Lebanon has been described as 'paradise that self destructs every few years.' Mike Gallagher reports on the convulsions that Lebanon's banking system is going through.
Ask anyone what they think of when you say the words 'Lebanon' or 'Beirut' and they will give two very paradoxical answers. The very idea of the city and nation conjures up images of both fantastic wealth and glamour, and outright destruction.
Lebanon has the unique reputation of being a city that everyone seems to want to move to, but at the same time always seems to be in a wonderful or woeful state. It was long called the 'Paris of the Orient' and has always been highly regarded by banking officials from all over the world, where new and exciting types of banking systems were experimented with, long before becoming the norm in the rest of the Middle East.
The country always seems to produce top class businessmen and inspired academics that set the world on fire with their ideas, and they and their ideas can be found all over the world. But banking is what Lebanon excels at, and it has a legendary reputation of having a robust banking system, even if it is going through a series of tough changes.
The odd thing though, is why the country cannot avoid routinely self destructing. It was in the early stages of recovering from a devastating civil war that lasted 15 years when someone assassinated the hugely popular Prime Minister, Rafik Hariri, in a blast that was, even by Lebanese standards, a little on the large side. A wave of public outrage at the assassination, blamed on the Syrian secret service, saw the occupying Syrian army, which had been in the country since 1982, sent packing.
Then Ehud Olmert, the new Israeli prime minister, decided to make his presence felt in the region. He sent his army and air force on a botched operation to raze substantial parts of the lower half of the country and the southern suburbs of Beirut after several Israeli soldiers were kidnapped near the disputed Chebba'a farms on the flashpoint border with Israel.
The country's parliament, already crippled by years of inaction as a result of internecine battles by various political groupings was left staggering by the bombardment, which caused widespread revulsion across the world and left the already ailing economy in tatters.
Then mass protests broke out in the center of the capital after thousands of protestors from Hezbollah, a Shi'a party, accused prime minister Fouad Siniora of being a western-backed traitor for keeping Lebanese soldiers out of harm's way during the Israeli attacks. The bombardment by the Israeli military concentrated most of its ire on the poor, southern Shi'a suburbs of Beirut and districts of Lebanon that are close to the Israeli border and where the group gets most of its support from.
There had been talk of banking reform going on in Lebanon for quite some time and those efforts were bogged down by internal disputes between banking representatives and government officials.
But now consolidation seems to be on the cards for many Lebanese banks. There are 40 banks in a $20 billion market and it is generally accepted that this is excessive. Basel II is thought to be a major reason why many smaller banks will be forced to merge to avoid closing down.
The preparations for Basel II and all of the costly requirements that go with it, which are due to come into force on 1 January, 2008 will put considerable financial pressure on many of the smaller banks. The small banks cannot afford to meet the capital-reserve rules and cannot afford to implement the expensive risk-management systems. The new calculations will double the amount of assets in the bank which are considered high risk, and the banks will have to raise their capital reserves in order to mitigate these risks.
The bigger banks should be able to cover the costs involved, but the smaller banks will feel the pressure to consolidate to avoid going under, and many are thought to be courting international investors, most notably from the GCC.
There has been speculation that banks from the GCC are circling, looking for opportunities, but still others think that it would be lunacy to invest in a country and banking system that is going through so much political and economic mayhem. Wait and see, say the pessimists and the realists. If mergers are to be expected then it will probably be amongst those banks with between $300 million and $700 million in assets. Absolute nonsense say some analysts, pointing out that the bigger banks would be crazy to acquire some of the smaller banks, some of which are probably not financially viable.
Mark Young, managing director of the CIS and MENA emerging markets region of Fitch Ratings said: "Lebanese banks are, by international standards fairly well run institutions. Saying that, despite their dominance of the local market, the Lebanese banking market is a small market and so banks outside the top tier are very small by international standards and for them to start applying Basel II makes it a relatively expensive exercise for them. That is one aspect of their limited franchise. The fact that the market is small means that there is also a somewhat limited appetite to acquire them."
The smaller banks face a strategic challenge as many of these banks are family owned and there is sometimes a reluctance by shareholders to sell on or consolidate, so in these situations it is often a crisis that precipitates any change in the structure of the banking system.
However, the operating environment is a particularly challenging one. The political issues that have dominated over the past 12 to 18 months has made the banking environment a very uncertain one, although whether that in itself will precipitate mere mergers or acquisitions remains to be seen.
The primary focus of the bigger banks has been to expand beyond Lebanese markets because they recognise that the Lebanese market is small, so they are looking for where they can apply their skills in the region.
The banks have shown themselves to be very capable of managing the institutions in a crisis situation, given what has happened and continues to happen in Lebanon on a regular basis. They have got plenty of experience of those conditions.
The curious thing is that 2006 was an exceptional year for banks in Lebanon, many of which saw record profits, despite the bombing. Some banks, fed up with a lack of will by the government to do anything to shore up the faltering economy, are looking abroad and places like Syria and Jordan are in their sights. The biggest banks in the country are those like Banque Audi Saradar and Blom Bank and they have been active in Damascus in recent years.
But the question is: Are they going to be competitive? If you go into Saudi Arabia, you will find that all the banks that are there are already larger than the largest bank in Lebanon. What additional products are they going to bring to Saudi Arabia?
Smaller banks like Byblos Bank and Fransabank are also believed to be on the look out for opportunities safely beyond Lebanese borders, especially in areas with large Lebanese expatriate populations. Some of the banks have called on the government to speed up efforts to privatise the infrastructure sector and inefficient government owned businesses, but to no avail.
Young said that "Maybe they will go to less developed markets like Syria, Algeria or Sudan. These are less developed, but high risk markets, so the strategy of going beyond Lebanon, while it makes sense is not without its risks, particularly into these other markets. So I think it is early days to see if the strategies will be a success. They obviously need to expand into markets where they can develop a profitable niche and that is going to be a challenge. "
Many banks did well from real estate investments in the first half of 2006, especially in the popular Solidere district of Beirut, until Israeli jets made buying buildings in the capital look like madness and potential investors went looking elsewhere.
Blom had been active throughout 2006, advising the government on the country's first Eurobond issue to be denominated in Lebanese pounds, but that has been a notable highlight in a year that saw the Beirut stock exchange paralysed by the bombing. Banque Audi recently opened a new branch in Saudi Arabia and there are rumours of several other players appearing in the GCC in the very future.
However, the market for Islamic banks is looking distinctly attractive for some. There are four Islamic banks licenced to operate in the country and these are Arab Finance House, Lebanese-Islamic Bank, which belongs to Credit Libanis, Al Baraka Bank and Blom Development Bank. All are retail banks. Islamic banking is still in its infancy in Lebanon and there is only eight Islamic bank branches compared to 800 conventional banks. Al Baraka 'dominates' this tiny sector with six branches, while Arab Finance House has two and Lebanese-Islamic Bank has just one, although all say they plan to open more branches in 2007.
Arab Finance House has been making optimistic sounds by declaring that it expects to eventually have around 20 per cent of the Islamic banking market, although it was coy about an exact timeline. AFH has also been talking about moving into Syria this year and Qatar Islamic Bank is believed to be a major joint shareholder in the venture.
The Lebanese government, which has been reluctant to offer any more banking licences, has paradoxically made favourable noises about allowing more Islamic banks to enter the market and the central bank governor has pushed ahead with a certification programme to train more Islamic banking staff.
Adnan Ahmad Yousif, the managing director of Al Baraka believes that many of the smaller banks will be taken over or will convert to Islamic banks. The banking laws, he pointed out, do not allow conventional banks to open Islamic windows. Conventional banks must fully convert if they want to enter the Islamic banking arena. Al Baraka has plans to increase the amount of braches it has in Lebanon, as well as offer new products.
International Investment Group from Kuwait is going to launch an Islamic bank with $400 million in start-up capital soon. Banque Audi is also believed to have initiated plans to open branches in Jordan and Sudan. Fransabank which recently announced that it was planning to move into Algeria, is also believed to be preparing to launch an Islamic window too.
Nabil Othman, the head of private banking at Arab Finance House in Beirut said that "the vehicle of financing maintained by Islamic banks is more flexible than the conventional banks in Lebanon. There is a growing appetite for Islamic banking in Lebanon, especially in the northern and southern parts of the country, where the majority of the population is Muslim. I understand that there is a chain of other licences to be given. There is a demand for Islamic products that probably has not been tapped that will continue to expand."
Analysts believe that if some conventional banks were allowed to convert their existing licences into Islamic banks and provide purely Islamic products and the location was right, that converting would make sense, given the potential growth in that particular market. It may give them that competitive edge, compared to the conventional banking market which is dominated by the Audis, the Bloms and the Byblos.
Young said that "We are expecting the conditions to come through with higher bad debts impacting on profitability this year. Depending on how the political environment evolves and its impact on the economy in general and whether that flows on into the following year, remains to be seen. Before the crisis the main banks in the market had a lot of capital injected into their balance sheets, new capital, while that was primarily earmarked for international expansion, it does put them in a position to absorb anything that comes along from the political crisis.
Their loan portfolios are relatively small in comparison to the overall balance sheet and interest rates have helped in terms that they are now earning higher yields from the government bonds from a couple of years ago when the dollar book was earning very low interest rates and they were effectively making a loss on that. That situation has changed slightly and it is helping them somewhat."
The country could be a test-case that many in the banking community will be watching extremely closely as the country's convulsions continue, both politically and economically well into 2008. Lebanon's turbulent evolution is going to continue for quite some time yet.
© Banker Middle East 2007
