In recent months, Lebanon’s improving political and security environment has generated cautious optimism among the country’s banking community. For years, Lebanese lenders have chartered a prudent yet profitable course through the country’s turbulent political waters. Faced with regional and domestic conflict, and a corresponding slowdown in the economy, banks have distinguished themselves through a careful commitment to sustainable growth. In doing so, they have anchored the broader economy during its most troubled years.
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Despite these challenging conditions, the country’s banks have carved out incremental growth from the limited opportunities presented by the domestic market, along with expansion abroad.
According to figures from the Association of Banks in Lebanon, the total consolidated assets of commercial banks in Lebanon increased 7.4% in January 2014 year on year, reaching $164.4bn. By January 2014, commercial banks’ loans to the private sector had increased by 9.1% year on year, to reach $41.8bn, while total resident, non-resident private-sector and public-sector deposits also increased over the same period by 7.7% to $138bn. And data covering Lebanon’s 13 largest banks, known as the Alpha Group, showed the consolidated net profits in 2013 matched the previous year at $1.7bn, while net operating income rose 4.7% to $4.5bn in 2013.
Revised outlook
In a promising sign for the country's banking sector and economy, on April 11, ratings agency Standard & Poor’s revised its outlook for Lebanon to 'stable' from 'negative', noting: “The government's debt-servicing capacity is materially determined by the strength of deposit flows to the financial system. In our view, this funding source has helped stabilise the government's financing needs during increasingly challenging times for the internal and external political environments. We note that deposit inflows have been stable, even during the domestic political vacuum in 2013 and also in the face of the increasing spillover from the deteriorating situation in Syria.”
On the domestic front, the success of Lebanese lenders in 2013 was in part thanks to ongoing stimulus measures of the country’s central bank. Injecting $1.4bn into the economy through loans to local banks at a rate of 1%, Banque du Liban’s incentives package had a significant impact on targeted sectors of the economy.
Nadim Kassar, general manager of Fransabank, says: "Loan activity in Lebanon showed positive growth in 2013. This is a good sign for the economy, and one which validates the central bank's policy of incentives packages. In our own portfolio, net loans and advances to customers totalled $5.288bn, with a growth rate of 9.27% as compared to the end of 2012.”
The country’s other major lenders also recorded sound improvements along most metrics. Blom Bank, Lebanon’s top bank by Tier 1 capital, recorded a 5% increase in net profit in 2013, in conjunction with a rise in total assets and deposits of 4.3% and 3.6%, respectively.
Byblos Bank also registered improvements to its retail loans, which increased by more than 10% from $1.4bn to $1.55bn, while deposits increased by 12% in the Lebanese market alone. In line with its conservative management strategy, Byblos Bank also increased its net provisions in 2013 by $57.3m as a buffer against any future uncertainties.
Meanwhile, Bank Audi, Lebanon’s largest lender in terms of total assets and deposits, saw net profits decrease due to heavy investment in a new Turkish subsidiary, Odeabank, although the lender saw substantial increases to total assets and customer deposits, year on year.
Security plan
In line with this success, the improving outlook for Lebanon’s political and security environment has been cause for guarded optimism among the country’s banking community. In April this year, the Lebanese army enforced a new security plan across the country’s northern and eastern provinces. Prompted by the growing violence between sectarian militia groups in Tripoli to the north, and the spillover of conflict from Syria in the Bekaa Valley to the east, the government’s intervention has so far proved effective.
Saad Azhari, chairman and general manager of Blom Bank, says: “We have seen a major improvement of the security situation especially in the north of the country and the Bekaa region. The army has been accessing areas where it has never entered before, including parts of Tripoli. The security forces have also taken over important areas on the frontier with Syria, so there is a renewed confidence emerging over the country's medium-term prospects. This in turn will promote confidence in the country and encourage both domestic and foreign investment.”
This new security environment is in large part attributable to the formation of a national unity government in February. Following nearly 10 months in which political infighting between opposition groups prevented the formation of a cabinet by incumbent prime minister Tammam Salam, a fresh political dynamic has emerged, providing Lebanon with its first functioning government in nearly a year.
“Driving this change has been a new political consensus among the country's opposing political groups. This is having a tangible improvement on security conditions which is hugely important for the country’s investment climate,” says Dr François Bassil, chairman and general manager of Byblos Bank.
While the performance of Lebanon’s biggest lenders continued along traditional growth trends, the highly competitive domestic market has proved more challenging for smaller and foreign banks. In particular, the stringent capital requirements imposed on Lebanese banks, which go beyond Basel III figures, have begun to squeeze returns on equity.
In this competitive banking space, in which the country’s top 10 lenders dominate 80% of the market, foreign lenders are finding it difficult to maintain a foothold. At the time of writing, the retail operations of Standard Chartered, Ahli International Bank and Emirates Lebanon Bank were reportedly being negotiated for acquisition by Lebanese banks, according to the domestic press.
Development opportunities
One exception to this trend is HSBC. Despite downsizing its retail operations three years ago, the bank has maintained a presence in the country since 1946 and continues to see opportunities for development. “Lebanon is an attractive market for a number of reasons,” says Peter Yeates, chief executive of HSBC Lebanon. “First, there is a high degree of regional and international connectivity, which sits well with HSBC's global outlook. There is also significant economic potential in the country, which the bank considers a growth market. We expect to see substantial foreign investment once greater political stability has been achieved.”
The bank has also benefited from a return on equity in Lebanon that surpasses the group’s global average, while recording attractive cost-efficiency ratios. In 2013, HSBC announced it would discontinue offering wealth management products to new customers in the country, as part of a wider strategic review of operations. According to Mr Yeates, this will enable the bank to focus on its core strengths of trade finance, payments and cash management services.
"Foreign banks have an important role to play in helping government and local businesses access lower cost financing with the support of export credit agencies. Larger projects, which have high foreign content, such as the Zouk and Jieh power plants, which were supported by the ministry of finance, Danish export credit agency and HSBC, can benefit from the international connections of foreign institutions operating in Lebanon,” says Mr Yeates.
Fresh challenges
As Lebanon’s fragile political and security environment shows incremental signs of improvement, the banking sector is facing fresh challenges. In early 2014, the country’s parliament opened discussions over whether to increase public sector wages in response to more than two years’ collective action from the unions.
To fund this proposed increase, new tax revenues are being sought to avoid further inflating the government’s ballooning public debt. To that end, the proposal now under consideration by the country’s parliament concerns a tax increase on interest generated from customer deposits from 5% to 7%, as well as a similar tax on banks’ investments in sovereign bonds.
"The rate of the proposed tax increase from 5% to 7% is not unduly problematic. But this tax will be levied on all depositors, both resident and non-resident, and this is worrying because it is effectively creating a blind tax on all deposits independent of their economic ownership. Moreover, the banks' investments in sovereign bonds will be levied, creating a double tax,” says Dr Makram Sader from the Association of Banks in Lebanon.
A final decision is expected soon. Despite the importance of the banking sector to Lebanon’s economy, it remains unclear which way the country’s cash-strapped lawmakers will lean on the issue. In light of these challenges, the Lebanese government’s approach to public finances has been called into question, particularly as the banking system continues to support the fragile public purse.
Highlighting the positive role played by the banks in the country’s economy, Standard & Poor’s notes: “Confidence in the Lebanese banking system underpins Lebanon's sovereign creditworthiness. Despite regional turbulence, this confidence remains intact and supported by remittances from the Lebanese diaspora and the interest rates banks pay on both local- and foreign-currency deposits.”
Systemic reform
Yet, it is widely recognised that without systemic reform, significant change to the country’s public finances will remain elusive. In particular, many in the banking community see room for reform in the country’s public sector, which is widely regarded as bloated and inefficient.
"Serious economic reforms are required in Lebanon to clean up the public sector and to reduce its burden on the private sector. This would be more beneficial than any changes to the tax regime. In particular, the electricity sector, which consumes huge sums of public money, is in dire need of structural change,” says Mr Bassil.
For the country’s banks, the traditional challenges posed by the domestic market have been offset by long-term regional and international expansion. The search for larger, more dynamic markets has led the banks more recently to look for opportunities in Iraq.
"Iraq is the main trading partner of Turkey, while foreign trade between Turkey and the Arab world has been growing exponentially over the last 10 years,” says Freddie Baz, group chief financial officer and strategy director for Bank Audi. “This was one of the main drivers of our decision to establish in Turkey, because of the growing business, financial and human synergies between Turkey and the Arab world.”
Both Fransabank and Blom Bank are also recent entrants to the Iraqi market, establishing offices in Baghdad and Erbil. “Fransabank recently inaugurated two new branches in Iraqi Kurdistan in March 2014. Furthermore, in view of its historical ties with the Lebanese expatriate community in west Africa, the group is in the advanced stages of establishing a presence in one or more of the west African countries,” says Mr Kassar.
This drive into Iraq has accompanied a longer term push into more conventional markets, in particular Turkey and the Gulf Co-operation Council region. Bank Audi’s aggressive drive into Turkey saw the group’s net profits take a hit in 2013, yet the size of the bank’s acquisition was vast.
Mr Baz says: "In 15 months of activity in Turkey, we have managed to build assets in the range of $9bn, which is almost 52% of the size of ING and HSBC's [assets in the country]. Both of these institutions have been in Turkey for about 25 years and have between 300 and 350 branches. With just 32 branches and in 18 months we have built a very competitive position in the market.”
GCC penetration
Moreover, Lebanese banks’ penetration in the GCC markets continues at pace. "Returns on regional operations remain attractive, particularly from markets such as Egypt and the GCC,” says Blom Bank’s Mr Azhari. “In Saudi Arabia, our investment banking operation has performed particularly well. Last year our profits there increased to $9m, giving us a return on equity of about 30%.”
In recent years, Lebanese banks have prioritised foreign markets to secure their long-term growth, particularly as domestic opportunities lessened in response to the diminishing security environment. Yet, if Lebanon can capitalise on its recently established political consensus and pursue badly needed political and economic reforms, the long-term potential for the country is enormous.
In August this year, the Lebanese government will conclude its offshore licensing round for the vast hydrocarbons reserves discovered off the country’s coast. With licensing awards expected in November, Lebanon’s prospects are promising.
“The country’s oil and gas reserves represent the possibility of real transformational change. In my opinion, when we start exploiting oil, three or four years down the road and when we have established production 10 years from now, we can assume a gross domestic product in the range of $200bn,” says Mr Baz.
The benefits of starting oil and gas production will, in all likelihood, compel Lebanon’s political authorities to overcome their differences to commence extraction. Once this happens, it will be a new dawn not only for the country’s banking sector, but for the nation as a whole. However, as in so many other countries blessed with abundant resources, managing the spoils of wealth will present a new set of challenges. To benefit the country, political groups would do well to follow the example of its banks; one of long-term vision, prudence and steady success.
