Financial services account for eight percent of gross domestic product in the country of six million.

Lebanon‘s economic crisis is a litmus test for the resilience and domestic support of its banks as well as their potential for sparking contagion abroad.

Lebanese lenders remained closed for a seventh working day on Friday, with the small, heavily indebted Mediterranean country paralysed as hundreds of thousands of people protested over economic strife, leaving schools and businesses shut.

The government has responded by promising reforms that involve banks stumping up 5.1 trillion Lebanese pounds ($3.4bn) towards deficit reduction in next year’s budget, partly through an increase in taxes on their profits.

“These measures should weaken the banking sector, as they will cut into their profit margins over the next year,” said Natasha Smirnova, portfolio manager at PineBridge Investments, pointing out the levy was just a one-off for next year.

Financial services make up eight percent of gross domestic product (GDP) in the country of six million. Bank deposits to GDP stand at 243 percent, the third-highest ratio globally after Luxembourg and Hong Kong.

“Banks have an enormous role in government funding, as they are almost their only source of financing, and the cabinet [and] central bank will proceed with utmost caution so they do not hurt the sector too much,” Smirnova added.

Lebanon’s unorthodox “financial engineering” relies on drawing in foreign exchange deposits from abroad by offering high interest rates to help shore up the country’s pressurised foreign exchange reserves.

Lebanon has 66 registered lenders, with commercial banks holding just over $260bn of assets, central bank data showed, though a handful of large players dominate.

But while banks in Lebanon have an unusually wide geographic spread due to the country’s estimated diaspora of about 14 million, the banks’ seven-day closure so far appears to pose relatively little threat to wider financial stability.

Global reach

The Lebanese have a long history of emigration and settling around the world, with large, mostly Christian, expatriate populations in Brazil and the United States in addition to Shia communities in Africa.

“Lebanese banks have significant operations in the region, but this is mainly through a subsidiary model, where those operations are ring-fenced,” said Farouk Soussa, an economist with Goldman Sachs. “This minimises the risk of financial contagion either way.”

Bank Audi – Lebanon’s biggest bank in terms of assets – operates in 11 countries including Saudi Arabia, Egypt, France and Switzerland. Its annual report showed that of its total assets of $47.2bn, nearly 70 percent came from Lebanon at the end of 2018 compared with just over 60 percent the previous year.

Business from Bank Audi’s Turkish arm, Odea Bank, in which Bank Audi holds a 75 percent stake, accounted for nearly 13 percent of assets, while business from Egypt accounted for 8.2 percent. However, the share of both countries in total assets had declined due to currency depreciation.

“Bank Audi’s branches and subsidiaries abroad are stand-alone entities and are therefore not affected by the crisis Lebanon is currently witnessing,” the bank said on Friday in response to questions from Reuters news agency.

Lebanon’s BLOM Bank operates in about 10 countries including the United Kingdom and Romania. But of the bank’s $36.7bn of assets at the end of 2018, nearly 83 percent came from Lebanon, with another nine percent from the Middle East and North Africa, including Egypt, Jordan and Iraq.

Asked what effect the crisis in Lebanon was having on its branches and subsidiaries abroad, BLOM Bank said it had “witnessed an increase in its foreign operations”, without giving any further details.

Bank of Beirut in 2011 bought Australia’s Bank of Sydney, which offers mortgages, home loans and savings accounts and states on its website that deposits were covered by the Australian government’s deposit guarantee.

Salim Sfeir, chairman of both the Bank of Beirut and the Association of Banks in Lebanon, said he expected banking operations in the country will fully resume once banks reopen. Bank Audi said it was servicing and replenishing ATMs, collecting cheques deposited at smart ATMs and “processing emergency requests”.

Whenever, wherever

Many of Lebanon’s lenders focus on banking expatriates rather than being systematically entangled in the financial ecosystems of other nations.

The other factor limiting the potential repercussions of the stresses in the Lebanese banking system is that many western banks have limited exposure to the country, which was shattered by civil war between 1975 and 1990.

Lebanon now faces sluggish growth and high unemployment.

“It might make you think of Ireland where banking sector stress will completely bring down the whole economy,” said Nafez Zouk, a strategist at Oxford Economics. “But Lebanon’s banking sector is pretty plain vanilla – it is not risky, there is a lot of macro-prudential regulation … it’s very, very pure and simple banking.”

Of the major western banks, Citigroup remains one of the few with a presence in Lebanon, with 35 staff offering corporate and investment banking as well as trade finance, the US bank’s website shows.

JPMorgan has just a handful of people based in Lebanon, working in treasury services, which is part of wholesale payments.

Other banks have withdrawn altogether.

HSBC sold its Lebanon subsidiary to BLOM Bank some two years ago, while banks from other Arab countries have also dialled down their activities.

Some are pointing to cooling relations between Beirut and some of its historic allies such as Saudi Arabia over Hezbollah and the group’s growing influence in Lebanon’s government.

Saudi Arabia’s largest lender, National Commercial Bank, closed its two branches in Lebanon in 2016.

Qatar National Bank, the largest bank in the Middle East, still has operations in Lebanon, yet a spokesman said that on the ground, it has just one branch with limited business.

“The situation in Lebanon is idiosyncratic and unlikely to have any contagion on emerging markets as we have seen historically with political developments there,” said Smirnova of PineBridge Investments.