It’s unclear how much trauma Lebanon’s beleaguered financial sector can take.

Lebanon’s financial sector stands at a crossroads, caught in a cascade of internal and external crises that threaten its future. Sanctions, de-risking practices, and heightened regulatory scrutiny have fractured Lebanese banks’ connections to the global financial system. At home, political dynamics and fear of international sanctions have led banks to adopt internal de-risking practices, exacerbating social divisions and destabilizing the economy.

This analysis delves into the compounded effects of these forces, especially the role of the country’s central bank, whose failure to prioritize domestic financial stability has fueled financial exclusion, increased social fragmentation, and driven many into the informal economy. With the Financial Action Task Force (FATF) decision looming—possibly leading to Lebanon’s blacklisting—the urgency for systemic reform becomes impossible to ignore.

Lebanon’s financial foundations began to quake in October 2019 amid an unprecedented economic collapse, deepening in March 2020 with the chaotic sovereign default. These twin crises destabilized the banking system, causing severe strains on public trust. But even without these upheavals, Lebanon’s financial sector would still be under significant strain. The global phenomenon of de-risking, fueled by U.S. Treasury sanctions and regulatory pressures, would have continued to exert massive pressure on Lebanese banks.

Today, Lebanon’s financial future hinges on international regulatory bodies. As the FATF’s decision approaches, Lebanon must maintain its status or risk a far harsher fate on the “grey” or even “black” list. This decision complicates an already tenuous banking ecosystem beset by sanctions and de-risking.

Domestically, Lebanon’s central bank has failed to shield society from the consequences of local de-risking. In its focus on external threats, the central bank has overlooked the severe impact of internal policies that cut off individuals and businesses suspected of Hezbollah affiliations. By neglecting these issues, the central bank has fueled financial exclusion, social divisions, and the growth of informal financial networks. This lack of action has deepened Lebanon’s economic isolation, worsening the crisis and eroding trust in the banking system.

The U.S. Treasury’s sanctions, particularly against Hezbollah-affiliated individuals and institutions, have had profound consequences for Lebanon’s financial sector. These measures create an atmosphere of caution among international banks, who worry about inadvertent sanctions violations, which has led to increased compliance costs and diminished trust. This environment discourages foreign investors and complicates the flow of foreign aid vital to Lebanon’s economic stability.

The implications of sanctions extend beyond the banking sector, affecting the broader economy. Fearing sanctions, international banks increasingly sever ties with Lebanese institutions, exacerbating Lebanon’s liquidity crisis and limiting the country’s ability to operate within global markets.

However, de-risking practices extend beyond external influences, manifesting internally as Lebanese banks adopt stringent policies to avoid sanctions violations. This internal approach, driven by sanctions fears, has heightened Lebanon’s financial isolation. These practices specifically target those suspected of Hezbollah affiliations, leading to financial exclusion, social and economic fragmentation, and a rise in the informal economy.

One notable consequence of Lebanon’s internal de-risking has been the expansion of Al-Qard Al-Hassan, an organization outside the formal banking structure. This institution has filled the vacuum left by Lebanese banks, which, in turn, has reduced the formal banking sector’s relevance and credibility. The central bank’s inability to control these internal de-risking practices has inadvertently fostered informal networks, weakening the credibility of Lebanon’s formal financial institutions.

The effects of internal de-risking on Lebanon’s economy are dire. Large portions of the population, perceived to have ties to Hezbollah, are cut off from essential banking services, limiting their ability to conduct business, receive salaries, or access credit. These exclusions widen Lebanon’s social and economic divides, undermining the financial sector’s role in fostering cohesion. Instead of unifying communities, the banking system’s policies drive them apart.

As formal financial services become less accessible, those impacted increasingly turn to the informal economy. This shift reduces transparency, raises the risk of economic crimes, and deprives formal banks of much-needed capital. The emergence of Al-Qard Al-Hassan exemplifies this trend, illustrating how internal de-risking has catalyzed the growth of informal financial institutions.

While internal de-risking sought to shield Lebanon’s banks from international penalties, it deepened the financial crisis. By failing to address these issues, the central bank has allowed de-risking practices to destabilize the banking sector, leading to the proliferation of informal financial networks that threaten the formal banking system.

Addressing these issues will require a multifaceted approach. Lebanese banks must openly dialogue with international regulators to clarify compliance terms and rebuild trust. Enhanced transparency can help preserve crucial international banking relationships. Additionally, Lebanon’s regulatory frameworks must be strengthened to meet global standards, minimizing the need for excessive de-risking.

For Lebanese banks to regain the trust of local communities, they must establish clear guidelines for customers impacted by de-risking. Financial literacy programs and alternative banking solutions can help citizens retain access to essential services.

Lebanon’s banking sector faces a confluence of external and internal challenges, and a balanced approach is essential to navigate this rugged terrain. Meeting international compliance standards while addressing Lebanon’s socio-economic needs will enable Lebanon to restore its financial stability and reintegrate into the global financial system.

To overcome these complex challenges, Lebanon must adopt a comprehensive strategy. Enhanced transparency, strengthened diplomatic efforts, and adoption of technologies like AI and blockchain can all improve Lebanon’s compliance capabilities, helping rebuild confidence among international partners.

Lebanon’s financial system is at a critical turning point. Both external sanctions and internal policies have isolated Lebanese banks, deepened the liquidity crisis, and fueled economic hardship. As the FATF decision approaches, Lebanon has little time to waste. By bolstering regulatory oversight, engaging diplomatically to address sanctions, and embracing new technologies, Lebanon can chart a path out of financial paralysis toward economic recovery and growth.