The reason behind this year’s success in banking and the mood of Lebanese bankers can be summed up in one word: confidence.
“If depositors lose confidence in their bank, they will lose confidence in all the banks in the country,” said Chairman of the Banking Control Commission Walid Alamuddin in a speech to the Union of Arab Banks at their yearly conference in Beirut in November.
Not only have depositors shown up in record numbers this year, but due to a seemingly irresistible interest rate spread, they have also converted their deposits into local currency at unprecedented rates — creating a challenge for bankers used to a highly dollarized balance sheet.
Overall deposits into Lebanese banks increased 21 percent in the first nine months of 2009 compared to the same period of 2008, totaling $92.2 billion, according to the Association of Banks in Lebanon (ABL). Lebanese lira (LL) deposits saw a 55.6 percent year-on-year increase by end-September.
High deposit conversions have been heralded as proof that nationwide faith has been restored in the LL, as dollarization of deposits dropped to a nine-year low of 65.9 percent at the end of the third quarter, according to Bank Audi.
“It is important because the Lebanese [lira] is regaining its role as a stock of value as a deposit currency,” said Marwan Barakat, head of research at Bank Audi.
But only time will tell whether these overwhelming conversions were truly a vote of confidence in the local currency from Lebanese depositors, or simply the product of a large spread between deposit rates in LL and United States dollars (USD).
At the start of the year, the average interest rate on LL deposits was 7.22 percent, while USD deposit rates averaged 3.31 percent. Dollar deposit interest rates have dropped steadily since the end of 2007, losing 153 basis points in 22 months. Lira deposit rates, however, did not follow this trend as strictly, losing just 46 basis points over that same period. This has created an interest rate spread of 378 basis points at end-September 2009: a significant increase from the 361 point spread between the two currencies in the same month in 2008.
The LL deposit rate has been dropping ever so slowly from 7.22 in January to 6.94 at the end of September, most likely because of market pressure and recommendations from the International Monetary Fund and the ABL, the latter of which actually recommended in October that a ceiling of 7 percent be placed on LL deposit rates. But the spread between LL and USD rates is still enticing, and it remains to be seen whether the Lebanese predilection for extremely gradual change will end up costing its banks.
IMF interest U-turn
Walid Raphael, deputy general manager at Banque Libano-Francaise (BLF), said that the slow drop in the LL deposit interest rate is likely due to interbank competition and an unwillingness to put profitability before growing customer bases.
“[It is] maybe because they are fighting for market share,” he said. “We might see a change and a stronger reduction in interest rates on deposits in Lebanese [lira] by next year. But you have to keep a spread between the dollar and LL to maintain the attractiveness of the LL.”
The IMF’s November 2009 recommendation is particularly noteworthy here, as it is a shift from their earlier position. Since there is a need for high liquidity in local currency, due to Lebanon’s high public debt, the IMF had said in an April 2009 public information notice that, “Given heightened near-term risks, directors agreed that there is little scope for lowering interest rates over the coming months.”
Perhaps in light of the overwhelming deposit conversions and surprise excess of liquidity in local currency, the IMF changed its position in its November country report, stating, “In the near term, interest rates should be allowed to decline further, but at a gradual pace.”
Where the lira is lagging
The USD remains the preferred standard of deferred payment. Dollarization of loans has been holding strong at 85 percent for almost a decade, which presents a problem when the funding side of the balance sheet switches to local currency.
Private sector loans grew 11.4 percent by the end of the third quarter, growing by $2.8 billion, down from $4.4 billion in growth for the same period of 2008, notwithstanding this year’s high liquidity and corresponding flexibility. However, despite the steady dollarization rate of loans in Lebanon, LL lending accounted for 29 percent of the loan growth in 2009, compared to 12.3 percent lending in LL in 2008.
Most of this can be attributed to the central bank’s actions in July and September, lifting reserve requirements on 60 percent of lending categories in order to incentivize local currency lending and absorb some of the banks’ excess liquidity.
Before the release of these circulars, banks were required to keep 15 percent of their local currency in the central bank at zero percent interest, making lending in LL even more expensive. The change lifted this requirement to the tune of approximately 60 percent. This allowed banks to lower LL lending rates to around 5 percent interest; enough to offer some attractive new products in home loans, car loans, education loans, some industry-related loans and green initiative loans. The measures were almost immediately touted as successful, but lending continues to be relatively low.
The September 2009 spread of USD to LL average lending rates was the smallest it has been since December 2007, at 198 basis points, with the LL rate at 9.22 percent and the USD rate at 7.24 percent.
The central bank circulars allowed certain loans to drop to around 5 percent interest, which is where most of the LL lending has taken place. But, despite the uptick in local currency lending, BLF’s Raphael still believes that more needs to be done, including searching for new markets.
“The problem with Lebanese banks is that the size of their assests is three to four times the size of the economy,” he said. “So the banks are very liquid and we need to find good opportunities to lend. This is why we are growing out of Lebanon. This is why we are trying to find new markets.”
Alpha banks’ rankings as of end-September 2009 (in $millions)
Narrowing options and dwindling returns
Treasury bills and certificates of deposit remain the primary methods of putting local currency liquidity to use; 85 to 90 percent of Lebanese liquidity is absorbed using these tools.
But the weighted average yield on LL treasury bills has been decreasing fairly steadily since the start of 2009. T-bills carried a 9.01 weighted average interest in January, which decreased by 22 basis points to 8.70 in September 2009.
Yet, despite these declining interest rates, monthly issuance for September 2009 reached its highest in nearly two years, with 2,289 bills issued over the month, marking a 58.6 percent increase on the same month of 2008.
This hike in the popularity of T-bills is no doubt due to the disappearing options to earn on local currency liquidity. Until July 2009, the central bank was offering 5-year certificates of deposit, which capped at a yield of 9.25. But, after issuing an equivalent $6 billion in certificates of deposit, this option was dropped by the central bank when the circulars lowering reserve requirements came out, in order to encourage lending.
“This should push banks to reduce interest rates on deposits, which was happening a bit, but not as much as it should,” said Raphael. “So right now banks are still paying high interest.”
Nowhere to go but down
The coming year for Lebanon will be all about the balancing act.
“We are not a charity organization, but we are not opportunistic. We are somewhere in between,” said Freddy Baz, chief financial officer and strategy director at Bank Audi.
In 2010, as international interest rates are predicted to stay low, industry experts say that Lebanon should follow suit. And Lebanese banks are set to lower interest rates even more: a move that may affect their precious liquidity.
“If these low levels of interest rates continue to prevail in 2010, our bankers will lower the domestic structure of interest rates to avoid losing money,” said Makram Sader, secretary general of the ABL. “Our bankers are managing the interest rate structure to maintain some spread between the domestic rates and the international rates. But we are seeing a gradual decrease in the interest rate and I expect, if the international rates stabilize where they are now, to see a lower differential.”
But again, Sader warned that this change would be gradual: “It is much more complex to manage a decrease of interest rates than it is to manage an increase.”
