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Interest rates on the rise

Declining deposit growth could make for borrowers’ blues

by Marwan Mikhael

The Lebanese banking sector has been tested against internal and external shocks many times through recent decades, and it has been tested yet again this year. The sector still enjoys high liquidity ratios, enabling the banks to weather economic turmoil, while the sector as a whole has also been steadily reducing its heavy government exposure — a positive trend amid the numerous challenges Lebanon’s commercial banks have faced in 2012.

The sector remains the main source of financing for the Lebanese government but its exposure to the highly indebted sovereign has been on a declining trend since 2006. Banks’ claims on the public sector constituted 21 percent of their total assets at the end of 2011, down from 28 percent at the end of 2006. Banks hold around $29 billion, or close to 54 percent of the gross public debt, which stood at $54 billion at the end of 2011.

The weight of public debt in the economy, however, whilst still high, has witnessed a large decline since 2005. The ratio of public debt to gross domestic product dropped from 182 percent in 2006 to 135 percent in 2011. This decline was led by high economic growth rates from 2007 through 2010, as well as a lower growth rate for public debt, with the government registering large primary surpluses during the same period. 

Moreover, the relative importance of bank claims on the public sector declined when compared to bank credit to the private sector. While the banking sector continued to lend to the government from 2007-2010, their claims on the private sector increased at a much faster rate, skyrocketing 222 percent from $15.5 billion in 2007 to $34.5 billion in 2010.

Funding the public and private sectors

This economic boom took place in an environment of low interest rates on government debt and helped the banks lower their exposure to the sovereign. When such interest rates are low, banks prefer to lend to the private sector, as the rates charged are higher than the yields banks generate from their government securities portfolio. This is compounded by interest rates on deposits declining less than global interest rates, which has put pressure on banks’ profit margins. Hence banks are turning more and more toward the private sector in order to improve their profitability.

Lowering banks’ exposure to the sovereign reduced the ‘crowding out’ effect, which happens when the government has large financing needs and the available resources are limited — namely, when there is not enough increase in deposits to finance both public and private sectors without enduring an increase in lending rates. In the case of Lebanon, there is a certain growth rate of deposits that has been sufficient to finance government deficit without crowding out the private sector. Total lending needs of the economy including both public and private sectors stands at between $5 billion and $7 billion per year, which means that deposits must grow by 6 to 7 percent in order not to induce an increase in interest rates and consequently a crowding-out effect. Since 2006, there have been enough capital inflows into the country to cater to both the private and public sectors.

A bleak outlook

Growth in bank deposits for 2012 stood at 5.2 percent as of the end of September — similar to 2011 but much lower than previous years, and just enough to provide the necessary financing needs for both the private and public sectors. Going forward, any further reduction in bank deposit growth would mean interest rates would have to increase, with competition between the public and private sectors over the available funds intensifying. Consequently, the cost of servicing the public debt will increase for the government and the cost of new investments will also go up for the private sector; an unwelcome possible scenario for 2013.

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Marwan Mikhael

Marwan Mikhael, is the head of the research department at BLOMINVEST Bank.

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