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Adventures in banking

By Rayya Salem June 2011

Arab Spring upsets stable markets
For years, Lebanese bankers were buoyant when talking about the potential for expansion throughout the Middle East and North Africa (MENA) region. But even the best risk assessment teams couldn't have predicted the 'Arab Spring', nor could they have anticipated it coinciding with Lebanon's political vacuum. Now, caught between domestic stalemate and regional instability, Lebanon's big banks are putting the brakes on their foreign conquests and talking conservatism and contingency planning. And while they may claim they still firmly believe in the MENA region's fundamentals, many of the Lebanese alpha and beta banks are ogling new territories. Be it to diffuse the risk or make money off of it, Lebanese banks' future expansion plans are as bold as they are chancy.

Risky business

In the first quarter of 2011, ratings and economic growth forecasts for troubled MENA countries crumbled. According to Merrill Lynch, Egypt's real gross domestic product contracted by 7 percent in the first three months of the year. Meanwhile, EFG Hermes forecast non-performing loans (NPL) at Egyptian banks to rise 150 basis points in 2011. The numbers were anything but comforting to other international banks and institutions who have poured resources and investments into the country; Lebanese banks are no exception.

For Bank Audi , which operates in Egypt through its subsidiaries -- the online brokerage firm Arabeya Online and commercial and retail business Bank Audi Egypt -- the stakes are high.

"We have assets in the range of $3 billion in Egypt, which is a very important presence," says Freddie Baz, chief financial officer at Bank Audi , adding that the bank had to quickly react through immediate contingency plans when protests began in Cairo. "We froze all our development expenses and delayed all our new branches, and we adopted a conservative strategy in assets dollarization in order to safeguard the quality of our assets and to consolidate our customer franchise," he adds.

For Saad Azhari, chairman and general manager at BLOM Bank, the pain in Egypt was felt, but short-lived. "There are some delays that we have seen in Egypt, [such as] in the beginning of the year in retail lending because the bank was closed for a while," he says.

And while Egypt seems to be on the path toward economic and political reform, this offered little relief as Syria's recent debacle hit even closer to home with Lebanon's alpha banks [see story page 74]. In early May 2011, the Institute of International Finance downgraded Syria's sovereign, political and overall country risk amid a deteriorating political and security situation in the country. It also expected its economy to contract by 3 percent in 2011. As the Syrian scene unfolds, banks are wary of the outcome.

"It's a natural market for Lebanon and it's a natural market for us. [Now] We're in a grey area. We don't know exactly what will happen," says Walid Raphael, general manager at Banque Libano-Française ( BLF ).

For Baz, the deterioration in Syria is too fast and too recent to assess damages. "The country is facing political challenges and this will have a [negative effect] on the economy. We have applied the same contingency plan for Syria that we did in Egypt," he adds.

François Bassil, general manager at Byblos Bank , admits there is a price to pay for operating in an unstable region. "We have insurance for all the investment we are doing in all these countries. It costs a lot but we have to do it," he says. Byblos Bank is sure to keep a close eye on the situation in Syria where it operates extensively through 11 branches, and so will other alphas; both Fransabank and BLF offer full-fledged banking services in four branches in Syria, two of which are outside Damascus.

There to stay

When asked about planning for the unforeseen in countries like Syria and Egypt, Raphael considers Lebanon to have thoroughly acquainted its banks with risk. "We have experience in Lebanon and whatever happens in Syria, it should not be very different from what we have experienced in Lebanon," he says. BLF has been slated to open a fifth branch in Syria this year, and not without reason. Much to the delight of international investors, in July 2010 the Syrian government issued presidential decree 56, which raised the ceiling of foreign ownership in local commercial banks with capital over $200 million from 49 percent to 60 percent.

For BLOM's Azhari, the bank's strategy for becoming a full-service bank in the region means staying in Syria, even when it hurts. "Our plan is to be there indefinitely... The strategy did not change, but maybe the pace [will be slower]," he explains, adding that the convenience of similar languages and cultures in the Arab world helps greatly in acquiring market share.

Where others see challenge, Baz says he sees opportunity, and more importantly, profitability. "I believe that the empirical link between more democracy and freedom and better economic governance efficiency is being implemented in Egypt."

A success, he says, that would translate into a more efficient economy, more foreign direct investment and higher GDP growth, all of which would benefit the banking industry. For the shorter term, however, Baz looks to Audi's Egyptian corporate loan portfolio. In early February 2011, the bank decided to accrue a major part of corporate pretax earnings as collective provisions, part of a preemptive effort to weather the storm in the country. These accruals, a sort of delayed gratification, would automatically boost Audi's 2011 income statement. "Hopefully at year end a major part of those collective provisions will get back to our income statement and account for net earnings," says Baz.

In the long run, Lebanon's alpha banks seem unanimously set on having a more balanced breakdown of assets and earnings between Lebanon and abroad. "We have a target of 50 percent [share] of profits and lending outside Lebanon," says Bassil.

Likewise, Bank Audi aims at serious expansion in Lebanon's neighboring region. Since 2005, and up until the first quarter of 2011, Audi had upped its MENA share of total earnings from 1 percent to 12 percent, and share of total loans to customers from 3 percent to 30.7 percent; the bank is aiming at a split between domestic and foreign earnings and assets of 60:40.

As for Byblos' Bassil, the current situation in the Arab region calls for shifting focus toward other markets. Stressing the need to continue consolidation in Lebanon through branches and acquisitions, he also sees the money in unchartered territories. "For the time being, Europe and Sudan are most profitable," he says. Byblos Bank could also benefit from its presence in the Democratic Republic of the Congo, as the International Monetary Fund forecasts a 6.5 percent economic growth for the country in 2011.

Eyes on Iraq

After Syria and Egypt destroyed the traditional notion of the safe bet, a country that once appeared to be an untamed frontier and a risky investment has banks salivating for its untapped potential: Iraq.

"There is a potential risk. [But] do you accept the risk or not?" asks BLF 's Raphael when asked about the bank's decision to open in Baghdad by year's end. Byblos Bank made the first move when it opened its Erbil branch in Iraq in 2007, and another one in Baghdad three years later. While the decision was bold, talks of Iraq becoming the next business hub had plenty of foreign investment pouring in to the country, including those of Lebanese banks.

Both International Bank of Lebanon and Bank of Beirut and the Arab Countries banks have branched out to Erbil, while Bank of Beirut has one representative office in Baghdad. The race to Iraq was on after the Iraqi government's efforts to attract foreign banks through 10-year tax-free status and guarantees of privatization. Of course, the country offers less than favorable conditions for running businesses smoothly, but aside from Iraq's evident security risk, banks and financial institutions in particular face a somewhat nationalized, loosely regulated banking sector and a public that doesn't trust it. Up until 2003, operations such as international transfers and opening foreign currency letters of credit were off limits for banks in Iraq.

But Chawki Badr, head of international expansion at BBAC, says he believes that there is money to be made from the mayhem in Mesopotamia, as opportunities lie in the country's dire need for investments away from oil, and into reconstruction and infrastructure.

"Iraq's economy is 95 percent dependent on oil. There is quite the potential to develop other sectors, especially the banking sector," says Badr, adding that to date, government banks account for 85 percent of the overall balance of deposits of banks operating in Iraq.

As for expansion elsewhere, Badr says that the quick pace of change in the MENA region calls for a wait-and-see mood, at least for now. "In the short run, the unrest will be costly in terms of cash inflows, production and investment. But in the long run, the tide will turn if the region successfully transitions towards developing institutional structures, regulating governance and promoting freedom," he adds -- a recipe for success in more than just banking.

© Executive 2011