Prepared by Scherzando Karasu
Lebanon’s halcyon post-colonial days of the 1950’s and 60’s witnessed the emergence of the country’s financial services sector as the entrepôt to the Middle East.
At a time when their banking secrecy legislation enabled Lebanon to position it’s self as a safe regional financial hub, attracting money driven from the wider Arab world. Lebanon served as a magnet to depositors weary of the political upheaval and the socialist and pan-Arab political experiments that were sweeping across the region.
After Lebanon’s civil war between 1975 and 1990 the sector once again became the catalyst for the country’s development and indeed to an extent that of the broader region. With the stability of the Lebanese banking sector reflecting, to a significant extent, its remarkable success in attracting a constantly large stream of foreign funding. Primarily from the Lebanese diaspora, The Gulf and wider Middle Eastern depositors.
In recent years the banking sector has picked up momentum continuing to reap Arab funds thanks to a number of distinguishing features such as an entrenched liberal economic system, Lebanon’s ancient mercantilist history, their storied expertise in banking and their numerous intra-regional networks of connections. As well as interest rates set above international norms the strength of the Lebanese Central Bank’s guarantee and critically the banking secrecy legislation that is seen as stricter than that even of Switzerland.
Moreover, the recent period of relative political stability since the sectarian political parties struck a political deal in Doha three years ago has meant manifold benefits to the country.
Lebanon’s financial resilience stems from its recent history of terrible internecine warfare, political volatility and currency fluctuations that have inculcated a kind of systemic “conservative reflex” built into the regulatory architecture.
This bullet proofing of the banking system has meant Lebanon’s economic performance has been nothing less than remarkable in the face of the global recession. With the economy managing to buck international trends and maintain strong growth momentum in spite of large underlying vulnerabilities.
Elements of this model such as conservative funding and asset structures reflect prudent banking regulation and supervision supported by a strengthening economy. This has meant that the banking system has remained profitable highly liquid and well capitalized with very low-rates of non-performing loan ratios.
As Lebanon’s finance minister Raya El Hassan was at pains to stress, “It is a testament to the resilience of the Lebanese economy that even though we witnessed the financial crisis in 2008 and its repercussions in most of the developed countries, Lebanon has been essentially immune to the crisis and in fact come out even stronger than before. And this is why we see these large capital influences coming in from abroad, primarily because of the strength of our banking sector and the policies put in place by the government and the central bank.”
This counter-cyclical experience was echoed by BankMed’s Chairman, Mohammed Hariri, who gave us an insight into the esteem in which the regulators are held by the private sector, “They have done a great job, I think the Lebanese banking sector is one of the best regulated sectors in the world. And we have proved that during the financial crisis.”
The steps taken include forbidding toxic assets in 2004, such as sub-prime paper, long before they almost sunk the global economy. With investment in derivatives needing to be approved by the central bank. Strict regulation of structured products preventing banks leveraging their balance sheets, credit discipline, especially in real-estate and shares, (40% equity in real estate and 50% in shares lending).
Consequently, Lebanon’s banks find themselves in an enviably solid position. Enjoying high levels of deposits and a strong flow of inbound capital all while operating in an economy that expanded rapidly in recent years and is expected to do so again in 2011.
Although the rates of deposit growth have started to cool from last years 23%, banks are still growing sharply and continuing to report double-digit profit rises.
However, in a small economy like Lebanon’s this presents a fundamental problem and one that is becoming harder to ignore. Simply that there are not that many places to put the money. While private sector lending has increased since this deposit windfall and with Lebanon enjoying strong growth, GDP is still less than a third of the banks total assets of around $127 billion. So there is a major structural imbalance.
Exacerbated by the fact that Lebanon is a very small country and perhaps excessively well banked with 65 lenders competing to place this money in a market comprised of just 4 million people. Therefore this does not leave much room for domestic expansion.
Banks have also come in for some sharp criticism for not investing more of their liquidity in small and medium-sized enterprises. The vast majority of Lebanese businesses comprise less than 10 employees. Yet bankers counter that SME’s lack the capital and know-how to propose viable investment opportunities.
Additionally while the country has largely escaped the impact of the global crisis and the subsequent recession, the banks are becoming increasingly uneasy about the governments failure to reduce the national debt. With a government debt-to-gross domestic product ratio of approximately148% this remains one of the highest in the world and is the key macro-financial challenge requiring major structural reform.
However, this has come down sharply in recent years from as high as 175%. And reducing this will help to sustain confidence and keep interest rates steady. It is also worth mentioning that despite enduring a bitter 15-year sectarian civil war Lebanon never once defaulted on its sovereign debt.
Foreign currency reserves are also very high when compared to those of other countries, with the Central Bank’s liquid holdings at approximately $31 billion and holdings in companies and real estate at around $2 billion.
This gives Lebanon’s central bank a strong balance sheet approaching $45 billion and very close to the GDP of the entire country.
It is believed that Lebanon has to have at least one powerful argument when it goes to the markets and that this foreign currency position is in effect the country’s insurance policy, a hedge against the “unexpected events” that have bedeviled the country.
Historically, the well spring of Lebanese banking profits have flowed from their lending to government where about 23% of their assets in treasury bills and government bonds remain.
Subsequent to the wrenching trauma of the post-war period, Treasury bill yields remained very high at up to 40%. Although a prolonged period of relative stability has now enabled these to fall in line with international markets with Treasury bill yields now at just 5.5% and this has obviously led to a narrowing of bank’s profit margins.
So one of the key challenges facing the industry will be how far the banks manage to wean themselves off this comforting business model acting as intermediary between depositor and government and to an extent “crowding-out” other lending opportunities.
As Minister of finance, Raya El Hassan went on to say, “I think what our banks need to do now is to diversify their asset holdings away from their focus on financing the government and instead to provide financing to the private sector.”
Indeed the coming years will see many opportunities presented with big banks expanding into regional markets - a growing trend over the last several years. With 20% of banks assets now outside the country and loans to non-residents tripling since 2006, they now account for some 16% of private sector credit.
As Makram Sader, Secretary General of the Lebanese Association of Banks told us, “Our banks are certain to focus more on the regional market as we have a real comparative advantage there and by following our clientele in their businesses outside Lebanon. Especially within the Gulf Cooperation Council countries as well as even some African countries where you have a massive Lebanese diaspora.”
Indeed this enhanced focus on overseas expansion maybe one of the best ways for banks out of the dysfunctional impasse distorting the Lebanese economy.
As well as this the drive towards further privatization will also create ample opportunities for Lebanese banks in many areas like electricity and telecommunications and the further securitization of government assets.
Another perennial area of concern is the overheating of real estate. With the property market continuing to expand buoyantly year-on-year, there is a constant danger that the recent surge in values and the accelerating credit growth will feed off each other to produce a real estate bubble.
Although, the long-standing governor of the central bank for the last 17 years, Riad Salameh has dismissed this observing that, “default in residential loans is less than 1%”. Concluding that the demand is real rather than speculative and furthermore, “that mortgages require 40% equity with loans related to real estate not exceeding 10% of banks balance sheets and residential loans at less than 3%.”
The sector does certainly appear to be well regulated and closely monitored for any signs of hubris.
One area where further progress is perhaps needed is in anti-money laundering and by implication the combatting of terrorism. With Riad Salameh recently having to instigate an investigation into the US Treasury Department’s allegations against the Lebanese Canadian Bank over suspicious transactions allegedly connected to facilitating money-laundering activities of an international narcotics trafficking and money laundering network. Despite LCB denying any involvement and confirming that it would fully cooperate with the authorities.
In the wake of this the governor has re-emphasised that banks must regularly review their clients and conduct “know-your-customer” procedures more frequently and notify the regulators of suspicious accounts or transactions. As well as strictly following and implementing the rules and regulations relating to their dealings with foreign exchange bureaus in order to identify and check owners and sources of cash deposited at Lebanese banks.
With the Lebanese economy expecting to achieve a growth rate of 6% in 2011 according to the IMF this trend will certainly be reflected in the banking sector and shall remain the main driver of growth and the healthiest sector in Lebanon.
Banks should now be willing to provide credit facilities to finance both public and private projects. With a particular willingness to finance much needed infrastructure projects especially those related to electricity, telecommunications, water and road projects especially through the Public-Private-Partnership (PPP), which will bring back even more prosperity to the Lebanese economy and create job opportunities an attract local Arab and even international investors.
With the rest of the world still enduring a long hangover after the wild excesses on the global markets in recent years. The Music in Lebanon never really stopped. The Lebanese are a nation of highly adaptive survivors who have paid a heavy price for the prosperity they are now enjoying and through their travails they have learnt to seize the day but also against the odds, how to bank for tomorrow.
Lebanese Banks International Expansion – Feature
Prepared by Scherzando Karasu
The big banks in Lebanon have been steadily expanding their overseas presence with fully 20% of banks assets now outside the country they are increasingly financing and lending to diaspora clients, as well as looking after their assets.
Historically many of the larger Lebanese banking players had existing European operations that acted as a hedge on the risk of crises in Lebanon. European entities in countries like Switzerland, France, Belgium and the UK were set up mostly in the 1970’s, to service the then swelling ranks of the Lebanese diaspora and to funnel funds away from war-torn Lebanon.
Today these operations maintain the same role but have been vastly developed in terms of their sophistication and are now increasingly competitive vis-á-vis their larger local peers. At various critical points in the past the presence of this archipelago of overseas entities was key to preventing valuable Lebanese banking assets from shifting to foreign competition.
Now though as new regional markets open up and returns on Government treasury bills and bonds, the traditional source of Lebanese banks revenue in a limited local credit market, have shrunk they have recognized that overseas expansion offers an increasingly attractive opportunity to diversify revenue away from potentially problematic Lebanese sovereign exposure.
By seeking international expansion to enhance profitability and diversify earnings as well as assets while increasing their product range and offsetting political risk by allowing the channeling of funds into safer zones. Indeed geographical expansion is now seen as essential to risk diversification.
With the key strategy being expansion into neighboring emerging markets that typically have low levels of banking penetration and strong economic growth. Such as the Maghreb, the Levant and sub-Saharan Africa. And significantly all regions with a large presence of Lebanese expatriates.
Makram Sader Secretary General of the Association of Lebanese Banks elucidated, “We will continue with our regional expansion despite it being more difficult to operate abroad but we have to continue this regional movement, whilst of course being prudent in how we expand abroad”
However whether such an audacious strategy will pay off remains to be seen with some analysts arguing that Lebanese banks overseas expansion will be limited, the main obstacle being entrenched local competition.
However with an increasing level of liquidity, (a feature that has always characterized the Lebanese banking sector), Lebanese banks are now regardless of the nay-Sayers aggressively looking for new opportunities and investment horizons to mitigate risks generated by the political instability in their home country And to diversify sources of income that are restrained by the relatively small size of Lebanon’s domestic market.
With most Lebanese banks, particularly the listed ones, looking to geographic expansion as a move towards a universal banking role by expansion into regional markets long considered captive and natural markets for them to explore. And offering substantial potential returns in retail banking, project and trade financing.
With banks such as Blom, Audi, Byblos, Bank of Beirut (to name some of the listed banks) having already ventured into Syria, Jordan, Qatar, Sudan, Algerian and Saudi Arabia. They are now pondering further regional expansion, with this new regional role auguring well for the future of earnings and the dilution of balance sheet risk.
According to recent IMF data there are now some 16 Lebanese banks spread across 32 Arab and foreign countries through 85 units (36 subsidiaries and associates, 31 branches of Lebanese bank, one sister bank, one branch in the free zone in Syria and 17 representative offices). All together associate, subsidiary and sister banks have branches in 187 countries.
As Makram Sader went on to say, “We will focus more on the regional than the international market because regionally we have a better comparative advantage. The Lebanese are mainly following their clientele. So the main focus for us is likely to be in regional countries, such as the GCC and even Iraq or example. All of these are promising markets for us and so are even some African countries where you have massive Lebanese immigration rates and huge Lebanese communities, so these two key areas will be where our banks will expand and invest money in future”.
Lebanese Islamic Banking
Prepared by Scherzando Karasu
Islamic banking under Sharia principles is one of the world’s fastest growing financial sectors and has gained increasing prominence and momentum in the wake of the global financial crisis.
A recent report issued by the consultancy firm AT Kearney predicted that assets and deposits of Islamic banks would rise to $1 trillion in 2012, propelled by average annual growth rates in the sector of between 15 and 20 percent as investors increasingly seek more ethical ways of investing.
However while Lebanon is seen as being capable of potentially attracting a lot of investments due primarily to its position as the traditional financial nexus between East and West and their unparalleled regional expertise in the banking sector they have thus far been lacking in attracting more of this business.
In mitigation though this is a very new industry to Lebanon, where Islamic banking only became officially available in 2005 after a law was passed validating Islamic finance practices. With several other factors also contributing to the relatively slow pace of its development such as the demographic composition of Lebanese society compared with the wider region. The lack of understanding of Islamic contracts by the general public and the legacy of conventional banks entrenched within the Lebanese business community.
As well as a relatively thin specialized regulatory and supervisory framework, the lack of corporate governance rules that entice investors into Islamic banks and the relatively high rates of taxation compared with the region impacting the flow of regional deposits and the inability of the Lebanese Islamic banks to structure and sell Islamic products to the regional investor. Perhaps also of significance is the non-existence of an Islamic money market.
According to statistics provided by Lebanon’s Central Bank Islamic assets currently represent a tiny fraction of the sectors total with less than 1 percent ($251 million) of the total assets of conventional banks. With just four local Islamic banks 0perating in Lebanon there are around 800 branches of conventional banks compared with only eight branches of Islamic banks; Al-Baraka, Arab Finance House, Lebanese Islamic Bank (A unit of Credit Libanais), and BLOM Development Bank. With all four mostly focused on retail banking and consumer finance and with a fifth having just received its license.
This niche sector does though have an ally in Banque Du Liban Governor Riad Salameh who has overseen Islamic banks pioneering several development initiatives producing several new Sharia-compliant products that have found their way into other regional markets.
With the further development of specialized competencies in the sector Islamic banks have identified Lebanon as a base for cross-border expansion despite the size limitations of the local market.
Even from this low base assets of Lebanese Islamic banks grew 17 percent last year and 12 percent in both 2008 and 2009. Recently L’ecole Superieure Des Affaires in Beirut - the top national business school - launched an Islamic finance qualification program in cooperation with the Securities and Investment Institute.
Despite the good work regulators have done in recent years, there is still much to be done in order to improve the environment and facilitate the growth of Islamic finance.
However considering the abundance of highly skilled professionals, the quality of local financial education, professional firms, IT infrastructure and high quality of life. Lebanon may well play a regional role in Islamic banking and offshore banking regulation could provide Lebanon with a springboard to take the industry to the next level especially given the efficient and transparent dispute resolution system that mitigates local legal risk.
Essentially the task in hand is simple; Lebanon must spread awareness of Islamic products and sell the industry as one of balanced and ethical banking that is highly relationship orientated and at competitive rates.
Lebanon's BASEL III preparedness
Prepared by Scherzando Karasu
In December 2009, a new set of banking standards were announced by senior officials from The Bank of International Settlements to serve as a continuation of the international rules for banks capital adequacy requirements. Thus attempting to avert any recurrence of the global financial crisis, to provide enhanced safety to the international banking industry and to protect international economies from future financial calamities.
"We are pinning high hopes on the new international criteria most notably Basel III requirements to avoid new financial crises on the individual and systemic levels," said Joseph Torbey, the head of the Association of Banks in Lebanon.
Originally promulgated with the Basel I agreement of 1999 and subsequent Basel 11 agreement of 2004, the new Basel III requirements, which are expected to be applied towards the end of 2012, will have a range of stipulations.
Banks will be expected to increase their tier-one capital ration to 4.5 percent. In addition, they will have to carry a further “counter-cyclical” capital conservation buffer of 2.5%. As well as taking measures to limit counter party credit risk and short and medium-term quantitative liquidity ratios. With any bank failing to meet these new requirements expected to be banned from paying dividends to shareholders until it has improved.
These expectations are not however considered unduly onerous in Lebanon with most Lebanese bankers expressing confidence that they will be able to meet the conditions set by Basel III, noting that the capital adequacy ratios of the banks in Lebanon are high, even by international standards.
Riad Salameh, governor of the Central Bank that supervises and regulates the banking system has endorsed this position, claiming that it is easily capable of meeting them, “The capitalization of Lebanese banks – better known as Tier-one- is expected to reach 10 percent over the next few years from the current ration of 7 percent, well above the required ceiling set by Basel III.”
Since the late 90’s, commercial banks in Lebanon have been required to meet a minimum capital adequacy of 12 percent obligatory reserves and corresponding to 10 percent annual profits and systematic recourse to the provisioning of non-performing loans and in line with the earlier Basel II agreement.
It is now a cliché but Lebanese banks weathering of the global financial crisis is mainly attributed to their having one of the highest liquidity ratios in the world, with an estimated average liquidity ratio at more than 30% of total deposits.
As well as Lebanon’s tightly proscribed restrictions governing high risk investments and complex securitization and re-securitization practices that exposed and exacerbated such profound weaknesses in the banking and financial service sector activities across the world. With so many major international banks having built massive debts both inside and outside their balance sheets.
“Among the basic issues which the international financial crisis has revealed is that many banks did not have sufficient capitals to back up the risks which they have taken. Later these banks discovered that the magnitude of the crisis was above all their expectations," Said Torbey of The Association of Banks in Lebanon.
While Lebanon’s economy is small - estimated recently by the IMF at some $39 billion – its banks punch well above their weight with a balance sheet approaching $133 billion, over three times the country’s overall GDP. And given that the economy is wide open with Lebanese banks now operating in some 32 Arab and foreign countries it will certainly behoove Lebanon to continue abiding by the international rules.