Having sailed through the global financial crisis thanks to conservative lending practices and a reliance on deposits, Lebanon's banking sector is now encountering headwinds due to instability in Syria and prolonged political deadlock. The challenge for the long term will be to transform short-term capital inflows to banks and real estate into investment in productive sectors of the economy.
The economy took a hit in 2011 as a result of violence in neighbouring Syria, with GDP growth falling from 7.5% to around 1.5%, according to the IMF. Tourism was also affected by regional instability, as were Syrian affiliates of Lebanese banks which saw their assets drop by 17.2% from $7bn to $5.8bn, with the losses concentrated among the country's three largest banks, Banque BEMO Saudi Fransi, Bank of Syria and Overseas, and Bank Audi Syria. Overall deposits weakened slightly in 2011 after years of double-digit growth but still expanded by a respectable 8%.
Bank Audi, the country's largest bank, had to take provisions on $45m in debt from Egypt and Syria. The crisis also halted expansion plans for Lebanon's larger banks, which had been looking to diversify away from the small local market into the greater Middle East.
Moreover, Western sanctions on the Syrian regime are affecting local banks, even though the government has not legally mandated that they stop doing business with sanctioned individuals. Rather, US and European institutions, facing strong legal pressure from regulators at home, are pressing their foreign partners to adhere to the sanctions. Lebanese bankers, by and large, have chosen to forego their Syrian ties to stay in good stead with the international community. In fact, banks continue to see regional expansion as their long-term growth plan, notwithstanding the current political uncertainties in neighbouring countries. The incentives to move abroad are clear: Lebanon is a small, fairly saturated market, where government debt has long been one of the major sources of income.
Indeed, the government's expanding debt and its inability to raise tax revenues means that public debt is occupying an increasing share of banks' balance sheets. Local banks hold $29.4bn, or 54%, of the government's total of $54.37bn debt.
With a debt-to-GDP ratio of 137% - the fifth-highest in the world - combined with major political deadlock, Lebanon's credit-worthiness is being increasingly called into question. And with such high exposure to government debt - about 20% - local banks suffer as a result.
This was shown by Moody's decision to downgrade Lebanon's banking sector in December from stable to negative. Analysts expect that, without suitable alternatives, banks will continue to buy government bonds while pushing the Ministry of Finance for higher yields.
A long-term solution to the government's fiscal problems, meanwhile, will require an end to the stalemate that has characterised Lebanese politics for years. The government has been unable to pass a budget since the assassination of Prime Minister Rafiq Al Hariri in 2005, and its expenditures are frozen at the same $6.8bn spent that year.
The political deadlock has its advantages and disadvantages: it keeps the government from pursuing expansionary fiscal policies that would widen the deficit, but also delays any serious attempt to prune the debt by raising taxes or cutting back on frivolous spending. The 2012 budget, which is still in parliament, would raise value-added tax by one percentage point and increase the tax on bank deposit interest, as well as increase the minimum wage.
The structure of Lebanon's banking sector reflects the promise and pitfalls of economic development in the country as a whole. As highlighted in a March 2012 study from the World Bank, the banking and real estate sectors have surged in recent years thanks to strong capital inflows.
Deposit growth is coming largely in the form of remittances from Lebanese workers in the Gulf, and a comparatively small percentage of those assets are being put to use in productive sectors of the economy, such as industry, technology and agriculture.
The conservative lending practices of Lebanese banks, enforced by strict regulations, are one contributor to this trend. But structural reforms - improved infrastructure, more efficient public spending, and better competitiveness - are central to this effort. Implementing such changes - long suggested by outside observers, and repeated by the World Bank - would both boost the banking sector and set the country on a course for sustainable economic growth.
© Oxford Business Group 2012
