Unlocking the potential of Banks

Dr. Shadi Karam

Chairman and general manager, BLC Bank

E BLC appears to be on the verge of being sold. What do other non-alpha Lebanese banks need to do to be more competitive and attractive to investors and buyers?

You have to compensate for size with creativity. This is what we have done. It so happens that we have grown to become an alpha bank over the last three years. You can never put yourself in the shoes of others because you don’t know what sort of resources they can muster, but I think that creativity is the key. You really have to look for things that are not being done and provided you can find the resources to do them then you become attractive. I also think that image building is something essential. And that can only be achieved if you manage to change the culture of the bank. To change the corporate culture, you have to train your people well, you have to be present, and you have to rework the entire moral support apparatus that exists in those institutions, because these types of banks are often family-owned. There is one guy who decides what the weather is going to be. It’s a very unhealthy situation and very difficult to change because of the paternalistic structure that we live with. A serious measure of governance has to be introduced. There has to be greater involvement from the base and you have to work out all the things that improve the productivity such as better morale, better adherence to procedures, involvement of each and every employee in client acquisition and preservation, things of that sort. This is what we’ve done here and these are unheard of types of efforts here in the banking sector in Lebanon. BLC is unique because very early on, since early 2003, it has started working on the principle of quality asset and client acquisition at every level in the bank, and client preservation, but not at any cost. No bottom line is more important than the reputation of the bank. So, people are told that it’s fine to bring in new clients and business but it has to be super clean and super profitable. It has worked for us. Plus, we have a very creative management team. Other banks have to change their mentalities. You have to forego short-term profits for long-term institutional development and that is not what is commonly accepted here. Finally, it can’t be bad for banks in this country if they go back to the classical banking business – which they stopped doing a long time ago. Most of them function like portfolio managers. They take deposits at high rates and invest in treasury paper at high rates and they take a spread. They forget that banks are in the business of lending money to people and encouraging businesses to expand. Plus, the difference between us and others is that we were willing to go into niche business, which other banks don’t consider attractive. Now they’re waking up to it, to things like micro-credit, very small retail business, very small consumer credit, and so on.

An outside institution would never come and buy a Lebanese [bank] if it’s not a clean, transparent bank with governance, a solid balance sheet and profitability.

Maurice Iskandar
Head of the Corporate Banking Division,
Banque Libano-Française


E What impact has the 2005 crisis had on banks’ loan portfolios? Which sectors have been the most affected? What are banks doing to resolve the problem?

There has been a slight decline in loan portfolios, due to a steep drop in imports (and therefore LC openings) between February and June. This has affected the off-balance sheet commitments of banks and the follow-on import re-financing lines. Many businesses, especially in the sectors of tourism, luxury products, and investments have suffered from the crisis. However, underlying asset quality was not placed under excessive stress and non-performing loans did not increase disproportionately during that period. However, it is expected that, going forward, some loans will sour due to the crisis and that this will be reflected in slightly higher NPLs and the need for additional loan loss provisions from some of the banks. During the third quarter of the year, volumes picked up as real estate investments witnessed an increase and imports regained some momentum.

In the weeks following the assassination of former prime minister Rafik Hariri, tourism, imports and construction were the sectors most affected. In tourism, the number of tourists declined by 17% and VAT receipts decreased by 14%, reflecting a drop in private consumption. In commerce, imported equipment dropped by 13%. And with respect to construction activities, permits decreased by 13%, probably reflecting a drop in investment expenditures.

Some banks put credits to the difficult and heavily impacted sectors on a watch list and monitored account movements closely. In certain cases, some flexibility was given to certain clients in terms of repayments. Some of the more innovative banks proposed constructive solutions to their clients in the form of restructuring their facilities, extending additional medium term facilities, or extending seasonal loans and advising on ways to weather the crisis.

Alexandre Salem
Head of the Treasury and Capital Markets Division, Credit Libanais

E What is the real value of government securities? It is clear that Lebanese securities have had improving yields. Why is that? What is the vision of banks on government securities?

In the aftermath of former prime minister Rafik Hariri’s assassination, spreads on Lebanese Eurobonds witnessed a big widening to 365 bps on March 31, 2005. Since then, following the improvement in the political and economic landscapes in Lebanon, spreads have drifted lower, to finish at 285 bps, as on October 31, 2005. When compared to Lebanon’s peer group (Turkey, Brazil, Indonesia, Ukraine, and the Philippines), Lebanese spreads still have some room to tighten, especially with the increase in foreign demand lately and the strong support the government is receiving from local banks. It must also be noted that volatility on the Lebanese debt has been very low when compared to other emerging markets issuers, due to the strong commitment of local banks to buying and holding Lebanese Eurobonds. They were looking for $750 million. Demand was very strong. It reached over $2.5 billion.

The improvement in yields is due to several factors: there has been an increase in local demand due to ample liquidity in the banking sector, coupled with the improvement in the political situation and the improvement in the economic macro indicators in the second half of 2005. Add to this the expectations that the international donor meeting scheduled for early 2006 will bear fruit and help reduce both the debt inventory and the debt interest burden. There has also been an increase in foreign demand for Lebanese government bonds due to both macro and technical factors. On the macro front, the positive expectations concerning the international donors meeting and its positive impact on the debt levels and the debt cost of financing alongside the government reform program for the next several years are being well perceived by foreign investors. It has to be noted that the rating agency Fitch changed Lebanon’s outlook to positive on November 18, 2005, while the same day S&P kept Lebanon’s outlook stable. On the technical side, spreads on Lebanese debt were very wide, when compared to spreads of Lebanon’s aforementioned peer group. This has incited foreigners to be heavy buyers of Lebanese eurobonds lately. Finally, the fact that the level of international interest rates is still very low, even though US rates have started to go up gradually, is pushing investors in search of yields to buy Lebanese debt.

We have a positive and constructive, if slightly cautious, view on Lebanese securities. This view hinges on the willingness and ability of the government to implement structural reforms to reduce the fiscal deficit, to embark on the privatization of public companies and the securitization of the state receivables. Furthermore, the success of the international donors’ meeting will lead to enhanced and better debt metrics, which in turn will lead to an upgrade in Lebanon’s credit ratings, and hence increase demand both locally and abroad for Lebanese securities, thus tightening the spreads on Lebanese debt robustly.

Samih Saadeh
General manager, BEMO

E What plans are there for revenue diversification, geographical expansion, and product and activity development? Which areas of banking appear most promising?

We have a branch in Syria. We are concentrating on continuing to grow there and being the leading bank there. We’re offering retail banking in full-force there. That’s our new product in Syria. In Lebanon, we’re continuing to invest in our vision, which is corporate and private banking. We will continue to come up with private banking products to offer to our clients, and try to concentrate more on having a niche, a specialized bank. That’s our plan for next year. For profitability, we want to continue to generate more fee income, and that’s why we’re going into private banking and why we have what we call a PR and trust division – trust services. We are going to try to promote a family office actively next year. At this point in time, we have no plans for further geographical expansion.

Most Lebanese banks have realized that they have to use their ability and resources more efficiently, given Lebanon’s limited market. So they are going into neighboring or regional banking, which is normal. This expansion, from Algeria to Sudan, Dubai, Qatar and Syria, represents natural growth for Lebanese banks. I think the expertise of Lebanese bankers is not being used to the maximum. They will benefit from this growth and use the resources they have here in know-how or even in capital – with the increase being witnessed by the Lebanese market. Private banking is also promising for Lebanese banks, with the money coming into the Arab world, and the movement on capital markets in the Arab world. On the local Lebanese market many banks have been investing in and utilizing retail banking. If you have a universal bank presence around Lebanon it is a good source of money, especially on the deposits side. If you get cheap deposits in Lebanon you make money. If you want to have a niche product you lose money because we outbid the market regularly. So if you go to a variety of branches, that’s where you can get cheap money, and invest it properly. In Lebanon we are also witnessing a reduction in small business activity. However, we have been bombarded by requests for large projects. It appears that the construction sector is picking up and that will take everyone with it, so that’s promising.

Philippe Saleh
Head of corporate risk management, Byblos Bank

E With Basel II compliancy looming out on the horizon, how are preparations going? What is capital going to look like once Basel II guidelines have been applied to Lebanese banks? What if banks need more capital? Where are they going to get it from?

The bank has already embarked on a Basel II compliance program through the creation in 2004 of the Corporate Risk Management Division, which is in charge of ensuring the proper implementation of the three-pillared Basel II principles across the institution. In this regard, a high level roadmap, which has been set and approved, encompasses not only the meeting of the minimum capital requirements laid down by pillar one but also addresses the implications of pillars two and three on the future shape of the bank. Challenges remain with respect to reaching our Basel II ambitions, with large and complex programs under way, which will affect fundamental business processes throughout the organization. That is why we will require the close and effective coordination of risk management, strategy development, business applications and IT, to allow us to deliver the full range of opportunities arising from Basel II.

Capital requirements will first be measured by adopting, over a transitional period, the less sophisticated approaches within the range of alternatives under the new accord. In the meantime, and given that advanced approaches imply careful preparation including requirements on the quality and quantity of data, preparatory work has already started vis-à-vis the advanced approach, specifically for credit risk (IRB) through the rating of our commercial portfolio (corporate and SMEs), which is still under rigorous testing, in an attempt to review and oversee the accuracy and consistency of the output.

On the other hand, we are spreading the Basel II culture across the business lines through workshops and aligned procedures to bring more awareness to operational risks. The concept of risk-adjusted performance is also being introduced through the regular dispatch at all management levels of results and findings of tests run on the historical data base for the determination of expected losses on performing loans, and consequently for the adequate pricing of the risk.

The technical challenge for the banks will be to determine how much capital will be necessary to serve as a cushion against unexpected losses. If capital levels are too low, they will be unable to absorb a high level of losses. Alternatively, a too high level of capital will lead to an inefficient use of resources and will affect the return to shareholders.

We believe that the top-ranked banks are already overcapitalized, to be able to meet Basel II requirements, while small and medium-sized Lebanese banks may need to increase their capital base. However, in our opinion, the main challenge remains the implementation of a comprehensive risk management framework encompassing process changes, adequate governance, systems and data capture and cultural changes. Aside from the capital increase in tier one and tier two, which remains the most common alternative, the market will probably witness partnerships and mergers and acquisitions. If banks have already implemented more advanced risk management techniques, a reallocation to more profitable segments may also be considered, while we may still question the impact of the securitization on capital funding needs.