By Babu Das Augustine, Banking Editor

Dubai: The recent political developments in Lebanon such as the
election of President Michel Aoun and the designation of Saad Hariri to
form the government is expected to boost investor confidence in the
country’s financial system. However analysts say in the short to medium
term, banks’ foreign asset holdings paint a grim picture.

In
mid-October, Banque du Liban (BdL), Lebanon’s central bank, published
data showing that Lebanese banks’ foreign assets, mostly in the form of
foreign bank placements, had declined by $1.9 billion (Dh6.9 billion)
between May 2016 to August 2016, and by $1.1 billion in August alone. As
a result, Lebanese banks’ net foreign liabilities increased to $18
billion in August from $15 billion at the beginning of the year.

The
repatriated $1.9 billion of foreign assets were invested in long-term
Lebanese government Eurobonds and BdL certificates of deposits (CDs)
that increased the banks’ overall exposure to the sovereign.

The
large reduction in Lebanese banks’ foreign assets is the result of a BdL
financial operation that began in May. Although the BdL has not
disclosed details of this operation, according to Moody’s estimate, BdL
bought $2 billion of Eurobonds from the Lebanese Ministry of Finance in
exchange for an equivalent amount of debt denominated in Lebanese
pounds.

Additionally, there are reports that BdL bought roughly $6
billion of Lebanese pound denominated Treasury bills over the summer
from commercial banks at a premium and sold them the $2 billion in
Eurobonds and an additional $4 billion in CDs. Banks were required to
keep the profits generated from these transactions as Lebanese
pound-denominated reserves ahead of the implementation of International
Financial Reporting Standard No 9, which takes effect in 2018.

These transactions increased BdL’s foreign assets to a record $40.6
billion at the end of September 2016 from $34.6 billion in May.
Including gold, BdL’s foreign assets now cover a record 26 months of
imports.

Budget deficit

Speaking at the
opening of a banking conference organised by the Union of Arab Banks
last week, Central Bank Governor Riad Salameh said the Central Bank’s
foreign currency reserves in September 2016 have risen 5 per cent and
reached a historical record.

Political paralysis and ongoing
regional instability led to almost flat GDP growth, and deposit growth
slowed in the first half of the year to $3.2 billion from $4.2 billion
in the year-ago period. Lebanon continues run a large budget deficit,
which Moody’s analysts forecast at 8 per cent to 9 per cent of GDP for
2016-17, and relies on the domestic banking system to finance that
deficit.

“The [central bank] transactions have significantly
reduced Lebanese banks’ dollar liquidity and have increased banks’
already large exposures to Lebanese government Eurobonds, which we
estimate are at 1.2 times banks’ Tier 1 capital as of July 2016. We
estimate the banking sector’s overall government exposure to be more
than 5 times banks’ Tier 1 capital,” said Marina Hadjitsangari,
Associate Analyst at Moody’s.

To shore up dollar liquidity banks
raised interest rates on dollar deposits in May. Some banks were also
able to recover some of their foreign liquidity by selling Eurobonds in
the secondary market to foreign banks.

Despite the recent
political developments, rating agency Standard & Poor’s said in the
context of sluggish growth rates in the country the banking sector is
likely to face further deterioration in operating conditions resulting
in pick up in credit losses.

“Our view is underpinned by the
banking system’s high direct and indirect exposure to the real estate
sector, totalling 35.6 per cent of the banks’ loan book at year-end
2015,” S&P said in a recent note.