Banking Sector Reform and Its Stalled Laws

Since 2019, Lebanon has faced the worst financial and economic crisis in its modern history, one that the World Bank ranked among the three worst crises the world has witnessed since the 19th century. It followed the freefall of the pound's exchange rate and the faltering of the banking sector, after three decades of accumulated fiscal deficits and debt that reached record levels, alongside crises of economic recession, unemployment and emigration, culminating in the complete collapse of the social safety net.

Since then, the country has sunk deeper into a spiral of crisis amid a persistent inability on the part of the political class to enact financial reforms to address the crisis and its repercussions, owing to internal divisions, a lack of political will and opposition from the economic elite. This has unfolded alongside the judiciary's inability to perform its role and the political authorities' refusal to put economic and banking controls and reforms in place, even as resolving the banking sector crisis represents an essential step for depositors to recover their savings under a loss-distribution plan required of the government.

Since the election of General Joseph Aoun as president of the republic and the subsequent formation of Prime Minister Nawaf Salam's government, Lebanon has witnessed a dynamic and challenging legislative process that began with the legislature's passage of amendments to the Banking Secrecy Law. That step is seen as the first legislative achievement of the new Lebanese government in introducing reforms aimed at restoring the confidence of depositors, the International Monetary Fund and other international donors, and as an initial step on the path to recovery from the country's protracted financial crisis.

The government's approval of the draft banking reform law reflects the executive branch's determination to affirm its commitment to the required reforms. It followed extensive deliberations spanning three Cabinet sessions, in the hope that this step will help clear the obstacles to reaching a new agreement with the International Monetary Fund and the World Bank that would allow financing and financial assistance to flow under an economic rescue plan aimed at addressing the financial gap and distributing its burdens among the state, Banque du Liban, commercial banks and depositors.

According to experts, the draft banking reform law recently approved by the government establishes a modern legal framework aligned with international standards that the Lebanese banking system had lacked, giving the government and Banque du Liban legal tools to deal with current and future financial crises, after the current crisis cast its heavy repercussions on depositors and the national economy.

Ironically, the provisions of the draft banking reform law, which forms the second phase of reforms following the amendments to the Banking Secrecy Law passed by Parliament last April 24, will not take effect if enacted until another complementary law is passed, as Article 37 of the bill explicitly stipulates that the implementation of its provisions is contingent upon the enactment of a law addressing the financial gap, which is considered an essential step toward restoring financial regularity in the country.

Although some view the new bill as better than the old version, a cause for concern is the omission of exceptional technical measures to address banks' suspension of payments. That makes it akin to an ordinary law for handling banks under normal conditions, rather than a law for restructuring banks and reforming and regulating the banking sector under exceptional circumstances. As long as banks remain in default, they cannot be treated as though they were in normal circumstances, needing nothing more than ordinary procedures to reclassify them and determine the conditions for their continuity, merger or liquidation.

The bill contains the phrase "limiting the use of public funds" in bank reform operations, stirring fears among depositors and a large segment of the financial sector. The concern is that the aim of this phrase is for the state to refrain from covering banks' placements with Banque du Liban, which stood at roughly $48 billion according to the forensic audit report by the firm Alvarez & Marsal. Nor did the bill clearly address the question of dealing with the accumulated losses on the central bank's balance sheet, which include around $16 billion in foreign-exchange differences and $5 billion in international bonds.

The bill does not address the distribution of losses among banks, the state, Banque du Liban and depositors in a direct and fundamental manner, settling instead for general provisions that could end up imposing additional burdens on depositors, particularly given the allusion to adopting a guarantee or internal rescue mechanism (Bail-in), which inflicts losses on depositors without directly and formally writing off their liabilities. Moreover, while the bill states that "depositors' funds are protected", it offers no clear vision of how individual deposits will be protected, especially those denominated in dollars prior to the crisis, which could open the door to unequal treatment among categories of depositors.

Another irony is that the proposed bill allows banks to appoint those charged with valuating their assets and holdings, giving banks a free hand in a process that constitutes a fundamental step in examining their condition and exploring how to reform them. This is all the more concerning given that the current bill does not mandate the dismissal of the managements of distressed banks, the freezing of their assets until their responsibilities are established, and the appointment of new managements, opening the door to the manipulation or concealment of information to obstruct audits and hide the facts.

However important what has been achieved to date may be, whether in passing the amendments to the Banking Secrecy Law or in the government's referral of the draft banking reform law, and regardless of the reservations, what remains paramount is completing the draft financial gap law, without which the provisions of the aforementioned bill will not enter into force even if passed by Parliament. That makes banking reform contingent upon passing the law on the financial gap, estimated at around $73 billion in depositors' funds, and determining how to address it, restore order to public finances and resolve the deposits problem.

Yet the current government still has no draft of the financial gap bill to put before the Cabinet for review and approval, while leaks regarding previous drafts indicate that they fall short of achieving reform and securing justice. It should be noted that every delay in approving the draft financial gap law in the Cabinet will delay its review and passage in Parliament owing to the approaching parliamentary elections.

Urgent as it is to complete the bill in the Cabinet and refer it to Parliament as soon as possible, the new draft must uphold transparency in determining the size of the financial gap and fairness in distributing losses among economic actors, starting with the state, Banque du Liban and the banks, down to the depositors. In distributing losses, the bill must also observe the principle of proportionality between the size of a deposit and the degree of responsibility, meaning that small depositors must not bear the same burdens as shareholders and large depositors.

Translated from Arabic with AI. Read it in Arabic