Moody's Investors Service on Friday said that the outlook for Lebanon's banking system is stable, attributing this to expectations of deposit inflows and slightly increased economic growth.

The new government, formed in January, provides some respite from months of investor and depositor uncertainty,” said Alexios Philippides, AVP analyst at Moody’s.

“We believe that despite a recent slowdown in deposit growth, inflows will be sufficient to allow banks to finance the government and the economy, provided that the new government implements reforms to bolster confidence.”

The rating agency noted that the operating conditions for banks will remain challenging in the next 12 to 18 months, adding that the outcome of this period will be dependent of the government's ability to implement fiscal and economic reforms.

"Failure to implement reforms will further compound recent pressures, and wide fiscal and current account deficits will be key structural issues in the interim," the report warned.

Moody's pointed out that Lebanese banks’ profitability would be under pressure because of higher funding costs, subdued new business and higher provisioning charges, from low levels.

“They will seek to mitigate these challenges through cost control and growth abroad. Political developments affecting the pace of economic reform and depositor confidence are a key risk for Lebanese banks. The banks’ large sovereign exposure remains their main source of financial risk,” the agency said.

It also expected annual deposit inflows to pick up to around $6.5 billion in 2019, from $5.6 billion in 2018, provided the new government is able to implement reforms to shore up confidence.

“Capital flight remains a key risk for banks and the sovereign."

“Lebanon’s financial system maintains substantial foreign liquidity against this risk, which has been centralized at the Central Bank,” the report noted.

“We expect continued pressure on banks’ loan quality, driven by several years of subpar economic growth, high interest rates and a struggling real-estate sector."

“We expect banking sector equity-to-total assets to remain at 8 percent for 2019.

“We have raised our risk weights to reflect the recent sovereign downgrade to Caa1, which will lower our adjusted risk-weighted capital ratios,” the report said.