How to Destroy a Banking System: A Lebanese Guide to Populist Economics

01 June 2025

Despite its lack of functionality and the absence of effective legal repercussions, the statement by the newly appointed Governor of the Central Bank of Lebanon (BDL), Karim Souhaid, affirming that bank loans must be repaid by debtors in their original contracted currency, stands out as a significant indicator. 

It highlights that prior decisions or deliberate inaction were largely driven by populist governance, wherein previous officials and relevant authorities prioritized appeasing voting constituencies over implementing necessary, yet politically unpopular, measures. 

One such neglected yet essential decision was to prohibit debtors from discharging their obligations in the devalued local currency, a practice that undermined financial stability and basic contractual integrity.

In 2022, the International Monetary Fund assessed that the financial consequences of the crisis reflected as profits for borrowers and losses for depositors reached around $15 billion. Since the IMF’s report, this number has likely grown, as many loan repayments continued to be made at values below their true market worth. Some estimates now suggest the figure may be closer to $20 billion. Looking at the broader picture, bank lending to Lebanon’s private sector stood at approximately $55.5 billion in 2019, the year the crisis erupted. Of this amount, about $37.5 billion was in foreign currencies, while $18 billion was in Lebanese pounds. By the close of 2024, the total loan portfolio had sharply contracted to near $7 billion. 

This significant reduction is primarily due to borrowers repaying their loans in Lebanese pounds using the official exchange rate of 1,500 LBP per dollar or by issuing bank checks whose actual value was far below the original loan amounts.

In general, banks operate by taking deposits from customers, which they then use to issue loans to other clients. When a customer deposits money in a specific currency, such as USD, the bank is expected to return that currency upon withdrawal. However, if the bank issues loans in a different currency, or allows repayments in a currency that depreciates significantly, it creates a currency mismatch. This means the bank may collect repayments in a weaker currency while still owing depositors in a stronger one, leading to losses and potential liquidity problems if it cannot meet its obligations in the original deposit currency.

For example, a borrower who took a $100,000 loan could repay it in LBP at the official rate of 1,500 LBP/USD, even though the market rate was over 10,000 LBP/USD. As a result, banks were receiving a fraction of the real value of the loans in return while still being liable to return full dollar deposits to their clients, worsening the banking sector's insolvency. 

As a result, notwithstanding various other factors contributing to the banking crisis, banks were unable to repay depositors their USD deposits since they were collecting the USD-denominated debt in Lebanese liras.

At the time, political factions rushed to propose laws that would compel banks to accept repayment of USD-denominated debts in Lebanese pounds (LBP), in a clear attempt to placate a public enraged by the deepening economic crisis. These legislative initiatives were framed as efforts to alleviate the financial burden on debtors struggling with the consequences of the collapsing exchange rate. However, such justifications lacked any basis in serious socio-economic analysis and were, in essence, nothing more than political slogans. One must ask: Did the political class consider that such populist measures could further destabilize the financial system? Did they weigh the possibility that some debtors were profiting at the expense of depositors? More fundamentally, did they attempt to classify debtors or differentiate between those genuinely unable to repay and those exploiting the system? 

Clearly, they did not.

In the same vein of populist policymaking, the indecisiveness and lack of proactive measures within the corridors of the Banque du Liban (BDL) significantly contributed to the worsening of the crisis. By implicitly encouraging the repayment of USD-denominated debts in Lebanese pounds through the maintenance of an artificially pegged official exchange rate while the market rate was soaring, the BDL distorted financial realities. This was further compounded by the issuance of circulars permitting debtors to repay their dollar-denominated obligations in LBP under certain conditions, as well as the implementation of unsustainable subsidy programs, all of which exacerbated financial imbalances and deepened systemic instability.

Looking back, the government consistently failed to implement a credible economic recovery plan and neglected to take necessary steps to safeguard depositors' funds, most notably by abstaining from enacting a capital control law. Although then-Minister of Finance Ghazi Wazni proposed such legislation, it was ultimately shelved by the latter due to political pressure from those benefiting from the prevailing financial disorder, as well as a desire to avoid public backlash. This inaction reflects a broader pattern of short-term political calculus overriding long-term economic responsibility.

Although the politicians' stance was unjustified, the political discourse may make it seem comprehensible. On the other hand, the Judiciary followed the same trajectory, but in a more hypocritical, ironic, and paradoxical manner. 

This was evident in contradictory rulings issued by the same judge in cases involving a major Lebanese bank. In one ruling, a borrower was allowed to repay a multimillion-dollar loan using a bank check in Lebanese pounds, calculated at the outdated official exchange rate of 1,500 LBP/USD, an amount that in real terms is equivalent to a small fraction of the loan’s true value on the open market. Conversely, the same judge had previously ordered the bank to return depositors’ funds strictly in U.S. dollars and in cash, asserting that checks were not a valid means of settlement. This inconsistency in judicial reasoning reflects a populist approach aimed at appeasing public sentiment rather than upholding coherent legal standards.

Going back to Souheid's statement (although its legal value is null), it signals a shift in framework toward a more professional and transparent approach compared to previous ones, despite the tremendous period that has elapsed. However, this flashback is fundamental to reinforcing the idea that opportunities for economic and financial salvation must not be compromised for the sake of popular votes or public expectations. 

As Edmund Burke aptly stated, "Your representative owes you not his industry only, but his judgment; and he betrays, instead of serving you, if he sacrifices it to your opinion."