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Middle EastJune 1 2017

Are Lebanon’s Salamé days coming to an end?

Long-serving governor Riad Salamé is coming to the end of his fourth term at the helm of the Banque du Liban, Lebanon's central bank. Speculation is rife about whether he will be replaced but, as he tells Edward Russell-Walling, the decision is out of his hands.
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Riad Salamé

Lebanese bankers have plenty of things to worry about in the present climate. But right now their most immediate concern is not legislative paralysis, looming special taxes or even the Syrian crisis. It is whether the governor of their central bank will be asked to stay on in the job after his term expires in July.

The reality is that, for the past six years, not much has stood between the Lebanese economy and collapse except the Banque du Liban (BdL). And for ‘BdL’, read Riad Salamé, the man who has run it for the past 24 years. 

For nearly all of that time, Mr Salamé has maintained a stable currency. He has ensured that the Lebanese banking sector remains sound and therefore able to fund the government’s spending shortfall as well as private sector development. And in the absence of any other economic leadership, he has directed funds to those sectors he felt would bring the greatest benefit to the economy in future.

End of an era?

After a 20-year career with Merrill Lynch in Beirut and Paris, Mr Salamé was appointed to the first of his four six-year terms as BdL governor in 1993. Today he also chairs the country’s Higher Banking Commission, the Special Investigation Committee (which fights money laundering) and the Capital Markets Authority. But his fourth term is now coming to an end.

To fill the vacancy, the minister of finance will submit three names to the Council of Ministers, who will then pick one of them. But bankers say that, in reality, it will be newly elected president Michel Aoun’s decision. And there’s the rub. 

“The Aoun camp thinks that the governor’s monetary policy, which has stabilised the Lebanese pound at a high level, caused the deficit,” says one Beirut banker. “They have just replaced the head of the army and the head of army intelligence, so why not the head of the central bank?”

Is the governor himself willing to serve another six years? Mr Salamé is not to be drawn on the subject. “I leave it to the government to decide,” is all he will say. But those who know him say that he would definitely accept a fifth term.

In the meantime, Lebanon’s banking system is in an “excellent” state of health, Mr Salamé maintains. He suggests that this is a direct result of 2016’s controversial swap programme, in which the commercial banks delivered US dollars to the BdL and were generously rewarded with Lebanese pounds.

The programme demonstrated the governor’s ingenuity when it comes to solving problems, even if this was not immediately appreciated by some parts of the political establishment. “The financial engineering was necessary at the time,” says Mr Salamé. “In the first half of 2016 there was slow growth in deposits, and a big deficit in the balance of payments. The central bank was getting weaker in terms of foreign assets, so we had to either find some financial engineering to change that, or increase interest rates.”

Dollar peg

Mr Salamé notes that an increase in rates at a time when growth was running at only 1% could have brought it down into negative territory. With public debt at $75bn and private sector debt at $58bn, every percentage point increase in interest rates would cost the country another $1.3bn. So the BdL is committed to keeping interest rates stable, as well as the Lebanese pound, even if they are rising elsewhere in the Middle East or the wider world. That is why when the US Federal Reserve hiked rates in March, the BdL stayed put.

The Lebanese pound has long been pegged to the US dollar, which accounts for its stability, and Lebanon is a highly dollarised economy. Interest rates on dollar deposits in Lebanon average 3.5% compared with 1% or less in the US, and the differential plays an important role in attracting deposits from expatriate Lebanese.

Hard currency remittances are crucial to closing the trade balance gap, and have been under some pressure, decreasing from $7.5bn in 2015 to $7.3bn last year, according to World Bank figures. Lower oil prices have affected flows from Gulf states, while remittances from parts of Africa have been reduced by weaker home currencies. Remittances have continued to decrease in 2017, Mr Salamé says, and are 20% down compared with peak years.

So in 2016 there was every reason for the BdL to want to beef up its foreign reserves. “The financial engineering consisted of the banks bringing us dollars and, as an incentive, we bought from them treasury bills or certificates of deposit [CDs] in Lebanese pounds,” Mr Salamé explains. “We paid them half of the interest to which they were entitled, while the central bank retained the other half to compensate for the immediate revenue created for the banks.”

Cash exchange

This was an open offer, with volumes dictated by the commercial banks’ appetite, which was considerable. “We gave them all that they wanted – we were receiving, not giving,” says Mr Salamé, who adds that banks created partnerships with high-net-worth individuals and shared the income with them. Many were reported to be offering 6.5% on dollar deposits more than $1m, and some were said to be paying a 20% profit up front – in Lebanese pounds – for three-year deposits upwards of $10m.

In return for US dollars, the commercial banks received Eurobonds and dollar-denominated CDs, the latter with rates from 6.5% to 6.8%, depending on maturity, which ranged from six to 13 years. “It brought $13bn into the central bank,” says Mr Salamé. “Suddenly the banks had growth in deposits. By the end of the year there was an increase in deposits of 8%, whereas prior to the financial engineering the expectation was for 2%. And the interest rate remains unchanged.”

At the end of 2016, gross foreign reserves were $34.03bn, covering 22 months of imports and a year-on-year improvement of 11%. The swaps have also helped to restore the fortunes of some banks that were having difficulties, which may not have been an accidental benefit. All were told not to book their windfall profits but, in descending order, to use them to meet  International Financial Reporting Standards 9 (IFRS 9) from 2018 onwards, to recapitalise or write off investments in troubled foreign operations, and to allocate to Tier 1 and Tier 2 capital. The whole exercise did not play well with the public, however, provoking harsh criticism and calls for a windfall tax.

Another consequence was that the banks were awash with local currency liquidity, which has posed some challenges. Nonetheless, the dollar situation is now stable, according to Mr Salamé. He says that banks are now attracting more deposits “to fund the economy”, because they are seen to be more solid. “Today the banks have proper ratios, they have cleaned their books and are attracting funds at very acceptable rates for Lebanon,” he adds.

Would he do it again? “For the time being, there is no need,” he replies. “But the mandate of the central bank is to preserve stability in the currency. Lebanon needs stable purchasing power, and we must make every effort to achieve that, particularly with the weight on the economy of 1.5 million Syrian refugees.”

Up to standard

Lebanese bankers say that their fastest expanding departments are compliance and legal and, despite some legislative foot-dragging, the BdL has seen to it that its charges are up to speed with the welter of new international standards and regulation. “Lebanon is compliant with international laws on terrorism financing and tax evasion, and with the principles of IFRS 9,” says Mr Salamé. “We are exceeding Basel III in terms of capital adequacy and are now at 15%.” He also credits that to his financial engineering, which created the returns that banks were then asked to capitalise.

The BdL has already ensured compliance with a US law imposing sanctions on banks that do business with Lebanon-based Shi'a Islamist militant group and political party Hezbollah. Now a draft of new legislation tightening up that law is doing the rounds in Washington, DC. The Hezbollah International Financing Prevention Amendments Act of 2017 would prevent dealings with parties close to Hezbollah, as well as associated educational, social and media organisations.

Mr Aoun has said that this would “greatly harm” Lebanon and its people. Mr Salamé merely reiterates that the country has implemented what is required to fight terrorism, money laundering and tax evasion. “We are no longer on a list of people to be monitored, so I guess we are doing fine,” he says.

The imminent end of Mr Salamé’s term of office came up for discussion when he appeared on television recently. Asked whether the currency would remain stable if he was no longer governor, he replied that he could not guarantee it. Now he says this was mischievous editing of a much fuller response, in which he said that the BdL policy to keep the currency peg will last as long as he is around. Most Lebanese bankers hope that he will be, for at least a while longer.

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