Paradox of Lebanese banking
Lebanese bank credit ratings are today a derivative of the Republic of Lebanon’s own sovereign credit risk ratings, writes Matein Khalid

Ever since France’s Ottoman Bank opened its doors from a seafront palace in the 1860s, Lebanon’s financiers have earned a worldwide reputation for entrepreneurial flair, helping to forge pre-war Beirut’s reputation as an offshore banking hub, the Switzerland of the Levant. It is no coincidence that some of the leading power brokers of modern Lebanon were either bankers or owned banking empires, from former President Elias Sarkis to three Prime Ministers (Salim Hoss, Rafiq Hariri and Fouad Siniora). As a quintessential service economy with a laissez faire capitalist ethos that seeks to regain its historic role as a financial entrepot in the Mediterranean, banks are mission critical for Lebanon’s economic growth, foreign trade and the financing of government debt in a nation whose public sector debt / GDP, at 180 per cent, is the highest in the world. The Lebanese banking system has survived a succession of recent traumas – the assassination of Prime Minister Hariri, Israel’s devastating aerial attack and ground invasion last summer, the political gridlock between the government and the opposition over who will succeed President Emil Lahoud and the multiple wars in Iraq that cost Lebanon billions lost in exports and remittances. Moody’s recently downgraded the credit ratings of Lebanon’s four leading banks to a financial strength of D to reflect a grim political milieu and the increasing reluctance of bankers to increase their holdings of the government’s sovereign Eurobonds and Treasury bills.

The assassination of Prime Minister Rafiq Hariri in February 2005 still haunts the Lebanese financial markets and banking system. Hariri was the symbol of Lebanon’s economic renaissance in the 1990s, whose Solidiere real estate firms rebuilt Beirut’s gutted downtown after the Taif Accords ended the 1975-90 civil war. He was instrumental in attracting billions of dollars from the Lebanese diaspora, Gulf sovereign agencies and Wall Street investment banks to finance Lebanon’s postwar reconstruction and development, orchestrating the Paris donor conference in 2002 that averted a sovereign default which would have meant monetary Armageddon for the Lebanese banking system, whose assets are primarily invested in financing the government’s debt. In Beirut recently, I was stunned by the visible evidence of Israel’s assault on Lebanese infrastructure. Every major bridge in the Bekaa Valley, the Beirut-Jounieh highway and the Sidon coastal road was bombed by the IDF. The Israeli war machine inflicted US$11 billion in damages on Lebanon and led to the destruction of hundreds of roads, fuel depots, factories, homes, bridges and power generation plants. Yet, amazingly, only six per cent of the Lebanese banking system’s loans are estimated to be at risk as a result of the Israeli destruction and reconstruction will be largely financed by Hezbollah, the Lebanese government, GCC sovereign donors and the World Bank, with only a minor role for Beirut’s private bankers. Riad Salameh, the governor of Banque du Liban, estimates that only US$100 million in provisions is needed in the banking system’s US$17-billion loan book. Yet the secondary impact of the war caused incalculable damage to Lebanon’s fiscal future, with lost VAT, export and tourism revenues. Lebanon’s credit risk is way below investment grade at a dismal B, meaning that its banks’ credit ratings cannot exceed the sovereign ceiling since they hold so much government debt, whose political risk premium escalated dramatically after the assassination of Hariri. Moreover, more than US$4.5 billion of the US$7.8 billion in funding pledged by international donors at the Paris III conference is conditional on economic reforms under surveillance from the IMF. But historically, privatisation and the reform of loss-making Lebanese state-owned utilities are paralysed by sectarian patronage networks and the political cleavages in the Siniora Cabinet. While Banque du Liban managed to keep the Lebanese lira rate stable to the dollar at 1500 and has accumulated no less than US$19 billion in hard currency reserves and gold bullion, the central bank cannot solve the existential macro dilemmas that haunt Lebanon.

Lebanon is, ironically, the only Arab state where private financiers, not the government, own virtually all banking assets, and the state has never nationalised a bank. Moreover, the end of the civil war after the Taif Accord and the Hariri era enabled banks to expand their assets ninefold since 1992, with banking assets now 350 per cent of GDP, among the highest in the world. Lebanese banks also boast exceptional liquidity by any standards in the emerging markets, with deposits at US$60 billion or three times its GDP. Lebanon is also a de facto dollar economy, with almost three-fourths of deposits and loans denominated in the greenback. With almost 70 commercial, Islamic and private banks, Lebanon’s branch per capita metrics easily compares with Western European countries. Yet Lebanon’s bankers are hostage to their sovereign’s public finance. After all, Lebanon borrowed heavily since Taif, with its gross public debt rising from US$3 billion in 1992 to almost US$40 billion now, making Lebanon the most frequent Arab sovereign issuer in the Eurobond market. However, almost half of outstanding sovereign Lebanese Eurobonds are not held by fund managers in London or Wall Street but by Lebanon’s five major commercial banks. Lebanon’s banks are significantly exposed to their own government, which in turn is exposed to the vagaries of war, peace and capital flight in the Middle East. Lebanese bank credit ratings are thus a derivative of the Republic of Lebanon’s own sovereign credit risk ratings. A natural strategy to reduce their sovereign debt exposure risk compelled the major Lebanese banks to accumulate assets in Syria, Algeria, Egypt and the GCC. Lebanon’s banks are liquid and well managed and the Banque du Liban is among the most respected central banks in the Arab world. If the state overcomes political shocks and succeeds in the IMF adjustment programme, Lebanese banks’ profit, growth and credit worthiness would warrant a compelling bullish case.

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