The economy has been brought to a near standstill by domestic and regional political turmoil, but the country’s banks report rising deposits and profits and feel they can ride out the crisis. Published in Euromoney, September 2011
If any economy in the Middle East should be inured to political unrest, it is Lebanon’s. The country has suffered more than its fair share of wars, political assassinations and the like, but even it has found the level of disruption this year unusual.
From mid-January to mid-June, the country languished without a government, just as revolutions and uprisings elsewhere were moving ever closer, from Tunisia to Egypt and then right up to Syria on Lebanon’s border. One problem could perhaps be coped with, but the two events happening at the same time brought the economy shuddering to a virtual standstill.
After posting a 9.2% rise in GDP in the first half of 2010, Lebanon’s figure for the first half of 2011 was just 0.8%, according to Nassib Ghobril, chief economist at Byblos Bank, one of the country’s big three banks alongside Bank Audi and Blom Bank.
"Since the beginning of 2011, the Lebanese economy has been facing a convergence of domestic instability and regional turmoil," he says. "This is the first time that these have happened simultaneously and that’s what led to the significant slowdown in economic activity in the first half of the year."
The eventual formation of a new government under prime minister Najib Mikati in June has helped to improve the situation, but the damage had already been done. At times in the past, Lebanon’s banks have benefited from disruption elsewhere in the region, as expatriate Lebanese and others have sought to protect their assets, but the domestic squabbles have meant that they missed the opportunity this time. There may be shiny new towers going up around Beirut marina, but the influx of capital slowed down in the first half of this year and many building sites around town now appear quiet.
The situation leaves Freddie Baz, chief financial officer of Bank Audi, the country’s largest bank, exasperated. According to his calculations, the value of bank deposits in Jordan, Egypt, Tunisia and Syria is some $16 billion lower today than they would have been without the turmoil. Tourism receipts in those countries are down as much as 80% as is foreign direct investment. At least some of that would have found its way into Lebanese banks.
"If you add foregone deposits to foregone FDI to foregone tourism receipts on a yearly basis, you have $49 billion of potential benefits," says Baz. "For Lebanon, getting 10% to 20% of this would be up to $10 billion. Those are opportunities lost for us. When you see the huge amount of lost opportunities, it’s frustrating. We are paying a price for the political bickering."
Still, Lebanon’s banks have, on the whole, coped well. Overall deposit levels have continued to rise this year, as have profits, if not at the same rate as recent.
Blom Bank, for example, saw its pre-tax profits for the first half of the year reach $196.8 million, 5% higher than last year. Assets have risen by 3% since the start of the year to $23.1 billion and customer deposits are up 4% to $20.3 billion.
Bank Audi did even better, in terms of profits at least. It posted a 10% year-on-year increase in its pre-tax earnings for the first half of 2011 to L£335 billion ($221 million). Customer deposits have crept up by 2% to L£37.8 trillion since the start of the year and assets by 1% to L£43.8 trillion.
For the sector as a whole, assets climbed above the L£200 trillion mark in April for the first time, according to figures from Banque du Liban, the central bank, and have continued to rise.
There are some warning signs, though. Moody’s Investors Service struck a note of caution in mid-July when it placed four Lebanese banks on negative outlook, citing the potential impact of regional turmoil on the big three banks and the Bank of Beirut. It also downgraded the smaller Banque Bemo.
The impact of the unrest in Syria and Egypt on Lebanon can be seen most clearly in the rise in the scale of provisions that banks are now making for non-performing loans. Bank Audi, for example, increased its general provisions to $69 billion at the end of June, out of a total of $197 billion in provisions. Blom Bank has put aside $28 billion for collective provisions, out of a total of $134 billion.
However, the banks insist that this is merely a sign of their conservative nature. Bank Audi says that in reality few if any of its customers in Egypt or Syria have reneged on their debts.
"We have been doing corporate portfolio reviews twice a month in Egypt and we have not downgraded a single corporate loan to NPL status," says Baz. "There is no impact at all on the quality of our corporate loans. Some of our accounts have been downgraded to ‘watch list’, not because of any fundamental issues with those accounts but for considerations that relate to politically exposed persons. In the previous Egypt[ian regime], the biggest corporates were owned by people close to the regime; after the political change, most of them have been put in jail, so they have suddenly become politically exposed persons, but there is no issue at all with the fundamentals of those accounts; they are behaving very well."
It is a similar tale for the bank’s retail customers. "In the retail portfolio, the average of payments over instalments due in the first six months is at 98.4%," he adds. "This is normal business. One would have forecast more material impact."
The political situation in Syria remains far more fluid than in Egypt and it is still too early to say whether a trend in loan repayments will emerge there. However, the banking sector still appears to be functioning smoothly. In Syria branch closures have been made by branch managers, based on the level of violence in the immediate area. To date, the Lebanese banks in both countries have been able to rely on their own capital without turning to their Beirut head offices for help.
All of Lebanon’s largest banks have branches or subsidiaries in Syria, following efforts by Damascus to open up its finance sector over the past decade, and they now account for 60% of all private bank branches in Syria. But while Lebanese banks are a powerful presence in the Syrian market, the contribution these branches make to their parent groups’ results is still limited, accounting for perhaps 5% of total profits.
The expansion into Syria has been part of a wider push by Lebanese banks into countries around the region in recent years, but it is a long-term strategy and the unrest is unlikely to deflect any of them. At most, they may be forced to slow down the pace of their rollout in the short term.
Domestic market focus
While their overseas ambitions are in check, the banks’ focus will remain on their domestic market, which accounts for 80% of Lebanese banks’ business. This in itself is a potential problem, however, given the likely weak performance of the local economy this year.
With the new Lebanese government still finding its feet and continued regional unrest undermining business and consumer confidence, most economists are predicting growth for this year of 2.5% to 3%. This is well below the performance that the country has managed in the past two years: growth was around 8.5% in 2009 and 7% in 2010. Much of the fall is due to the lacklustre performance in the first half of this year, when real-estate sales dropped off and stock market activity dived.
"When people are faced with a bit more uncertainly, they don’t act on a big decision such as buying or selling a home; they’d rather just sit and wait," says Nadim Kabbara, head of research at FFA Private Bank. "That’s probably what’s been happening, not only in the real-estate sector but also in the capital markets. We’ve seen very little volume in the stock market this year compared with last year.
"You’ve certainly seen lower inflows this year as opposed to previous years. [Such inflows] typically benefit the banking, real-estate and other sectors of the Lebanese economy. There’s still money coming in, but just not as much."
But the domestic economy is also suffering indirectly from the problems across the border. Syria is a relatively minor trading partner for Lebanon, accounting for $339 million of imports and just $221 million of exports, but it plays a crucial role as a transit route, both for Lebanese goods heading to other parts of the Arab world and for tourists coming to Lebanon.
For evidence of that, one only needs to wander along the likes of Allenby Street or Foch Street in central Beirut – the streets in this neighbourhood are cluttered with high-end luxury brand names, but customers are few and far between and many shops are advertising deep discounts in their windows. The problem is the lack of free-spending Saudi tourists who, like their Iraqi and Jordanian counterparts, prefer to drive when they visit Lebanon. With the route through Syria now looking unappealing if not impassable, they simply haven’t come this year.
The indirect impact of the unrest can also be seen in the rise once more in dollar deposits in local banks, after this figure fell in 2010.
"[The use of dollar deposits] has increased from 63.2% at the end of December 2010 to 66.5% by the end of May 2011," says Marwan Mikhael, head of research at Blominvest, the investment banking arm of Blom Bank. "At the same time, a dollarization rate of this level shows that people are not worried much about the situation – we witnessed much higher dollarization rates of deposits during previous periods of instability."
Long-term growth concerns
One reason for the relative calm is that the Lebanese economy is at least growing, but there are some concerns about its longer-term potential. Those luxurious streets of downtown Beirut may give the impression that it is the equal of any global city, but the reality is that the country’s infrastructure is in a poor state of repair, with short power cuts a routine occurrence.
"[In order] to increase our potential output, the government has to embark on an investment programme to modernise the economy," adds Mikhael. "Most of our commercial laws are outdated and the law-enforcement mechanism is not at the level required. Regarding infrastructure, Lebanon is well behind Gulf Cooperation Council countries and needs immediate reforms in several sectors such as roads, telecoms and power."
There is hope that the new administration, which is more politically homogenous than the previous national-unity government under Saad Hariri, will be able to push ahead with some of these much-needed reforms.
"We are allowed to have a degree of scepticism, because we’ve been talking about the electricity reforms and other structural reforms for at least 10 years," says Ghobril. "There have been draft laws sitting in drawers for longer than that."
Relations between the government and the country’s banks are not as good as they might be, with tension over the amount of public debt, which is running at around 135% of GDP. Awash with liquidity as they are, the country’s banks have to date been willing to buy as many bonds as the government cared to sell – in the words of one banker in Beirut, "in Lebanon the bank of last resort is the commercial banks, not the central bank".
However, this cosy relationship might not last. Banks are warning they would like to see change.
A big concern is sovereign debt," says Nadim Haidar, senior private banker at FFA Private Bank. "The Lebanese banks are the largest creditor to the government; they hold around 55% of government debt. The banks have cautioned the government and said they’re only willing to roll over maturing debt, not take on any additional exposure. They’ll help the government but not give it free rein to go and spend."
However, others in Beirut feel the banks have little option but to continue buying government debt. Their high levels of liquidity mean that they need to put their assets to work, while restrictions imposed by Riad Salamé, the long-standing governor of Banque du Liban, restrict the number of places where they can invest.
Many credit the central bank governor’s conservative policies for ensuring that the banking sector avoided both the toxic assets that lay behind the 2008 financial crisis and a more recent housing bubble. The latter was avoided thanks to a central bank rule that banks cannot lend more than 60% of the value of any real-estate project, although the actual average loan-to-value ratio in the industry today is closer to 40%.
The high esteem in which Salamé is regarded by most, if not all, in Beirut saw him being appointed to a further six-year term in August, having already been in the job for 18 years. "He’s somebody that all parties realise they need for confidence in the banking sector in Lebanon in general," says Kabbara. "That’s one thing that goes beyond party lines."
The presence of one central bank governor for such a long time would be rare in any country, but is all the more remarkable with such a turbulent political scene. But there are a number of other dependable features of the Lebanese political and economic system that have also helped to maintain the strength and stability of the country’s banking system.
Among them is the reliable appetite among expatriate Lebanese for sending money home. With large numbers of them working in the Gulf economies, which are enjoying the benefits of high oil prices, this is as true as ever. Indeed, their enthusiasm for investing their earnings back home is the key reason why bank deposits in Lebanon are almost three times the country’s GDP.
"Commercial banks’ total deposits represent 275% of GDP, almost all of which are held by residents, non-resident Lebanese or other Arabs with vested interests in Lebanon," points out Pik-Yee Foong, general manager of Standard Chartered Bank in the country. "This reduces the liquidity risks of such a situation."
The country’s democracy has also become an important stabilising factor, say locals. While Tunisians, Yemenis, Syrians, Egyptians and Bahrainis have had to take to the streets and face down armed forces for their voice to be heard, in Beirut the fighting now generally takes place within the corridors of institutions. When Lebanon changed its government earlier this year, it was done within the confines of its parliamentary system.
That is not to say that politics might not become more troublesome. In particular, problems could quickly emerge if the UN Special Tribunal for Lebanon makes a concerted effort to enforce the indictment against four members of Hezbollah for the assassination of then prime minister Rafik Hariri in 2005.
But in the end, perhaps the greatest strength of Lebanon’s banks is its hardiness: that they’ve seen all this and worse before. The confluence this year of so many events at once might be unusual, but with a government now in place, they feel they can overcome the latest crisis.
"The Lebanese banking sector overcame much worse conditions in the past," says Ghobril. "It will be able to withstand the shocks. The impact is maybe a deceleration in the growth rates of the profits of the banks, but the quality of the assets will not be materially affected and banks will continue to operate normally. When you go through the 15 years that Lebanon went through from 1975 to 1990 [when the country fought a civil war] and everything that followed, then what is happening in other Arab countries looks very manageable for Lebanese banks."
To date, just one bank has failed this year, but it was for reasons unrelated to the collapse of the government in January or the revolutions of the Arab Spring. In February, the US Treasury Department named the Lebanese Canadian Bank as being guilty of money laundering to support drug trafficking. Its assets were bought up by the local affiliate of Société Générale.
Salamé is confident that no others will follow. "We do not anticipate any others being similarly affected," he says. "There are a lot of rumours, but they are unfounded. The US has stated clearly that it is not targeting the Lebanese banking sector."
Today, the former head office of Lebanese Canadian Bank, which lies in the shadow of the old, bullet-ridden Holiday Inn hotel in central Beirut, is empty. A guard waves away anyone that approaches, but the green light of the ATM machine on the side of the building still blinks hopefully.
For the rest of Lebanon’s banking sector, the lights remain very firmly on, even if prospects might have dimmed slightly for now.