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Lebanon's Banking Crisis Transformed Far More Than Bank Balance Sheets; It Transformed The Very Nature Of Bank Deposits
Mohammad Ibrahim Fheili
Executive in Residence with Suliman S. Olayan School of Business (OSB) at the American University of Beirut (AUB) and Capacity Building Expert
Published
July 12, 2026
Introduction: A Question Lawmakers Have Not Yet Asked
As this paper goes to print, Lebanon's executive and legislative branches have finally entered the room they avoided for nearly seven years. Cabinet sessions and parliamentary committees are now debating draft banking resolution and gap laws, weighing formulas for allocating losses among the state, Banque du Liban, commercial banks, shareholders, and depositors. After years of paralysis, this is progress. It is also, in its current form, an exercise built on an unexamined assumption.
Every draft circulating in Beirut proceeds as though the word "deposit" still means what it meant in 2018: a fungible, on-demand, par-value claim, identical in substance no matter whose name sits on the account. Committees argue over haircuts, thresholds, and phased repayment schedules. They argue far less over what, precisely, is being cut, thresholded, or repaid. That silence is the single greatest risk to the legitimacy of whatever law eventually emerges.
This paper makes a direct appeal to those now drafting Lebanon's banking resolution and gap laws: define the object before you legislate its fate. A restructuring law is, at its core, an instrument for reallocating a claim. It cannot responsibly reallocate a claim whose legal description and economic substance have quietly diverged, without first stating which of the two, the legal fiction or the economic reality, the law intends to govern. Skipping that step does not simplify the task. It only postpones the dispute, and moves it from the legislature to the courts, where it will resurface as litigation over whether the law expropriated something that a 2019 deposit slip said it should never have to.
The definitional question is not academic hair-splitting; it is the load-bearing wall of the entire resolution architecture. If lawmakers define a deposit as the demand liability it was before 2019, then any haircut is a taking, and must be justified, and likely compensated, as one. If they instead acknowledge what this paper documents, that years of BDL circulars already reclassified deposits into economically heterogeneous claims with divergent liquidity, access, and recovery profiles, then the law's task changes. It is no longer inventing a loss allocation from scratch; it is formalizing, transparently and equitably, a stratification that administrative practice has already imposed informally. These are not cosmetic differences. They lead to different formulas, different legal defenses, and different levels of public acceptance.
End of Dispatch
A gap law that allocates losses without first defining, clearly, objectively, and in the text of the law itself, what a deposit is at the moment the law takes effect, is not resolving Lebanon's banking crisis. It is drafting the next one, in the form of a decade of litigation over a term it never bothered to specify. Lawmakers do not need to accept this paper's framework to take the underlying point seriously. They need only accept that "deposit" is no longer a self-evident word, and that legislating around it without saying so is not neutrality. It is a choice, made by default, that will not survive first contact with a courtroom.
The remainder of this paper sets out why that definitional question arose in the first place, and what answering it honestly would require.
For nearly seven years, Lebanon's financial collapse has been described through a familiar vocabulary. Analysts have debated the size of the financial gap, the distribution of losses, the responsibility of the state, the role of Banque du Liban (BDL – Lebanon’s Central Bank), the conduct of commercial banks, the rights of depositors, and the conditions imposed by the International Monetary Fund (IMF). These debates have produced thousands of pages of reports, policy papers, and political arguments. Yet they have largely overlooked a more fundamental question. What became of the bank deposit itself? This is not merely a legal or philosophical inquiry. It lies at the very heart of understanding Lebanon's banking crisis.
Public debate has been dominated by questions such as: Where did the deposits go? Who should bear the losses? Should depositors accept a haircut? These are undoubtedly important questions. But they all begin from an implicit assumption that the financial instrument we continue to call a "bank deposit" remained the same throughout the crisis; it certainly did not. That may be the single most overlooked aspect of Lebanon's financial collapse.
Legally, deposits never disappeared. Commercial banks continue to recognize them as liabilities on their balance sheets. Depositors continue to receive statements showing balances that often differ little from those recorded before the crisis. From a contractual perspective, the deposits still exist. Economically, however, they became something entirely different.
A conventional bank deposit is one of the simplest and most trusted instruments in modern finance. It is expected to be immediately accessible, payable at par, freely transferable, and accepted as money for virtually every economic transaction. Its value rests not only on the amount recorded in an account but also on the confidence that the funds can be accessed whenever needed. That confidence has largely vanished.
Since late 2019, millions of Lebanese depositors have discovered that their deposits no longer possess the characteristics that traditionally define a demand deposit because access has become conditional; liquidity has become scarce, repayment has become uncertain, and purchasing power has been eroded by multiple exchange-rate regimes, inflation, and prolonged administrative restrictions. What once functioned as money increasingly behaves like a distressed financial claim whose value depends on uncertain future recovery rather than immediate availability; this distinction changes the way we should think about the crisis.
The dominant narrative has portrayed Lebanon's banking collapse as a story of disappearing wealth. A more accurate description is that the economic identity of deposits gradually changed while their legal identity remained largely intact. Depositors did not simply lose access to their money; they found themselves holding financial claims whose economic characteristics had been fundamentally transformed without any comprehensive restructuring law or formal banking resolution.
This transformation did not occur overnight, nor was it the product of a single policy decision. It emerged gradually through the interaction of sovereign default, central bank fragility, liquidity shortages, exchange-rate fragmentation, and successive regulatory interventions designed to manage a banking system operating under conditions of functional insolvency. By the time policymakers began debating bank restructuring, the deposits they sought to restructure were no longer the same financial instruments that had existed before the crisis.
Recognizing this reality is more than an academic exercise. It changes how we assess depositor losses, how we evaluate proposals for banking resolution, and how we allocate responsibility across the state, the central bank, commercial banks, shareholders, and depositors themselves. Most importantly, it forces us to ask a different question. Rather than asking only who should bear the losses, we must first understand how the deposits themselves were transformed long before those losses were formally recognized. Only then can we begin to design a banking recovery that reflects economic reality rather than accounting fiction.
Deposits Were Never Money. They Were Always Financial Claims. One of the greatest misconceptions in modern banking is also one of its greatest strengths. Most people believe that when they deposit money into a bank, the bank simply stores it until they decide to withdraw it. The language we use reinforces this perception. We speak of "my money in the bank" as though the bank were merely providing a secure vault. That is not how modern banking works.
Legally, the moment funds are deposited in the bank, ownership of the cash transfers to the bank. The depositor no longer owns the specific banknotes that crossed the counter. Instead, the depositor acquires something different: a contractual claim against the bank for repayment of an equivalent amount. This distinction may appear technical, but it lies at the foundation of every modern banking system.
Banks do not safeguard deposited cash in isolation. They transform it. Deposits finance mortgages, business loans, government securities, trade finance, and countless other economic activities. They also support the payment system that allows economies to function efficiently. In return, depositors receive an unsecured promise that the bank will repay them on demand. That promise normally works because society has confidence in the institutions standing behind it.
Commercial banks are subject to prudential regulation. Central banks stand ready to provide emergency liquidity under exceptional circumstances. Deposit insurance schemes protect smaller depositors in many jurisdictions. Capital requirements, liquidity standards, and supervisory oversight all exist to reinforce a simple expectation: that a bank deposit can be treated as the functional equivalent of money.
For generations, this arrangement has worked remarkably well. Confidence became so deeply embedded that few depositors ever stopped to consider the legal reality underlying their accounts. Banking functions because people trust promises. The importance of that trust becomes apparent only when it disappears.
Every major banking crisis in history has revealed the same underlying truth. A bank deposit is not money in the physical sense. It is a financial claim whose value depends on the institution's ability, and ultimately the financial system's ability to honor that promise. Normally, the distinction is invisible, and during systemic crises, it becomes everything. This is precisely what unfolded in Lebanon.
As confidence in the banking system began to erode in late 2019, depositors first encountered what looked like temporary operational restrictions such as: withdrawal limits appeared, transfers abroad grew harder to execute, and administrative approvals multiplied where each measure of those was presented by policymakers as an exceptional response to extraordinary circumstances; a description that would prove far more durable than the circumstances themselves. But systemic crises have a way of transforming temporary measures into structural realities.
As liquidity continued to deteriorate, the characteristics that had made deposits function as money gradually disappeared as a result of a number of measures: Immediate access became conditional; full convertibility became uncertain; the certainty of repayment weakened; and time itself became an instrument of adjustment as depositors waited months and then years without knowing when or under what conditions they would regain unrestricted access to their savings. However, and despite all this, the legal contract between the bank and the depositor remained largely intact. The economics of that contract did not.
This distinction helps explain why many observers have struggled to understand the Lebanese crisis. They continued to analyze deposits as if they were ordinary demand liabilities while their economic characteristics had already begun to resemble those of distressed financial assets.
Financial markets routinely value bonds, loans, and other claims according to expected recovery rather than contractual promises alone. A corporate bond issued by a financially distressed company may retain its full legal face value while trading at a substantial discount because investors doubt whether the issuer can honor its obligations. The same logic applies to sovereign debt. Governments may continue to recognize their obligations in full, yet markets price those claims according to expected repayment, timing, and risk.
Lebanon's banking crisis extended that same logic to ordinary bank deposits. Without any formal restructuring law, millions of deposits gradually ceased to be valued solely by their nominal balances. Their economic worth increasingly depended on liquidity, accessibility, repayment uncertainty, exchange-rate treatment, and confidence in the interconnected balance sheets of commercial banks, Banque du Liban, and ultimately the Lebanese state. In other words, deposits did not disappear; they were repriced. Recognizing this shift is essential because it changes the very starting point of the debate. If deposits had already evolved into distressed financial claims, then proposals to restructure deposits were not addressing unchanged financial instruments; they were attempting to resolve claims that had already undergone years of silent economic transformation.
Lebanon Didn't Just Freeze Deposits. It Quietly Reclassified Them.
If deposits were gradually transformed into financial claims, another question naturally follows: were all those claims still the same? Legally, the answer is largely yes. A U.S. dollar deposit remained a U.S. dollar deposit. Banks continued to recognize their obligations. No law formally divided depositors into different legal classes. Economically, however, something very different was taking place. Imagine two Lebanese depositors who each held USD 500,000 before the crisis. On paper, their claims appeared identical. Yet as the years passed, the practical rights attached to those deposits increasingly diverged. One depositor might have gained access to fresh funds transferred after the crisis (BDL Basic Circular 150, and 165); another remained confined to legacy balances subject to withdrawal ceilings (BDL Basic Circulars 151 and 166), administrative approvals, and exchange-rate conversion mechanisms. A third might have qualified for preferential treatment under a specific BDL circular (mainly BDL Basic Circular 157, 158, 161, or other arrangements) a more favorable exchange-rate platform, a medical or educational withdrawal exemption unavailable to others holding the same nominal balance. The contractual obligation remained unchanged. The economic experience did not.
This transformation was not the result of a single law or one dramatic policy decision. It emerged incrementally through successive regulatory circulars issued by Banque du Liban. Each circular was introduced to address an immediate operational challenge: preserving scarce foreign currency liquidity, managing payment pressures, or maintaining the functioning of an increasingly fragile banking system. Viewed individually, these measures appeared temporary and technical. However, when viewed collectively, they accomplished something far more profound.
They progressively differentiated deposits according to their practical economic characteristics, so that liquidity, accessibility, and transferability no longer meant the same thing from one account to the next. Exchange-rate treatment varied depending on which circular applied. Expected recovery timelines diverged. Purchasing power eroded at different rates depending on how and when funds could be accessed. In effect, deposits that remained legally homogeneous became economically heterogeneous. I describe this phenomenon as Implicit Deposit Tranching.
The term intentionally borrows from the language of structured finance, but only as an analytical metaphor. In structured finance, securities are intentionally divided into contractual tranches before investors purchase them. Senior investors knowingly receive greater protection than junior investors, and the hierarchy is fully disclosed from the outset; Lebanon followed the opposite path. Depositors never chose different categories of deposits. They all entered the crisis holding what they reasonably believed were ordinary demand deposits. Only after the banking system became functionally insolvent did successive administrative measures begin assigning different economic characteristics to claims that had originally been identical.
The hierarchy emerged after the crisis, not before it. More importantly, it emerged without Parliament enacting a comprehensive banking resolution law or formally redefining depositor rights; which means administrative practice accomplished what legislation never explicitly declared.
Whether policymakers intended this outcome is ultimately beside the point; the cumulative effect was unmistakable. Lebanon did not merely manage a liquidity crisis; it quietly reshaped the economic nature of bank deposits themselves.
Recognizing this transformation helps explain why so many restructuring proposals have struggled to gain public legitimacy. They often treated deposits as though they had remained economically unchanged, when in reality years of regulatory intervention had already altered their value, liquidity, maturity, and expected recovery.
Understanding what happened to deposits must therefore precede any meaningful discussion of what should happen to banks. The real loss wasn't the haircut; it was the transformation.
Public debate has long revolved around the size of the financial gap and how it should eventually be allocated among the state, Banque du Liban, commercial banks, shareholders, and depositors. Yet this debate overlooks an equally important question. How were those losses transmitted in the first place? The distinction is more than semantic; it changes how we understand the entire crisis. Losses do not suddenly materialize on the day a restructuring law is passed. They accumulate gradually. They spread through the financial system long before they are formally recognized. That is precisely what happened in Lebanon.
Depositors did not wait for an official haircut to experience losses. Those losses arrived through different channels over several years: inflation steadily eroded purchasing power; exchange-rate fragmentation reduced the real value of withdrawals; and liquidity restrictions deprived depositors of opportunities to invest, consume, educate their children abroad, or preserve their wealth. Time itself became a mechanism of financial adjustment; discounting claims that remained legally intact but economically impaired. In effect, depositors absorbed significant portions of the crisis before anyone officially acknowledged that losses existed. This distinction between loss transmission and loss allocation deserves far greater attention than it has received.
Loss transmission describes the economic mechanisms through which wealth is gradually redistributed during a systemic crisis. However, loss allocation concerns the legal and political decision regarding who should ultimately bear those losses. The former often precedes the latter by years. Ignoring this sequence risks misunderstanding both the scale of depositor losses and the fairness of any eventual restructuring. A depositor who has already endured years of inflation, restricted access to savings, exchange-rate distortions, and foregone economic opportunities has already absorbed a substantial share of the adjustment even if no formal write-down has yet occurred.
Future restructuring frameworks must begin by recognizing this economic reality rather than assuming that the adjustment process begins only when legislation is enacted.
Why This Matters Far Beyond Lebanon? It would be tempting to dismiss Lebanon's experience as unique as a consequence of exceptional political dysfunction, sovereign default, and institutional paralysis. That would be a mistake. The broader lesson extends well beyond Lebanon.
Financial crises are becoming increasingly complex; governments are often reluctant to declare banks insolvent; and resolution is delayed for political, fiscal, or social reasons. Moreover, regulators increasingly rely on temporary administrative measures to preserve financial stability while avoiding immediate legal restructuring.
Such strategies may prevent sudden collapse. But they also carry an underappreciated consequence.
Over time, they may quietly transform the financial instruments they seek to protect.
This possibility deserves greater attention from central banks, financial supervisors, international financial institutions, and policymakers responsible for designing future crisis-management frameworks. Banking resolution cannot focus exclusively on balance sheets and legal creditor hierarchies. It must also recognize how prolonged regulatory intervention can reshape the economic characteristics of financial claims long before formal restructuring begins.
Lebanon may therefore represent more than an isolated national tragedy. It may offer an early case study of how unresolved systemic banking crises evolve when governments postpone comprehensive resolution while relying on administrative management to preserve institutional continuity.
Conclusion
Modern banking rests on a remarkably simple social contract. Depositors entrust their savings to financial institutions because they believe a bank deposit represents immediately accessible money. That confidence underpins payments, investment, economic growth, and financial stability itself. Lebanon's banking crisis revealed how fragile that confidence can become.
The country's greatest financial transformation was not simply the disappearance of liquidity, the collapse of the exchange rate, or the emergence of a massive financial gap. It was the gradual transformation of deposits from trusted monetary instruments into uncertain financial claims whose value increasingly depended on regulatory decisions, sovereign capacity, and political negotiations.
That transformation occurred quietly. It unfolded without a comprehensive banking resolution law, without an explicit reclassification of depositor rights, and without formally extinguishing the legal obligations recorded on bank balance sheets. Yet it fundamentally altered the relationship between citizens and their banks.
If there is one lesson that policymakers should carry forward from Lebanon's experience, it is this: restoring confidence requires more than recapitalizing banks or balancing public accounts. Confidence cannot be rebuilt while deposits continue to behave like distressed assets rather than money.
Before allocating losses, we must understand how they were transmitted; before restructuring banks, we must recognize how deposits themselves were transformed.
Only then can Lebanon, and any country confronting a prolonged systemic banking crisis, hope to restore not only financial stability, but also the public trust upon which every banking system ultimately depends.
