Industry Forecast - Banking Sector Stable, But Rising Risks Of Sanctions - MAR 2018

BMI View: Lebanon's commercial banking sector will continue to benefit from a loyal depositor base and strong support from the central bank, bolstering stability and facilitating asset growth. That said, rising potential for the imposition of Gulf and/or US economic sanctions against Lebanon poses risks to this outlook.

Our core view remains for Lebanese banks to experience robust asset growth over the coming years, as their loyal depositor base continues to provide liquidity. In addition, given the banking sector's crucial role in financing the government and keeping the economy afloat, we expect it to continue to benefit from strong support from Banque du Liban (BdL). Overall, we forecast asset growth to average 8.4% between 2018 and 2022. That said, we do see mounting headwinds for the sector following the recent political crisis, owing to a deterioration in investor sentiment, as well as a rising risk of sanctions.

Growth Slowing, But Still Robust
Lebanon Commercial Banks - Assets, Loans & Deposits
Source: Banque du Liban, BMI

We expect Lebanese banks to remain resilient over the coming years, despite our more cautious outlook for the Lebanese economy in 2018. The recent political crisis - which saw Prime Minister Saad Hariri resign from Riyadh, Saudi Arabia on November 4 before reversing his decision on November 22 - will weigh on confidence in the Lebanese economy over the coming quarters, underpinning our view for a protracted recovery ( see ' Slower Recovery As Political Instability Weighs On Confidence ' , November 28 2017). While we have revised down our forecasts for the banking sector slightly on the back of this, we still expect commercial banks to perform strongly. Even in times of economic downturn, Lebanese banks have continued to expand at a rapid pace. Between 2011 and 2016, assets at commercial banks expanded by an annual average of 8.0%, while the economy registered average real GDP growth of only 1.9%. The banking sector benefits from a loyal depositor base, largely consisting of the Lebanese diaspora: it is estimated that 15-20mn Lebanese live outside the country, against a population of 6mn.

Banking Sector To Remain Resilient, Despite Weak Growth
Lebanon - Real GDP Growth, % y-o-y
e/f = BMI estimate/forecast. Source: UN, BMI

Commercial banks will also continue to benefit from strong support from BdL, which will not hesitate to take measures to encourage deposit and lending growth. Assets at commercial banks accounted for 386% of GDP in 2016, and banks also play a crucial role in financing different sectors of the economy, as well as the government's large deficits. BdL has taken various measures since 2011 to support lending growth, including subsidised loans (especially targeting the crucial construction industry) and the relaxation of reserve requirements for banks offering specific types of loans. In summer 2016, facing slowing deposit growth, BdL introduced a financial swap in order to encourage capital inflows. Under the swap, BdL acquired newly-issued eurobonds from the Ministry of Finance, against Lebanese pound-denominated treasury bills, and subsequently bought back domestic treasury bills from domestic banks at a significant premiums, in exchange of these dollar-denominated eurobonds and commitment to place foreign currency deposits at BdL. This measure had a positive impact on asset and deposit growth. Given the precarious state of economic recovery, the key role of the banking sector in the economy, and the fragmentation of Lebanese politics - resulting in BdL playing a major role in supporting economic activity - we believe that BdL would step up support for banks if deposits were to slow significantly, or if the sector's stability was at risk.

Economic Sanctions Would Threaten Remittances, Deposits
Lebanon - Deposits At Commercial Banks
Source: Banque du Liban, BMI

Rising Risk Of Gulf, US Sanctions Amid Political Tensions

That said, recent political events point to a number of risks for the sector over the coming years. As mentioned above, November 2017 saw the resignation of Prime Minister Hariri from Riyadh, which served to highlight Lebanon's exposure to the proxy conflict between Iran and Saudi Arabia ( see ' Crisis Averted, But It Will Leave Scars ' , November 28 2017). Although not our core scenario, Saudi Arabia could try to put additional pressure on Lebanon, especially through the introduction of economic sanctions. This would severely affect remittances from the Gulf, which are a key source of deposits for commercial banks. According to the World Bank, remittances accounted for 16.0% of Lebanon's GDP in 2016, a vast share of which originate from the Gulf.

In addition, the crisis has also exacerbated the polarisation of the region, also raising the risks of US sanctions on Lebanese banks. Over the past year, there have been various reports that the US was seeking to expand the scope of the US Hezbollah International Financing Prevention Act (HIFPA). Enacted in May 2016, HIFPA threatens sanctions against anyone who finances Hizbullah or its affiliated media outlet al-Manar in a significant way. While the banking sector has so far been resilient to the sanctions, the circulation of US drafts seeking to expand the scope of sanctions and target all political allies of Hizbullah - potentially extending to members of President Michel Aoun's Free Patriotic Movement and of the Amal movement - in 2017 raised fears that the US government is seeking to introduce more comprehensive sanctions. This would undermine Lebanese banks' ability to deal with Western counterparts and receive significant remittances inflows. At this stage, we believe that the US government will be willing to limit instability in Lebanon, but the threat is unlikely to go away amid elevated tensions.

Key Banking Forecasts (Lebanon 2015-2021)
2015 2016 2017f 2018f 2019f 2020f 2021f
BMI/Central Bank of Lebanon
Total assets, LBPmn 280,378,000 307,999,000 331,098,925 357,586,839 387,981,720 420,960,166 456,741,780
Total assets, % y-o-y 5.9 9.9 7.5 8.0 8.5 8.5 8.5
Client loans, LBPmn 72,427,400 76,942,600 80,789,730 85,637,113 91,631,711 98,504,090 105,891,896
Client loans, % y-o-y 5.9 6.2 5.0 6.0 7.0 7.5 7.5
Client deposits, LBPmn 238,378,800 254,429,000 271,730,172 292,109,934 315,478,729 341,663,464 370,021,531
Client deposits, % y-o-y 5.2 6.7 6.8 7.5 8.0 8.3 8.3
Loan/deposit ratio 30.38 30.24 29.73 29.32 29.05 28.83 28.62
Loan/asset ratio 25.83 24.98 24.40 23.95 23.62 23.40 23.18
Lebanon-Banking Sector Risk Snapshot
Poor Sub-Optimal Adequate Good Excellent
Note: Arrows signal trend (| = improving, O = stable, | = deteriorating). Source: BMI
Asset Quality |
Funding Structure |
Sovereign Support Capacity O
Regulatory Body Assessment O

Asset Quality: Lebanese banks - the larger ones in particular - generally have good asset quality metrics, with non-performing loans (NPL) equal to 4.5% in total in 2016. That said, the weak growth of Lebanon's economy in recent years, and the modest prospects for the future, point to a gradual rise in NPLs over the coming years. Although banks are generally well-positioned to withstand the deterioration in credit quality, this trend is likely to weigh on profitability. The reliance of the banking sector's income on government securities is a more structural, and far larger, vulnerability.

Funding Structure: Deposit inflows are the key source of funding for the economy. At three-times the size of the economy, the deposit base remains large, but deposit growth has slowed significantly since the onset of the Arab Spring. While not our core scenario, we cannot rule out a significant shock to the confidence of non-resident depositors, particularly given Lebanon's elevated exposure to the region's instability. Bond yields and credit spreads would spike, while Lebanese banks - and the currency's peg to the US dollar - would come under pressure. Although the central bank has policy tools - and sufficient foreign exchange reserves - available in the event of a protracted collapse in investor sentiment, interest rates would have to rise even further, weighing on the already sclerotic Lebanese economy.

Sovereign Support Capacity: The ability of the Lebanese sovereign to support the country's banks is highly uncertain, given the sector's significant size relative to the economy, the government's limited effectiveness in terms of passing timely policies, and the existing public debt load. Our baseline forecasts see the budget deficit remaining around 8% of GDP in the coming years. In the event of a systemic crisis affecting one or more of the major banks, the state would struggle to participate in a recapitalisation plan.

Regulatory Body Assessment: The Central Bank of Lebanon (BdL) plays a key role in maintaining macroeconomic stability and the oversight of the financial system, and is held in high regard in international financial circles. In the absence of structural reforms by the government, the BdL has helped to support banks' margins and maintain the country's financing structure intact, by keeping interest rates high and offering well-remunerated term deposits in local currencies. The BdL has also been able to support economic activity to some degree through consecutive stimulus packages, worth USD3.4bn since 2013. The monetary expansion, in the form of subsidised loans offered by commercial banks for housing and new projects, will continue over 2018.