The Lebanese economy has been the subject of an intense economic crisis, which began to unfold in 2019 and was further aggravated by the COVID-19 pandemic, an explosion in the Port of Beirut in 2020, and most recently the ongoing hostilities between Hezbollah and the Israeli military in connection with the war in Gaza. The currency has rapidly depreciated, inflation has skyrocketed, foreign reserves have dried up, the banking sector has collapsed, GDP has plummeted, and public debt has worsened.

Role of the Central Bank:

 The Lebanese Central Bank (Banque Du Liban) has not only been at the center of the economic crisis in 2019, but is also a core component of the current effort to rebuild the Lebanese economy. An understanding of the changing role of the Lebanese central bank requires an understanding of some of the changes in leadership the bank has experienced. Riad Toufic Salameh was governor of the Lebanese central bank from 1993 to 2023. Prior to 2019, Salameh was widely respected and credited as being a key part of Lebanon’s economic recovery from the civil war which lasted from 1975-1990. However, within the past few years, Salameh has come under fire for alleged large-scale financial mismanagement akin to a Ponzi scheme. Not only is Salameh being accused of financial mismanagement he is the subject of criminal investigations for embezzlement and illicit enrichment. At least seven countries, including Lebanon are conducting criminal probes, which claim that Salameh laundered upwards of $300 million. These funds are alleged to have been transferred from the central bank of Lebanon to Europe between 2002 and 2015, and were purportedly used to purchase luxury real estate and other European assets. Additionally, France and Germany have issued arrest warrants for Salameh, and have seized some of his assets. Salameh denies the accusations and maintains that his wealth is the result of his work in the private sector for 20 years prior to becoming governor of the central bank. Lebanon rejected extradition on the basis of domestic law, but the United States, United Kingdom, and Canada imposed sanctions which pressured the government in beirut to freeze Salameh’s assets in Lebanon. 

The Central Bank Under Riad Salameh: 

While Salameh is currently the subject of these investigations and allegations, he is indicative of a larger system of corruption in Lebanese politics and finance. While he may have engaged in the misappropriation of public funds for personal gain, his alleged actions are a symptom of the network of corruption that has run rampant in the Lebanese central bank for too long, and the mechanisms which allowed it to do so. A report by global professional services firm Alvarez & Marsal (A&M) which was commissioned by the ministry of finance emphasized the central bank’s lack of transparency, exceptionally large amount of power concentrated in the hands of the central bank governor without necessary checks on that power, atypical methods of accounting used to obscure unfavorable outcomes, and inflated assets and profits with reduced losses. The close connection between the Lebanese ruling class and the banking system resulted in the misconduct and corruption within the bank benefitting only a small percentage of the population while burdening the majority.

While the extent of the economic crisis became fully apparent in 2019, Lebanon experienced liquidity shortages in the years prior. Financial engineering employed by Salameh obscured the depth of the crisis leading up to 2019. Financial engineering refers to various mechanisms which essentially provided banks with considerable returns for new dollars. The result of this financial engineering was an increase in foreign reserves due to improved flow of dollars. However, liabilities also rose simultaneously, which was not wholly obvious at the time. Many bankers suggest that financial engineering may have been a prudent tactic had it been accompanied by reforms at the tail end, but it was not. Leading up to the 2018 election,  politicians delivered a public sector pay rise, despite the fact that the cost of addressing Lebanon’s debt was at least a third of budget spending, and the state needed to cut expenditures. Foreign donors held back on pledges of billions of dollars in aid due to the lack of reforms enacted by the government. Finally, taxes on services such as WhatsApp calls in October of 2019 exacerbated discontent with the low tax regime that tended to benefit the wealthy. The unrest manifested itself in mass protests against the political elite. Banks’ foreign exchange reserves dried up, and they were unable to pay dollars to depositors. The Lebanese currency collapsed from 1,500 to the dollar to 23,000 in early 2022. The government also defaulted on its foreign debt. 

The Risk of Greylisting:

The central bank of Lebanon is currently at risk of being added to the Financial Action Task Force’s (FATF) grey list of countries under special scrutiny. Lebanon received a preliminary evaluation in 2023 which warranted being greylisted. Some of the categories which exhibited weaknesses included anti-money laundering measures and transparency relating to beneficial ownership of firms. Following the preliminary evaluation, Lebanon was given a year to address gaps in the system before the final ruling set to be made in October at the FATF plenary. The impact of being placed on the grey list could be adjustments to credit ratings, higher transaction costs, and disruptions in Lebanon’s capital flows as banks cut ties to customers in the country to reduce compliance costs. Furthermore, the listing would be particularly damaging for Lebanon given the timing, as the country has attempted to enact vital reforms as requested by the International Monetary Fund (IMF) in 2022 to lay the groundwork for a deal with the organization, but has been slow to do so. The FATF declined to comment on the upcoming final decision regarding Lebanon’s potential placement on the grey list. 

The Role of Central Bank in Rebuilding Lebanon’s Economy:

The question now is what the Lebanese central bank, headed by interim governor Wassim Mansouri can do to combat corruption and rebuild the economy. Aligning with the IMF’s recommended reforms, which include debt restructuring, improved governance, and phased out subsidies to corrupt state enterprises are vital to securing much needed international assistance. Mansouri has advocated for the implementation of these reforms, but more momentum is needed if the central bank wishes to secure a deal with the IMF. Further reforms that Mansouri is encouraging include restructuring the banking sector and introducing capital controls laws. These reforms aim to stem capital flight which has been an ongoing issue since the beginning of the crisis, as well as to restore trust in the banks. The central bank of Lebanon can also work to improve transparency within the bank, including the completion of a forensic audit initially begun under Salameh. The goal of the forensic audit is to uncover financial irregularities and maintain accountability to restore the credibility of the central bank. Finally, Mansouri is pushing for the reintegration of remittance into the formal banking system as a way of curbing the cash economy. It is estimated that USD 7 billion in remittances remains outside of the financial system, so reintegration could be crucial to control the circulation of money, increase liquidity, and counteract financial instability. The central bank of Lebanon did not respond to a request for direct comment on the strategy it will employ going forward. 

Conclusion: 

The central bank has been a core component of the tumultuous Lebanese economy over the past few decades. Under Salameh, financial engineering, accompanied by rampant corruption within the bank, ushered in a disastrous economic crisis in 2019. Lebanon has suffered  the collapse of its currency, depleted foreign reserves, rapidly contracting GDP, exorbitant rates of inflation, and mounting debt. Citizens have been frozen out of their savings accounts by banks, forcing the country into a primarily cash economy. Now, the central bank has the opportunity to play a substantive role in Lebanon’s economic recovery. With Salameh under criminal investigation, and Lebanon at risk of being placed on the grey list, it is a critical moment for the central bank under interim governor Mansouri to enact substantial reforms. This will require mechanisms to identify and stamp out systems of corruption within the central bank, as well as to improve transparency and stability in the formal banking system. Implementing such reforms will allow the central bank to rebuild its credibility, engage in critical international deals, and combat financial instability. The road to economic recovery may be daunting, but if Lebanon’s central bank embraces the necessary reforms, it can pave the way for a more stable future.

References

“The World Bank in Lebanon.” Worldbank.org. World Bank Group, 2022. https://www.worldbank.org/en/country/lebanon/overview#1. 

“Lebanon central bank governor says 'working hard' to prevent grey listing.” Middleeastmonitor.com. Middle East Monitor, 2024. https://www.middleeastmonitor.com/20240822-lebanon-central-bank-governor-says-working-hard-to-prevent-grey-listing/.

Sabaghi, Dario. “How Lebanon was plundered by its own central bank.” Dw.com. DW, 2023. https://www.dw.com/en/how-lebanon-was-plundered-by-its-own-central-bank/a-66613994. 

Tobias, Ben. “Riad Salameh: Lebanon's tainted central bank chief steps down.” Bbc.com. The British Broadcasting Corporation, 2023. https://www.bbc.com/news/world-middle-east-66359575. 

Blair, Edmund.“Explainer: Lebanon's financial crisis and how it happened.” Reuters.com. Reuters, 2022. https://www.reuters.com/markets/rates-bonds/lebanons-financial-crisis-how-it-happened-2022-01-23/. 

Barazy, Maan. “Mansouri’s First 100 Days: Navigating the Winds of Lebanon’s Financial Reforms.” Nowlebanon.com. Now, 2023. https://nowlebanon.com/mansouris-first-100-days-navigating-the-winds-of-lebanons-financial-reforms/.