With praise from international media raining in for his steadiness at Lebanon’s financial helm, Executive sat down with Central Bank Governor Riad Salameh to discuss the current and future state of Lebanese Banks.
E As a foil to the rest of the world, Lebanese banks have actually struggled to find profitable uses for their excess liquidity, especially in local currency. Do you believe that the banks have enough tools to keep this liquidity from becoming a burden?
Well, as you know, the amounts that came to the banking sector after the collapse of Lehman [Brothers], and between September 2008 and July 2009, were very large amounts compared to the size of deposits already existing in the banking sector. Plus they were mostly converted into Lebanese pounds. It is normal that the banking sector can’t find immediate use for such amounts when they total around $16 billion. The credit market in Lebanon usually increases by $2 billion to $3 billion a year.
So the central bank issued 5-year certificates of deposit (CDs) in Lebanese pounds in order to mop up some of that liquidity, and the
Ministry of Finance also issued more treasury bills in Lebanese pounds than needed, in order to keep discipline, prevent bubbles, speculation and inflation. And this money will be gradually used again in the economy in Lebanon.
Therefore, we have to face the positive aspect of not having been touched by the crisis and embrace the confidence in our system, and we thought that it was an opportunity for Lebanon to receive and keep all these funds, as there will be a need for them in the future, whether to finance the public sector or the private sector.
E Why did the central bank stop issuing five-year CDs?
We have issued circulars to enhance credit in Lebanese pounds and we have given incentives to lend for housing without placing price ceilings, so you can now see the banks competing to lend money at rates that are around 5 percent for medium-term [loans].
We have also given incentives for the financing of new projects, not only those covered by the previous circulars, which means that any project besides industry, tourism, agriculture, or technology that is launched between now and June 2010, and we’re going to extend it until June 2011, will be able to be funded with low rates of interest. We have also launched student loans and environmental loans using those same incentives.
Given this package, we thought that we had to leave some liquidity in the hands of the banks in order to motivate them to lend according to these circulars. As we look forward, we can have good growth in 2010 if the credit activity is maintained and intelligently directed. So, the markets started to find a certain equilibrium despite the fact that we stopped these CDs.
We still had conversions from dollars to Lebanese pounds. We still had a balance of payments that showed a positive balance of $6 billion by the end of October, which is a record for any year in Lebanon for the first 10 months. Therefore, we thought that we can now afford now some gradual decrease in rates.
Nonetheless, if we see that our management of the liquidity in the market requires us to reenter by selling CDs, we will do that, and we have announced that we might come back with 7-year and 10-year maturities.
The idea is to acquaint the market with longer maturities in Lebanese pound denominated papers, and that the government later on can also issue bonds for 7-year and 10-year maturities in Lebanese pounds.
By extending the maturities on debt we will have less pressure on the refinancing of that debt on a yearly basis, and that will help maintain a more acceptable structure of interest rates.
E As interest rates decline, do you expect the dollarization of deposits to remain around 66 percent?
We think the market is keeping that ratio. This is one of the equilibriums that we are starting to see. And today we have approximately $27 billion in liquid foreign currency on our balance sheet at the central bank, which is also a historical high. This means that out of the capital inflows coming to the country, 66 percent remain in dollars, while the rest are converted to Lebanese pounds. We find that it’s up to the market to define the equilibrium, but I believe we have seen the markets at this level for the past three or four months.
E Both the prime minister and the finance minister have stated that they are keen to implement Paris III initiatives that include raising taxes on interest earned in local banks from 5 to 7 percent. Do you think this will actually happen in this government’s term?
The tax on the interest on deposits is not, I think, a priority for the time being, especially in that this tax was envisaged before the international crisis. And even though it is presented as a law to be voted, there is an understanding that this cannot be implemented before we have stability in the banking sector worldwide and in the region.
The tax approach is also not the priority, as I understand, because the priority is going to be given to more growth in the economy and to fix activities that are creating large deficits for the government, like Electricite du Liban.
Anyway, the government is presently discussing the economic program that they want to present to the Parliament or at least a declaration on that, and we will wait to see what will be approved. But I know that growth is the priority and for that, everything is going to be done to facilitate growth.
E You’ve been successful in swapping the short-term debt for long-term debt with more maturity. How do you see Lebanon coming out of its debt situation?
Our priorities really are to reduce the yearly deficit because the present stock of debt that is in the market is perfectly sustainable, due to the high liquidity that we have and also to the increased confidence in the financials of the country. As you can see, the credit default swap that is quoted internationally for Lebanon for the past five years has declined to reach 2.3 percent, at certain times it was at 7 and even at 10 percent. So there is demand on the Lebanese paper, and interest rates in the secondary market have substantially decreased.
The future expectations of inflation are going to diminish the real value of that debt, which is stated today at around $48 billion. And the present value or the real value of that debt will look less important in the next four or five years, as the purchasing power of currency is going to be depleted worldwide. So what the market requires are signals showing that the deficit is declining, and for that purpose we hope that the originators of this big deficit be addressed in the reform program of the government. The most important sector to reform is the energy sector in general and electricity in particular.
We have to wait for the government declaration in order to see if the program of privatization is going to be implemented fully or partially and in what ways.
E In light of the likelihood of the dollar decreasing in value, is the central bank changing the ratio of its foreign currency reserves?
No. We have the same ratios because we intervene in US dollars, so by departing too much from our structure of reserve in the dollar, we will incur risks on the Forex markets, dollar vis-à-vis euro or sterling or yen, which is not good for a central bank.
We cannot be speculators on the exchange markets, but we have created a model that preserves the real values of our reserves and don’t forget; the central bank, on its balance sheet, has a large stock of gold that represents around 30 percent of that balance sheet today. So the country is well hedged against any future development in terms of inflation internationally or a weaker dollar if this trend continues.
E Is the devaluation of the dollar going to help us get to a higher balance of payments now that our exports are going to be more attractive?
You know, the dollar is decreasing in value against all of the currencies and most economic activity, whether in terms of production or services, is dollarized. This gives a competitive advantage to the country. And we have seen that in the correlation between the growth in the economy in Lebanon and the decline in value of the dollar. Of course we are talking about the economy in general. We are not talking about savings and the purchasing power of savings but this is an issue that concerns the people, the owners of capital, not the central bank. At the central bank, we have a diversified portfolio in terms of currency. We have a large stock of gold. But our transactions will remain related to the US dollar as long as the markets are dealing in that currency. If the markets change to another currency, then we will change as well.
E To what extent are banks in Lebanon compliant with Basel II?
They are fully compliant to the criteria of Basel II; the solvency ratio in the country is around 12 percent. As you know, most banks worldwide are struggling to get to 8 percent, which is the norm. And this 12 percent is by applying all the criteria of Basel II. We are also working on the governance issue and on the risk and transparency issues along with the banks. We issued circulars in that regard and we have created, at the central bank, a unit for good governance that is going to work in the field to make sure that good governance is implemented, and we will start by a strict analysis of the composition of the board of directors and their prerogatives in the bank’s management.
The group is within the central bank so effectively it will give its recommendation to the governor. The governor will present it to the central board and there will be a decision that has enforcing powers. This is a follow-up activity, nonetheless there is also the banking control commission that is empowered and has the teams that are in the field working to see how our circulars are being implemented in the banking sector.
E The sentiment at the Union of Arab Banks conference in November was that Basel II is insufficient to prevent a crisis like we are seeing right now from happening again. Do you agree with that?
The crisis happened after Basel II had been approved, so Basel II is not enough to prevent a crisis. Here, we added to Basel II the liquidity factor that did not exist before. So in Lebanon, the banks have to constitute a liquidity of 30 percent on their balance sheets, 15 percent as a reserve requirement with the central bank and 15 percent on their own books. The fact that we have low leverage and high liquidity has helped the sector refrain from going into adventurous credit, and Basel II is more on the capital side than on the liquidity side. So it has to be developed more. Anyway, Basel II is just guidance because the major countries did not even implement it, like the United States or India. There is no better protection for a bank than its management because they know what is really happening in the bank, and for a banking sector, the local central bank should be aware and prudent, to moderate leveraging in the sector.