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Middle EastOctober 4 2009

Pillar of strength

Lebanon's banks are thriving and this is in no small part down to the actions of the country's much-admired central bank governor, Riad Salameh. He spoke to Charlie Corbett about how he plans to maintain the country's financial stability.
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Pillar of strength

The office of Riad Salameh, governor of Lebanon's central bank, exudes the rich odour of expensive cigar smoke. The governor is seated behind an expansive oak desk nestling on a deep Persian rug, on the top floor of Lebanon's central bank building in Beirut. He is smoking a cigar.

Somehow this image of a central banker, relaxed and puffing on a cigar, is incongruous with today's financial climate. Mr Salameh's contemporaries in the developed markets can only dream of a time when they commanded the kind of respect and admiration that justified the public consumption of such extravagant items. For them, the past year has been a time of frenetic activity as they pumped emergency liquidity into their ailing banking sectors in a desperate bid to stave off financial calamity.

Lebanon's central bank governor, on the other hand, has had no such concerns. The country's banks are thriving and it is in large part down to Mr Salameh's prudent overseeing of the sector. Despite widespread fears that the crisis in developed markets could spell disaster for Lebanon's small, open economy, the doomsayers have been proved wrong. Deposit inflows were up by 15% across the banking sector in 2008 and are up $8bn already in 2009; the currency has remained stable against the dollar and the central bank has amassed reserves of more than $23bn. Add to that gold reserves of $8.5bn and it is easy to see why Mr Salameh appears so relaxed to his guests. Furthermore, he has achieved all of this amid a backdrop of severe political uncertainty that has veered between street protests, political assassinations and war with Israel in 2006.

The listening bank

Central bank chiefs have a tendency to divide opinion, but not so in the case of Mr Salameh. Senior bankers across the country's capital, Beirut, are universal in their praise for him. "The central bank has managed to maintain the stability of the currency and that has been a cornerstone of confidence in the system," says Nassib Ghobril, head of economic research at Byblos Bank. Saad Azhari, chief executive of Blom Bank, praises Mr Salameh for his prudence: "When the central bank saw excesses going on, it issued regulation to avoid speculation," he says. Varouj Nerguizian, chairman of Emirates Lebanon Bank is equally gushing: "It is a central bank that listens and not a central bank that dictates. This has been the key to the success story of Lebanon recently."

Mr Salameh says that the most important targets for any central bank are to improve confidence in the financial system and deliver on its promises. "The central bank cannot avoid problems in individual banks but should act pre-emptively and in anticipation to avoid problems that could shake the whole banking system," he says. This is exactly what the central bank did in 2004 when it barred Lebanese banks from purchasing the complex derivative instruments that brought Western banks to their knees. This move, perhaps more than any other, insulated the system from the worst effects of the financial crisis.

Mr Salameh's philosophy revolves around the twin pillars of solvency and liquidity. "Our vision is that banks should preserve the deposits," he says. "We have stressed the solvency issue, but also the liquidity issue so that banks don't have to rely only on the interbank market." As a result, deposits account for 80% of Lebanese banks' capital bases and have been the mainstay of financial stability throughout Lebanon's recent troubled history. Unlike the situation in other volatile emerging markets, its numerous political crises have never led to a run on the country's banks.

Lebanese conversion

Another sign of the system's stability, according to Mr Salameh, is the increasing conversion of dollar deposits into Lebanese pounds. Dollarisation in Lebanon had fallen from a peak of nearly 90% down to 67% at the time The Banker went to press. Banks have also increased their lending in Lebanese pounds as opposed to dollars. "We are seeing a bigger increase in loans denominated in pounds than in loans denominated in dollars," he says. "We hope this liquidity will serve as a means to fund the private and public sector in new projects." Spreads on the country's credit default swaps have also plummeted from a high of 10% down to 4%. "The overall market message is one of confidence and optimism for the future," he adds.

The governor, however, stresses that the top priority for this year and next will be to maintain liquidity and solvency, rather than focus on profits. Guidelines have already been issued to the banks, stating that they cannot distribute more than 25% of their profits for 2008. "Banks have responsibilities to the nation and should not approach business the way a start-up company would," he says. There are also plans to launch a five-year treasury bill with a rate of about 9%, two years longer than the usual maturity. "This is a major achievement in terms of interest rates in Lebanon, given the rating of the country which is B-, but also it means that the perception of risk has diminished as far as the value of the pound is concerned," says Mr Salameh.

New leader, old problems

Despite the almost infectious optimism that surrounds Lebanon's financial sector, the country's political situation inevitably causes bankers' brows to furrow. The peaceful elections in June that saw the appointment of Saad Hariri as prime minister, son of the assassinated former prime minister Rafik Hariri, caused a universal sigh of relief. However, politics in Lebanon rarely remain stable for long. Mr Hariri has yet to form a government of unity between the country's fractious parties, and economic and financial reforms are much needed.

Mr Salameh is aware of the need for reform. After decades of conflict and political stagnation, the Lebanese government has built up debts of $44bn. This translates to 160% of gross domestic product (GDP) and is one of the highest ratios of debt to GDP in the world. His concerns, however, lie not so much with Lebanon's debt mountain, but with its fiscal deficit, which increased by 18% in the fist six months of 2009, compared with the same period last year. "The government will have to address the issue of the deficit and will have to address other reforms, especially related to the energy sector," he says. "The vulnerability in our system is not really in the debt we are carrying [although it is large, the monetary base is large enough to sustain it], the vulnerability comes from the increasing yearly deficit in the budget of the government. That, of course, is the major effort that will require co-operation between all political parties."

The key to the future prosperity of Lebanon lies in politicians pushing through reforms of the electricity sector, which remains a huge drain on the nation's treasury, and wide-scale privatisation of utilities and, in particular, the country's two mobile networks. "If there is a political agreement on reforms, then things can be done. We have high liquidity and therefore privatisations can be successful," says Mr Salameh.

The biggest challenge for Mr Salameh will be to oversee the Lebanese banks' relentless expansion across the Gulf region and beyond. Building on their success at home and their strong deposit bases, Lebanese banks have expanded across the Middle East and Europe and he is keen to temper this expansionism with prudence. "The success is not just about profitability, but sustainability," he says. "They need to build up a good reputation and build up business prudently so they don't jeopardise the system at home." Another priority is to improve the country's archaic system of payments. "This will serve not only the financial sector but also the consumer sector and therefore the economy," says the governor.

The next step for Lebanon's banking sector will be to consolidate. The number of banks in the country has already dropped substantially, but further consolidation is needed to beef up their capital bases. "It is essential to hedge the risks. We also want to improve the human resources in the banks so that they can be more in line with Basel II requirements of good governance, transparency and management of risk. Also, [they must be able] to deal with more complicated financial products," says Mr Salameh.

Growth prospects

Lebanon's relative insulation from the full effects of last year's global economic turmoil is testament to the policies of its central bank, which has taken a prudent view on regulation and maintained a steady exchange rate. Lebanon is accustomed to dealing with crises, whether they are home-grown political ones or foreign-inspired economic ones.

Mr Salameh is optimistic for the future. "We have achieved this success in very bad times and we are confident we can continue to achieve stability," he says. "If the political and security situation remains as it is today, we believe the country will achieve good growth." The International Monetary Fund agrees, recently predicting that the Lebanese economy would grow "substantially faster" than its previous GDP growth estimate of 4% for 2009. However, Lebanon's fortunes will depend heavily on the new prime minister establishing a unity government and implementing much-needed economic reforms.

Only time will tell how successful Saad Hariri will be in building a stable political coalition in a country renowned for its instability. On one thing at least he can rely, and that is the country's solid banking system. Mr Salameh has earned his cigar.

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Read more about:  Middle East , Lebanon