Lebanese banks have weathered punishing conditions, including a tough new tax regime. Technological innovations continue to drive progress, but as James King reports, structural economic flaws must be addressed if they are to continue to thrive. 

Blom Bank

Lebanon’s banks have, in recent years, been operating in less than ideal conditions. The economy is estimated to have grown between 1% and 1.5% in 2017, after expanding by about 1.8% in the previous year, according to the International Monetary Fund.

This sub-optimal growth has been accompanied by escalating political and security concerns both at home and across the wider Middle East region. Domestically, ineffective governance has failed to address structural flaws in the economy, while the introduction of a new tax regime, in which Lebanon’s banks were a key target, has piled pressure on the county’s lenders.

Alpha banks

But generating a profit under adverse circumstances is an area in which Lebanese bankers do particularly well, and the past year has been no exception. The county’s 14 largest banks, known as the 'alpha banks', registered a 6% increase in net profits in 2017 in US dollar terms. Total assets grew by a similar amount, at 6.6%, thanks in part to an uptick in domestic lending. The story behind this relative success is a familiar one: Lebanon’s banks adapt, innovate and hunt for efficiency to an almost peerless degree.

“In the past 12 to 18 months, Lebanon has witnessed challenging economic and political situations that have affected the entire banking sector. However, and despite all these difficulties, Fransabank was able to register a sustainable performance with total assets, customer deposits and net loans that have grown steadily,” says Fransabank general manager Nadim Kassar.

That the country’s big-hitting banks have emerged relatively unscathed from the travails of recent years is no surprise. But the extent to which they have prospered despite these difficulties is worth noting. For instance, Lebanon’s second largest bank by assets, Blom Bank, registered a return on average common equity and a return on average assets of 17.1% and 1.56%, respectively, in 2017. By the end of the year, the bank’s net profits had grown by 4.7%, compared with 2016, to reach $484.69m.

“All things considered, Blom Bank’s performance in the past year or so has been pretty good. The country is still in the midst of an economic slowdown and the region remains unstable politically, so operating conditions continue to be challenging,” says Saad Azhari, Blom Bank chairman and general manager.

Lebanon’s largest bank by total assets, Bank Audi, also registered strong growth over the period. This was in part due to the bank’s focus on cost control and the search for greater efficiencies in a more a challenging domestic environment. “We were able to decrease our operating expenses by $76m in 2017 compared with 2016. And this is what has impacted the bottom line,” says Freddie Baz, general manager and group strategy director at Bank Audi.

The country is still in the midst of an economic slowdown and the region remains unstable politically, so operating conditions continue to be challenging

Saad Azhari

Green financing

Beyond the numbers, Lebanon’s banks have continued to push the boundaries of their products, services and wider offerings. Several lenders are harnessing innovation – which has always been at the heart of Lebanon’s financial sector – to address the challenges facing the wider economy. A case in point is Fransabank’s April 2018 green bond issuance, which made it the first bank in Lebanon and the wider to Levant to execute a transaction of this kind. An initial issuance of $60m-worth of series one green bonds will be followed by other series out of a total global green bond programme of $150m.

“For years now, Fransabank has strategically positioned itself in financing sustainable energy projects. This includes energy efficiency, renewable energy (wind, solar), waste management, water treatment and water management. We have been pioneering in this segment of the market and have financed more than 175 projects for about $110m,” says Mr Kassar.

The launch of Lebanon’s Capital Investment Plan (CIP), an ambitious infrastructure development initiative designed to boost the economy with support from international investors, was seen by Fransabank as a logical opportunity to “build an innovative financial instrument to support environment-related projects”, according to Mr Kassar.

The green bond transaction builds on Fransabank’s strong track record of sustainable energy financing in the country. “During the past three years, through our Sustainable Energy Finance Initiative, we have allowed a decrease of 2500 tonnes of carbon dioxide emissions and saved more than 4.2 million kilowatt hours [of energy use] per year. This comes within Fransabank’s global strategy of fighting climate change and global warming,” says Mr Kassar.

Payment innovations

Market innovations in the payments space are also afoot. In August 2017, Blom Bank launched its e-payment service, Blom Pay. The bank’s Visa card customers can execute payments via their android mobile phone through the bank’s standard mobile app, known as the eBlom app. The service is the first of its kind in the Lebanese market and will improve payments’ security standards, according to Mr Azhari.

“The Blom Pay architecture is built on the Visa token service, which is based on the global tokenisation standard that enables financial institutions to replace the 16-digit primary account number with a digital token. This is a much more secure method of payment and is a prerequisite to adopt new wallets such as Apple Pay and Samsung Pay,” he adds.

But despite these innovations, and others, Lebanese banks are still being buffeted by strong headwinds. In 2017 the government passed a range of new taxes to fund an increase to public sector salaries. These tax hikes include a jump in corporation tax to 17% from 15% and an increase on the tax on banks’ deposits and securities held with the Banque du Liban.

IFRS 9 will oblige banks to have a conservative approach for lending, and in parallel to look for additional capital, to consolidate its regulatory ratios

Nadim Kassar

“The banks have been targeted for tax increases in particular. Our deposits at the central bank are being targeted for tax, which is against all norms. There is now double taxation on our income,” says Nassib Ghobril, chief economist at Byblos Bank.

Bankers in Beirut argue that any additional tax pressure on the banking system would be unfair, not least because of the already high contributions that the county’s lenders make to the government’s tax haul. “Broadly, the banking sector represents about 7% of gross domestic product in Lebanon but as an industry we contribute up to 40% of total income tax collected by the government. When the industry opposes increased tax pressure it is with respect to our relative weight in the national economy,” says Mr Baz.

Speaking to the Financial Times in November 2017, Riad Salame, governor of Banque du Liban, the country's central bank, noted that the increased tax rates would be likely to hit the profitability of the country’s banks and spur inflationary pressure. In the first quarter of 2018, Byblos Bank, one of Lebanon’s largest lenders, saw net profits shrink by 3% year on year, a performance the bank attributes to the impact of the ‘double taxation’ on the banking sector.

Regulatory landscape

Meanwhile, a shifting regulatory environment is introducing new opportunities and challenges in Lebanon. In March 2018, the Banque du Liban issued Circular 145 on the application of the Basel liquidity coverage ratio (LCR) for commercial banks. The LCR is applicable on an unconsolidated basis to banks in the country as well as their overseas units and any subsidiaries. The liquidity ratio is mandated to be at least 100% of currency that constitutes a minimum of 5% of bank’s total liabilities. In practice, this will mean both Lebanese pounds and US dollars.

As research from rating agency Moody’s has noted, the LCR circular states that banks’ non-reserve deposits with the Banque du Liban (including certificates of deposit and government securities in local and foreign currency) are deemed to be high-quality liquid assets. Since almost 50% of the Lebanese banking sector’s assets are composed of these types of securities, Moody’s expects most banks to be already compliant with LCR requirements.

Indeed, according to Alexios Philippides, an associate vice-president and analyst at Moody’s, the application of the LCR will bring some benefits to Lebanese banks. “We expect that the LCR ratio will improve banks’ short-term liquidity management and help them avoid liquidity shortages, a credit positive,” he says.

IFRS issues

Meanwhile, Lebanese banks have been contending with the introduction of IFRS 9, which was implemented at the start of 2018. The immediate impact was negligible for most of the country’s biggest lenders, since they were already in good shape regarding their provisions – partly due to the Banque du Liban’s process of financial engineering, which began in 2016.

In an effort to boost its foreign currency assets, the central bank sold Lebanese pound-denominated treasury bills at a premium to commercial banks, in exchange for the banks buying dollar-denominated instruments from the central bank. Some lenders used the revenues generated through this to book provisions linked to the implementation of IFRS 9, according to research from Moody’s.

“The IFRS 9 regulation that came into force at the beginning of 2018, in addition to the LCR, will have a significant impact on the banking sector. It will oblige banks to have a conservative approach for lending, and in parallel to look for additional capital, to consolidate its regulatory ratios,” says Mr Kassar.

Though most Lebanese bankers accept that operating conditions are less than ideal, there is room for some optimism as growth opportunities are developing in the country’s burgeoning information and communication technologies (ICT) sector. They also point to the massive volume of loans (amounting to $11bn) promised by the international community at the Paris IV Conference or Conférence Économique pour le Développement, par les Réformes et avec les Entreprises (Cedre). Funds guaranteed at the conference will be allocated to major infrastructure projects detailed under the CIP, which should offer a big boost to the country’s banks over the longer term.

“There are some opportunities emerging from an interesting few developments occurring now and in the near future. First are the opportunities arising from the Cedre funds; second are the opportunities from the banking sector’s investments in the ICT knowledge economy through Banque du Liban’s 331 directive; third are the opportunities that will come from a resurging oil price regionally; and fourth are the opportunities that will emerge with oil and gas discoveries in the country,” says Mr Azhari.

Expanding abroad

These opportunities will take time to unfold. And before their full impact is realised, most Lebanese banks are continuing to profit from their regional expansion. Bank Audi, for instance, has continued to benefit from its move into Turkey and Egypt despite the strong currency volatility experienced in those markets in recent years. Similar moves have been made by most of Lebanon’s largest banks, which have, on the whole, enjoyed considerable success through their international expansion.

Alongside this international growth, most banks are also looking to diversify their customer base inside Lebanon in the search for stronger growth. “The diversification in the clientele portfolio by segment and sector remains a key success factor: this includes focusing on industries, contracting, infrastructure projects and renewables. Moreover, Fransabank’s focus on small and medium-sized enterprises will continue further as it is essential to support this segment of the market as it represents the backbone of the economy,” says Mr Kassar.

For Lebanon’s banks – and the wider economy – to prosper, meaningful economic reform is needed. Until that happens, the country’s lenders will be faced with sub-optimal operating conditions. And even though Lebanese banks have remained both strong and profitable despite decades of political, security and economic uncertainty, a new wave of geopolitical risks are starting to threaten the country. Unless Lebanon’s political leadership is capable of dealing with this potent mix of domestic and external challenges, the pressures on Lebanon’s banking sector will only deepen.  


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