With deposits flowing in unabated, banks in Lebanon find themselves in an almost singular global position — they have an overabundance of liquidity.
“We definitely have an excess,” said Marwan Barakat, head of research at Bank Audi. “But this liquidity pays in difficult times, such as [those] we are passing through nowadays. Excessive liquidity has been paying for Lebanon.”
The Central Bank of Lebanon reported $14 billion in capital inflows for the first eight months of 2009, though some analysts contest this number. Bank Audi estimated that $5 billion of this amount were converted into Lebanese lira (LL) during the first half of 2009, gaining on the $8 billion worth of conversions for the whole of 2008.
Though total liquidity is not at its record high, it is the massive conversions into LL that have created an excess of liquidity in local currency, which could, eventually, become a burden if not properly handled.
“This is what I call an enviable problem for Lebanese banks,” said Nassib Ghobril, head of economic research and analysis at Byblos Bank. “Since the crisis started, banks around the world have tried to attract liquidity and they haven’t all succeeded. They’ve had to use government intervention and bailouts. [In Lebanon], the banks are the ones who have supported the government for a long time.”
Deposits have been converted into LL at unprecedented rates in recent years, with dollarization of deposits dropping from 77.3 percent in 2007 to 69.6 percent in 2008. That number is down to 65.5 percent today, according to Ghobril.
The sharp increase in LL deposits led to an overall increase in LL money supply of 8.8 percent for the first half of 2009, with the majority of this increase coming from LL savings deposits, which increased 18.5 percent during the same period.
Lebanon’s primary liquidity ratio at the end of 2008 was 51.5 percent of total deposits, which — compared to an average of 28 percent in the Middle East and North Africa region, 34 percent for emerging markets and 30 percent globally — puts Lebanon in a unique fiscal position.
“More than the number of inflows, the important thing is the balance of payments surplus — the difference between what is coming in and what is going out of the country,” said Barakat. According to the central bank, the balance of payments surplus was $4.8 billion over the first nine months of 2009, which is a record high for Lebanon.
Confidence into cash
These figures are the product of famously conservative practices on the part of Lebanese banks and prudent regulations by the central bank banning high-risk investments such as structured products and derivatives, which have kept the Lebanese banking sector relatively unaffected by the global credit crisis and spurred confidence in the local currency.
Increased confidence in the local currency has also been aided by an attractive interest rate spread. Interest rates on deposits in LL have hovered around 7 percent for the past two years, dropping from 7.23 percent in August of 2008 to 7 percent for the same month in 2009, while US dollar rates have dropped from the already low 3.55 percent in August 2008 to 3.18 percent in August 2009. In order to keep the spread from growing any further and to slow the rush of local currency conversions, the Association of Banks in Lebanon has recommended that banks cap their LL deposit rates at 7 percent.
“The trend was liquidity over profits, liquidity over expanding the balance sheet, liquidity to be on the safe side,” said Ghobril of the banks’ practices during the financial crisis.
And Lebanon’s top banks have managed to turn a profit this year, a relative anomaly in today’s financial landscape. BLOM Bank has reported $138 million in profits, a 5.8 percent year-on-year increase. Bank Audi’s profits increased 1.9 percent from last year, totaling $133 million, and Byblos Bank saw 2 percent growth from last year with $64 million in profits.
But despite praise coming from international organizations and the media, this growth has slowed, and is predicted to continue on that declining trajectory without profitable outlets for capital.
Banking sector deposit rates
Banking sector dollarization ratios
Too much of a good thing
Though most bankers and economists would argue over the syntax of the situation — “It’s a challenge not a problem,” said Ghobril — the fact remains that Lebanese banks need to find a way to turn the staggering amount of liquidity into profit in order to afford the expense of such abundant deposits, given the high interest rates offered on them.
“Because so much of it is converted into Lebanese [lira] and there are no outlets, now the banks are rushing to buy treasury bills,” said Ghobril.
But treasury bills are becoming a less attractive outlet as yields steadily decrease. In fact, despite the stacks of capital stored at the banks and the few opportunities to capitalize on them, the treasury bills portfolio of Lebanon’s commercial banks decreased in the first half of 2009 by the equivalent of $1.09 billion.
The simple solution is for banks to lend more in LL. However, due to Lebanon’s unique financial nexus, increasing local currency lending is easier said than done.
“Interest rates cannot decline on their own because we have a high fiscal deficit, a high public debt and we have not done anything to reduce the public debt or the fiscal deficit,” said Ghobril. “As long as we have these structural deficits in addition to the lack of long term political stability, there is no way to reduce interest rates much further.”
Short-term fix
The Central Bank of Lebanon has made several efforts to provide the banks with outlets for their excess liquidity, but none have yet proved a lasting remedy.
Until early July, the central bank was issuing LL certificates of deposits (CDs), with banks particularly taking advantage of the high-yielding five-year variety. The return rate on the CDs dropped from 10.9 percent at the end of 2008 to 9.25 percent at the end of June 2009. After issuing the equivalent of $6 billion in CDs, issuance of the popular five-year category was suspended, possibly because the program became too expensive, with demand in 2008 doubling in only the first half of 2009.
The central bank then shifted its efforts and is now attempting to spur lending in local currency. With 57.8 percent of the public debt held by domestic commercial banks as of August this year, lending in local currency continues to be expensive and banks have struggled to lower interest rates in order to spur LL lending.
As of August, the LL lending rate was down 69 basis points from the same time last year, at 9.27 percent. US dollar lending rates stood at 7.05 percent in August, which is 12 basis points lower than August 2008.
Furthermore, banks are working against usual practice. As of June 2009, lending continued to see a dollarization rate of 85.4 percent, which has been the case since the beginning of the decade.
In addition to the unattractive LL lending rates, some argue that the worldwide tightening of purse strings has affected loan requests.
“It’s a demand problem. We have enough liquidity for sure. But, you need two people to dance,” said Makram Sader, secretary general of the Association of Banks in Lebanon.
In order to encourage banks to lower LL lending rates, the central bank lifted reserve requirements on certain loan categories beginning in late June. The reserve requirement exemptions mostly affect housing and education loans and represent what Bank Audi said is the central bank’s only remaining option to spur lending.
“Within this environment, the policy of subsidizing debtor interest rates in LL rises as the only plausible exit for the current distortions within the context of massive capital inflows and currency conversions,” said Bank Audi in a recent report.
“The initiative is to exempt Lebanese [lira] lending from reserve requirements to the extent of 60 percent,” said Barakat.
And the banks have responded with housing, personal, car and education loans in LL with interest rates around 5 percent for the first year.
Treasury bills yields
Looking to the long-term
In September, an International Monetary Fund working paper on the “Determinants of Bank Deposits” said that Lebanon’s “domestic commercial banks which, given their large existing exposure to government, are de facto captive in this system, in the sense that the viability of government finances and that of the banks’ balance sheets are mutually dependent.”
Analysts expressed confidence in the forecasted success of the central bank circulars to increase LL lending, but the limited categories for which reserve requirements have been lifted don’t allow for private sector development.
“It is yet increasingly wished that the central bank expands the relatively limited scopes of the circulars, said Bank Audi. As the aggregation of all such categories does not constitute the bulk of lending growth requirement in the coming couple of years,” said the report.
