Doomsayers defied but challenges loom for Lebanese banks

Dr Freddie Baz, the chief executive of Lebanon's biggest bank, Bank Audi, points proudly towards the view from his window. Located in the bank's gleaming sandstone and glass headquarters in central Beirut, Mr Baz's office overlooks myriad construction projects. Numerous cranes punctuate the skyline and tell a story of a city under reconstruction.

After decades of political and civil strife, Beirut is once again rebuilding itself. "They are building two new hotels that you can see from here, The Hilton and The Four Seasons," says Mr Baz, proudly. "Tourism is the key." Visitors to Lebanon are up nearly 60% so far this year, which will undoubtedly provide a major boost to the economy, but it is the success of the banking sector that has turned the most heads in the past year.

The Lebanese banking sector has proved itself to be resilient to the wider global malaise in international finance. After the collapse of Lehman Brothers in late 2008 and the subsequent government takeover of major lending institutions in the US and the UK, Lebanese depositors lost confidence in foreign banks. As a result, funds have been pouring into the country's local banks, which are enjoying record levels of profits and liquidity. These inflows allowed Lebanese banks to boost their lending to the domestic economy by $5bn in 2008. "Beirut was regarded as the Switzerland of the Middle East in the early 1970s," says Mr Baz. "We lost that role because of the war [between 1975 and 1990], but now we are going beyond expectations by becoming a financial centre once again," he says.

What crisis?

Mr Baz's predictions are not without some substance. Total assets for the Lebanese banking sector according to The Banker's latest Top 1000 rankings were up 11% to $80.2bn, compared with $70.9bn in last year's rankings and now stand at $84bn. This year's Top 1000 rankings also indicate that profits across the sector were up. According to those Lebanese banks listed both this year and last, total pre-tax profits across the sector were up nearly 27% to $1.1bn.

Bank Audi itself experienced a 21% leap in deposits in 2008, which now stand at $20.4bn, and its net profit soared by 19% in 2008 to $238.5m. In the first six months of 2009, assets for the bank were up 10% and deposits were up 11.5%. But it is not only Bank Audi that is reaping the benefits of financial stability; most of Lebanon's other major players have had bumper years. Fransabank boosted its net profits by 45% in 2008 to $88.3m and grew its assets by nearly 17%, Blom Bank increased its pre-tax profits by 25.4% in 2008, Byblos Bank increased its pre-tax profits by 20% and Bank of Beirut increased its pre-tax profits by 34.8%.

Strong resilience

Adnan Kassar, chairman and chief executive of Fransabank, says that Lebanon's financial sector has shown great resilience to the global financial crisis. "The effects of the crisis on Lebanon remain virtually non-existent, with the Lebanese banking sector maintaining its growth on the one hand and the economic conditions of the country improving on the other," he says.

Not everyone, however, is quite so confident that the financial crisis will pass Lebanon by without a scratch. Nassib Ghobril, head of economic research at Byblos Bank in Beirut, takes a more cautious view. "Talk of Lebanese banks being resilient to the financial crisis has become an overused expression," he says. "The Lebanese economy is a small, open economy with linkages to the rest of the world and therefore it is inevitable that it will not be isolated. It is true that the economy has been immune from the direct impact of the crisis, but it is not isolated from it. The banks have been resilient but they are not immune from what is happening."

Dr Freddie Baz, chief executive of Bank Audi

Not immune

Bank Audi's Mr Baz agrees. "The global turmoil has, to a large extent, been beneficial to Lebanon, but we have not been totally isolated," he says. "Last year GDP [gross domestic product] growth was 8%, but the International Monetary Fund has revised that down to 4%. Foreign demand is 25% of total demand, so the recession will have an impact. We live on planet earth." He adds, however, that a 4% increase in GDP growth for 2009 is pessimistic. "Exports grew by 7% in the first half of 2009. Even 6% [GDP growth] is still very conservative because domestic demand, which makes up 75% of demand, is undiminished."

A major fear for bankers after the crisis hit developed markets was that foreign remittances, which are a huge source of bank deposits in Lebanon, would dry up and newly unemployed Lebanese ex-pats would flock home and put pressure on the state's finances. But so far, this has not been the case. "At the end of last year we expected lower growth because there was an expectation that remittances would fall as a result of the financial crisis," says Saad Azhari, chief executive of Blom Bank in Beirut. "Everyone was surprised when remittances actually increased in 2009. We also didn't see unemployed Lebanese return and drain the economy."

The banking sector has seen some fall-off in lending as a result of the crisis, but Mr Ghobril explains that this is more due to a drop-off in lending overseas than lending to resident Lebanese people. As for remittances, rather than drop off they have actually increased in 2009. According to Mr Baz, $16bn flowed into the country from abroad in the first six months of 2009, a whopping 55% increase on the corresponding period in 2008. Lebanon's domestic deposit base now represents four times that of the country's GDP, which was $29bn in 2008. "From a deposit basis, we are not feeling the impact of the crisis," says Mr Ghobril. "On the contrary - while across the rest of the world governments bailed out their banks, in Lebanon the bank sector has been supporting the government for many years."

Pound for dollar

Another sign of growing confidence in Lebanon's financial system is the rate of de-dollarisation. Although the economy is still largely dollarised, with nearly 70% of deposits made up of dollars, this figure has fallen from past highs of 92%. Undoubtedly the increase in deposits in Lebanese pounds can be put in large part down to the higher interest rates offered. Depositors in local currency receive 7.5%, whereas those who deposit in dollars receive 3.2%. However, the mere fact that people have enough confidence to deposit in the local currency is testament to the sector's resilience. Or, put more cynically by one local businessman: "It doesn't matter if you deposit in pounds or dollars, if the economy dives and the banks collapse, you will lose your money either way."

A more telling statistic than deposits, however, is the amount of lending done in the local currency. Typically, rates are much higher on loans in Lebanese pounds, up to 10.5% compared with about 7% offered on loans in dollars, but there are signs that this too is changing. "There is still a 3% differential between rates on dollars and Lebanese pounds, but this is shrinking," says Mr Baz. "We are at the eve of a de-dollarisation of loans. There is no alignment yet, but the premium will certainly shrink."

Wider and wider still

Such financial stability has allowed Lebanon's banks to expand ambitiously overseas. It is a trend that shows no sign of easing. Lebanese banks have set up operations throughout the Middle East, Europe, Africa and some even have plans to service diaspora in the US. Such aggressive expansion policies could cause concern over banks overstretching themselves and threatening the financial stability at home. However, Riad Salameh, the governor of Lebanon's central bank, says that he is keeping a sharp eye on their practices abroad. Given the historic conservatism of Lebanese banks, he need not have much to worry about.

Byblos Bank, for example, which last year increased its overseas presence to Nigeria, Sudan and Iraq, follows a traditional approach to banking overseas. "The strategy is to look at under-banked markets and leverage our core strengths of trade finance, retail banking and commercial lending. The aim is to diversify the asset base by looking at opportunities abroad."

Blom Bank's Mr Azhari is equally cautious and maintains that the bank's strong profit growth in 2008 was due to prudent practices. "In all 10 countries in which we operate, we have seen an improvement in our profitability. We avoided the retail and property sectors because we felt it was a bubble, and focused mainly on trade finance," he says. Blom Bank opened 15 branches across Egypt, Jordan, Lebanon and Syria last year and recently launched operations in Qatar and Saudi Arabia. "As other banks in the region stopped their expansion plans, we continued to grow our presence," says Mr Azhari. "The culture is to grow organically and in a steady way. We keep our cost-to-income ratio below 40%. Our lending criteria are prudent - we don't follow the market."

Lobsters eating shrimps

The inevitable next step for Lebanon's banks will be further consolidation. Most in the market agree that scale will be critical if the banks want to reach the next level. "We haven't yet witnessed a real consolidation process," says Mr Baz. "What we witnessed over the past 10 years was lobsters eating shrimps, but we have yet to witness lobsters getting together to form giant lobsters."

Another likely scenario could involve banks in the wider Gulf region looking to purchase Lebanese banks. The trend has already started. In 2007, United Arab Emirates-based Bank of Sharjah (BOS) bought what was then Banque de la Bekaa in Beirut and renamed it Emirates Lebanon Bank (El Bank). Since that time, El Bank has boosted its capital base further still with the purchase, in late 2008, of local bank Banque Nationale de Paris Intercontinentale. Varouj Nerguizian is general manager of Bank of Sharjah and chairman of El Bank. He says that other banks across the region will likely follow BOS's lead. "We were the fist to do it and we won't be the last," he says. "Mergers will continue to happen [in Lebanon] in order to compete and survive, as well as to comply with Basel II capital requirements."

Debt mountain

Ultimately, the prosperity of Lebanon's banks is heavily dependent on the actions of the country's new government, led by prime minister Saad Hariri. After the peaceful elections in June, optimism in the country soared. However, as The Banker went to press, Mr Hariri had yet to form a unity government and much-needed fiscal and economic reforms remained on the back burner.

The national debt stands at $44bn, which equates to 160% of GDP and is one of the highest debt-to-GDP ratios in the world. The annual fiscal deficit is also increasing. Without wide-ranging fiscal reform and large-scale privatisation of the nation's main utilities, it is hard to see how this situation will change. Many analysts fear that the banking system could potentially be put under threat because Lebanese banks have a large exposure the country's sovereign risk. Lebanese Treasury Bills, Eurobonds and deposits make up about 50% of the central bank's total assets.

Few believe, however, that the Lebanese banking sector is under any undue pressure. This is because of a number of mitigating factors unique to Lebanon. The majority of government debt is owned by Lebanese banks and other Lebanese investors; the country has a very high deposit base that accounts for 300% of GDP and, crucially, central bank foreign currency reserves stood at $23bn as The Banker went to press. Lebanon also has the backing of international donors, which pledged $7.6bn in grants and soft loans at the Paris III conference in 2007. Most bankers in Lebanon are aware of the critical need for reform, but few believe that the national debt will hold back their aspirations for the shorter term.

The next step, according to Mr Baz, is to grow Lebanon's nascent capital markets. "Our ambition is to develop a much bigger and wider capital market in Lebanon," he says. "In 1920, the Beirut bourse was the most active in the region and we had 10 big European companies listed. We have the pedigree."