International ratings agency Moody's on Monday downgraded to negative from stable the outlook on Lebanon's banking system, due in part to upheavals in the Arab world, especially in neighbouring Syria.
Moody's said slower economic growth and the banks' asset and loan exposures to other regional countries experiencing political unrest or economic slowdown, such as Egypt and Jordan, contributed to the new rating.
"Although non-performing loans improved during 2006-10, it is now more likely that this trend will reverse," it said.
"In addition to the weakened domestic operating environment conditions, the banks, predominantly the larger ones, have material exposures to countries undergoing political transition or experiencing political unrest, particularly Syria and Egypt."
The rating agency added that it expects banks' profitability to come under pressure in the future as business activity eases causing a slowdown in credit growth and fee-generating income.
The Lebanese banking system is highly exposed to Lebanon's sovereign debt, estimated at more than $50 billion, it said.
Mitigating some of the downside risks, Moody's said, is the banking system's liquidity buffers and resilient depositor base.
"Highly liquid assets and placements with predominantly international banks account for approximately 25 per cent of total assets," it said.
"In addition, the sector retains a relatively stable funding structure driven by customer deposits, which account for approximately 90 per cent of total liabilities."
It said the deposits are supported by the influx of remittances, which in 2010 accounted for 22 per cent of GDP.
Remittances "have historically proven to be resilient even though the risk of capital flight increases during periods of political unrest," Moody's said.