In November 2015, Lebanon's members of parliament met for the first time in a year. Among the handful of overdue laws they ratified was one on money laundering and another on terrorism financing. The dysfunctional assembly acts only on issues where every group's interests are served, and on this they all agree – what is good for Lebanese banks is good for everyone.
Bankers had made it clear that unless the two bills were enacted, the sanctions on Lebanon and its banking industry would be severe. Since this is the jewel in Lebanon's rather tarnished economic crown, the feuding politicians put aside their differences and united behind the legislation.
A banking lifeline
The banking sector continues to serve as the durable heart of Lebanon's embattled economy. Yet it faces considerable headwinds. Domestic political paralysis and regional conflict are affecting economic growth, which stagnated in 2015. The fiscal deficit has widened further and there has been no progress on much-needed structural reform. Tourism, which has suffered, is picking up slightly but construction, another important industry in the country, has suffered a significant slowdown. Consumer confidence is down. Foreign direct investment has all but dried up and international trade is falling off.
Nassib Ghobril, head of economic research at local lender Byblos Bank, insists that the Lebanese economy is not "resilient", as everyone likes to say, but has suffered a major drop in output of $24bn. "The size of the economy should not be $51bn but $75bn," he points out. "And yet it is not about to disintegrate. The public finances are not about to collapse, and the Lebanese pound is stable. Why? Because depositors have trust in the banking sector."
Makram Sader, secretary-general of the Association of Banks in Lebanon (ABL), highlights how far Lebanese banks have travelled since the early 1990s. "Then, total capital was about $600m," he says. "Today it is $16.6bn." In terms of liquidity, solvency, the payments system and, now finally, regulatory compliance, Lebanese banks can compete easily against the best international banks, he says. "And what is very important is that over those 25 years we have had continuous, sustained confidence in our country. We invested a lot and we always took our country risk. If other sectors had behaved as we did, maybe today we would have a modern developed economy."
Hope and faith
Lebanon's 55 commercial banks (including domestic, regional and international lenders) have continued to expand their networks, even since the start of the civil war in neighbouring Syria. The number of branches in Lebanon increased by 4% to 1020 in 2014, according to the ABL. They have also gone further afield, and today have more than 260 branches in more than 30 countries, Mr Sader notes. "That facilitates our continuous contact with the Lebanese diaspora around the world," he says.
Lebanese expatriates tend to believe in their own banks. As the financial crisis unfolded in 2008 and 2009, the international Lebanese business community – from London, Paris and New York to Sydney and Mexico City – deposited money in Lebanese banks. "Deposits increased by $19bn in one year," says Mr Sader. Expatriate deposits continue to play an important role today.
Back home, both deposits and lending continued to grow in 2015, though at a slower pace than the industry might like. The consolidated balance sheet of commercial banks increased by 5.9% in 2015, with total assets rising from $175.7bn at the end of 2014 to $186bn. That is more than three times the size of Lebanon's gross domestic product. Loans to the private sector grew by 6.5% to $54.2bn. A measure of the slowdown is that while lending to the resident private sector grew by a nominal $3.5bn in 2014, that fell to $2.7bn in 2015.
Private sector deposits grew 5% to $151.6bn in 2015. "As long as deposits continue to rise, Lebanese banks can continue to lend to the private sector and meet the growing needs of government, while satisfying the central bank and maintaining high levels of liquidity," says Mr Ghobril.
Formula for success
Indeed, as Lebanese bankers will never tire of reminding people, liquidity is the industry's principal strength. Given the tough environment in which it operates, caution in this department is a virtue. Latest figures quoted by the ABL show that net primary liquidity to deposits rose from 30.8% in 2013 to 32.1% in 2014. The total capital adequacy ratio in 2014 was 14.6% (13.5% Tier 1). Asset quality improved slightly with the ratio of net doubtful and substandard loans to total loans falling from 2.25% to 2.15%.
Maintaining high levels of liquidity has its price in terms of profitability, and return on assets for the sector as a whole stood at about 1% in 2014. Return on equity was 11%. The ABL says that preliminary data for 2015 shows that the figures for profitability, capital adequacy, liquidity and asset quality were much the same as 2014.
The Lebanese banking model depends on attracting deposits, and lending the funds on to government, very profitably, as well as to the private sector with an emphasis on housing and personal loans. The government's appetite keeps growing as it struggles to deal with the influx of Syrian refugees but, in a low-growth environment, new private sector business opportunities for the banks are limited.
Retail assets are growing faster than corporate assets, not least because Lebanese corporates are overborrowed. "Lebanese companies can't afford any more loans," insists Mr Sader. "The ratio of bank loans to capital funds in the corporate sector is abnormally high. Their problem is that they need to increase their equity."
The central bank is working to make the Beirut Stock Exchange and equity play a bigger role in Lebanese corporate finances (see story pXX). However, most companies are privately and personally owned because their owners see no tax advantage in incorporation. Indeed, there are disadvantages – individuals pay no tax on property gains but companies do, for example.
"To increase equity participation, they need to change the tax system so that no one is disadvantaged by having assets in the name of a company," says one banker.
Opportunities overseasÂ
Declining opportunities at home have made foreign operations more attractive than ever. One recent feature of the Lebanese banking industry has been the way in which its international expansion has begun to pay off. The central bank has encouraged this process, as long as the banks concerned could afford it and promised to abide by Lebanese banking regulations. In some cases, it was as well that they did.
"Lebanese banks have been present in several centres that ran into problems, such as Cyprus, Egypt and Syria," says Riad Salamé, governor of the Banque du Liban, the country's central bank. "None of them suffered, because they complied with our regulatory approach."
While adverse exchange rate movements, notably in the Turkish lira and the Egyptian pound, took some of the shine off non-Lebanese contributions to performance in 2015, they have still provided a welcome addition to domestic income.
Bank Audi, for example, is now the ninth largest bank by assets in Turkey and the seventh largest in Egypt. With its non-Lebanese assets now making up 48.6% of the total, the bank was able to report a 15% improvement in 2015 profits after tax, which rose from $350m to $403m.
Blom Bank, which has a presence in 12 countries outside Lebanon, is among the top three retail banks in Egypt, where it has been doing particularly well. "There we are very strong in retail, which does not require a big balance sheet," says Saad Azhari, chairman and general manager of Blom Bank. "We have seen a more than 30% improvement in our results from Egypt. Lending was up by 24% in dollar terms, higher than anywhere else."
Mr Azhari adds that the bank is slowly increasing its share in the Egyptian corporate market, in spite of a relatively modest balance sheet. "But we have seen growth in most other countries, including Lebanon and Jordan, where we are the leader in car loans," he says. Blom Bank's unaudited 2015 results showed an 11% rise in net profits from $366m to $406m.
Fransabank has a presence in 10 other countries, including Belarus, Sudan and Côte d'Ivoire. It is also building on a relationship with China that dates back to the 1950s. It was the first bank in the Arab world with a dedicated China desk, and it has now teamed up with UnionPay, China's only bank card business, to introduce Union Pay credit cards in Lebanon.
Fransabank's 2015 net profits rose 23% from $145.8m $179.8m. It has been highly acquisitive, making its sixth acquisition in 2014, when it paid a reported $103m for the Lebanese operations of Jordan's Al-Ahli Bank. Al-Ahli opted for a sale rather than boosting its capital adequacy ratio, as it was being ordered to do, and the deal illustrated some of the forces driving consolidation in the Lebanese banking market.
Size matters
The Lebanese banking model works well for bigger banks that can afford to maintain the high levels of liquidity required. For smaller banks, in Lebanon as elsewhere, the picture is less rosy. They find themselves facing mounting fixed costs of operation and regulatory compliance, but lack the economies of scale to make these affordable.
At the same time, the business landscape has become more hostile and bereft of opportunity. They are also losing correspondent relationships. Bigger international banks, going through the de-risking process, have been terminating relationships with smaller institutions where the business potential is not thought to justify the cost of due diligence. From that vantage point, acquisition by a bigger bank can seem attractive.
The number of Lebanese banks has almost halved in the past 20 years, according to Mr Salamé. "Now there are 25 banking groups of Lebanese origin," he says. "In the 1990s there were more than 60." The central bank has adopted an understanding approach to consolidation, to the point of providing soft loans to make bank mergers easier. Mr Salamé has, however, ruled out the possibility of any mergers between the biggest banks. His reasoning is that this would reduce competition. It would also create institutions that were too big to fail, running the risk of destabilising the system and leaving the taxpayer on the hook for any rescue.
This year, in a deal worth $91m, Byblos Bank took over Banque Pharaon & Chiha, Lebanon's oldest bank, founded in 1876. In February National Commercial Bank, Saudi Arabia's largest bank, announced the closure of its two Lebanese branches, both in Beirut. It cited "low financial returns". HSBC wants to sell its Lebanese operations, which employ 200 people in three branches, and a corporate banking business in the country. This is part of a global scaling back at the London-based lender, which is about to build a new Middle East headquarters in Dubai. Newspaper reports say HSBC has received interest from local banks, and has held talks with parties including Blom Bank. Neither HSBC nor Blom Bank would comment.
Asked about his approach to acquisition in general, Blom Bank's Mr Azhari says he is always open to it in theory. "But I look at shareholder value, and very few candidates fit our bill," he says.
The political question Â
The fact remains that the bulk of Lebanese banks' income comes from interest on sovereign securities. This significant and growing exposure to the health of the public finances, in a weak economic environment, largely explains why ratings agency Moody's has had the Lebanese banking sector on 'negative' outlook.
"The sovereign relies on banks to fund a large part of the deficit," says Moody's analyst Alexios Philippides. "Their overall direct sovereign exposure has grown by 8% in 2015, and remains a key credit risk." While bank holdings of government treasury bills and Eurobonds have been broadly stable, the growth has been in central bank certificates of deposits and non-reserve deposits at the central bank. "So the central bank has funded the deficit, using part of those funds to support the sovereign," says Mr Philippides.
Banks' overall exposure is more than five times their Tier 1 capital, Mr Philippides observes. "Weakening of the creditworthiness of the government means a negative outlook on the sovereign, which translates into a negative outlook on the banks," he says. Nonetheless, Moody's still expects Lebanese banks to continue to grow their stable deposit-based funding bases, albeit at a slower rate this year, and to maintain solid liquidity buffers.
This year seems to have got off to a more hopeful start, and Mr Azhari says that Blom Bank is seeing an improvement. "The security situation has improved," he notes. "Business people have more confidence and are investing more to expand industry."Â
Tourist numbers and hotel occupancies have been ticking up, which is a good sign. But bankers agree that the most important thing that needs to be restored is political stability. Some note that the international community is beginning to take more interest in Lebanon, and more positive pressure on all parties might be forthcoming.
"We need to restore the proper functioning of our public institutions, starting by filling the long-standing void of the presidency," says Nadim Kassar, general manager of Fransabank. "In the longer term, Lebanon must start implementing a comprehensive, strategic fiscal and economic reform plan, aimed at restoring public finances and motivating sustainable growth."
