Lebanon's Financial Collapse
Lebanon once stood out as a symbol of prosperity and stability in the Middle East. For decades, it was known as the "Switzerland of the Middle East," primarily because of its banking secrecy laws, a stable currency pegged to the U.S. dollar, and a thriving financial industry. This reputation set Lebanon apart from its neighbors, turning it into a regional financial hub. But beneath the surface, structural weaknesses were building up. By 2019, Lebanon's financial system, and the broader economy, collapsed with astonishing speed.
Lebanon as the "Switzerland of the Middle East"
Lebanon earned the moniker "Switzerland of the Middle East" because of its banking secrecy laws and its relatively liberal financial system, which allowed depositors to keep their identities hidden. The banking secrecy laws in Lebanon, established in 1956, were unique in the region and made Lebanon’s financial sector a haven for those seeking discretion in their transactions. This was particularly attractive to wealthy investors from neighboring Gulf states, where financial systems were either underdeveloped or heavily regulated by governments.
Comparatively, neighboring countries like Saudi Arabia, Kuwait, or even the UAE were much more tightly controlled by their governments, especially in the areas of capital movement and transparency. Lebanon's relatively laissez-faire attitude made it the financial playground of the region, attracting deposits and investments.
But the financial sector’s strength wasn’t just built on secrecy. Lebanon's economy was highly dollarized and the Lebanese pound had been pegged to the dollar at a rate of 1,507 LL since 1997. This meant that even though the official currency was the Lebanese pound (LL), people routinely used U.S. dollars for transactions. By 2018, an estimated 75% of all deposits in Lebanese banks were in U.S. dollars, not local currency.
The Collapse
In 2019, Lebanon’s financial system hit a wall, leading to one of the most severe economic collapses in modern history. The numbers tell a devastating story: Lebanon’s nominal GDP plummeted from close to US$52 billion in 2019 to just US$23.1 billion by 2021. GDP per capita dropped by a staggering 36.5% during the same period, marking a dramatic decline in the standard of living. The World Bank reclassified Lebanon from an upper-middle-income country to a lower-middle-income nation in 2022.
The financial collapse triggered a humanitarian crisis. Before the collapse, Lebanon's poverty rate stood at roughly 28% in 2018. But by 2021, more than 80% of the population had fallen into poverty, according to the United Nations. The loss of wealth, coupled with soaring inflation and the devaluation of the Lebanese pound, decimated people's purchasing power. The middle class effectively disappeared as prices for basic goods skyrocketed—sugar prices increased by over 600%, and the cost of staple foods like wheat and rice surged by nearly 1,000%.
Public services also collapsed. Power outages became the norm, with electricity available for only a few hours a day in many parts of the country. The healthcare system, already under strain, buckled under the weight of economic collapse and the COVID-19 pandemic.
How did Lebanon go from being a seemingly stable financial center to the verge of becoming a failed state?
A Debt-Fueled Illusion of Stability
One of the most glaring warning signs was Lebanon's skyrocketing public debt. By 2019, the country’s debt-to-GDP ratio had soared past 150%, one of the highest in the world. However, high debt-to-GDP ratios don’t necessarily doom a country. Japan, for example, has a debt-to-GDP ratio of more than 200%, yet remains economically stable. So why did Lebanon’s debt become such a problem?
The answer lies in how the debt was managed—or rather, mismanaged. Lebanon was borrowing not to invest in infrastructure or economic growth, but to cover its enormous fiscal deficits. Over the years, successive governments had increased public spending—often for political reasons—without generating the necessary revenue. Lebanon was effectively using new loans to pay off old ones.
In an effort to attract more deposits and foreign currency, the Banque du Liban (Lebanon's central bank) started offering unsustainably high interest rates—sometimes as high as 15%—especially on U.S. dollar deposits. This attracted a significant inflow of capital, but the whole structure resembled a Ponzi scheme: the central bank was using new deposits to pay off the interest on existing ones. When fresh money dried up, the system began to unravel.
The Liquidity Crisis
The real tipping point came in 2019 when Lebanon found itself in a severe liquidity crisis. Banks, which had long been considered pillars of the economy, could no longer provide dollars to their depositors. Lebanese citizens had deposited their hard-earned savings in the banking system, mostly in U.S. dollars, with the promise that they could withdraw their money whenever needed. However, by 2019, banks were either freezing accounts or severely limiting withdrawals, effectively locking people out of their savings.
This was the core of the collapse: the liquidity crisis shattered the trust that both citizens and international investors had in Lebanon’s banking system. When people lost access to their money, panic set in. Protests erupted as citizens watched their savings evaporate. The official exchange rate of 1,507 LL to the dollar became a meaningless figure on paper. By 2022, the black-market exchange rate had surged to over 34,000 LL per dollar, wiping out the wealth of most Lebanese citizens.
External Factors
The Syrian Civil War and Regional Instability
Lebanon’s internal dysfunction set the stage for collapse, but external pressures accelerated its fall. Chief among these was the Syrian Civil War, which erupted in 2011 and displaced over 1.5 million Syrians into Lebanon. This influx strained Lebanon’s already fragile infrastructure and public services, driving unemployment up and further weakening the economy. International aid fell far short of what was needed, forcing Lebanon to bear the costs, which exacerbated fiscal imbalances.
The Withdrawal of Gulf Support
Historically, Lebanon had relied on financial support from Gulf countries, particularly Saudi Arabia, which had propped up the Lebanese economy through aid and investments. However, as Iran-backed Hezbollah’s influence grew in Lebanon, this financial lifeline was gradually cut off. Gulf states, wary of Hezbollah’s rising power, distanced themselves, reducing investments and withdrawing deposits from Lebanon’s central bank. Without this critical external support, Lebanon’s liquidity crisis deepened, further destabilizing its financial system.
The COVID-19 Pandemic and Beirut Port Explosion
Lebanon’s fragile economy was hit hard by the global COVID-19 pandemic in early 2020. Business closures, a collapse in tourism, and an already crippled healthcare system pushed the economy to its limits. Compounding the crisis, in August 2020, the Beirut port explosion devastated the city, causing billions in damage and killing over 200 people. The explosion not only destroyed vital infrastructure but also crippled Lebanon’s main port, further disrupting its already fragile supply chains.
Sectarian Politics
To truly understand why Lebanon collapsed, we need to consider the country’s deeply rooted sectarian political system. Lebanon’s government is structured along religious lines, with key positions divided among the country’s Christian, Sunni, and Shia Muslim communities. This system, designed to maintain balance, instead fostered corruption and political paralysis.
Over the years, many Lebanese politicians—some of whom had direct stakes in the country's banking sector—used their positions to enrich themselves rather than to enact the reforms needed to prevent the crisis. These politicians benefited from the central bank’s high-interest rates and were, therefore, incentivized to maintain the status quo, rather than push for the necessary reforms. For example, former Prime Minister Saad Hariri and his family have long been linked to BankMed, one of Lebanon's largest banks. Other political families, like the Frangieh and Aoun clans, also held significant stakes in financial institutions.
The Government’s Response
As the crisis deepened, Lebanon’s government and central bank tried several tactics to stabilize the economy, but they only made things worse. In an effort to support the Lebanese pound, the central bank began burning through its foreign currency reserves. This was an attempt to defend the currency peg, but it was unsustainable given the massive debt obligations Lebanon faced.
Another failed measure was the government's refusal to implement proper capital controls. Instead of formally regulating how money could move in and out of the country, banks began imposing their own withdrawal limits in a haphazard and unofficial manner. This only deepened the public's mistrust, as depositors were left with no legal recourse to access their funds.
These missteps highlight a deeper issue: Lebanon lacked the critical pillars that define successful and resilient financial centers. While Lebanon's government scrambled to manage a financial crisis that was rapidly spiraling out of control, global financial hubs like New York, London, and Singapore have weathered crises in the past and emerged stronger. This raises a vital question: what do these financial centers have that Lebanon lacked?
The Characteristics of a Stable Financial Center
Market Trust and Confidence
In successful financial hubs, trust is the bedrock. Depositors and investors rely on the belief that banks and financial institutions will fulfill their obligations, even in turbulent times. In Lebanon, this trust eroded long before the crisis hit in 2019. The Banque du Liban’s reckless strategy of offering unsustainable interest rates gave the illusion of health, but beneath it, the system was unraveling. When the liquidity crisis struck and banks froze deposits, that trust evaporated, and without trust, financial systems cannot function. In major financial centers, decades of reliability and prudent risk management uphold confidence, even in times of crisis.
Regulatory Oversight
Effective financial centers are supported by robust, transparent regulatory oversight that enforces accountability and mitigates risk. Countries like Switzerland or Singapore balance financial freedom with strict regulations that prevent over-leveraging and speculative behavior. Lebanon, on the other hand, was crippled by weak oversight and deep political entanglements.
Resilience to Economic Shocks
Resilient financial centers are designed to absorb economic shocks through diversified economies, strong foreign currency reserves, and sound fiscal policies. Lebanon’s economy, in contrast, was overly dependent on external sources like tourism, remittances, and foreign aid. By 2019, its foreign reserves were nearly depleted due to futile attempts to defend the currency peg. When global and regional crises hit—such as the COVID-19 pandemic and the Syrian refugee influx—Lebanon’s financial system had no buffer to absorb these shocks.
Conclusion: A Perfect Storm
Lebanon’s financial collapse is a stark lesson in how internal mismanagement and external crises can combine to unravel even a seemingly stable financial system. While the country’s reliance on unsustainable financial practices set the stage for disaster, the Syrian refugee crisis, withdrawal of Gulf support, and external shocks like the COVID-19 pandemic hastened its downfall. Lebanon's lack of market trust, weak regulatory oversight, and inability to withstand shocks made it highly vulnerable.
Lebanon’s story is a reminder that financial stability is not just about wealth; it is built on trust, transparency, and resilience. Without these elements, even prominent financial centers can fall apart quickly, as Lebanon tragically demonstrated.
