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Mounir Mahmalat, senior researcher at the Lebanese Center for Policy Studies


April 2020
Deposits Made “Sacred”: The Dangerous Red Line of Lebanon’s Elites

The government’s leaked “economic rescue plan” exposes Lebanon’s present-day power struggle between communal elites and a reformist protest movement. While several assumptions and projections are questionable, the plan depicts as inevitable a contribution of large deposits in the form of bail-ins to cover losses of $83 billion only in the banking sector—a magnitude twice as large as the national GDP in 2020. In such a scenario, a part of the largest deposits could be transformed into bank equity or placed into a dedicated fund to be replenished with reclaimed “stolen funds.”
 
Communal elites and party leaders didn’t spare strong words to denounce that plan. While Speaker of Parliament Nabih Berri unceremoniously declared deposits as “sacred”, former Prime Minister Saad Hariri prophesied “economic suicide” when deposits would be used to cover banks’ losses—this is assuming that much more could be dispatched of the economy. Other leaders from all political parties followed suit, including Hezbollah and the Progressive Socialist Party. Liquidity injections into the banking system in a bail-out scenario should leave deposits untouched and be financed largely by privatization of state assets.
 
Despite the high stakes at play for the bank accounts of politicians and their cronies as well as the legal complexity of bail-ins, this unusual unity is not trivial to explain. For sure, by accepting any cut on deposits, elites would admit political defeat and declare a 30-year legacy of economic policies as a miserable failure.
 
Yet, the lack of alternatives incurs high economic and political risks. As political or economic realities would render a contribution from large deposits necessary, political leaders will have to go a long way to avoid significant reputational losses. It could be cheap wins for an imaginary “progressive” leader to be willing to forego a part of his wealth for reputational and political gains in the future “in the interest of the country.”
 
Secondly and more importantly, such tough opposition raises the question as to how political leaders calculate the opportunity costs to bail-ins. As political and economic alternatives are—put mildly and as leaders know themselves—limited, the payoffs of an alternative scenario require scrutiny. As explained below, alternative policies would likely entail losing an even larger part of deposits, requiring anticipated payoffs from alternative scenarios to be higher than the losses from a bail-in.
 
In other words: What’s the tradeoff?
 
While complex, there are roughly two financing scenarios to cover banks’ losses, recover trust into the banking system, and eventually ease capital controls. The first is the above mentioned bail-in scenario, by which a certain percentage of large deposits will undergo a forced conversion into bank equity. Considering lessons from the 2008 global financial crisis, Cyprus, for example, has used such bail-ins to prevent bank failures in 2012 and 2013 by requiring depositors holding more than €100,000 to write off a part of their holdings. In Lebanon, the overwhelming majority of account holders would be unaffected by such a plan (the 2% of depositors referenced by PM Diab, those above $500,000, amount to roughly $93 billion). Alternatively, the governmental plan proposes the transfer of these deposits into a dedicated fund that would be replenished with the proceeds of anti-corruption efforts and reclaimed “stolen funds.”
 
The effect would be a redistribution of wealth from the richest to the remainder of the population, in particular smaller depositors. Accompanied in a comprehensive reform program, bail-ins are significantly more likely to attract international support. Capital account restrictions could be lifted relatively swiftly, and banks could start lending to the private sector again. Most importantly, however, bail-ins have the potential to change politics by giving elites incentives to pursue anti-corruption efforts to bail out themselves.
 
A bail-out scenario, on the other hand, would include cash-injections into banks. In the absence of external capital inflows, however, these funds would have to come from the sale of state assets (i.e. privatizations) or international organizations, such as the International Monetary Fund (IMF).
 
Yet, a bail-out scenario will prove woefully inapt to address the magnitude of the challenge. For one, privatizations in the present situation are questionable for a number of normative and economic reasons. Privatizations effectively transfer wealth from non-depositors—the poorest of society—and ordinary taxpayers, to major depositors—the society’s richest. Wealth would be concentrated even further in the hands of a few individuals and exacerbate inequality in a country that is already among the most unequal worldwide.[i]
 
Moreover, a bail-out would essentially free-up elites of any incentives to push for anti-corruption efforts and the recovery of stolen funds in any meaningful way. Their deposits would be secured independently which would significantly undermine the credibility of anti-corruption efforts and the attached reform program.
 
Privatizations are also questionable from an economic efficiency perspective. In corrupt polities, they tend to yield inefficient results due to political interference in tendering processes. Moreover, prices of state assets are likely to be undervalued during crises, as bidders can leverage the precarious financial position of states to push prices down.
 
Lastly and most importantly, however, even the privatization of all remaining state assets will fall short of attracting the funds needed to recover losses and restore confidence. That way, as happened in the case of Cyprus, any bail-out scenario would unlikely attract the international support necessary to stabilize the economy. In Cyprus, the IMF deemed losses of about 50% of GDP to be too large for a bail-out. The losses of 200% to GDP in Lebanon’s case will likely make this claim even stronger. Further import contractions would be unavoidable and risk a prolonged and severe recession that would induce high inflationary pressures and shortages of basic goods. Capital controls would remain in place. Foreign currency depositors would have no chance to recover their assets.
 
But if the alternatives to bail-ins threaten the entirety of elites’ deposits, why, then, would they oppose?
 
Two reasons explain such resistance. First, bail-ins threaten legal prosecution of politicians and elites. The prevailing banking laws require that not only board members, but also ‘special’ shareholders that can be proven to have had a significant influence on decision making at a bank, be held accountable in the case of a failure of a bank. With politicians being heavily connected in the banking sector,[ii] special investigations in case of any bankruptcy or forced losses threaten politicians with asset freezes and legal prosecution.
 
The second reason relates to the uncertainty of the distribution of costs of a bail-in.[iii] Due to Lebanon’s strict banking secrecy, none of the elites know for certain the extent to which other elites (and their cronies funding their various clientelist networks) are exposed to a bail-in. No one knows, who holds which deposits and assets in banks. From the perspective of elites, it is individually rational to prefer the status quo or a bail-out, as a bail-in bears the risk that an individual elite emerges worse off vis-à-vis other elites—without even knowing it. As the country’s stability rests on a delicate balance of economic, political, and military power,[iv] a bail-in threatens to shift this balance in unpredictable ways.
 
The danger, then, lies in elites’ perception of the opportunity costs of uncertainty. Opposing bail-ins essentially keeps inter-elite contestation over the distribution of losses within the realm of what is known. Elites now face the challenge of calculating the anticipated payoffs from maintaining the present-day balance of economic and political power in the future. These payoffs accrue from continued control over economic functions of the state. Economic recovery and large parts of an individual elites’ deposits would be a painful but necessary sacrifice.
 
And herein lies the tragedy of Lebanon’s present-day power struggle. Continued economic decline reinforces the very foundation of Lebanon’s political settlement, its clientelist networks. Spiraling inflation, protracted recession, and soaring poverty rates will deepen the dependencies of constituencies to elites and their partisan providers of social services. Shaken to its core during the October 2019 uprisings, elites work hard to seize the golden opportunity offered by the COVID-19 health crisis to strengthen their normative and economic power. All over the country, parties ramped up support facilities for COVID-19 patients and families in need that had lost their jobs and income over the lockdown. Even before the onslaught of the COVID-19 crisis was access to healthcare the number one priority of citizens for public services,[v] making it a prime service for targeted patronage.[vi] Identifying the recipients of the recent aid-package by the government of LL400,000 per family in need via local NGOs and parties figures too well in that picture.
 
Traditional networks, however, are likely to be as cash-stripped as the rest of the economy. The most important sources of rent generation simply dried up.[vii] This includes the public sector, exploited by extensive abuses of employment[viii] or procurement,[ix] as well as the private sector, riddled by both a supply and demand side shock, while much of elites’ money remains tied up in banks.
 
In the short term, the COVID-19 crisis might offer opportunities to ramp up political support via healthcare services. Longer-term, however, the strategies of partisan providers will have to adapt. Little will be left for citizens other than core supporters of parties, opening the doors for further polarization, exclusion, and conflict over scarce resources among communities.
 
Eventually, as providers reinvent themselves to sustain their constituents’ support, fear-based mechanisms might prove more effective to organize social and political life, such as fear of other communities or retaliation against defectors.[x] Municipalities all over the country already enforced segregation and closed their doors to protect residents of the perceived dangers of out-group members. This is only a part of a larger trend. In 2018, 21% of the Lebanese said they strongly disliked or disliked having members of a different religion as neighbors, up from 5% in 2007.[xi] Playing the fear card would lend legitimacy to Lebanon’s clientelist networks for the time to come.
 
Opposing any form of bail-in therefore essentially reinforces the model of sectarian governance that precipitated todays’ economic and financial calamity. The can will be kicked down the road, only that less state property can be made liquid in the next crisis. Mass protests will pick up and, fueled by decreases in purchasing power, heightened polarization and inequality, as well as the perennial feeling of injustice of elites, will potentially facilitate violence.[xii]
 
To be sure, bail-ins are no panacea. They are complex and can both economically and normatively only be legitimized as part of a larger reform program that offers prospects for compensation. But unless some elites have a hidden masterplan that includes a blanket check from a friendly government, opposing a contribution from large depositors renders staggering poverty and social disarray virtually inevitable. Well experienced in the threat or exercise of violence, it appears to be simply easier for elites to calculate the distribution of losses of potential conflict rather than the losses from a bail-in.
 
Who, then, could oppose the opposition? The country’s elites and the most powerful interest groups are united in rejecting a bail-in.[xiii]
 
Political headwind comes from the spirits elites have cited themselves. With external advice, the government under Prime Minister Hassan Diab appears to understand the gravity of the situation. By insisting on bail-ins, the plan avoids many contentious measures that would redistribute wealth from the poor to the rich. Most importantly, the plan offers a roadmap to increase the incentives of elites to curb corruption and execute structural reform. Threatened by the retrieval of political support by party leaders, however, the government will unlikely be able to withstand the united pressure of communal leaders on its own.
 
Tragically, the health crisis currently prevents another important interest group to chip in: The remainder of the population. As large-scale protests remain intricate for the time to come, alternative means of collective action need to be used.
 
For economics to improve, politics must change. Exposing this reality, international actors, the IMF in particular, must strongly condition financial support to a contribution of wealthy depositors to ensure their support for anti-corruption and reform efforts. By setting the criteria for bail-ins, however, it should aim to spare ordinary pension plans and life savings as much as possible. [xiv]
 
But depression is not a fate. It is now on Lebanon’s vibrant professional and scholarly community to shed light on elites’ dangerous tradeoff. Citizens’ engagement is needed at all levels to engage with local and national politicians to push for the counter-intuitive: Openly support the efforts of its government.
 
 
The author is grateful for inspiration from Sami Zgheib and Mohamad Faour.


[i] Facundo Alvaredo, Lydia Assouad, and Thomas Piketty, “Measuring Inequality in the Middle East 1990-2016: The World’s Most Unequal Region?,” Centre for Economic Policy Research, Discussion Paper, No. 12405 (2017).
[ii] Jad Chaaban, “I’ve Got the Power: Mapping Connections between Lebanon’s Banking Sector and the Ruling Class,” in Crony Capitalism in the Middle East – Business and Politics from Liberalization to the Arab Spring, ed. Ishac Diwan, Adeel Malik, and Izak Atiyas (Oxford: Oxford University Press, 2019).
[iii] Raquel Fernandez and Dani Rodrik, “Resistance to Reform: Stats Quo Bias in the Presence of Individual Specific Uncertainty,” American Economic Review 81, no. 5 (1991): 1146–55, https://doi.org/10.2307/2006910.
[iv] Mounir Mahmalat, “Balancing Access to the State: How Lebanon’s System of Sectarian Governance Became Too Costly to Sustain,” Lebanese Center for Policy Studies, no. forthcoming (2020).
[v] UNDP, ARK Wave VII
[vi] Melani Cammett, Compassionate Communalism - Welfare and Sectarianism in Lebanon (Ithaca and London: Cornell University Press, 2014).
[vii] Mahmalat, “Balancing Access to the State: How Lebanon’s System of Sectarian Governance Became Too Costly to Sustain.”
[viii] Bassel F. Salloukh, “Taif and the Lebanese State: The Political Economy of a Very Sectarian Public Sector,” Nationalism and Ethnic Politics 25, no. 1 (2019): 43–60, https://doi.org/10.1080/13537113.2019.1565177.
[ix] Reinoud Leenders, Spoils of Truce: Corruption and State-Building in Postwar Lebanon (Ithaca: Cornell University Press, 2012).
[x] Laura Paler, Leslie Marshall, and Sami Atallah, “The Fear of Supporting Political Reform,” Lebanese Center for Policy Studies, no. 31 (2018).
[xi] Arab Barometer Wave I and V
[xii] Lars-Erik Cederman, Kristian Skrede Gleditsch, and Halvard Buhaug, Inequalities, Grievances, and Civil War (Cambridge: Cambridge University Press, 2013).
[xiii] http://www.businessnews.com.lb/cms/Story/StoryDetails.aspx?ItemID=7561&NewsletterID=368
[xiv]








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