Shadow economy: How Hezbollah benefits from Lebanon's financial collapse

A year after the Beirut port explosion and two years since the beginning of popular protests, Lebanon is moving towards a dead-end, with financial institutions collapsing alongside the Lebanese pound and political powers struggling to form a functional government.

The threat of a crumbling water system across the country only compounds the shortages of fuel, medicine, and other basic consumer products.

Amidst this grim scene, one of the most powerful political entities in the country, Hezbollah, is exploiting the instability, utilising decades-old mechanisms and infrastructure developed by the group to cope with the challenges emerging from sanctions imposed by Western and Gulf powers on all Hezbollah-affiliated entities.

"Hezbollah has managed to maintain a considerable amount of funds outside of the country's official banking system"

The collapse of Lebanon's banking sector and national currency

Lebanon managed to re-emerge after a long, brutal civil war largely based on foreign funding from international institutions and assistance from Gulf countries. The country’s tourism industry has been one of the most critical contributors to the GDP, alongside the construction sector, where major projects have materialised in the aftermath of the war as part of the country’s rebuilding.

Lebanon’s banks enjoyed high flows of revenue and liquidity due to the multi-billion USD deposits generated by Lebanese expats, who stationed a considerable part of their fortune back home.

At the same time, Lebanon provided an alluring banking environment, both in terms of regulations and interest rates, which attracted many individuals and corporate entities to choose Lebanese institutions as their offshore banking option.

In this context, the currency exchange rate of the Lebanese pound to the dollar had remained unchanged over the last few decades, approximately at 1,500 to 1. This figure is still relevant in theory, as per the official exchange rates, however, the situation on the ground is completely different, with the Lebanese pound across the country’s black market being traded at over 15,000 LBP to the dollar and occasionally surpassing the 20,000 threshold.

The extensive exposure of Lebanese banks, alongside mismanagement and corruption within the sector, indicate how vulnerable and fragile the country’s economy has been. The extraordinary interest rates, which have been provided to lure foreign investors - and characterised by some as a Ponzi scheme - led major banks to asset deficiency, with their liabilities building up, while their relaxed lending policies led to the accumulation of nonperforming loans.

At the same time, the heavily dollarised nature of the Lebanese economy and persistent political impasses and social tensions have made the national economy even more unprotected and saw inflation rise to uncontrollable levels.

The first signs of the current crisis appeared in early 2019 with the collapse of foreign deposits and escalated in the autumn of 2019, when the Lebanese government planned to impose a special tax on WhatsApp, a popular communications platform.

This triggered wide political and social unrest across the country, with daily protests and demonstrations becoming the new normal. The outbreak of the Covid-19 pandemic in early 2020 and the massive explosion at the Port of Beirut last August, significantly escalated the emergency and created the worst financial and housing crisis the country has experienced in recent memory.

It is indicative that the World Bank recently described Lebanon’s crisis as probably one of the three worst in modern history, while the foreign currency reserves of the Banque du Liban have reportedly halved compared to late 2019.

Hezbollah, sanctions, and the black market

Hezbollah is probably a unique case in the global geopolitical and security landscape. It is an organisation that plays a prominent role in Lebanese politics and the government, is generally perceived as an influential regional player, maintains para-military units which in several instances exceed the capabilities of the Lebanese Armed Forces (LAF), and at the same time, it is designated as a terrorist group by numerous Western and Gulf powers.

This has led to a long-lasting regime of sanctions against individuals and entities related to the organisation.

The US Department of the Treasury’s Office of Foreign Assets Control (OFAC) has been coordinating an aggressive sanctions policy against Hezbollah for years, which escalated significantly during Donald Trump’s presidency, with the ultimate goal of blocking all financial activities of the group and stopping it from processing international transactions and accessing global markets.

The group has also faced sanctions from other important countries and organisations, including the Government of Australia, the Gulf Cooperation Council (GCC) and possibly the European Union (EU) in the near future.

The most important point here, though, is that this sanctions strategy has forced Hezbollah to seek alternative routes to transfer and manage its funds.

"Due to sanctions over many years, Hezbollah has consolidated a shadow economy and a black market framework removed from the current banking crisis"

Due to the severe challenges and restrictions posed by US-led sanctions, the group has created backchannels not only for money transfers and banking purposes abroad, but also for the allocation of goods and products through international smuggling networks.

Through company cells at home and overseas, Hezbollah has managed to maintain a considerable amount of funds outside of the country’s official banking establishment. Due to sanctions over many years, Hezbollah has consolidated a shadow economy and a black market framework, which is removed from the current developments affecting Lebanese banks.

In this respect, the group has also gathered and stationed considerable reserves abroad in foreign currency or even safe-haven assets, such as gold, according to some reports. Therefore, Hezbollah’s shadow financial ecosystem has placed the group in a favourable position within the current economic crisis, as the Lebanese currency and banking sector are facing an extremely precarious situation.

Iran has traditionally been the key patron for Hezbollah, as Tehran sees the group as an irreplaceable tool to expand its influence in the region and promote Iranian geopolitical objectives abroad. Tehran has been providing considerable funds to the group and has been importing basic items to Lebanon, from fuel to grocery products, through Syria.

This constant flow of goods from Iran has been of fundamental importance for Hezbollah’s strategy during the crisis. While Hezbollah officially condemns smuggling activities, the group is fully exploiting smuggling rings to promote its regional goals.

The OFAC has recently added several individuals to the sanctions list related to al-Qard al-Hasan Association (AQAH), an entity that is perceived to be Hezbollah’s financial arm for transactions at home and abroad. Al-Qard al-Hasan Association, also referred to as the “Hezbollah Bank” is officially a charity, therefore does not fall within the banking restrictions and capital controls applied in the country.

Even though sanctioned by the US since 2007, the association is still operating, providing loans on very favourable terms. Amidst the crisis, AQAH has seen a steady rise in its operations, as it is one of the very few banking alternatives without strict controls and restrictions in this period of great uncertainty.

Hezbollah is taking full advantage of the current conditions, considering that the revival of the Lebanese economy will be most likely based upon a costly debt restructure plan and probable Mergers and Acquisitions (M&As) across the banking sector, which would lead to a more centralised system with fewer banks surviving.

The participation of the IMF would be vital for this process. With steps being taken in this direction, strict measures and capital controls are being applied by banks, leaving millions of Lebanese citizens locked out of their savings. As people gradually lose trust in traditional banks, Hezbollah is offering a tempting alternate route.

Social work and welfare campaigns

Due to unprecedented levels of inflation and the shattered purchasing power of the Lebanese people, Hezbollah has utilised a common tactic to support struggling individuals and families, while gaining politically.

The establishment of the Al-Nour Markets, in areas such as the Bekaa Valley and the suburbs of Beirut, provides access to many cheap goods mostly imported by Iran, which enables the Hezbollah-run supermarket chain to work with much more competitive prices, compared to retailers selling goods imported from the West.

Hezbollah has also initiated the use of the ‘Al-Sajjad cards’, a sort of customer club card, issued to those who qualify based on economic and social criteria. Whoever uses these cards enjoys significant discounts on the already reduced prices at the markets.

Hezbollah has made those cards available to everyone across Lebanon, not only the Shia community, signifying the long-term and wider plans of the party to elevate further its current powerful position in the country.  

Hezbollah has also followed an interesting policy in the field of public health. With the consolidation of its presence in the Ministry of Health - the current health minister is Hezbollah-backed Hamad Hasan - group-affiliated entities have full access to the pharmaceutical market, enabling Hezbollah to provide pharmaceutical products in shortage to those in need.

"With the grim socio-economic crisis still ongoing and the international community incapable of adequately tackling the emergency, Hezbollah seems to be making significant gains"

As a part of this strategy, the party has acquired several pharmacies on the verge of bankruptcy, mostly in southern parts of the country, like Tyre.

With access to vital goods - from fuel to medicine and groceries - and a policy to make them accessible to all those who need them, Hezbollah once again is capitalising in a fragile context. It is a strategy that has traditionally made the party popular to the vast majority of the Shia community, and is similar to how Jihad al-Bina, Hezbollah’s construction company, and other affiliated entities have functioned in the past.

This time, however, Hezbollah’s purpose is not only to maintain its popular base but to win the hearts and minds of other vulnerable groups who are struggling with the economic crisis.

Approximately two years ago, when the protests across Lebanon started picking up, analysts were discussing how the emerging crisis could play out for Hezbollah.

Many anticipated a harsh backlash against the group which would eventually signal its toppling from Lebanon’s political scene, while others argued that Hezbollah could in fact benefit from the crisis and politically capitalise on the unrest and financial hardships of the Lebanese people.

With the grim socio-economic crisis still ongoing and the international community incapable of adequately tackling the emergency, Hezbollah seems to be making significant gains, targeting not only its traditional strongholds within the Shia community, but also across different parts of the population.

As the Lebanon-based journalist and geopolitical analyst Scarlett Haddad recently commented, “Hezbollah is currently in pre-electoral mode, alongside the rest of the political scene in Lebanon. Therefore, the party has already prioritized the protection of its popular base, utilising its plethora of resources, aiming to unite the Shia voters and at the same time seeking to avoid opening new fronts”.

The exploitation of financial reserves, the upgrade of its arsenal, and the welfare policies adopted by the group have undoubtedly boosted Hezbollah’s internal position. The possible involvement of France and the intervention of the IMF, which will certainly pursue unpopular austerity measures, will prompt the party to criticise “the West” and rally against neo-colonialism, rhetoric which will sound tempting to a large part of the struggling Lebanese people.

Notwithstanding hostile relations with Israel, an extensive armed confrontation remains highly unlikely; in this context, one could expect to see Hezbollah’s powerful grip on domestic politics to be further strengthened, as its ever-expanding imperium in imperio status remains well-consolidated.

Alex Kassidiaris is an International Security Advisor based in London. He holds a master's degree from the War Studies Department of King's College London and his research interests include security and politics in the Eastern Mediterranean and the Middle East.

Follow him on Twitter: @AlexKassidiaris