Lebanon Ran a Banking System on Deposits It Had Already Spent
Banks paid high interest to attract dollars, lent those dollars to the central bank, which lent them to the government. When inflows stopped, none of it could be repaid.
The Structure
Lebanon operated with the local pound pegged to the dollar for decades, and a banking system that attracted large dollar deposits, substantially from the Lebanese diaspora.
Banks paid attractive interest rates to attract those deposits. They then placed a very large share of the money with the central bank, which offered them high returns through what were described as financial engineering operations.
The central bank used those funds to support the currency peg and to finance government deficits.
The money was not sitting in the banks. It had been lent to the central bank, which had lent it to the state, which had spent it. The deposits existed as claims, not as assets.
Why It Required Constant Inflow
Paying above market interest on dollar deposits requires generating a return above that rate. The underlying use, financing a government running persistent deficits with a weak economy, did not generate any such return.
The gap was met by new deposits. Interest owed to existing depositors was paid from money arriving from new ones, which is a structure that functions only while inflows exceed outflows.
Inflows depended on confidence and on the diaspora continuing to see Lebanon as a safe place to hold dollars at attractive rates.
The Break
Through 2019, inflows slowed. Regional conditions, domestic political paralysis, and growing awareness of the fiscal position all contributed. Protests beginning in October 2019 accelerated the loss of confidence.
When depositors sought to withdraw dollars, the banks could not deliver them, because the dollars had been lent onward and spent.
What Happened to Depositors
| Measure | Effect on depositors |
|---|---|
| Informal capital controls | Withdrawals limited without any law |
| Conversion at unofficial rates | Dollar deposits paid in pounds far below market |
| Multiple exchange rates | Value depended on which rate applied |
| Currency collapse | The pound lost the vast majority of its value |
The capital controls were never legislated. Banks simply imposed limits, which meant there was no legal framework, no equal treatment, and no formal process. Depositors with connections reportedly moved money out while others could not.
The term lollar entered common use to describe a dollar deposit in a Lebanese bank: nominally a dollar, in practice worth a fraction of one, redeemable only in local currency at a rate the bank chose.
Why Resolution Did Not Happen
A conventional restructuring would allocate the losses among the state, the central bank, the banks and their shareholders, and depositors. Each allocation is politically contested, and the parties who would bear the largest share are well represented in the political system.
The absence of agreement meant losses were allocated by default rather than by design: through inflation, through informal controls, and through the gradual erosion of deposit value. That is the most regressive possible distribution, since it falls hardest on people with no way to protect themselves.
External support was conditioned on reforms including restructuring the banking sector, and progress was slow.
The Structural Lesson
A banking system that lends overwhelmingly to its own sovereign is not diversified. The banks, the central bank, and the state are a single credit exposure, and the appearance of three separate institutions conceals that.
High deposit rates in a weak economy are a warning rather than an opportunity. The return has to come from somewhere, and if the underlying use of funds cannot generate it, the payments are coming from new depositors.
The Bottom Line
Lebanese banks attracted dollar deposits with high rates, lent them to the central bank, which financed the state. The structure required continuous new inflows and collapsed when they stopped. Losses were never formally allocated, so they fell on depositors through informal controls and currency collapse, which is the most regressive outcome available and the one that happens by default when nobody decides.