* Some banks expected to miss capital deadline-sources * Asset sales will help Bank Audi, Blom Bank to meet target * Scrutiny of c.bank governor adds to uncertainty BEIRUT Feb 15 (Reuters) - Paralysed by financial crisis and riven with political risk, a number of Lebanon’s banks are struggling to meet a central bank target to raise their capital defences by 20% by the end of this month. Less than half of the country’s dozen or so large banks are expected to meet the requirement, which the central bank set in August to reinforce the sector, according to four banking sources with direct knowledge of the situation. Those that are on track to meet central bank targets have largely tapped existing shareholders or depositors, converting local dollar deposits into equity instruments or sold overseas businesses. The situation underscores the scale of the problem facing Lebanon’s banks, heavily exposed to one of the world’s most indebted states and starved of funding. Their customers have largely been frozen out of their dollar deposits and blocked from transferring cash abroad since late 2019. Given the wall of losses facing the sector, some investors and economists say it’s too little too late anyway. The 20% target laid down by Riad Salameh, Lebanon’s veteran central bank governor, is equivalent to around $4 billion, he confirmed to Reuters. That is far short of the $83 billion hole in banks’ balance sheets estimated by the outgoing government last year as part of a financial rescue plan it had drawn up. “They are all insolvent,” said Mike Azar, a debt finance advisor and a former lecturer in international economics at John Hopkins School of Advanced International Studies. “There’s no prospect for recovery as things stand, until there is a sector-wide bank resolution and restructuring and finally a fresh capital raise.” A central bank order for banks to request their largest depositors to repatriate up to 30% of their deposits also appears to have yielded little, the four banking sources say. Salim Sfeir, the head of Lebanon’s association of banks and the chief executive of Bank of Beirut, said most banks would “abide by the central bank guidelines”. “If we believe that there is no prospect for recovery we would be out of business by now. The challenges are difficult but we have a history of resilience and creativity and we will adapt to the new situation,” Sfeir said in an statement to Reuters. The central bank said it was premature to assess banks’ response to the capital hike target and to a separate request from it that they boost their liquidity by 3% with their corresponding banks. “Nevertheless, almost all banks have applied for the increase in capital and serious work has been done for the increase in liquidity,” Salameh said in an emailed response to questions. He acknowledged the banks could require more capital. “The Central Bank will work with the banks to tackle this issue individually,” Salameh said in emailed comments. With the end of February deadline approaching, speculation has bubbled on social media over which banks might be liquidated. The central bank issued a statement last week saying such discussions were “devoid of any truth”. The governor has warned that those who cannot meet the target would have to exit the market but some bankers told Reuters they expect it will be extended because there is so little hope of attracting fresh investment. FRESH SCRUTINY The financial rescue plan devised by the outgoing government envisaged wiping out bank shareholders but opposition from bankers and politicians torpedoed it, contributing to the collapse of financing talks with the International Monetary Fund. “A 20% increase in their capital is useful but insufficient,” said Khaled Abdel Majeed, MENA fund manager at London-based SAM Capital Partners, an investment advisory firm. “I would not touch Lebanese bank stocks at any price. Things will get much worse in Lebanon, before they get better.” Salameh, whose use of what he has described as “financial engineering” to keep Lebanon’s public finances afloat has attracted criticism, is also facing fresh scrutiny, raising questions about his future, bankers say. Switzerland’s attorney general said last month it was probing possible embezzlement tied to the Lebanese central bank. Salameh has denied any wrongdoing and did not respond to a request for comment about how the inquiry might impact his position and the wider banking sector. Bank Audi and Blom Bank, the country’s largest banks by assets, have sold foreign businesses to help bolster their finances. “The proceeds from the sale of the foreign operations would allow us to meet said regulatory requirements while positioning Bank Audi amongst viable Lebanese banks with adequate capital and liquidity levels,” Bank Audi management said in a statement to Reuters. Blom Bank did not immediately respond to a Reuters request for comment on its progress in raising its capital buffers and liquidity levels. It said last month the sale of its Egypt unit would allow it to comply with the central bank target. NO CONSENSUS For years, Lebanon’s banks were among the world’s more profitable lenders, funnelling funds from a scattered diaspora to the government’s coffers in return for high interest rates. But exposure to the state has ultimately been the banks’ undoing since dollar remittances dried up and anticorruption protests erupted, starving the financial system of funding. Commercial banks have lost roughly 49 trillion Lebanese pounds in deposits in the past two years, equivalent to around 22% of current total assets and large depositors are likely to be in the firing line in any resolution of the banking crisis. The government’s default on a $1.2 billion eurobond in March left banks, with government paper accounting for most of their assets, as the biggest casualty. Much of the remainder of banks’ assets are in real estate, where valuations have slumped amid the economic downturn. If those assets were to be marked to market, then combined with write-offs linked to government exposure, losses would overwhelm the sector’s capital base, said economist Nafez Zouk. Graphic: tmsnrt.rs/3rwxRBG The central bank told banks in August to provision for a 1.89% loss on their hard currency deposits with the central bank and a 45% loss on government Eurobond holdings, levels some economists have said underestimate the scale of the problem. The Lebanese pound has fallen 80% since late 2019 and Moody’s rating agency has estimated that Eurobond losses are greater than 65%. Privately, many bankers in Lebanon agree that the current banking sector, with at least 40 lenders and assets that swelled to as much as 167% of the country’s economic output at their recent peak of 2015, needs to drastically shrink. Some acknowledge that that will require shareholders, bondholders and customers to swallow losses. But there is no consensus on how many banks will need to be wound down and how big the losses should be. Without a new government -- the current cabinet serves in a caretaker role since resigning in August amid public fury over a devastating port blast in Beirut -- the bankers acknowledge a resolution appears unlikely anytime soon. Graphic: tmsnrt.rs/3tBqv1X