, and have a permanence that ensures stability in the banking system."

The inclusion of gold reserves in Lebanon's foreign reserves contradicts the Basel I requirement for capital to consist of liquid, marketable assets. Under Lebanese law (Law No. 42/1986), the country’s gold reserves are restricted from being sold or pledged, making them non-liquid and unable to absorb losses in times of financial stress. The misclassification of the revaluation of defaulted Eurobonds in the central bank’s reported reserves and gold as a foreign liquid asset to inflate the balance of payments is definitely not in conformity with the Basel I principles.

Further, under Pillar 1 of Basel II, capital adequacy assessments must reflect real, accessible financial resources that can be deployed in economic crises. 

BDL’s decision to value and include Eurobonds in its foreign asset calculations further exacerbates its misrepresentation of available reserves. Given their default status, these Eurobonds do not hold a reliable market value and cannot be considered liquid foreign assets. Basel II, specifically Paragraph 40, mandates that capital must be composed of elements that are freely available to absorb losses, a requirement that neither Lebanon’s gold reserves nor its defaulted Eurobonds fulfill.

Furthermore, Pillar 2 of Basel II establishes the necessity of proper risk assessment and supervisory review. Basel II emphasizes rigorous capital adequacy standards and risk assessment frameworks. Paragraphs 725 to 760 outline the expectations for banks to have robust internal processes to assess their overall capital adequacy in relation to their risk profile and to maintain capital levels commensurate with their risks. These paragraphs also highlight the role of supervisors in evaluating banks’ internal assessments and capital adequacy, ensuring that institutions operate with sufficient capital to support all material risks. The BDL’s inclusion of illiquid assets in its reserve calculations misrepresents the central bank’s true liquidity position and prevents effective risk assessment. 

The Basel framework was designed to prevent banks from engaging in deceptive accounting practices that distort their ability to withstand financial stress.

Pillar 3 of Basel II, which deals with market discipline and transparency, is also undermined by the BDL’s actions. 

The Basel framework stresses the importance of accurate financial disclosures, requiring banks and regulators to provide the public with clear and truthful information about their financial position. 

BDL’s manipulation of Lebanon’s balance of payments and foreign reserves presents an impression of economic stability. This directly violates Basel II, Paragraph 809, which states that banks must publicly disclose their true financial conditions, including risk-weighted asset calculations, to allow market participants to assess their solvency.

Foreign exchange (FX) risk management is also a key area where BDL has failed to comply with Basel standards. Basel I and Basel II require central banks and commercial banks to implement FX risk management policies to protect against excessive currency exposure. Lebanon’s banking system, under BDL supervision, failed in this regard, leading to severe currency mismatches and a lack of proper FX reserves. This violates Basel II, Paragraph 718, which requires banks to implement FX risk management strategies, and Basel I’s Market Risk Amendment, Paragraph 15, which states that banks must limit FX exposure and account for currency fluctuations in capital planning.

BDL’s failure to adhere to Basel standards and its misleading financial reporting misrepresent Lebanon’s actual liquidity position and financial stability prevents the drafting of sound macroprudential policies. This lack of transparency undermines both domestic and international confidence in the already struggling banking system, increasing the risk of economic instability and uninformed decisions. Without urgent reforms to restore transparency and credibility, Lebanon’s banking sector will continue to struggle with deepening financial distress unless we consider MEA’s airplane fleet, BDL’s building in Hamra, and the newly purchased armored vehicles by BDL as liquid assets on the balance sheet; if so, we should consider crediting the international community!