Banking Voices – Size still matters

Georges Abou Jawdeh: President, Lebanese Canadian Bank

E: After encouraging developments on the interest rate front, Banque du Liban has once again adjusted the rates upwards. In such an environment, how can the banking sector develop a more efficient corporate and retail lending culture?

Following the Paris II meeting for donor countries to Lebanon and the Lebanese banks’ contribution of $4 billion at 0%, interest rates on credit accounts in Lebanon dropped. And as of January 2004, the banks started to revise their interest rates on debtor accounts, to be more competitive, particularly on the regional market, where interest rates are lower. It is imperative for us now to revise the costs of funds again: in order to encourage lending, banks must reduce the price of lending. At present, we are at a significant disadvantage, internationally speaking.

Just to give you an example, banks are paying between 2.5% to 4.5% interest rates on US dollar credit accounts. Abroad, the rates are at 0.5%, so the difference is significant. Banks need to reduce interest rates to reach between 6% and 9% on commercial loans in US dollars. For deposits in Lebanese pounds, banks are paying between 6% and 8.5%, thereby landing loans in Lebanese pounds at interest rates between 11% and 14%. This is why we need to reduce the cost of funds. If banks are paying a high credit interest, they will be forced to lend at a high interest rate.

The solution to this problem lies first and foremost in the hands of the government. The Lebanese government must decrease its debt, so as to enable it to borrow at a lower cost. As long as the public debt remains as high as it is now, and keeps on growing, the perceived risk will stay high, and the government will keep borrowing at a high interest rate. This in turn affects the cost of lending for corporations and individuals alike – it is a cycle.

By reducing the debt, interest rates will go down, the credit and the debtor interest rate will fall and the business cycle will regain momentum. Looking ahead, what we need in 2005 is political stability – in the region, but even more so in the country, so that the Lebanese central bank does not need to intervene on a daily basis to maintain the price of the Lebanese pound to the US dollar.

At present, the central bank has $12 billion in foreign reserves, which puts us in a good position, but is not enough to ensure long term stability. Political stability would help generate domestic and foreign investments, which could inject fresh capital into the economy, beyond merely the real estate sector. What the banks need to focus on in order to promote healthy lending and credit underwriting is how to encourage small and medium enterprises, so as to gain new clients. In a small country such as Lebanon, where big enterprises are few, the economy stagnating and the number of loans issued dropping, this is the only strategy to pursue.

Shadi A. Karam: Chairman and General Manager, BLC Bank

E: Is there any danger that the current trend of regional expansion by Lebanese banks could lead to overextension, thereby damaging either the bank itself, the sector or the economy?

The regional expansion that some of the leading Lebanese banks have engaged in over the past two years has primarily been motivated by the high level of competition and a quasi saturation of the local market. An insufficient national growth pattern, political uncertainties and the need to reshuffle balance sheets laden with Treasury bills have also been driving factors. Expectations are that a regional expansion would help diversify sources of revenue and smooth out potential fluctuations caused by domestic contingencies. Theoretically, this is a sound strategy.

A closer look reveals that the branching out has occurred in neighboring, relatively familiar markets – Cyprus, Syria and Jordan – which mitigates the risks of expatriation.

Banks such as BEMO, BLOM, Audi and Société Générale are on familiar territory and have established anchor points going back to decades of client networking. This represents an advantage, if only from the sheer risk assessment, “local knowledge” viewpoint.

Naturally, one may deplore that money invested abroad is money not invested in the Lebanese economy, which is in dire need of fresh capital. However, it may be similarly argued that the stronger our banks become and the wider their regional reach is, the higher their added value to our national wealth is. As for the potential dangers this move may represent for the institutions themselves, it boils down to their equity “cushioning” capacity. It so happens that, at least in some cases, there is a satisfactory capital base and financially sound shareholders.

There remains the issue of latent sectorial and systemic risks should this experience turn into a debacle. Obviously one has to acknowledge the risk of local ripple effects should a major bankruptcy in a foreign subsidiary occur. This has happened in the past, and could have far reaching implications. However, given the amounts of capital engaged as a proportion of the banks’ total equity base and assets, the reputation of all concerned institutions for prudent management and their risk-averse track records, I believe the peril to be negligible.

As in every strategic decision management has to make, weighing the alternatives intelligently is half the answer: is it better to stand still and let leaner and meaner banks gradually nibble on your market share or take a measured risk that insures cross-fertilization opportunities and a further reinforcement of your dominant position?

Last but by no means least, a new business opportunity presents itself to banks with a regional presence: the possibility to participate in sizable deals region-wide with clients much larger than what the local market can offer and that could prove to be well “worth the candle” as the French would say.

Gerard Charvet: Advisor to Credit Bank

E: Do you fear any repercussions from political wrangling on the banking sector in 2005? How could this manifest itself and can the banks do anything to limit any unfavorable impact to the sector?

The instability created by the latest changes on the domestic political scene as well as the 1559 UN Resolution have created DE FACTO some degree of volatility in the monetary market. The US dollar has therefore become very much in demand as a result of this instability. The current political environment could over the medium to long-term have a negative influence on depositor behavior during 2005.

The local banks could react to such a situation by raising interest rates on deposits in Lebanese pounds and hence support the local currency for a while. However, such a policy emanating from the banks can only have an impact if the monetary authorities provide their full support. Local banks have no longer the financial capabilities to carry out such an initiative on their own. The local banking environment has become, during the last few years, increasingly competitive and deposit margins have moved downwards from 3.5% to less than 2% in the last five years. In this context of uncertainty, decreasing profitability and preparation for the new Basel II capital regulations, 2005 and 2006 are hence expected to witness a step up in the consolidation process of the banking sector. It is, therefore, desirable that the banking merger law is revived in order to support the much needed consolidation process and, as a consequence, help tackle the social aspect that might derive from such a process.

Nadim Moujais: Chief Strategist at SGBL

E: 2004 saw a classic merger at the top of the industry. What can we expect in 2005, especially among the medium–sized and smaller banks as well as within the Alpha group?

The rule regarding the pursuing of bank mergers in Lebanon cannot be different, although the number of banks per capita is still high. Theoretically, as long as a bank is achieving profits and a return on equity and its risk is well covered, it can continue on a solo trajectory. However, several factors have put pressure on Lebanese banks, irrespective of their size, to move towards the mergers and acquisitions. They include the Basle II capital adequacy, solvency and other requirements; the impact of the new IAS (international accounting Standards) rules and the central bank’s inclination to fortify sound banking practice, counting, in addition to its normal regulatory role, on a bank’s proven capability of management and achieved track record, to enlarge such practice through mergers and acquisitions.

Finally there is the ever-present issue of size, in which size still effectively matters, particularly in terms of capital base and balance sheet size. Whether it is for global asset/liability management (both on and off balance sheet items), or for regional expansion, major Lebanese-based banks have used Lebanon as the cornerstone of their regional development, where the comparison is imposed with some of the regions’ large-scale capital-based banks with their diversified assets composition. Hence, the quest for mergers and acquisitions will still be real in 2005 for banks with vision in Lebanon, CETIRUS PARIBUS on the political level. The real encounter depends of course on the political developments in Lebanon and in the region.