A strong deposit base and sizeable liquidity buffers have helped Lebanon's commercial banks weather an economic slowdown and political uncertainty in the Arab state, but future growth will depend on expansion into new markets and services, experts said.
Domestic political tension and spillover from the civil war in neighboring Syria have taken their toll on the Lebanese economy. Narrow interest spreads and a high exposure to the country's widening sovereign debt have exacerbated pressure on local banks, whose combined assets at the end 2013 were worth 3.7 times nominal gross domestic product.
Marwan Barakat, group chief economist and head of research at Bank Audi, said local banks are facing "challenging" operating conditions characterized by depressed business sentiment, slow economic growth and larger provisioning requirements. He said lenders with operations in regional markets are also exposed to the Arab Spring turmoil.
"The major challenge that banks are witnessing is the negative carry on their primary liquidity within the context of the low interest rate environment which is putting pressure on their interest margins and subsequently on their bottom lines," Barakat told Zawya.
He said the situation could improve starting from 2015 on an expected increase in interest rates abroad and the corollary increase in yields on liquid assets of Lebanese banks.
The combined net profit of Lebanon's 14 biggest lenders, called the Alpha banks, remained practically unchanged in 2013 and totaled USD 1.72 billion, according to Bankdata Financial Services.
The Alpha banks had reported a profit growth rate of 7.8% in 2012 and of 0.8% in 2011 compared with much higher growth rates in earlier years. A lender is included in the Alpha category if its deposits exceed USD 2 billion.
"The various components of return ratios show that pressures on interest margins and spreads continued during 2013, and overall asset utilization and net operating margins have been on the decline, driving an overall contraction in return ratios," a Bankdata report said.
LIQUIDITY CUSHION
Lebanon saw most of its economic indicators slump in recent years mainly due to the Syrian conflict. Real GDP growth was 1% in 2013 and is expected to remain unchanged in 2014, according to a report by the International Monetary Fund released in April. The growth rate reached an average of 8.3% in the 2007-2010 period, then began to slow down in 2011 with the outbreak of violence in Syria.
"The Syrian conflict continues to weigh heavily on Lebanon, with intensification of sectarian violence, hampered confidence, and added pressures to a deteriorating fiscal position--leaving growth flat in 2014," the IMF said. Projected real GDP growth for 2015 is 2.5%, according to the World Economic Outlook report.
Despite the tough circumstances, local lenders enjoy a rich deposit base and sizeable liquidity buffers, Barakat said. The banks follow a strict regulatory framework and have proved their ability to overcome severe systemic shocks, he added.
Consolidated assets of commercial banks grew 8.5% to USD 165.1 billion at the end of 2013 compared with a year earlier, according to central bank data. These assets are worth 3.7 times the country's nominal GDP which amounted to USD 44.3 billion in 2013.
REMITTANCES INFLUX
The asset growth was mainly spurred by an increase in deposits driven by a continuous inflow of Lebanese expatriate remittances.
"There is no single year where deposits have witnessed a contraction over the past twenty years. Over that period, remittances represented on a steady basis 20% of GDP and have grown by 16% per annum," Barakat said.
Resident and non-resident private sector deposits increased 8.97% to USD 136.4 billion at the end of 2013 compared with a year earlier, according to the central bank. These deposits amounted to nearly 83% of the banks' consolidated assets.
Remittances rose 4.1% in 2013 to USD 7.2 billion or 16.2% of the country's GDP, according to a Byblos Bank report released this month and based on World Bank figures.
"Even if the banks don't have a growth in deposits at present it is not such a big deal as it is hard these days to find lending channels for these funds; but this could be a problem when the country goes back to proper growth," economist Louis Hobeika, professor at Notre Dame University, told Zawya.
Salim Chahine, professor of finance at the Olayan School of Business of the American University of Beirut, told Zawya the expected increase in interest rates in the U.S. in the coming years could represent a major risk if Lebanese depositors withdraw their money and seek higher yields at lower risk levels in developed countries.
HIGH EXPOSURE
Lebanon's widening public debt is both a source of revenue for the local banks and a challenge, as it exposes them to a high sovereign debt risk. Lebanon's gross debt-to-GDP ratio, one of the world's highest, escalated to 140% last year from 134% in 2012, according to finance ministry data.
Standard & Poor's Ratings Services this month revised its outlook to stable from negative on the Lebanese republic and on local lenders Bank Audi, BankMed, and Blom Bank.
"The outlook revision reflects our view that the government's debt servicing capacity is materially determined by the strength of deposit flows ... [which] have been stable, even during the domestic political vacuum in 2013 and also in the face of the increasing spillover from the deteriorating situation in Syria," the rating agency said.
It said that despite the bank's sound geographic diversification and risk-control strategies, their domestic exposure was high. "The three banks' exposure to the sovereign, relative to their equity bases, has reduced over time--most notably in foreign currency--but still remains very high. We believe this strongly ties the banks to Lebanon's solvency."
Joe Sarrouh, advisor to the chairman at Fransabank, said Lebanon was caught in a circle of growing debt and a widening budget deficit and that this required urgent reforms in public finance and state administration.
The gross public debt of the small Mediterranean nation stood at USD 65 billion at the end of February 2014, up 11.9% from a year earlier, according to Byblos Bank. "Commercial banks accounted for 52.7% of the local public debt at the end of February 2014 compared with 52.2% a year earlier," Byblos Banks said in a report.
Commercial banks' claims on the public sector jumped 21% to USD 37.73 billion in 2013 while total assets grew 8.5% that year, according to central bank data. These claims represented 23% of the lenders' overall assets at the end of 2013 compared with 20% a year earlier.
"While the exposure is significant with Lebanese pound treasury bills representing 44% of Lebanese pound customer deposits, there is no default risk in Lebanese pounds, as the state can always print money and meet the market demands," Barakat said.
"Any default risk is in principle on the foreign currency side, but here the sovereign bond portfolio of the central bank is limited to 20% of foreign currency deposits, which mitigates the default spillover risk at large," he said. "Anyway, banks are maintaining highly liquid status with a primary liquidity ratio in foreign currency equivalent to 43% of foreign currency deposits in order to mitigate such a sovereign exposure risk."
CROWDING OUT PRIVATE SECTOR
The banks' claims on the resident private sector rose 9.7% to USD 41.57 billion at the end of 2013 while their claims on the public sector surged 21% that year, according to central bank data.
"The Lebanese government isn't managing its finances very well and it's letting its debt to the banks widen to a large scale and this is crowding out lending to the private sector which is in deep need for funds," said Notre Dame's Hobeika.
He said the industrial, agricultural, and services sectors presented good opportunities since it was currently difficult for small and medium enterprises and startups to get the required financing.
AUB's Chahine agreed, saying the manufacturing and services sectors could benefit from funding to develop innovative products that target regional market, but added that political stability would be required to attract investment in the private sector.
"Given the current economic weaknesses, there is an increasing risk in the private sector and limited profitable opportunities for Lebanese banks," Chahine said.
"Recent turmoil has adversely affected banks that started diversifying their activities regionally. Within the current low interest rates in developed countries, available options might be limited and potential options for growth should rely on innovative services or new regions."
The liquidity available in local banks exceeds the funding requirements of the public and private sectors in the short to medium-term, Sarrouh said. He said that while banks have enough money to increase plain vanilla lending, they would not be able to diversify into new products given the weakness in economic and fiscal performance.
One option to channel excess liquidity was to expand abroad in markets with growth potential, such as Africa. Lebanese banks would also be ideally placed from a financial, technical and managerial position to tap the Syrian and Egyptian markets once stability is reestablished in those countries, Sarrouh added.
Bank Audi's Barakat said Lebanese lenders could benefit from lucrative medium to long-term opportunities in "captive under-banked regional markets", adding that further geographic diversification would reduce overall exposure to specific markets.
CONSERVATISM VS INNOVATION
Lebanese banks have steadily diversified their products to meet growing demand for more sophisticated banking services, but revenues have been affected by economic conditions and a slowdown in spending.
"Banks can invest their liquidity into new products only to the extent allowed by the regulatory bodies, as stringent central bank regulations and self-imposed conservative practices and moderate risk appetite of banks have shielded them from toxic assets," Barakat said.
The experts said development of the energy sector could provide tremendous financing opportunities for the Lebanese banking sector. Potential oil and gas resources could garner Lebanon net proceeds in excess of USD 600 billion, Bank Audi said in a report in February, citing energy ministry sources. The figure is based on current gas and oil prices and on estimated reserves of 96 trillion cubic feet of gas and 865 million barrels of oil.
"The extraction of natural resources can put an end to the country's most significant post-war conundrum, which is public finances, while growth could turn into sustainably strong levels for a number of years, rapidly expanding output levels and income per capita at large," Barakat said.
"Banks have an important role to play and can position themselves as strategic partners throughout the many aspects of the production chain, be it at the level of drilling and extraction, power plants construction, or even at the level of pipeline building and across the broad distribution chain, by extending credit to the concerned market players."
AUB's Chahine said planning for development of the sector should be carried out in collaboration with the central bank and the Association of Banks in Lebanon. "Good governance and clear planning will be also key to play a significant role in attracting deposits and investing them in critical sectors for the future of the Lebanese economy."
Lebanon should follow the Norwegian model in managing the oil and gas industry by putting in place mechanisms to prevent corruption and investing energy revenues to spur economic growth and reduce public debt, Sarrouh said.
© Zawya 2014
