Lebanon's Central Bank Governor Riad Salameh speaks during a news conference at Central Bank in Beirut, Lebanon, November 11, 2019.

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Lebanon’s central bank meltdown is a cautionary tale of financial engineering running amok


Photo Credit: REUTERS/Mohamed Azakir


The recent announcement by US, British, and Canadian authorities freezing the assets of retiring Lebanese central bank governor Riad Salameh marked an ignominious end to an extraordinary episode in central banking. Salameh is already under investigation in several European countries, and arrest warrants have been issued.

While recent commentary has focused on accusations that Salameh may have embezzled over $300 million from the central bank (Banque du Liban), the wider story is of the remarkable financial engineering transactions in which that central bank had been engaged for several years, and which provided a cover behind which embezzlement could be concealed.

The financial engineering was presented as a device for ensuring monetary and exchange rate stability, but eventually it proved to be anything but. Lebanon’s banks had long been trusted for modernity and reliability in an unstable region, and they attracted a disproportionately large volume of deposits from the Lebanese diaspora and others, both in dollars and in Lebanese pounds. Now these dollar deposits are virtually inaccessible, and the Lebanese pound has lost more than 98 percent of its value.

Simplifying somewhat, the now notorious financial engineering operations essentially transferred the Lebanese banks’ foreign exchange reserves to the central bank, which then used them to service the foreign debt of Lebanon’s government and to cover some of the trade deficit. In return, the banks received paper assets on terms that made them look profitable (and enabled them to pay sizable dividends to their shareholders) but that cannot now be honored by the central bank.

The sums involved are eye-wateringly large—with the foreign exchange gap in the central bank’s assets now estimated at about $72 billion, or more than three years of Lebanon’s current GDP. Heavy losses indeed for those who trusted the Lebanese banking system. This failure has contributed to a disastrous collapse in economic activity. GDP now runs at less than two-thirds of what it was five years ago.

All along, the Banque du Liban reported a healthy balance sheet, but this was only by dint of highly misleading accounting and reporting practices that it would be charitable to describe as unconventional.

Salameh’s defenders may argue that his financial engineering was designed to maintain the exchange rate peg as an anchor of stability popular among elites in a country where politics has long been dysfunctional. Might this anchor not be useful to hold the fort until such time as, perhaps aided by a debt write-down from Lebanon’s creditors, fiscal policy could be reset on a credible path? This was a pipe dream. True, the exchange rate peg lasted for over 20 years, during which a few such rescues had been arranged. But, by easing the government’s immediate needs, the engineering worsened Lebanon’s underlying financial condition and postponed indefinitely the policy reforms prerequisite for another international bailout.

Besides, such an excuse wears thin against the evidence that these asset transfers were accompanied by commission payments to a shadowy brokerage firm controlled by a Salameh relative. At 0.375 percent, commissions on tens of billions soon run into hundreds of millions. One wonders whether the large transfers motivated a desire to cream off some, or the scale of the financial engineering was really driven by the desire to generate a substantial embezzlement. After all, 20 years ago Andrei Shleifer and Robert W. Vishny showed how mechanisms for corruption can generate economic losses to the rest of the society far in excess of the benefit to their architects.

Having been reappointed four times to six-year terms, Riad Salameh’s tenure at the Banque du Liban lasted 30 years. Although long-serving governors of other central banks have not always become compliant to the desires of the politicians who can reappoint them, let alone succumbed to the temptations of corruption, a better model for senior central banking appointments is arguably the European Central Bank’s eight-year nonrenewable contract.  

Over the years, various governments around the world have on occasion made allegations of criminal corruption against central bankers, though the sums involved have been smaller. To take a few recent examples, Governor Kyrylo Shevchenko of the National Bank of Ukraine resigned in October 2022 and fled the country when charged with embezzlement. People’s Bank of China Deputy Governor Fan Yifei has recently been fired for corruption. Back in 2008, Governor Burhanuddin of Bank Indonesia was jailed for five years for misuse of funds. Even in the euro area, there is the case of Governor Ilmars Rimsevics of Latvijas Banka, who is still awaiting trial on charges of accepting bribes.

To be sure, politicians can use false allegations of corruption to topple officials they want to be rid of. Governor Daudi Ballali of the Bank of Tanzania died in 2009 shortly after being fired for fraud; though I am assured by well-informed people that he was an innocent victim of a political power struggle. In Nigeria, courts acquitted former governor Charles Soludo of corruption charges in 2015.

Meanwhile, Lebanon’s miserable economic and political plight looks no nearer to a solution. Central banks should underpin economic prosperity, not undermine it.

Data Disclosure

This publication does not include a replication package.

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