Lebanon’s banks remain stable, seeing moderate growth

Standing against chaos

Socioeconomically, Lebanon at the end of 2018 gives the appearance of having experienced a year of only two seasons: an overlong Carnival of political absurdities, and a Halloween of economic horrors. As opposed to the usual cycles of tilling, seeding, ripening, and harvesting, these two seasons of 2018 were profoundly unproductive.

If this failure of productivity has led the country to deteriorate in popular perception into a haunted house with many vacant dwellings, the financial sector nonetheless remains the top-performing attraction in the house of Lebanon. In this sense, banking looks like a huge, flattering, magical mirror right in the hallway of this haunted house that affords those who look into it the best possible reflection of the national economic reality.

International observers, local economists, members of the business community, and broad swaths of the population appear unanimous in their view of the banking sector as the remaining primary motor of the Lebanese economy.

At the same time, however, there are also strong opinions that target banks are at fault for any and everything: from operating as an oligarchic sector and being politically exposed to standing in the way of genuine and equitable economic development.

On yet another perception frontline, views of the banking sector as healthy and pivotal for Lebanon’s economic sustenance are juxtaposed by widespread perceptions that the banks are unfairly siphoning profits away from society (although they are carrying large and increasing tax loads), and growing fears that the course of the monetary system, and the entire banking sector, is either unsustainable or could even comprise a large risk factor in an alleged trajectory toward a crash landing of the Lebanese economic system.   

Focus on the data

Compared with the adrenaline rush and emotional thrills that are triggered by horror scenarios like a warning of impending economic doom for Lebanon by way of a currency devaluation or other shocks, a review of the numbers is outright boring. Not only is such brain work inherently tedious, but could be unwelcome to Lebanon’s populists because the analysis of data variations and ratios in the national banking system go a very long way toward tempering any irrational impulse of flight, submission and resignation, unqualified complaint, or blind outrage.

On the upside, a look at the data can sober a person. Taking account of data in general, and of Lebanese banking sector data for 2018 in particular, is not conducive to generating panic. Rather, it is an outright antidote to such outbreaks when examining banking data with a view to economic forecasts on near-term horizons. However, assumption-heavy data speculations over the medium and long term cannot safely be preferred over the reading of coffee residues, tarot cards, or palms.

In 2018, the latest observations by Lebanese financial consultancy BankData available at time of this writing continued to report moderately encouraging growth in banking activity.

According to BankData, assets of the group of 15 Lebanese banks with deposits above $2 billion (alpha banks) grew by 7 percent over the first nine months of 2018, from $232.8 billion in December 2017 to $249.2 billion. At the funding level, the alpha banks’ domestic deposit growth in the period was $3.6 billion, translating to 2.3 percent. Albeit acknowledging that this increase was noticeably below the $6.9 billion growth in the first nine months of 2017, and also lower than the average growth of $5.4 billion in the same period over the past five years, BankData consultants pointed to the environment of political uncertainty. They explained that overall deposit growth was to 72 percent in foreign currency and to 28 percent in Lebanese lira, raising the dollarization ratio of domestic deposits to 67.7 percent in September 2018.

Juxtaposed to lending developments in 2017 as well as lending trends over the past five years, which saw loans to the private sector grow in the first nine months by $1.7 billion and $1.2 billion respectively, the nine-month period in 2018 saw loans to the private sector contract by $1.1 billion, driven by a contraction in private sector loans denoted in a foreign currency. Other data observations by BankData point to increasing average costs of funds for alpha banks in Lebanese lira and in foreign currency by 43 and 24 basis points (bps) respectively, which the consultancy noted was below the rise in the US benchmark rate.

Net contraction of lending portfolios and the imposition of added taxations on banks were reflected in declines of net profits for the alpha banks, even as they increased their efforts to control costs. According to BankData, net profits at the end of September contracted by 13.8 percent overall and 9.7 percent in domestic terms. “As such, alpha banks posted declining profitability ratios, with an annualized return on assets ratio of 0.94 percent against 1.17 percent over the same period last year, and an annualized return on equity ratio of 10.48 percent (11.43 percent for return on common equity), against 12.65 percent (14.01 percent for return on common equity) over the same period last year,” the consultancy said, adding that banking in Lebanon is “showing no sign of caving in, despite an accumulation of domestic economic stresses and external pressures.”

Asset utilization and net operating margins of alpha banks saw declines and overall performances in 2018 and clearly lag behind those of earlier, more glorious periods of growth. However, this is not what one should see as a field littered with macro-economic mines on hair-triggers, especially when assessed in context of Banque du Liban (BDL), Lebanon’s central bank, given its orientation and proven track record as a defender of stability and confidence.

Neither the historic nor present levels of BDL’s hard currency reserves lend credibility to mental assumptions by international banking analysts that the central bank would ever choose to fund the external financing gap purely from its own FX reserves. This would continuously degrade the domestic money supply (M2) to a mere 10 percent by the end of the period over five years between mid-2018 and mid-2023, as a December 2018 report by investment bank Goldman Sachs speculated. 

In light of realities, it does not seem appropriate to flatly buy into the twin assumptions by Goldman analysts that, over the next few years, capital inflows to Lebanon will fail to pick up from the 3 percent range of autumn 2018 while the country’s external balance sheet will continue to deteriorate. Predicated on those assumptions, the analysts wrote: “We believe it is only a matter of time before the BDL’s ability to maintain the peg will be widely questioned.”

Contrasting such ‘ifs’ and generally extreme assumptions, there are innumerable signals that the need for reform and the limitations of the (working) tool sets in BDL and commercial banks are increasingly understood across all levels of Lebanon’s monetary and financial decision making, and are even understood by fiscal policymakers. With this in mind, it is prudent to realize that the short-term perspective for the Lebanese banking sector is certainly not littered with risks and red flags anywhere near the extent that the Lebanese natural environment is littered with garbage and exposed to pollutants. 

Further domestic and

international contexts

The relative health of the Lebanese banking sector is accentuated in the overall financial markets picture when one expands the consideration to the domestic financial sector and the year’s challenges on emerging markets on the internal and external vision axes respectively.

First, however, any analyst of the banking sector in relation to the whole economy is well-advised to be cognizant of the dangers that come with the sector’s disproportionate role. Namely, there is a danger that policy decision makers look into the banking mirror and forget the need to be prudent in fiscal and economic reform decisions, along with the danger that bankers and their allies might be so over-awed when looking at their own images in this flattering mirror they become desensitized to the needs of the little players in the real economy. In the financial markets, the insurance and capital markets of Lebanon did pirouette through 2018 with less vigor and performance than banking.

International conditions and shifts in the world economy in the course of 2018 were perhaps to the greater or smaller advantage of advanced markets, but the same cannot be said when one considers the pressures that emerging economies and many small countries in the third world were exposed to. From the rising tide of trade conflicts affecting the largest emerging economy, China, and political uncertainties that have been prone to affect developed economies, who for decades had been insulated from heavy domestic and external political shocks, to the currency pains for financially exposed emerging markets that accompanied the normalization efforts of the Federal Reserve in the United States, disruptive impulses radiated throughout the global economy in 2018.

What could be easily overlooked in this regard is that Lebanon, despite its self-induced problems, handled itself not at all badly when compared with larger regional neighbors like Egypt and Turkey in terms of currency pressures, or with similarly sized or positioned countries in terms of income bracket (high middle-income) or their sovereign and financial credit risk ratings.     

On the domestic financial economy, the sole underwriting segment of the insurance sector with strong positive outlook for growth as measured by premiums development in 2018 is the medical business line, largely owing to changes relating to guaranteed renewability of medical insurance contracts and improved coverage continuity of employed persons who reach retirement age. Overall, it seems that insurers in Lebanon are faced with enduring international industry challenges, such as the need for digitization, and local ones related to the improvement of insurance awareness and acceptance.

Performance expectations for Lebanese insurers in 2018, apart from the medical line, are at best modest, and reported financial developments leave room for questions. This is even more so the case when the high inflation rates in 2017 and 2018, by local standards, are taken into consideration in conjunction with the sector’s total premiums in 2017—a year in which the sector according to the Association of Insurance Companies in Lebanon (ACAL) achieved written premiums of $1.636 billion, reflecting an increase by 3.45 percent from the previous year—and in 2018, where the Insurance Control Commission (ICC) expects negative growth in life insurance premiums alongside stagnation in the property and casualty lines. The ICC sees this as correlated with the economic situation in the country, and the anemic situation in many sectors.    

The picture turns still a few shades darker when looking at the 2018 “performance” of Lebanese capital markets, namely the market capitalization and trade volume developments at the Beirut Stock Exchange (BSE). Total trading volume at the BSE for the first 11 months of 2018 was $349 million, more than 36.5 percent lower than in the first 11 months of 2017. In that period, the total trading volume was $551 million (after having experienced a similar annual weakening from a multi-year high of $885 million in trading volume during 2016). With the market cap hovering up to $1 billion below the $10 billion line in 2018, the BSE represents less and less financial market fire power when one regards its market cap as a share of the official Lebanese GDP that amounts to more than five times this value.

“The anemic performance of the Beirut Stock Exchange stems from two main reasons,” Lebanon’s Capital Market Authority (CMA) tells Executive in response to emailed questions. “First, its current legal structure, which represents a public company that reports to the Ministry of Finance. Second, the rising economic uncertainty and political landscape in Lebanon has dealt a blow to the Beirut Stock Exchange.” CMA also expresses optimism that current “circumstantial performance of the BSE” would return to average performance levels seen over the past seven years, noting that fundamentals of companies listed on BSE have not changed and that the book value of many of these companies—most of which are banks—is higher than market prices of these stocks near the end of 2018 (to the chagrin of bankers).

While mirroring in the first instance the investor perception of listed assets, a fatigued stock market might also be an alert to imbalances in the functionality of the entire economy. The general consideration is that a highly valued or possibly overvalued securities environment is reached when market capitalization at national exchanges equals 120 or more percent of a nation’s GDP and that anything below 50 percent is an indicator of undervaluation of listed companies and the whole market. This could even signal some degree of dysfunctionality of capital markets or a drag on economic development, with the reasoning that highly functional financial systems facilitate better usage of economic growth potentials in economies by enabling the best investment opportunities to receive optimal funding.

Moreover, research conducted since the global financial crisis of 2008 has suggested that stock market performances in emerging markets contribute importantly to economic growth in these economies. Other research has noted that rich countries with large equity markets in relation to their GDP also have high standards of living, while underpowered capital markets tend to correlate with countries underperforming in terms of economic development.

When taken as mirrors of the real economy and signalers of good or ill health in the national context, the persistent and growing disproportionality of the Lebanese banking sector and the other pillars of the financial economy reinforces the acknowledged fact that a continuation of the financial and, by implication monetary, practices of the past quarter century cannot continue indefinitely, and that a reboot, invigoration, and rebalancing in the financial economy deserves a near-term higher ranking on the national to-do list than discussions over currency stability and parity.   

The weather is changing

International economists’ collective crystal balling on the coming year is comforting in that, whatever really comes to pass in the global economy in 2019, pressures and national worries are not going to be limited to Lebanon. In a poll of some 500 economists and economic analysts around the world taken by Reuters in September/October of 2018, expectations on a majority of the 44 economies covered in the poll were for unchanged or downward GDP growth rates and unchanged or increased inflation in 2019. By analysts and economic media, the specters of bear markets and recession were raised under questions of when, not if.

Hinting to already materializing risks in the global economy was, for example, the director of the International Monetary Fund (IMF), Christine Lagarde, when she said just in advance of the IMF-World Bank’s convening in Bali for annual meetings in October that it has become more difficult for most countries to deliver greater prosperity because the “global economic weather is beginning to change” when compared with spring of 2018. The IMF’s World Economic Outlook at the same time admonished in further detail that “downside risks to global growth have risen in the past six months and the potential for upside surprises has receded.”

The Organization for Economic Cooperation and Development (OECD) also voiced its concerns in an economic outlook in November. “As central banks progressively, and appropriately, reduce their liquidity support, markets have started re-pricing risks as reflected by the return of volatility and the decline of some asset prices,” the OECD observed.

Pointing to reversing capital flows away from emerging to advanced economies, especially the United States, the report noted the increase of political and geopolitical uncertainty in Europe and the Middle East, along with highlighting the uncertainty caused to businesses by heightened trade tensions and the risk that these tensions could be “disrupting global value chains and investment, especially in regions tightly linked to the United States and China.”

In this broad context of under-optimistic global forecasts for the coming year, trade confrontations between large economic powers, and oil price developments, there is naturally  room for nuances in such a vast and challenging landscape of expectations. For example, in its outlook on global markets, Bank of America Merrill Lynch (BofAML), in a research report published in December of 2018, expects 2019 to see “modest gains in equities and credit, a weaker dollar, widening credit spreads, and a flattening to inverted yield curve.” The research team thinks this will translate into a tighter squeeze on liquidity that would likely contribute to higher levels of volatility.

Besides a continuation of late-2018 bear vibes in the US securities markets and a slowing of the US economy overall, BofAML expects global profit growth to decline and global economic growth to decelerate amidst global monetary policy divergences and a weakening dollar. Alongside a “modestly positive” outlook for commodities and projections of strengthening euro and yen, the research team opines that the outlook for emerging markets in this scenario is broadly positive, as EM assets are “cheap and under-owned.”

For the economy of Lebanon—which is neither overly correlated with other emerging markets nor typical by profile—it is not necessarily a bad thing that prominent expectations for geo-economic developments in 2019 are accompanied by narratives of impending risk and uncertainty. It will perhaps be more important that the latest global outlooks have room for factors such as less upward interest rate action by the Fed, and a relaxation of oil prices. Both factors might contribute to relieving external financial pressures on the Lebanese state.    

Much more meaningfully, on the domestic front, the potential for improvement has a numerical advantage at the end of 2018. Possibilities of grave shocks always exist, but the hopes for stability have a stronger currency.

Encouragement and room for positive expectations come, for example, from the impact that political constructiveness—a formation and great performance leap on the government level—would have on public investment growth and for financial inflows. News of the past few months have been actually pointing to improvements on some infrastructure fronts such as the PPP outlook, as elusive as parts of it still looks today, and on the internet connectivity side.

Nota bene, one of the side effects of the superb strength of Lebanon’s banking sector as a distorting mirror attracting attention in the economy, is that other aspects of the financial economy, such as development of capital markets and the microfinance industry, can be overlooked and left behind. That is unfortunate, as demonstrated by a report on the current state of stock markets around the world,  published in December 2018 by the World Federation of Exchanges (WFE). The report explains how international portfolio investments can be attracted to exchanges in emerging and frontier markets, and how these can then contribute to economic development.

Necessary factors to this development, according to WFE, include adoption of reporting standards (such as IFRS), encouragement of English-language corporate disclosures, and implementation of elevated corporate governance practices. Stating that “the greatest predictor of foreign inflows into emerging markets is emerging market equity returns,” the WFE report notes that an increase of domestic returns on equity by merely 1 percentage point can be associated “with a $24.4 million increase in monthly inflows” to the average market.

In capital markets, we have waited another year for hot news (as Executive expected in our 2017 year end issue). However, the CMA confirms that after having conducted a flurry of other constructive activity throughout 2018, in early December it finally issued its Request for Proposal (RFP) to launch its Electronic Trading Platform (ETP), which the CMA counts on to “significantly improve liquidity in the Lebanese markets, allowing Lebanese diaspora easier access to invest in Lebanon, and contributing to the growth of the economy.”

According to the CMA, the RFP sets the guidelines for developing the ETP and the securities allowed for trading on the platform and thus enables financial institutions that are interested in owning and operating the platform to apply for the license issued by the CMA.

“With the enhancement in the types of securities available for trading by local and international investors, we are certain that the Lebanese capital markets will regain their appeal and attract an enhanced private sector participation given the renewed opportunities that the ETP provides,” the CMA confirms—so, in short, there is finally something moving in regard to the BSE/ETP.

Elsewhere in the financial economy, BDL has sent new and positive impulses that actors in the small, but motivationally important microfinance sector see as encouraging and, along with the arrival of veritable Fintech initiatives in the entrepreneurship ecosystem (see Executive’s November report), some announcements hint at new and improved initiatives in regard to cybersecurity and at least further considerations of digital currency at the central bank level.

This leaves the big long-term task of banks upgrading themselves to contribute to the digital transformation of the economy and activate new thinking in ways that should help in bursting through many current mental and operational idiosyncrasies, barriers that have formed as collateral of the years, while banking was the only reliable engine of the Lebanese economy.      

Thomas Schellen

Thomas Schellen is Executive's editor-at-large. He has been reporting on Middle Eastern business and economy for over 20 years.

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