Littlelakes /Foter

Extracted from “Moody’s Weekly Credit Outlook”, dated October 31, 2011

Last Monday, Maura Connelly, the US Ambassador to Lebanon, warned of “serious consequences” if the Lebanese government fails to cooperate with and fund the Special Tribunal for Lebanon (STL). Moody’s believes that any sanctions, particularly if they are aimed at the banking sector, would be credit-negative for Lebanon, which relies on its banks” capacity to attract deposits and buy government debt.

The STL was established in March 2009 with the purpose of holding trials for the people accused of carrying out the attack on 14 February 2005 that killed 23 people, including the former prime minister of Lebanon, Rafiq Hariri. The STL published its findings in June, charging four Hezbollah members and reviving tensions between communities within Lebanon. The current Lebanese government has to manage competing pressures from its domestic political base, which rejects the STL”s role and findings, and concerns about possible international sanctions.

In Moody’s view, a decision to fund the STL could lead to a domestic political crisis, and potentially a fall of the current government. The dispute over the STL already caused the resignation of the previous government in January 2011, which was followed by five months of negotiations over the composition of the cabinet. The country is required to transfer $32 million, or 49% of the STL”s annual budget to the United Nations. Failure to fund the STL could lead to economic or financial sanctions from the international community.

While sanctions appear unlikely, Moody’s cautions that potential consequences could be severe. The stability of the Lebanese banking sector rests largely on banks” capacity to attract a stable inflow of customer deposits. In early 2011, the US authorities accused Lebanese-Canadian Bank (LCB, unrated) of money-laundering, and subsequent sanctions on the bank triggered a run on its deposits. Customer deposits fund 83% of Lebanese banking system assets, and are supported by remittances, which account for over 20% of Lebanon”s GDP.

Moody’s adds that sanctions that reduce the inflow of remittances or deposits could pose a threat to the stability of the banking system and the sovereign”s finances. Lebanese banks are the main lenders to the highly indebted Lebanese sovereign and their capacity to fund government debt depends on the stability of their depositor base.