Restructuring Lebanon’s Banking Sector: A Roadmap for Restoring Confidence, Fairness, and Institutional Viability

LEBANON’s banking sector lies at the heart of the country’s financial meltdown. With an estimated $81 billion hole in the system, the banking sector today exists largely on paper—crippled by insolvency, mired in political denial, and deeply distrusted by depositors and the international community. This paper outlines an actionable roadmap for bank restructuring. It integrates global best practices with the specificities of Lebanon’s political economy and aims to deliver financial justice while laying the foundation for future recovery. The restructuring must begin not with cosmetic reforms but with public trust, a legal reset, loss recognition, and credible mechanisms to treat large depositors fairly—because without trust, there is no system.

1. Diagnosing the Crisis: Anatomy of a Broken Balance Sheet

To understand the true scale of losses in Lebanon’s banks, we must first look at what their assets are really worth today—not what the books claim. Loans are deeply impaired because many businesses and individuals can no longer pay. The billions placed with the central bank are tied up and likely unrecoverable in full. And the state’s Eurobonds? They’ve defaulted and are nearly worthless in global markets. These are the hard truths behind the so-called “haircuts”—a financial term for writing down asset values to what they could actually fetch. This is the first honest step in fixing the system.

A successful restructuring strategy must start with a sober assessment of the financial hole. Using realistic, market-informed value, a typical Lebanese bank’s balance sheet is catastrophically insolvent. Here is an illustrative example: 

This means most banks are economically insolvent, and recapitalization alone is not enough—Lebanon must allocate the losses and reset the financial sector’s foundations.

Asset Haircut Assumptions

In assessing the solvency of Lebanon’s banking sector, it is essential to move beyond book values and apply crisis-adjusted, market-informed valuations. Asset haircuts are not arbitrary—they reflect the impaired nature, illiquidity, and recovery prospects of key holdings. The logic is rooted in both financial realism and international restructuring standards: loans to the private sector are heavily impaired due to widespread defaults and currency devaluation; placements with Banque du Liban are largely illiquid and entangled in fiscal dysfunction; and Eurobonds have defaulted, trading at steep discounts. These haircuts anchor the recognition of actual losses and are a necessary prelude to any fair and transparent allocation of those losses across stakeholders.

2. Misframing the Crisis: Liquidity vs. Capital — A Strategic Misdiagnosis

While Lebanon’s banking collapse has consistently been portrayed as a crisis of capital, the underlying reality is far more specific and dangerous: it was, and remains, a crisis of foreign currency liquidity. This distinction is not semantic—it reveals how political narratives, regulatory inaction, and institutional denial helped delay resolution, erode trust, and deepen public harm.

A Liquidity Shortfall Disguised as Capital Loss

At the heart of the crisis lies a structural mismatch: Lebanese banks and the central bank (BDL) had accumulated vast short-term, foreign currency liabilities (largely depositor funds) and invested them in long-term, illiquid, or impaired assets—notably sovereign Eurobonds and placements with BDL. When foreign inflows dried up in late 2019, the financial system ran out of U.S. dollars. This was a textbook liquidity crisis: institutions had obligations they could not meet—not due to a sudden collapse in capital value, but because the dollars simply were not there. However, the response to this crisis consistently used the language and tools of capital adequacy, not liquidity resolution.

The implications of this misframing extend beyond technical inaccuracy—they shape the very architecture of reform.

Why the Crisis Was Framed as One of Capital

Several strategic motives—both political and institutional—drove the deliberate mischaracterization of the problem:

• To Shield the Central Bank: Admitting to a liquidity shortfall would have placed Banque du Liban at the center of scrutiny, exposing its misuse of reserve assets and entanglement in quasi-fiscal operations.

• To Delay Insolvency Recognition: Treating the problem as one of “capital erosion” enabled banks to avoid legal insolvency declarations, giving time to seek asset revaluations or superficial recapitalization schemes.

• To Avoid Legal and Political Accountability: Acknowledging the real nature of the crisis would have invited prosecution for mismanagement, insider abuse, and violation of fiduciary duties—especially among politically connected actors.

• To Maintain Elite Bargaining Power: Labeling it a capital problem allowed the banking elite to position themselves as part of the solution (e.g., through voluntary contributions or financial engineering), rather than as parties complicit in the crisis.

The Consequences of Misdiagnosis

This distortion of reality has had serious implications:

• Trust Deficit: Depositors were lulled into believing their funds were intact. In reality, liquidity had vanished, and withdrawal restrictions merely concealed this fact.

• Policy Paralysis: Policymakers focused on recapitalization scenarios rather than emergency liquidity support, structured loss allocation, or rebuilding foreign currency buffers.

• Delayed International Engagement: Global institutions like the IMF were presented with misleading data and misaligned reform proposals, slowing Lebanon’s access to conditional assistance.

• ·       Social Fragmentation: Small and large depositors alike suffered from the absence of a clear, transparent explanation of what truly happened to their savings.

Correcting the Narrative as a Prerequisite to Reform

Before any restructuring framework can succeed, Lebanon must correct the public and institutional narrative. The financial collapse was driven by systemic foreign exchange illiquidity, compounded by regulatory failures and financial engineering—not by a sudden disappearance of capital.

Recognizing this truth opens the door to targeted solutions: rebuilding FX reserves, restoring monetary confidence, managing liability structures realistically, and aligning depositor recovery instruments with real institutional capacity—not with fictional accounting.

3. Rebuilding Confidence — The Prerequisite to Any Reform

Confidence is not a luxury. It is the oxygen of financial systems. In Lebanon, trust has been suffocated by opacity, denial, and elite impunity.

a. Public Acknowledgment of the Crisis. The state must formally recognize the insolvency of banks and the impairment of deposits. Transparency is not a threat; it is the currency of trust.

b. Enacting a Modern Banking Resolution Law. The law must:

• Clearly define hierarchies of loss absorption: shareholders → subordinated debt → large depositors.

• Establish an independent Resolution Authority with political insulation.

• Protect small depositors fully.

c. Bank Classification. Based on Asset Quality Reviews (AQRs), banks must be sorted into:

• Category A: Currently Viable with adequate liquidity in foreign currency, and after injection of fresh and high-quality capital.

• Category B: Potentially Viable. Restructurable through mergers.

• Category C: Non-viable; to be resolved or liquidated.

d. Start with Clean Institutions. Rebuild from a base of restructured, recapitalized, and transparent banks operating under new governance framework and risk culture.

4. Treating Large Depositors Fairly — A Political and Ethical Imperative

With most banks showing negative Net Asset Value, large depositors cannot be made whole, but neither can they be robbed silently. A just conversion mechanism must offer a realistic path to recovery.

Principles:

• Losses must be shared, but upside potential must be preserved.

• No depositor should receive worthless instruments with no hope of future value.

Conversion Instruments:

1.      Debt-to-Equity Swaps. Deposits above a threshold (e.g., $10 M) are converted to equity in restructured banks. This gives depositors future upside as bank profitability returns—but only after toxic assets are removed.

2.      Subordinated Debt Instruments. Deposits converted into long-term (5–7 year) notes that may earn conditional interest based on recovery.

3.      Hybrid Instruments (Equity + Warrants). This model aligns depositor interests with long-term bank performance, ensuring fairness and transparency.

For instance, a depositor with $15 million might see $5 million returned via the DRF, $5 million converted into equity, and $5 million into a conditional recovery bond.

5. Valuation and Structure: The Need for a Clean Break

Without proper valuation, conversion becomes legalized expropriation. Therefore:

• functional Bank / non-functional Bank Split

• Toxic assets—Eurobonds, BDL placements—are shifted to a Recovery Vehicle. Clean banks retain viable loans, branches, and systems.

Independent Valuation. An internationally credible auditor (e.g., IMF or EU-certified) should conduct fair post-cleanup asset assessments.

Conversion Fairness Framework

• If a restructured bank is worth $1B and large deposits total $10B, a 1:10 conversion ratio is justified.

• Add performance-based step-ups to reflect long-term upside.

6. Deposit Recovery Fund (DRF): A Bridge for the Betrayed

Depositors must be offered a dual pathway to partial recovery:

1.      Equity or Debt in Clean Banks

2.      Long-Term Recovery Bonds

• Issued by the state and backed by oil & gas, privatization proceeds, and restructured bank profits.

• Staggered repayments over 10–15 years.

The DRF should be:

• Independently governed

• Internationally monitored

• Credibly funded by future-state revenue streams

7. Governance and Oversight: International Involvement is Non-Negotiable

a.      International Supervision. Lebanon must borrow credibility: IMF, World Bank, or EU technical teams should monitor Asset Quality Reviews (AQRs), bank classification, and resolution steps.

b.      Public Communication Campaign. “What happened to your money—and how we fix it.” This must be the anchor of public messaging.

c.       Accountability for Crimes. Fraudulent transfers, insider lending, and regulatory failure must face legal consequences. Without justice, reform lacks legitimacy.

8. Implementation Roadmap: Step-by-Step Towards Stability

Restructuring Lebanon’s banking sector is not a single event—it is a process that requires careful sequencing, institutional coordination, and public communication. Given the depth of financial damage and the erosion of trust, a phased roadmap is essential to avoid chaos, restore confidence, and maintain political momentum. Each step—from acknowledging the truth to executing deposit conversions and prosecuting financial crimes—builds the foundation for the next. This structured approach ensures that reform is not only ambitious in vision but also credible in execution, with accountability mechanisms and international oversight embedded at every stage.

• Phase 1: Truth & Transparency. Government–BDL joint statement; public education campaign.

• Phase 2: Legislation. Pass the Resolution Law; empower Resolution Authority.

• Phase 3: Classification. Conduct AQRs; classify banks (A, B, C).

• Phase 4: Structural Separation. Establish Bad Bank; prepare viable banks for recapitalization.

• Phase 5: Conversion & DRF. Execute deposit conversion; launch DRF and Recovery Bonds.

• Phase 6: Oversight & Justice. IMF/EU supervision; forensic audits and legal actions.

The Time for Action Is Now. Lebanon’s banking crisis is not merely a technical failure—it is a test of political will, ethical responsibility, and institutional maturity. The cost of delay is already immense. What’s needed now is a vision anchored in fairness, implemented with credibility, and carried forward by leadership unafraid of the truth. Restructuring is not about making banks look good. It’s about making the financial system trustworthy again. If the newly formed government seeks a path out of economic collapse—one rooted in sound economics, institutional legitimacy, and depositor justice—this roadmap provides it.