Back to banking for the future

The economic need to answer impossible questions and define improbable options

Illustration by Ivan Debs

Lebanon without banks. That is far more difficult to envision than Mount Sannine without snow or the coast line without illegal buildings and the hills without litter. Asking some Lebanese economists if they can imagine the country without banks is like asking a king salmon if it can live without water. “It is true that there is an over-dependence on banks for financing but I would shift the question to ask, ‘what if there were more developed capital markets? What if you had a developed stock market that would enable companies to raise equity? What if you had a developed private equity sector and a venture capital sector?’” retorts Nassib Ghobril, chief economist and head of research at Byblos Bank.

“You cannot answer this question that way. In any country, banks are building the currency. You should ask this question differently: Can you imagine any society where there is no currency?” comments Freddie Baz, chief strategist and vice-chairman of the board at Bank Audi.

With currency he describes not only narrow money but also broad money, which is created at banks through deposits. “Currency is not cash, it is scriptural currency, deposits. The central bank is responsible for issuing banknotes. We create the other currency through our loans. We are financing the Lebanese economy exclusively; there are no capital markets. You cannot imagine any country without a banking system, unless you want to go back to barter economies,” Baz explains further.

Both economists are unequivocal in their appreciation of banking as elementary constituent of an economy and Ghobril emphasizes that banking would flourish even more successfully if it were supported by another systemic element. “Capital markets would complement commercial banks rather than compete with them and that would definitely reduce the burden on the banking sector of financing the entire economy and the government on its own. That would reduce the pressure to attract deposits,” he says.

While their concepts of money cannot be expected to reach the complexity of economists’ understandings, it is a safe bet to assume that the thousands of invitees at a cocktail reception with dignitaries from Lebanon’s top bank were in agreement on the importance of banking in Lebanon. As they were lining up to shake the hands of Samir Hanna, Mark Audi et al (after already having queued in their vehicles around the Centre Sofil block and into the nearby through streets), their voices were summed up in the words of a well-known business man and consultant. “Lebanon could not exist without its banks,” he commented when asked by Executive how important banks are for the country.

“Currency is not cash, it is scriptural currency, deposits. The central bank is responsible for issuing banknotes. We create the other currency through our loans.”

The same view exists from abroad. When asked why UK-based events company Euromoney Conferences was coming to the small Lebanese market to stage a financial conference for the second year in succession, director for the Middle East and Africa, Victoria Behn, commented that they are “convening in Beirut to provide a platform for discussions on the future of finance and technology in Lebanon.” Lebanon’s “financial and business success stories should be told to the international markets and to our core audience of financiers and investors,” she adds and enthuses, in response to a why-here question, “Lebanon has an incredibly strong banking sector with globally recognized banks.

Points acknowledged. Lebanon stands out in banking and it is unthinkable to contemplate a modern – i.e. short of returning to Paleolithic barter – global economy without it. Still, there are reasons today, and increasing numbers of such evidentiary factors, to send the conventional economic thought box to the shredder. Perhaps not so much Lebanese reasons, but all the more valid macroeconomic and geo-economic ones.

Consider this: Productivity growth in all member countries of the Organization for Economic Co-operation and Development (OECD) has been declining in the pre and post crisis years, the OECD at the end of May said in a press statement with new data in preparation of its June 1 & 2 Paris Summit on the theme of “enhancing productivity for inclusive growth”.

Affirming that growth of productivity constitutes the central driver of “rising economic output and material living standards”, the OECD said it found that the rate of decline was much sharper in recent years than in the period between 1996 and 2004. Plus, the slow growth is worrisome because it has the potential to exacerbate income and wealth inequalities as it can trap people in low-productivity activities with high job insecurity, as the organization admitted.

It said, with an undertone of puzzlement, “In most OECD countries the slowdown has cut across nearly all sectors, affecting both large and small firms, but has been particularly marked in those industries where digital and technological innovations were expected to generate productivity dividends such as in the information, communication, finance and insurance sectors.”

In sum, the fabled knowledge economy sectors in developed economies did not deliver what they were expected to do. And the pictures do not get better if one looks up and down the road, left and right.

Dark clouds but nothing severe

In the local direction, banking is as vital as ever, and that means the economy is both sensitive and exposed to this segment. As the emerging markets-focused ratings agency Capital Intelligence observed in a note published in April, the state of the Lebanese economy’s vulnerability was on a trajectory of only getting worse in 2015 and beyond. “Refinancing risk remains high, with the government’s gross financing requirement at about 29 percent of gross domestic product (GDP) in 2015 and likely to top 33 percent in 2017,” it said, and continued, “The government is reliant on the domestic banking system for the bulk of its financing in both local and foreign currency. The economy would therefore be vulnerable to a shock that adversely affects the risk appetite of local banks or the confidence of depositors.”

Ratings agency Fitch was more supportive but hardly voicing good prospects for the future when it said in May that on the one hand Lebanon is in the group of banking systems with low outlook when it comes to vulnerability to shocks but on the flipside Fitch gives the banking system a B, a non-investment grade; Standard & Poor’s likewise upheld a non-investment grade ranking with negative outlook in March and the World Bank Group’s view on the role of the banking system and its interplay with fiscal realities in the recently published “Systematic Country Diagnostic” (SCD) on Lebanon is also, well, not flattering. “Fiscal policy is not transparent, lacks basic accountability, is prone to being captured by vested interests, and therefore is inefficient and unproductive,” it says (page 60). The banking sector “has reached a size seen only in a few countries in the world” but to improve financial inclusion “returns from lending to the private sector have to be better than the low risk, low cost, and high margins that banks are realizing by lending to the sovereign”.

This is hardly a new story and on top of this description, the SCD characterizes the central bank as “trapped in a Stackelberg follower role vis-à-vis the fiscal authority”. This term from game theory is not elaborated on in detail or explained to us in its theoretical depths. In a Federal Reserve paper written in the early 80s by US economist Alan Blinder, a central bank in Stackelberg follower role is actually prone to have the hand at the wheel; “Under a leader – follower arrangement, the follower runs the show, albeit subject to some constraints placed on him by the leader’s prior decision” he explained, and the follower’s room to maneuver can allow him to obtain the optimum if the follower only has enough instruments at his disposal so that he can effectively function as “single stabilization authority”. But given the view on the quality of fiscal policy voiced before, the limitation to central bank independence that is implied in the SCD observation is certainly not encouraging.

Still, Lebanon is not anywhere near the epicentres of the new money problems, which are based on the propensity to generate a financial sector that is exceeding the real economy by multiples. Lebanon’s banking sector appears to preoccupy itself with considerations of growth and competition that are very conventional, not to say tedious. Structurally, nothing major is visible at the surface of banking in 2016.

Lebanon’s banking sector appears to preoccupy itself with considerations of growth and competition that are very conventional

The alpha banks – the financial animals with bellies stuffed with over $2 billion in deposits for each of the 14 institutions in this group – can be seen as a class with approximately four peer groups. At the top are the two super-alpha banks, over-achievers Audi and Blom, whose diversification and size is advanced enough that they in foreseeable years will not be challenged competitively by any other Lebanon-based banking group. Then there are banks vying for the third spot and competing in the first follower segment. They make nice when the teacher is looking but are kicking each other under the table. A bit further down in the pecking order are banks that chase the top performance and size spots in the lower half of the top ten banks, and further down the five or six contenders that haggle with their peers in this size group for leadership laurels in niches or market segments.

Other than making marketing noises and reaching modest positioning gains – SGBL was the sole bank with improvements in every major category – these banks did not roll out models of revolution or new ideas. Even the largest ownership transaction in the sector – the sale of 9.5 million shares, or 40 percent, in Credit Libanais Bank by Egypt-based investment bank EFG Hermes is shrouded in secrecy.

When contacted by Executive, EFG Hermes said it would not comment because the bank has a habit of only issuing statements after the completion of a deal, but by all appearances the transaction, worth over $310 million plus fees and with potential to reach $480 million if all 66 percent of its Credit Libanais shares were sold by EFG Hermes, was more connected to the investment bank’s situation in Egypt than to any local issues in the Lebanese economy. In a local deal, Byblos Bank completed the transaction to acquire Bank Pharaon & Chiha, paying according to its statement $91 million for a bank with five branches, 30,000 accounts, 100 employees and $242 million in assets. It was the ninth acquisition move by Byblos in about 20 years but the first such event since 2010. In a smaller divestment HSBC’s local ops is for sale but bankers say nothing is known to have been decided.

The transformation of Near East Commercial Bank, Banque de Industrie et du Travail, and various entities in the Saradar Group into a new powerful contender is perhaps progressing with less-than-promised speed – also, nothing unusual in Lebanon. As far as operating environments and profits go, nothing new needs to be said beyond the habitual check of the numbers (see analysis page 28). In short, there is still excitement to be waited for, but nothing urgent on the table now. For those cherishing urbanization, building activity will be watchable in the new head office construction projects by Bank of Beirut and Banque Libano-Fran çaise.

The global economic quagmire   

Looking down the global economic road, traffic is even more confused than in Lebanon; dangerous driving abounds. The top economists in positions of influence, such as then-Fed chairman Ben Bernanke, could not foresee the Great Recession because they were thinking within in the boxes of backward induction, said James K. Galbraith, American economist and son of another famed economist, John K. Galbraith, in his book, The End of Normal. In this thought box, Galbraith wrote, the “preferred conclusion is inferred from the improved outcomes. Alternatives are ignored.”

Under the prevailing basic growth theory, central banks could only make two errors – of too loose or too tight monetary policy – and face in consequence only the dangers of inflation or deflation. Near-stable prices meant that it was assumed that central banks did their job. “Far be it from a central banker to master the larger world of industrial profitability, job gains and losses, the build-up of private debts, or the balance of supply and demand in the commodity market. Let alone the malfeasance of private bankers,” Galbraith wrote, arguing that this was why this breed of economists was unable to conceive of the Great Recession in advance of its outbreak.

Looking down the global economic road, traffic is even more confused than in Lebanon; dangerous driving abounds.

Galbraith’s was a book in a recent range of clarion calls with fin-de titles given to them by, one suspects, marketing executives who were gauging the international mood as moving into depression or acceptance of downward prospects.

In 2013, Venezuelan author and one-time World Bank executive director Moises Naim published The End of Power, describing how ever-greater power accumulations in a wide range of areas, including corporate and finance behemoths, make the possession of power positions ever more short-term and perilous. In 2014 Galbraith published The End of Normal. And in 2016 two current works are reinforcing the impression that some leading economic minds are now voicing worries and considerations as if they were moving, in the Kuebler-Ross model of grieving, into an acceptance phase.     

One of these new noteworthy books is sold by marketing agents under the fin-de outlook: The End of Alchemy by former Bank of England Governor Mervyn King. The other’s title is – on its sound value – more reassuring. It is The Only Game in Town, by Mohamed A. el-Erian. But the works have more in common than marketing accolades of the kind: “this is the only book that you ever need to read”. Both authors are addressing the aftermath of the Great Recession, the roles of central banks and commercial banks, along with key questions on the future of the global economy, and they can both, as can Galbraith’s, be characterized as works for which gloomy is too weak a term.

Even darker clouds

King opens by saying that the financial crisis triggered “a worldwide collapse of confidence”. El-Erian, the finance man with many hats and even more publications under his belt, opens by saying that the post-crisis era’s “frustrating ‘new normal’ of low growth, rising inequality, [and] political dysfunction” is coming to a sort of maturation point – even this “new normal” (a term which he popularized himself in 2009) is getting exhausted, he says.

Naim cites expert findings that diagnose dissatisfaction with political systems and economic core institutions “is a growing and global phenomenon”. He notes, “The economic crisis that erupted in 2008 in the United States and then ravaged Europe has also fueled powerful sentiments against powerful actors that the public blames for the crisis: the government, politicians, banks, and so on.” He also draws attention to the shrinking power franchises of some top banks in the era after the crisis, and the diminished “freedom of action” of bankers.

Galbraith is more direct. He opines for a slow growth system as a “qualitative different form of capitalism”. In his perception, which seems more in line with traditions associated with the Left but not socialist enough to find the Left’s approval, banks are nothing more than intermediaries. Their usefulness is given only when they support “either household consumption or business investment – and then only as long as they do so in an effective, responsible, low-cost way.”

“Perhaps the country would be better off without its big banks,” he speculates in typically America-centric ways. He believes the financial institutions, along with other big entities, should be scaled back and advocates that the economy should migrate toward a “decentralized system with smaller top-level units, less powerful bankers, and stronger controls”.

“A long-term program for the reform of money and banking and the institutions of the global economy will be driven only by an intellectual revolution”

The newer recipes and concerns are taking things a step farther. At the end of The End of Alchemy, King’s prescription is as limited as any acknowledgement of – inevitable – human information deficiency has to be. “A long-term program for the reform of money and banking and the institutions of the global economy will be driven only by an intellectual revolution,” he says, and argues that “without reform the economic and human costs of [the next] crisis will be bigger than the last one”.

Only a proper diagnosis, namely a recognition of the severe disequilibrium into which leading economies have fallen, will give us the courage – “the audacity of pessimism” when one has nothing to lose – to undertake bold reforms, he thinks.

El-Erian for his part thinks that “seldom has the global economy been engaged on such a path to a T-junction”, meaning a fork in the road from where one of two possible roads is leading the global economy into even lower growth, higher unemployment and greater inequality than was seen in the recent past.    

The other road, which can herald more inclusive growth, in his opinion, will require something utopian. “High inclusive growth and lasting financial stability requires a more comprehensive policy response that sees other government entities joining central banks in steadfast and serious effort,” he writes at the end of his too short book, and while he says that there is nothing preordained about our future, taking the better road will require our governments to get their act together.

In his words “a more comprehensive policy approach is urgently needed and is available” by governments and central banks and he postulates that they, and companies and households, will have to come to terms with their blind spots and do more to gain greater control of their destiny under either road out of the T-junction. Everybody working together? El-Erian might as well be asking for a lunar colony to deliver answers to the world’s economic problems. In the case of Lebanon, the request would be for a colony to function on the backside of our orbiter.

The silver lining

Compared to the troubles of the global banking scene, the Lebanese banks are reassuringly boring. Baz points out that this is continuing to be the case. “Look at our balance sheet as an industry. It is very simple; 90 percent of our funding is customer deposits. If you look at the assets side, there is no borrowing from the markets, it is customer deposits and equity. Loans represent 50 percent of our assets. We have some portfolio investments, but in Lebanese and some regional securities that we understand. The remaining is primary liquidity which is placed either with the central bank here or with our main correspondents abroad. Lebanese banks are boring banks,” he emphasizes. 

The banking troubles of today are actually economic problems that are rooted in a past of fragility and conflict, not of crises of the financial system. According to Baz, the steady-state size of an undisrupted Lebanese GDP – i.e. growth continuing at the average rate achieved in the two decades prior to the outbreak of the Civil War in 1975 – would make the country reach $120 billion in today’s economy. Even if one takes into account that this figure is hypothetical and that history cannot be reversed and restarted toward a more favourable outcome, the discrepancy between what could be and what is, is in the billions. Baz assumes that the economic utilization rate is 75 percent, and the economy, which he estimates at $55 billion at present, could therefore stand at $73 billion.

In Ghobril’s assessment, the gap is similar. “The point is the decline in consumer confidence correlates with the decline in GDP growth, which averaged about 1.4 percent between 2011 and 2015. Compare this with the average growth rate over the period between 2001 and 2010, which was about 4.6 or 4.7 percent. The output losses from declining growth in the past five years [sum up] to about $24 billion,” he tells Executive. 

In Lebanon, banks feel that their problem is that “we are impacted by the underperformance of our economy”

This means that Lebanon, due to regional strife, political inaction, and similar issues, is suffering an “opportunity cost for the overall economy”, and this translates into less lending opportunities to the private sector for banks. “We extended $2.9 billion to the private sector last year, compared to $3.9 billion in 2014. The banking sector would definitely like to see the economy grow and expand, so that it can find more lending opportunities. Banks cannot be successful if there are no successful sectors to lend to,” he says.

Another entrenched problem is the opacity of the economy and the lack of information on most sectors which makes it impossible to say how large a share of corporate profits go to the banks. “As your question is, how much the $1.9 billion dollars of banks’ corporate profits represented in 2015 in percentage of corporate profits in Lebanon, and the answer is we don’t know. We don’t have figures,” Ghobril affirms. This means that everyone looks to banks as the institutions for all seasons and purposes.

“Is there an over-dependence on banks? Yes, there is over-dependence on banks in the sense that they are the only source of financing for the private sector and almost the only source of financing for the government. Between commercial banks and the central bank, and in absence of political will to reduce the fiscal deficit, which is the weak link in the economy, the banks will have to continue to attract deposits so the government can continue to meet its maturities and dates of payment,” he confirms.

In Lebanon, banks feel that their problem is that “we are impacted by the underperformance of our economy,” as Baz puts it. Where ignorance of sustainable economic mandates is endemic, central bankers and forward-looking commercial bankers would be waiting till the end of times if they wanted, in the sense of el-Erian’s recipe, real support from their political counterparts who are not trained in relevant skills. Lebanese politicians – if they get their heads out of demagogistan or wastastan and away from populist and simplistic decision attempts on promising sectors – will be hard pressed to find solutions to even exit their own communal backyards and gain regional perspectives on issues like developing oil & gas or employment.

At their best, the observations and recipes of global thought leaders like King and el-Erian perhaps qualify as belonging to the phase of grief over the loss of the small business world, a phase where we come to acceptance of information that the future will be different from what we expected before the Great Recession. That means also – positively – accepting limited but existing options that will be at our disposal to influence the future. After all, as King says, in a capitalist economy money and banks play such a critical role because they constitute “the link between the present and the future.”

Thomas Schellen

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