PARIS (Standard & Poor's) Jan. 10, 2006--Economic risk inherent in their fragile operating environment is the main driver of the ratings on Lebanese banks, according to a report, "Bank Industry Risk Analysis: Lebanon (Republic of)", released today by Standard & Poor's Ratings Services.

The government's high indebtedness, fiscal deficit, and fragile political stability, together with adjustment to these factors, are causing severe constraints on the banking system. "After former Prime Minister Rafik Hariri's assassination on Feb. 14, 2005, the Lebanese economy was virtually put on hold. During the next four months, the country's banking system was under constant and heavy pressure.

It showed strong resilience, however," said Standard & Poor's credit analyst Anouar Hassoune. "The coordinated crisis management by the Banque du Liban, the Banking Control Commission, and the banking community helped restore confidence. The Lebanese pound was not devalued, and although the central bank's foreign exchange reserves shrank dramatically over the crisis period, the risk of the financial system becoming illiquid was avoided."

Lebanese banks have a number of specific features that make them unique in the Middle East. The most striking characteristic is the size of the banking sector: banks' assets are 3.3x as large as the country's GDP. The banking system in Lebanon is also heavily dollarized and about 50% of assets are made up of Lebanese sovereign risk. This also reflects the limited scale of the retail banking market.

In a less turbulent environment and the clear awareness that using their balance sheets to fund the government's skyrocketing financing needs is unsustainable, some banks are switching to new strategic orientations. Helped by high-quality management teams and sound regulation designed by a supportive regulator, Lebanese banks are targeting new markets in the region.

Lebanese banks have also been cleaning up their balance sheets. Although NPL ratios are still high, they are trending down at a sustained pace. Given this recent momentum, the banking system's resilience to shocks, and the new political situation following Syria's withdrawal from Lebanon, the rating outlook on Lebanese banks is stable, in line with that on the sovereign.