Political divisions in Lebanon over a controversial banking bill could derail the country’s drive to pass reforms that would secure an IMF deal and pull it out of its crushing financial crisis.

The draft law is the most important in a series of reforms Prime Minister Nawaf Salam’s government has introduced since taking office last year, vowing to restructure the banking sector and negotiate a deal with the IMF where its predecessors had failed.  

Lebanon’s 2019 economic collapse, triggered by a foreign currency crunch and decades of policies by a central bank governor facing embezzlement charges, which he denies, was ranked by the World Bank as one of the worst globally in nearly two centuries.

Much of the country was plunged into poverty as the local currency lost more than 90 per cent of its value, banks cut savers off from their money and the government defaulted on its debt.

More than six years later, Lebanon’s finance ministry, the central bank and banking sector remain divided over how much of the estimated $70bn of losses from the crisis commercial banks should bear versus the state. 

The controversial bill is a pillar of the IMF’s requirements for any funding deal and outlines how hundreds of thousands of depositors whose savings were frozen will be repaid.

Wrangling over who should shoulder the biggest losses will intensify when parliamentarians debate the bill formally in the coming weeks.

“The government is trying to placate big depositors, the banks, the public and the IMF at the same time, and you really can’t do that within debt sustainability constraints,” said Mike Azar, an expert on Lebanon’s financial crisis.

Every depositor will be paid up to $100,000 within four years under the proposal, with the central bank contributing 60 per cent and commercial banks 40 per cent.

Large depositors will also receive securities issued by the central bank. Backed by revenues from central bank assets, or proceeds from their liquidation, these will mature over 10 to 20 years, depending on the size of the deposit. Commercial banks will cover a fifth of those payments. 

The draft law has long been the most contentious of Lebanon’s reform attempts because it forces bank shareholders to absorb losses and is an admission to depositors that not all of their money will be returned, which is seen as politically toxic, Azar said.

Banks warn the bill threatens their existence and punishes those with the most money, with little guarantee the securities will maintain their value or be paid back on time.

“The draft adopts a logic that amounts to the liquidation of the banking sector,” the Association of Banks in Lebanon said in January. “It sacrifices large depositors, upon whom the Lebanese economy depends, destroys confidence in the banking sector, [and] wipes out banks’ capital.”

Disagreements over the proposal centre on two main points: how much the state will pay the central bank to fund the plan, and whether commercial banks will bear losses before or after a deduction for items such as interest earned and money transferred abroad.

An IMF deal is seen by Lebanese authorities as key to recovering from the crisis. But to unlock funding, the IMF says Lebanon must pass laws that restructure its banking sector and address the losses from the disaster.

Previous administrations have failed to pass most of the reforms demanded by the IMF — stymied by infighting and pushback from economic and political elites. A preliminary 2022 deal with the IMF stalled after authorities failed to deliver the required changes.

The latest government has said it is determined to negotiate an agreement. It has already enacted a banking secrecy law and a framework for how authorities should approach defaulting banks — both key reforms demanded by the IMF.

But the draft of the latest law falls short of IMF requirements. The Fund is not satisfied that the reforms would leave the state able to pay for public services and honour its debts. It also wants bank equity to be depleted before the deduction on deposits applies.

That puts it at odds with commercial lenders, the central bank and politicians who want the state to shoulder more of the losses and for the deduction to apply first.

Yassine Jaber, Lebanon’s finance minister, said that if the state was forced to foot a large part of the bill, the burden would fall on taxpayers.

“Who will pay? Who is the state? Who is the treasury?” Jaber said in an interview with the FT. “The state is people.” 

“In agreement with the IMF, our priority is the small depositors, who are the majority of the people,” Jaber said, adding that 85 per cent of accounts will be repaid in full over the first four years of the plan.

While some MPs will push in coming weeks for changes that satisfy the IMF, others want amendments that align with the central bank and banks’ position. Ministers for the powerful Lebanese Forces party opposed the law in cabinet.

Banks and some politicians accuse the state of spending much of the money that was lost in the crisis and say it is now dodging responsibility.

“The state cannot act as if it was sitting on the Copacabana beaches and it read in a newspaper that there is a crisis in distant Lebanon,” said Nassib Ghobril, chief economist at Byblos Bank, one of Lebanon’s biggest lenders.

A major concern for the IMF is a clause that says the state must recapitalise the central bank if needed.

Azar warned that because the central bank and the banks may not be able to meet their future payment obligations under the bill, this could impose a large potential debt on the state and cause it to default on its debts again.

The draft law also says the finance ministry must agree with the central bank how much the state owes it — a sum that is bitterly contested.

Critics have said a high amount risks balancing the central bank’s books — minimising the banks’ liabilities — at the expense of government spending and the broader economy.

The central bank said in a statement it had “worked collaboratively” with the finance ministry “to determine the state’s obligations” towards it.

Discussions around the bill were “constructive”, it said, adding: “There are no insurmountable obstacles — only serious and ongoing negotiations”.

Jaber said the government wanted to “reach an understanding with the IMF on what’s, in their opinion, a ratio that will keep our debt sustainability reasonable to be able to move on with an agreement”.

If the demands of the central bank and banks are met, he warned, parliament “will kill the IMF deal”.