Is it worth the risk?

Terrorist threats and fierce competition have led many foreign banks to scale down their operations in Lebanon

Fluctuating performances, a harsh competitive environment, a limited market, and high threats of terrorism and war are just a few of the critical factors affecting both the current operations of foreign banks in Lebanon, and their future strategies with that regard.

Major shock waves have hit foreign banks in Lebanon over the past few years, ranging from the economic recession plaguing the country since 2000, to the threat of terrorism and heightened war activity in the region. Foreign banks in Lebanon, as in other countries in the Middle East and the Mediterranean, suffered a number of terrorist attacks or attempted attacks. A major explosion at HSBC headquarters in Turkey late in 2003 sent all European and American banks in the Middle East scrambling for additional security measures, to the extent of almost paralyzing daily operations. In the case of Lebanon, this has translated into armed guards protecting the entrances of European and American banks, in addition to those of Arab countries considered at risk of terrorism. It remains to be seen, however, how such banks have coped with years of struggle and hurdles, how they have performed, and what are their strategies for the near future.

Numerous banking professionals have addressed the presence of foreign banks, often criticizing their inability to compete with the major local institutions, and their overall risk aversion towards lending and retail banking.

While the end of the war in Lebanon saw the return of a number of foreign banks to the “lucrative” financial sector in Lebanon, the trend has been reversing over the past four years, with a number of banks abandoning their attempt to establish a significant presence in the country. At present, there are 12 foreign banks operating in the country – of which seven are Arab or Iranian – compared to 17 in 1999. The latest foreign bank to shut its operations in Lebanon was Dutch banking giant ABN Amro NV, which sold off its assets to Byblos Bank SAL and halted operations at the end of 2001.

Total assets of foreign banks in Lebanon have shrunk by more than 24% between 2000 and 2002, reaching $3.9 billion, compared to a growth of 15% for the Lebanese banking sector, and 20% for Alpha Group banks. Accordingly, total deposits at foreign banks in Lebanon have also fallen by more than 24% between 2000 and 2002, to $3.3 billion, compared to a growth of 15% for the Lebanese banking sector and 18% for Alpha Group banks. Loans and discounts have also dropped in tandem with the shrinkage in customer deposits and total assets.

Of the existing foreign banks in Lebanon, the three largest (Arab Bank, BNPI, HSBC) account for close to 80% of both total assets and total customer deposits of foreign banks in Lebanon. Arab Bank is the largest, with total assets of $1.5 billion, and customer deposits of $1.3 billion – thus making it party to the elite Alpha Group of banks. Furthermore, Arab Bank enjoys a market share of 2.9% of customer deposits domestically, compared to 1.8% for BNPI and 1.2% for HSBC. Other foreign banks in Lebanon, such as Citibank, Saudi National Commercial Bank, and National Bank of Kuwait, play a much more limited role in Lebanon, with respective market shares not exceeding 1%.

The overall performance of foreign banks in Lebanon is mostly geared towards that of Arab Bank, HSBC, and BNPI. Significant improvements in profitability, resulting mainly from better lending strategies and lower cost of funds, have contributed substantially to the bottom line of Arab Bank and HSBC, especially between the years 2001 and 2002. On an overall note, growth in the net earnings of foreign banks in Lebanon has fluctuated widely over the past few years. The year 2000 saw a 10% drop in net earnings, which was followed by a significant 51% gain in 2001, led by HSBC’s ability to turn an $11 million loss in 2000 into a $2.5 million net gain for 2001. Things improved in the year 2002, with net income for foreign banks in Lebanon jumped by a staggering 68% to reach $35.6 million. This growth was heavily influenced by the performance of Arab Bank and HSBC, which saw their bottom line increase by 206% and 167%, respectively, to $10.9 million and $6.7 million. Bearing such fluctuations in mind, the compounded average growth in net income for foreign banks in Lebanon between 1999 and 2002, remains in excess of 25% annually. This compared to a shrinkage in net income of 9% for the whole banking sector in Lebanon over the same period.

Excluding such outliers as Arab Bank and HSBC, however, the sector’s net earnings have grown by a more modest compounded average of 3% per year over the same period. While basically contributing the majority of revenues to foreign and local banks alike, interest income has played a minimal role in the increased profitability of foreign banks in Lebanon over the past few years. In fact, interest income for the sector as a whole grew by merely 6% annually on average between 1999 and 2002, compared to the 25% growth in net income. With the high number of banks operating in Lebanon creating strong competition, and foreign banks’ common policy of avoiding interest war with local banks, most opted to offer value added private banking and other specialized banking services. Backed by their international networks, foreign banks have been able to tap into a niche of banking services yet not fully supported by local banks. The foreign banking sector’s net financial income grew by an average of 10% between 1999 and 2002, while net commission income grew by an average of 8% over the same period.

As previously stated, foreign banks in Lebanon have attempted to tap into a niche market of private banking and other specialized services in which the Lebanese market is not yet saturated. In such a sense, foreign banks are dwarfed by local entities in terms of deposits and loans, while they remain highly competitive in other banking services. Such a strategy has, to a certain extent, limited their direct exposure to political and economic risks in the country, while, on the other hand, limited their ability to achieve sizeable income. While this approach may have a certain risk-control aspect to it, its restrictions on growth and gain in market share has severely misrepresented the attractiveness of Lebanon to foreign banks with, as of yet, no presence in the country. In such a sense, the highly competitive environment and the resulting slim margins put Lebanon at a competitive disadvantage to other emerging markets such as Africa, Qatar, Russia, and Eastern Europe.

These developments have been accelerated by the threat of terrorism against western interests globally, which have partially led many international banking institutions to scale down on their operations in emerging markets. As such, Europe’s leading banking institution, ABN Amro, has opted to shut down its operations in a number of countries in the region, including Lebanon. In addition, it has been recently rumored that a number of international banks are seeking to sell their equity stakes in major Lebanese banks. Although such developments may be misinterpreted initially as originating from domestic or regional factors of various natures, it is rather, a result of revisions to strategies regarding emerging markets.

Nevertheless, the activities of foreign banks in Lebanon are certainly not on a definite shrinkage route. In fact, a number of foreign banks, namely HSBC and Standard Chartered, have successfully clawed their way into a decent market share. Their strategy was aggressive and focused on services – including, credit cards, internet banking, investment products, and other special banking packages. Needless to say, the growth of foreign banks in Lebanon, or lack thereof, does have a direct impact on the Lebanese banking sector as a whole. In essence, large Arab banks or sizeable international banks grabbing a foothold in Lebanon would put pressure on the smaller Lebanese banks, thus enticing consolidation in the banking sector – a development long sought after by Riad Salemeh and the central bank.