Global Arab Network | Success and Resilience - Lebanese banking sector attracting foreign funding

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Success and Resilience - Lebanese banking sector attracting foreign funding

Global Arab Network - - George Haddad

Tuesday, 02 November 2010 01:28

Lebanon's banks are is a solid position, enjoying high levels of deposits and a strong flow of inbound capital while operating in an economy that expanded rapidly last year and is expected to do so again in 2010.

After two years of substantial accumulation, international reserves have reached adequate levels. Reserves now cover a comfortable share of broad money and short-term debt, are large enough to withstand plausible Lebanon-specific shock scenarios, and have reached optimal levels, reports Global Arab Network according to IMF statement.

With comfortable reserves in view of the IMF staff, monetary policy has shifted focus to moderating deposit inflows. Policy interest rates have been allowed to drop markedly (by more than 400 bps since mid-2008 on 5-year T-bills/BdL CDs, of which 70bps in April and May of 2010 alone).

However, the decline in deposit rates has been more gradual and modest, reflecting imperfect monetary transmission with variable lags. Deposit rates have recently started to fall more rapidly, and given the recent erosion of bank interest margins, further declines are likely in the pipeline.

A pause in policy interest rate reductions may be warranted to ensure a smooth adjustment process. There was broad agreement that care should be taken not to overshoot on reducing policy rates, as risks were judged to be asymmetric. The risk of a possible drying up of inflows because of lags in the response of market interest rates to past monetary policy actions was believed to be costlier than the risk of temporarily accumulating more reserves than optimal.

Cautious interest policy would also reduce the risk of having to backpedal if world interest rates and/or emerging market risk premia were to rise, for example in the context of the Southern European crisis. Given the importance of guiding market expectation in the adjustment process, IMF staff encouraged the BdL to clearly communicate its monetary policy objectives to the public.

In its latest study of the Lebanese banking sector, ratings agency Moody's said the credit outlook for the industry was stable, thanks to the buoyant performance of the local economy last year, the reduction of tension in the domestic political sphere and relative stability in the region.

The exchange rate peg provides a strong nominal anchor and remains the lynchpin of financial stability Maintenance of the peg is essential in light of the government’s high debt and debt service obligations in foreign currency, and the substantial currency mismatches of corporations and households, owing to widespread loan dollarization.

IMF staff encouraged the authorities to work towards reducing these vulnerabilities. The authorities agreed with IMF staff’s assessment that, although the recent strength of the U.S. dollar has led to some real appreciation of the Lebanese pound, the real effective exchange rate remains broadly in line with fundamentals.

The authorities are focusing bank regulation and supervision on preventing excessive risk taking. For example, they limited the loan-to-value ratio for most real estate loans to 60 percent. IMF staff agreed that the BdL and the Banking Control Commission (BCC) should remain vigilant to the potential risks of weakening credit standards, increasing leverage in specific sectors, and deteriorating asset quality. IMF staff noted that, despite conservative prudential regulation on leverage and limited bank exposure to the real estate sector, care should be taken that the recent surge in housing prices and accelerating credit growth do not feed off each other to produce a real estate bubble.
Moreover, prudential regulation may need to support monetary and fiscal policies in dealing with the booming economy. In particular, if credit growth accelerates further, the authorities should consider increasing effective reserve requirements, including by phasing out existing exemptions that were created to stimulate lending in domestic currency. Looking forward, the BdL and BCC could also consider the merits of introducing countercyclical prudential regulation.

The regional expansion of Lebanese banks justifies the BCC’s heightened focus on effective cross-border supervision. Current supervisory activities are broadly in line with good practices and could be further enhanced through continued efforts to deepen de facto cooperation and information sharing with host country supervisors, and greater focus on conducting stress testing and scenario analyses.

"The stability of the Lebanese banking sector reflects, to a significant extent, its remarkable success in attracting a constantly large stream of foreign funding from the Lebanese diaspora and Gulf investors," said the Moody's report, authored by Stathis Kyriakides, an assistant vice-president and analyst at Moody's. "Indeed, bank deposits have displayed a notable resilience to political shock throughout the country's turbulent recent history."
Though a mark of success and resilience, the banking sector's ability to attract funding can also pose difficulties. Many of Lebanon's banks have a problem that lenders in some other countries would be delighted to have to deal with – having too much cash in hand. According to central bank figures, more than $1.5bn is flowing into Lebanese bank vaults every month, drawn by the 7% interest rate on deposits in the local currency and the fixed exchange rate.
To try and soak up some of this excess liquidity, and thus keep inflation in check, the central bank resumed selling certificates of deposit at the beginning of March, having stopped in June last year, and also sought to take some of the heat out of the money market by lowering its overnight lending rate from 3.25% to 2.75%.
"We have an objective of keeping inflation at 4% and we want to absorb excess liquidity that could cause an increase in prices," the cental bank governor, Riad Salameh, told international media on March 2. "We want also to prevent speculation, especially in real estate, as too much liquidity could cause that."
Salameh said the central bank has started issuing certificates of deposit after the Ministry of Finance announced that it would temporarily stop selling treasury bills as it had sufficient funds to meet its short-term fiscal needs.

Further progress is needed in the areas of anti-money laundering and combating the financing of terrorism (AML/CFT). The authorities are committed to conform their AML/CFT framework to the Financial Action Task Force’s 40+9 Recommendations. The recent Middle East and North Africa Financial Action Task Force Mutual Evaluation Report recognized significant progress accomplished by the authorities in several areas, including the performance of the Financial Intelligence Unit, while noting that the framework needs further strengthening in other areas, in particular the criminalization of money laundering and the financing of terrorism, and the reinforcement of the AML/CFT supervisory system.

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