The Dreadful Truth About Banking in Lebanon: From Cushion to Caution

Lebanon's banking crisis is much more than a liquidity problem or a consequence of economic mismanagement—it is a systemic failure of risk management, transparency, and leadership. Once celebrated as the financial heart of the Middle East, Lebanese banks have now become emblematic of what goes wrong when short-term gains and regulatory complacency take precedence over sound governance and effective risk management.?

A Legacy of Trust, Now Broken

For decades, Lebanese banks enjoyed the trust of local and international investors, driven by a well-regarded reputation for financial stability and a tradition of excellence. This trust was built on solid executive leadership and the perception that Lebanese banks could weather any storm. However, the financial crisis of early 2020 has shattered this image. Much of the blame was initially placed on the government for its irresponsible fiscal policies, but the truth is that the banking sector’s own failures were equally significant. Banks were overly reliant on a deeply flawed model of investing heavily in Lebanese government debt—a risky strategy that ultimately led to disastrous consequences.?

The Role of Overconfidence and Regulatory Complacency

A central aspect of the crisis was the misguided belief that compliance equaled safety. The Central Bank of Lebanon, Banque Du Liban (BDL), and the Banking Control Commission (BCCL) often operated more like partners than regulators, offering banks a false sense of security. Banks were allowed to "pick and choose" which risks to manage, relying heavily on regulatory assurances instead of independent risk assessments. This overconfidence meant that when real risks emerged—from rising political instability to currency devaluation—banks were unprepared to respond effectively.

For years, banks took comfort in knowing that their regulatory capital was deemed sufficient by BDL, without adequately considering the full scope of the risks involved in their investments. This compliance-focused approach meant that while the static components of risk (like basic credit risk or operational risk as defined in Pillar 1 of the Basel Accord) were cushioned, the more dynamic and systemic risks (as identified in Pillar2 of the Basel Accord) were largely ignored. When the crisis hit, banks were exposed, and the true fragility of the system was revealed.?

From Cushion to Caution: The Fallout of a Failed Risk Culture

The shift from "cushion" to "caution" has been abrupt and devastating. Initially, Lebanese banks failed to maintain sufficient capital buffers, overestimating their capacity to withstand shocks. When the crisis unfolded, many banks turned towards extreme caution—an overcorrection that further harmed the economy. Instead of managing risks in a nuanced way, banks chose to de-risk entirely, cutting off lending and financial support that businesses and individuals desperately needed. This overzealous caution stifled economic activity, leading to a credit crunch that left the local economy gasping for air.

The real tragedy lies in the failures of banks' risk management functions. Compliance with Basel requirements, particularly Pillar 1, provided a false assurance that banks were secure, ignoring the importance of more dynamic risk management practices like stress testing and assessing risk velocity. Risk professionals and Board of Directors, instead of proactively assessing the landscape, often deferred to regulatory guidelines that fell short of addressing the emerging complexities of the Lebanese economic situation. The result was a risk culture where regulatory compliance was prioritized over resilience.

An Overreliance on Government Debt

Another key issue was the banking sector's overreliance on government debt. By 2012, the banking community was already aware that Lebanon's public debt levels were becoming unsustainable. Despite warnings, Lebanese banks continued to invest heavily in government-issued debt instruments, a decision that turned catastrophic after the government’s disorderly default in March 2020. The banks' excessive exposure to government debt meant that when the default occurred, they were left with virtually worthless assets on their balance sheets.

The government default exposed a fragile financial system, revealing a symbiotic and toxic relationship between banks and the state. Banks were the primary financiers of government debt, and in return, they were provided with regulatory leniency and implicit guarantees of stability. This cozy arrangement fell apart when the government could no longer service its debts, leaving banks with no recourse and depositors facing severe restrictions on their own savings.?

The Consequences of Poor Risk Management

The inability to identify, assess, and mitigate key risks extended beyond government debt. Banks also engaged in risky lending practices, with a high loan-to-deposit ratio that reflected an aggressive stance on growth without adequate safeguards. Problems like adverse selection and moral hazard became glaringly evident, with banks continuing to lend even as economic conditions were deteriorating. The consequences of this recklessness were only exacerbated by the fact that banks were hesitant to downgrade loans and acknowledge the true quality of their assets. By avoiding provisions for loan losses, banks presented an overly optimistic view of their financial health, misleading both regulators and the public.

The absence of effective communication further damaged the relationship between banks and their clients. As the crisis unfolded, banks imposed restrictions on withdrawals, card usage, and fund transfers with little or no notice. There was no unified communication strategy, and each bank acted independently, adding to the confusion and frustration of depositors. The Association of Banks in Lebanon, which should have played a key role in mitigating this communication breakdown, remained conspicuously absent.

Pathways to Recovery: From Caution to Competence

The recovery of Lebanon's banking sector requires a fundamental shift in both mindset and strategy—moving from caution to competence. Recapitalization is a crucial first step, but it must be accompanied by deep reforms. Banks need to enhance their capital adequacy, not just through fresh funds but by restructuring their balance sheets and addressing their portfolios of non-performing loans. A focus on effective risk management, beyond mere regulatory compliance, is essential for ensuring long-term stability.

The banking model must evolve from being an originate-to-hold model to one that incorporates elements of dynamic risk assessment and mitigation. This includes regular stress testing, reassessing the capacity of key management roles, and improving the composition of Boards of Directors to ensure they can effectively oversee risk management functions. Furthermore, the relationship between banks and regulatory authorities must be redefined—it must move away from a partnership that breeds complacency to a more accountable and transparent supervisory framework.

Banks must recognize that true resilience lies not in avoiding risk altogether but in understanding and managing it effectively. The challenges that led Lebanese banks from a state of cushion to one of excessive caution can be addressed only by embracing a proactive approach to risk, investing in better management information systems (MIS), and fostering a culture that values ethical leadership and transparency.

Rebuilding Trust Through Competence

The crisis in Lebanon's banking sector is a stark reminder that the complacency of good times can lead to catastrophic outcomes in bad times. A banking system that was once the pride of Lebanon has been brought to its knees by a combination of poor risk management, near-absent Board of Directors, overreliance on government debt, and regulatory complacency. Moving forward, the focus must be on rebuilding trust—not through empty promises or superficial compliance but through competence, accountability, and an unwavering commitment to sound risk management.

The road to recovery will not be easy, and it will require painful adjustments, including potential mergers, consolidation, and restructuring of both assets and management. However, by focusing on effective risk management, ethical governance, and transparent communication, Lebanese banks can begin to rebuild their reputation and, in turn, contribute to the stabilization and growth of the nation's economy.

A future where Lebanese banks are again seen as pillars of stability and trust is possible—but it requires a fundamental reassessment of priorities, moving beyond caution to embrace competence, resilience, and integrity.