US Sanctions To Beirut Port Blast: Key Moments In Lebanon's Economic Downfall

The banking system was the "crown jewel" of the Lebanese economy for decades. Even as recently as 2011, they ruled the Middle East banking sector. Now they are struggling for survival.

The cornerstone of the success of Lebanese banks was the banking secrecy law passed in 1956, which created serialised banking accounts that were immune from state inspection, including the Lebanon Central Bank.

The banking secrecy law helped attract an influx of Palestinian capital and petrodollars seeking safe haven. It led to an unprecedented growth in the size of Lebanese banking sector, both in terms of total holdings and number of banks.

Thanks to prudent regulation, Lebanese banks also enjoyed a strong reputation among regional investors and the Lebanese diaspora.

The banking system managed to stave off any capital flight from Lebanon during the civil war (1975–1990) and the 2008-2009 international financial crisis.

The financial sector was still booming until 2011, when instability in the Middle East increased. Since then, the banking sector and the economy at large has suffered.

In 2010, the top 15 banks with the largest growth in assets came mostly from Lebanon, according to the Asian Banker Ranking.

In 2011, six Lebanese banks were among the top 10 strongest commercial banks in the Middle East.

In 2019, there were no Lebanese banks in the top 10 strongest commercial banks in the Middle East.

The Asian Banker said in its latest ranking for 2019 that banks in Lebanon have lower average strength scores than other Middle Eastern countries under evaluation. In addition to subdued balance sheet growth, banks in Lebanon posted much weaker profitability and asset quality than their regional peers amid a "challenging operating environment."

So how did Lebanese banks get to this point?

Syrian war:

The conflict in Syria since 2011 has weighed heavily on Lebanon's economic and social fabric.

Lebanon's economic situation has become increasingly alarming since the Syrian war. Economic growth, at only 1.4 percent on average since 2011, slumped to an estimated 0.3 percent in 2018 - a far cry from the pre-Syrian crisis average of 6.3 percent between 2003-2010.

The Syrian war led to a drop in exports and worsened investors' fear of instability.

Political vacuum:

Lebanon has a track record of lengthy negotiations to form governments, given its fractured political landscape.

It took 29 months to elect former army commander Michel Aoun as president on Monday October 31, 2016, ending a presidential vacuum.

Then came the nine-month political vacuum between the May 2018 election and eventual government formation on January 31, 2019 weighed on business confidence.

After three months of political vacuum, Lebanon got a 20-minister government led by former minister Hassan Diab on January 21, 2020, after 33 days of arduous negotiations.

Tensions with GCC countries:

On November 4, 2017, Prime Minister Saad Hariri issued a televised statement from Riyadh resigning his position, citing Iranian influence via Hezbollah. Hariri and his family were able to leave Saudi Arabia, and he withdrew his resignation on December 5, calming the situation down, but tensions have remained high.

Since tensions with Saudi Arabia erupted, there has been a sharp decline in remittances from 400,000 Lebanese working in GCC countries, and tourism from Gulf visitors, who spend the most money while in Lebanon. Saudi tourists’ spending fell 21.4 percent in the first half of 2018 compared to the same period in 2017. Similarly, total visitors from Saudi Arabia were down 21.1 percent compared to the same period last year, and visitors from the UAE were down 32.2 percent.

The mysterious resignation may have spooked wealthy Lebanese depositors and encouraged them to move funds out of Lebanon. Bank deposits collapsed, interest rates spiked, bank lending to the private sector declined and GDP growth dropped to 0.25 percent. The increase in interest rates only further deteriorated the fiscal situation. Things then properly fell apart with the collapse of foreign deposits in early 2019.

American sanctions:

The American sanctions triggered the collapse of the largely indebted economy.

The first to be impacted was the powerful banking system, which effectively shut down, fearing a run on the banks by panicked depositors seeking to withdraw their savings.

In September 2019, Lebanon’s Jammal Trust Bank was forced to wind itself down after being hit by US sanctions for allegedly helping to fund the Iran-Backed Hezbollah movement.

The same happened in 2011 when the US claimed that the Lebanese Canadian Bank, one of the five most important banks in Lebanon, had ties to Hezbollah.

Because of the sanctions on Syria, Lebanon could not benefit from the capital and business outflows out of Syria after the eruption of the Syrian war in 2011. The United States sanctions came in March 2011 and another batch was added in August 2011. Lebanese banks were therefore reluctant to accept any transfer or deposit from Syrian nationals.

October 17, 2019 revolution:

A planned tax on free phone calls for popular social media applications, announced on October 17, 2019, along with other austerity measures, was the straw that broke the camel’s back.

On that evening, groups of youths took to the streets and closed major intersections in and around Beirut with burning tyres. On October 18, the phenomenon spread to other areas, bringing most of the country to a standstill.

Lebanon has been swept by a wave of mostly peaceful protests aimed at the country's elite, which prompted Prime Minister Saad Hariri to resign on October 29, pushing the country deeper into economic crisis.

Lebanese banks were enduring a difficult period following last October’s political upheaval, and were forced to place limits on withdrawals and international transfers.

Rating agencies took action in 2019 amid mounting concerns that the country's methods of managing its vast debts and defending its dollar peg are unsustainable.

Moody's downgraded Lebanon's rating in January and placed it under review in early October.

Fitch Ratings did similar in September, downgrading Lebanon's long-term foreign-currency rating and also Bank Audi, the country's largest bank by assets.

S&P Global Ratings revised Audi's ratings to negative from stable in March and said more recently that the lender's ratings cannot exceed those on the sovereign due to its "credit risk largely concentrated and skewed toward Lebanese sovereign debt."

Triple crises in 2020:

Three major shocks have hit the Lebanese economy in less than a year. The financial crisis of October 2019, the coronavirus pandemic and the Beirut Port explosion.

For the first time in its history, Lebanon defaulted on its international bond due on March 9, after the grace period expired. On March 23, Lebanon announced that it would cease servicing other outstanding foreign-currency debt. Four days later, the public debt restructuring commitment was extended to include local-currency debt.

Panic and anger gripped the public as they watched their local currency, pegged to the dollar for nearly three decades, plummet, losing more than 80 percent of its value. Public debt has soared while the economy contracted and foreign inflows dried up in the already heavily indebted country, which relies on imports for most of its basic goods.

While banks have imposed informal capital controls, limiting the withdrawal of dollars and foreign transfers in the country, some well-connected depositors have been able to move their funds abroad, estimated at $20 billion.

Then came the coronavirus pandemic, which added to the country's financial, economic and political crises.

A massive explosion in the Port of Beirut then rocked the city on August 4, killing 200 people, wounding more than 6,500, and displacing around 300,000 after destroying 200,000 homes. The detonations destroyed the country’s largest port. Losses and damage are estimated at $8 billion. The explosion is expected to cause further output loss due to discontinued economic activity.

Challenging transition period

Lebanese banks are facing a critical transition period and operating conditions will remain challenging and depend on the government's ability to implement highly anticipated fiscal and economic reforms. Some restructuring of private banks should take place, including recapitalization, liquidation, merger, and possibly foreign acquisition.

Riad Salameh, Lebanon’s Central Bank governor, said last month: "If the Lebanese banks failed to increase their capital by 20 percent by the end of February 2021, they have to exit the market."

Is fixing the tumultuous geopolitical environment that's challenging banking operations in Lebanon beyond their capabilities this time?