Moody's has rated Lebanon's banking system outlook as stable on expectations of modest economic growth and inflows of foreign deposits, helping banks to finance the government.
Domestic credit will grow slightly at two to three percent over the next 12 to 18 months as interest rates rise, the credit agency said in a report on Tuesday. Any significant slowdown in deposit inflows would challenge banks' ability to finance the government and is the main risk to the stable outlook.
"Lebanese banks will continue to attract the needed inflows of customer deposits, much of this from the Lebanese diaspora," the report said. "Deposits should grow five to six per cent over the outlook period."
The country's economy has been battered by political divisions and a six-year war in neighbouring Syria during which an influx of refugees stretched Lebanon's public finances and infrastructure. The tiny nation also has one of the world’s highest ratios of debt to gross domestic product, standing at more than 150 per cent. Last month, the International Monetary Fund urged Lebanon to take immediate action to improve the sustainability of its public debt by increasing value-added tax rates, restraining public wages and gradually eliminating electricity subsidies.
Lebanese banks' profitability will take a hit from subdued business activity, higher provisions costs from low levels in 2017 and higher taxes, Moody's said. Banks will post a net income to tangible assets of about 1 per cent over the next 12 to 18 months, which is below the 1.2 per cent average recorded last year.
The credit agency said Lebanon's economy grew 1.9 per cent in 2017 and forecast a "modest" rise in GDP growth of 2.5 per cent this year and 3 per cent next year. This outlook is based on expectations of greater economic policy coordination and that the government will resume long-delayed public investment projects.
Lebanese banks' exposure to sovereign debt will grow, which will increase their financial risks.
"Large fiscal deficits of about 8 per cent this year and next will again be financed by the banks," Moody's said.
Sovereign exposure made up about half of banks' total assets last year, linking their creditworthiness with
the heavily indebted Lebanese government and exposing them to liquidity risks. Moody's rates Lebanon at B3 with a stable outlook.
"Continued pressure on the banks' loan quality is expected, driven by seven years of sub-par economic growth, rising interest rates and the impact of low confidence on the real-estate sector and consumption," Moody's said.
Further geopolitical unrest could slow the implementation of Lebanon's economic reform agenda and damage investor confidence.
Prime minister-designate Saad Hariri has been appointed to form a government following the May parliamentary elections - the first to be held since 2009 - and has emphasised the importance of proceeding with long-delayed economic reforms.
In April, donors from various countries pledged at the Cedre investment conference in Paris to provide Lebanon with over $11 billion in soft loans to mainly fund infrastructure projects. The pledges were linked to reforms, which include lowering the fiscal deficit by 1 percentage point annually over five years among other measures.
Lebanon's banking system has considerable liquidity buffers to withstand a period of "slower financial inflows or short-terms outflows" that would partially "mitigate the risk of deposit flight," Moody's said.
Banks' capital buffers are still "modest" and equity to assets ratio is at about 9 per cent, given the lenders' heavy exposure to the government and a challenging operating environment, according to the report.