Revitalizing banking

The central bank

Despite its proud regional reputation, Lebanon’s banking sector has faced a number of hurdles in the past few years. Strong regional competition, stemming from the spawning of a number of large-scale Arab banks – mainly in the Gulf – have created obstacles for a sector seeking expansion, while a high level of liquidity, a large number of small-scale, inefficient banks, and an overcapacity of banking institutions for a country of Lebanon’s size have not helped the sector.

The central bank, in close conjunction with the Association of Lebanese Banks, has been working hard to overhaul the banking sector and allow it to regain its regional competitive advantages. One initiative was the unprecedented move in late February by the central bank to amend two laws – 1998’s law number 7055 and 1999’s law number 7274 – allowing Lebanese banks to lend to non-residents and invest in foreign debt securities respectively.

The amendments to law number 7055 would allow any Lebanese bank to extend loans to non-residents up to an amount of 5% of its equity per borrower. The total loans to non-residents, however, may not exceed an aggregate amount of 25% of the bank’s equity. This compares to a ceiling of 20% per resident borrower.

Prior the amendment to law number 7274, banks were restricted to securities issued by the governments of no more than 10 nations, including the US, Japan, and certain European countries. The new changes allow Lebanese banks to invest in any foreign debt security, be it sovereign or corporate, as long as the security is rated BBB or higher by any of the internationally recognized rating agencies, such as Standards and Poor’s, Fitch, and Moody’s.

The moves are being highly debated in Lebanese financial circles, as they constitute a major turnaround in the policies of central bank governor Riad Salameh, who was traditionally set on maintaining a high level of liquidity in the banking sector in Lebanon, and ensuring that such liquidity remains within the country’s borders (a policy that was underpinned by the two original laws). As such the central bank’s change in direction raises questions as to the motives behind the amendments to the laws.

The banking sector in Lebanon has grown substantially over the past few years, with growth in assets and deposits witnessing a compounded average annual growth of 15% each between 2000 and 2004. Following the events of September 11, and the subsequent so-called US-led war on terror, Arab funds have been flowing into Lebanese banks, increasing liquidity. Salameh has estimated the excess liquidity in the Lebanese banking sector at the beginning of 2004 at almost $5 billion.

On the other hand, Lebanon’s investment environment, although witnessing significant growth in certain sectors is relatively small, compared to the level of funds available for investments. Despite the lower interest rate environment, deposit rates on foreign currency deposits remain in excess of 4% among the large Lebanese banks, and may be even higher for long-term, large deposits. With such developments occurring rapidly, Lebanese banks faced problems in securing high-yielding uses of funds. A globally low interest rate environment, a limited investment climate in Lebanon, and a high risk surrounding Lebanese government bonds, might have made it difficult for Lebanese banks to achieve enough returns on all the excess liquidity to justify paying such interest rates on deposits.

In a pre-emptive move, the central bank allowed Lebanese banks to seek alternative investments for their funds, albeit in a highly selective and restricted manner, aimed at maintaining the sector’s image of safety and high liquidity. The market for such investments may be lucrative. However, the rapid growth of infrastructure-related projects in the region requires a massive amount of debt financing by regional banks. Infrastructure projects are spawning in the Gulf and Africa, in such sectors as power-generation, water desalination, and others. To this day, the long-term financing required by such projects has been restricted to international banks and major Arab (non-Lebanese) banks. Such projects present attractive lending opportunities for Lebanese banks enjoying high levels of liquidity. In fact, such projects typically enjoy a high level of safety and cash flow predictability, as they are often guaranteed by government organizations or international insurance coverage policies offered by such institutions as the World Bank affiliated Multilateral Investment Guarantee Agency (MIGA).

In such a sense, the Lebanese banking sector stands to greatly benefit from such opportunities. On the profitability front, Lebanese banks may substantially widen their interest margins, achieving higher returns on loans to non-resident companies in the region. Such returns would compare favorably to the low-yield deposits by Lebanese banks at foreign financial institutions. Moreover, such moves by Lebanese banks would significantly improve their efforts to expand regionally and compete with major Arab banks. While Lebanese banks have been historically successful in attracting Arab funds, their abilities to invest funds outside Lebanon have been highly restricted by the central bank’s regulations. The recent amendments would certainly allow Lebanese banks to aggressively expand geographically.

It remains to be seen, however, if such changes by the central bank are a precursor to more liberalization in the sector in the near future. Banking experts fail to see any other major changes in the near-term, unless drastic changes in market conditions necessitate it. After all, changes in market conditions such as the sudden increase in excess liquidity, and the lack of investment opportunities in Lebanon were potentially the main drive behind the central bank’s move to liberalize foreign lending and investment.

On the other hand, the central bank’s attention is likely to turn to a consolidation of the sector in the near term. The recently announced merger between Banque Audi and Banque Saradar has triggered much speculation as to the possibility of the merger becoming the first of a series of such activities, aimed at consolidating the highly fragmented banking sector. While the central bank governor has yet to approve the Audi-Saradar alliance, such moves have been historically encouraged by the central bank. This latest development may be used by the governor as a launching pad to entice other players in the sector to follow suit, or face the risk of being dwarfed by the scale of local and regional market leaders.