Last Wednesday, Lebanese Prime Minister Saad Hariri"s national unity government collapsed following the resignation of 11 ministers sympathetic to Hezbollah. This development is credit negative for Lebanon"s banks as it brings into question the country"s 2011 economic growth prospects, which, prior to the collapse of Mr. Hariri"s government, were projected at around 5%, versus 8% in 2010. Even in the absence of a worst-case scenario whereby the situation deteriorates into factional (or worse, regional) clashes, the combination of potentially slower economic growth and market uncertainties would, should they materialize, take their toll on Lebanese banks.
In particular, with their profitability weighed down by substantial liquidity buffers, Lebanese banks would suffer losses if that slower economic growth leads to rising loan delinquencies. Sectors to which banks have material credit exposures and are affected by slower economic growth include retail lending, tourism, and construction and real estate, all of which have performed strongly in recent years. Larger banks such as Bank Audi (B1 stable; D-/Ba3 stable), Blom Bank (B1stable; D-/Ba3 stable), and Byblos Bank (B1 stable; D-/Ba3 stable) tend to have higher exposures to these sectors by virtue of their size, but these banks also tend to be better regionally diversified than their domestic competitors.
In the meantime, rising event risk will, as it has in the past, likely lead banks to further increase their dollar placements with international financial institutions. This provides Lebanese banks off-shore dollar-denominated liquidity buffers that enable them to pay out deposits in the event of a run on the bank (if needed though their international branches or subsidiaries in the event that the political tension disintegrates into violence). This, however, would increase their liquidity drag on profitability, particularly as dollar interest rates have come down sharply in recent years.
Protracted market uncertainty may also result in a widening of yields on Lebanese government securities, which, at around $29 billion, constitute around one-quarter of banking system assets (excluding similarly sized central bank placements). Thus, potential losses together with revaluation write-downs of banks" available for sale government securities may erode Lebanese banks" capital adequacy ratios. The banking sector"s aggregate Basel II capital adequacy ratio is estimated at around 13%. Although that ratio is above the 8% regulatory minimum, it is not high considering Lebanon"s operating environment risks. Asset quality can deteriorate rapidly in countries at Lebanon"s stage of development (and Lebanon"s level of event risk), and given that Lebanese banks" profitability does not provide a substantial buffer, their capitalization would under such a scenario sustain a significant impact.
The risks confronting the banking sector exist even in the absence of a sharp or prolonged flight of capital. And though capital flight remains a significant risk, the Lebanese banking sector has survived extreme strain in the past (most recently following the assassination of Prime Minister Ragif Hariri, father of the current prime minster, in 2005 and the war with Israel in 2006). Significant stability is provided by the Lebanese Central Bank"s high foreign currency reserves, which amount to $31 billion (excluding gold reserves) and account for nearly 100% of the country"s GDP, or 30% of banking sector deposits. These, together with commercial banks" placements with international financial institutions, provide a significant defense against the effects of a possible capital flight and underpin Lebanon"s exchange rate stability.
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