Lebanon’s conservative banking sector had a good financial crisis, attracting record deposits from clients in search of a safe haven.

But the political turmoil that has since hit the Levant has hurt profits and prevented banks from parlaying this windfall in to a more sustainable model of growth.

The financial crisis in Gulf and western nations spurred a surge in deposit growth that reached $1.5bn a month at its peak in 2009, prompting the big banks to pursue regional expansion plans.

While they also expanded lending domestically, the local economy’s capacity to absorb this level of liquidity is limited – the banks’ deposits are nearly three times Lebanon’s gross domestic product.

When the Arab uprisings swept the region in 2011, however, protests and the regimes’ violent responses severely disrupted economic activity. Voluntary provisions in the Egyptian and Syrian markets slowed the profit growth of the big three banks – Byblos, Audi and Blom.

“Lebanese banks have been looking to Egypt and Syria to grow because Lebanon is so saturated. Now what we’re hearing is that they’re going to maintain a ‘wait and see’ approach,” says Nadim Kabbara, head of research at FFA Private Bank.

“I don’t think ‘wait and see’ is very profitable.”

Most of the sector’s exposure is to the domestic economy, but prospects are far from rosy there either. The turmoil in Syria has reduced tourist traffic from the Gulf and the fear that it might spill over into Lebanon has eroded consumer confidence – bad news for a consumption-driven economy.

The property market is cooling after a hyperactive few years. New investment from the Gulf, Lebanon’s main source of foreign direct investment, has slowed. New private sector lending has fallen from $6.6bn in 2010 to about $4bn in 2011. Official figures show a decline in growth in the economy from 7 per cent in 2010 to 1.5 per cent in 2011.

Some feel the situation shows signs of improving. “I don’t have a crystal ball to forecast what will happen in Syria, but other things are constant,” says Marwan Barakat, head of research at Banque Audi, who argues that the domestic tensions at the beginning of last year in which a spat between the Shia group Hizbollah and the Sunni majority party led to the toppling of the government, had more of an effect on private sector confidence than the turmoil next door.

“What we are witnessing this year is a continuation of the moderate growth in the second half of 2011.”

The International Monetary Fund predicts a slight recovery to 3.5 per cent in 2012, but Nassib Ghobril, chief economist at Byblos Bank, says this is optimistic. “It’s not going to be worse than 2011 but it’s not going to be much better either,” he says.

Even if a decline is averted, the domestic and regional turmoil has not helped the banking sector diversify away from its high exposure to government debt of about 20 per cent (excluding deposits with the central bank).

Moody’s, the credit rating agency, downgraded the banking sector from stable to negative in December.

The agency noted, however, that credit risk was mitigated by the banks’ unusually resilient deposit base, which has not seen a significant outflow since the 2006 war with Israel, in spite of, various headline-grabbing political shocks since then.

Although nobody can predict how the Syrian turmoil might affect Lebanon, the consensus is that it would take a significant security incident in Lebanon to send depositors running.

With deposits accounting for more than 80 per cent of the banks’ funding, and being held mainly by Lebanese nationals who tend to take a robust approach to risk, some bankers feel that prospects for the sector are actually stronger than the turbulent environment would suggest.

“I think [turmoil] is affecting the real economy more than the financial sector,” says Mr Barakat. “The asset quality is still being maintained. You need to have a recession for a long time for the asset quality to be effected.”

Mr Ghobril cautions, however, against assuming the banks’ well-known prudence will protect them from an impact in the event of a sustained slowdown. “The banks are well managed, highly capitalised and highly liquid,” says Mr Ghobril. “It doesn’t mean that they are insulated from what is happening in foreign or domestic markets.”

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