Understanding The 2019-2020 Banking and Financial Crisis in Lebanon

This paper explores the nature of the 2019-2020 financial crisis in Lebanon through the lens of the financial engineering operations instituted by the central bank, Banque du Liban (BdL). This study seeks to explore the effects of the financial engineering policy on the BdL balance sheet and the commercial banking system, whether the financial engineering policy met its stated objectives and the discrepancies in rating agencies’ evaluation of Lebanon’s outlook. This paper uses a constructed BdL balance sheet and an aggregate banking system balance sheet that both use standardized definitions and allow for comparisons and tracking of flows between the two systems over time. The analysis suggests that while in the short term, certain goals of financial engineering were met, it was not a sustainable long-term policy in the Lebanese environment of increasing current account deficits, lackluster GDP growth, and a currency peg to the US dollar. Another conclusion is that in the long term, financial engineering operations - while very complex and hard to track - amounted to BdL protecting its stated equity by adding fictitious assets on its Balance Sheet through the “Other Assets” entry. Through this mechanism, it temporarily obscured losses until Other Assets grew so large that it raised concerns over its status as an asset. This led to a short term increase in rating agencies’ outlook on the country during that time interval. Finally, financial engineering exponentially increased the private financial sector’s exposure to the Lebanese government, thereby increasing the banking system’s insolvency risk.