For at least the past four years, foreign banks have been leaving Lebanon in regular succession. The exodus began in 2001, when ING Baring sold its franchise to Byblos Bank, followed by ABN Amro also selling its Lebanese operation to Byblos Bank in 2002, while Credit Lyonnais sold its franchise to Credit Bank, a smaller domestic bank. More recently, during 2004, Crédit Agricole also left the country, selling its 51% stake to local individual investors.
It has also been six years since a foreign bank announced its intention to acquire a local bank, let alone set up a branch in Lebanon. In fact, most international banks have shied away from entering the Lebanese market, which has only four major Western banks, HSBC, BNP Paribas (BNPI), Standard Chartered and Citibank, all of whom have a decades-old historical presence and are committed to the country. This is the main reason why BNPI and HSBC are still operating, while Standard Chartered has a global emerging market franchise, and is keen to give itself more time to develop its presence. Citibank’s size in Lebanon is too small and doesn’t impact the consolidated balance sheet. The bank has however closed its branch on the highway and, no doubt looking to cultivate a better class of depositors, told all customers with less than $25,000 to close their accounts.
The fact of the matter is that most foreign banks have viewed Lebanon with caution. Those who were interested kept a cool head during the euphoric times of the mid-1990s, and opened only small offices. Others, such as ING Baring, predicted Lebanon would regain its position as the region’s banking center and were quick to open a fully-fledged branch, only to pull out altogether after five years. Those that remain such as BNPI, HSBC, Standard Chartered and Citibank are still considering the level by which they will increase their market share and compete heavily with the larger domestic banks, many of which have gone regional.
Some local partners of foreign banks argue that therein lies the dilemma. They say Lebanon cannot be viewed as a sole entity. Its natural disposition is that of a regional hub and local banks that have prospered have penetrated regional markets. The instinct therefore is to expand, while foreign banks may be reluctant to “interfere” with their other regional offices.
Risky business
The reason Lebanon makes foreign banks twitchy may lie in its country risk, as reflected by Standard & Poor’s rating of the Lebanese government, one that establishes a benchmark for the entire Lebanese economy, which has shown significant signs of weakness and volatility for virtually the last decade. Doubtful loans have been very high, both on the corporate and retail sides, averaging more than 20% of banks’ loan portfolios, while earning diversification and recurrence has been suffering. Furthermore, there are little fund placement or investment opportunities, and both local and foreign banks find it extremely difficult to place gathered deposits into risk-free or low-risk loans or securities. For this reason, foreign banks have been reserving significantly against Lebanese risk at head office level, and have found their Lebanese presence to be costly. Those banks that sold their Lebanese franchise did not do so to simply cash in on the value of the local franchise, but rather to be able to release reserves at Europe head office level.
Another major reason for the foreign flight is the imminent Basel II Capital Accord due to be implemented with all banks within the G10 countries (including the Netherlands and France). This accord forces banks to determine capital according to risk weightings on assets. The risk weightings are in turn determined by credit risk ratings, whether these are internally developed or provided by internationally recognized rating agencies, such as Moody’s, Standard & Poor’s and Fitch. Therefore, a B– rating, such as the one carried by the Lebanese government and just about every rated institution in Lebanon, would carry a minimum risk weighting of 150% for international banks with any exposure in Lebanon. For example, if a foreign bank with total assets of $75 billion had a presence in Lebanon amounting to say, $3 billion in terms of assets, it would then have to risk weigh this amount at 150% and set aside $360 million in terms of capital just in order to comply with the Bank for International Settlements (BIS) minimum regulatory capital requirements, which sets the lower limit of the BIS Capital Adequacy ratio at 8%. The international bank in question would much rather allocate the $3 billion in less risky markets in Europe, where ratings are higher and risk lower, and which do not cost as much in terms of capital.
Incentives to stay
A capital allocation such as that described above could have been worthwhile if yields in Lebanon were significant and the domestic market profitable, but yields have dropped substantially in the last few years, while economic, political and social risks have stayed, if not worsened. The government has done a relatively good job in reducing interest rates on the Lebanese pound, but has done little to accompany interest rate drops with appropriate reforms, financial restructuring and privatization.
Given the political power games at play and threats of international sanctions in recent years, even today’s hopes for a better government cannot ameliorate the situation, particularly considering the killing of former premier Rafik Hariri in February was a big blow to the country’s stability. Furthermore, the government also showed significant incompetence in handling the fallout.
The bottom line for foreign banks is that Lebanon represents too much volatility and risk. The low rating – coupled with the small size, lack of diversity and capital market developments – hamper any desire for a foreign financial institution to either venture into or remain in Lebanon.
The absence of a developed local capital market is also an obstacle to a greater foreign presence. International banks, which have a presence in most world markets, rely on market funding or the issue of debt and hybrid debt securities (e.g. preferred shares, subordinated debt, etc.) to fund their placements. In turn, their placements usually involve a high degree of sophistication, which sometimes necessitates the use of capital markets for their corporate clients. In Lebanon, foreign banks usually operate with a handicap with regard to deposit gathering, as their approach toward retail customers is less appreciated by the Lebanese public than is the case with Lebanese banks. A reliance on capital markets is therefore crucial in foreign banks developing activities in local markets.
Relationships
Further issues arise with local partners, whose presence is very beneficial during the initial years when the foreign bank needs to make itself known to local clients. But if and when the market and economy grow and develop significantly, requiring the local partner of the foreign bank to be up to the task financially in terms of capital injection, then the relationship can run into trouble. For a while, a local partner – whether an individual or an institution – might be able to inject sizeable capital, but today’s banks, particularly those in a high risk environment such as Lebanon, need to be capitalized to the tune of sums in the high eight and nine figures. In Lebanon, with the exception of a handful of billionaires, few bank partners can do this.
The absence of sophisticated banking regulations and the Lebanese government’s monetary policy are also a problem for foreign banks, who unlike local banks, can engage in activities that are useful when hedging against volatilities and risks in the local market – such as securitization and derivative products like swaps, options and futures. The central bank, quite rightly, forbids resident banks from engaging in such activities but foreign banks would be handicapped and hampered in their efforts to carry out what they believe are standard banking and asset/liabilities practices.
The government’s post-war policy of using the local banking system as the major funding tool for the state or as the reservoir of Treasury Bills and other government debt securities, was the final straw for foreign banks aiming at funding the Lebanese economy and not the state. They were (and still are) unwilling to play the game, mainly because of their own internal policies and guidelines that forbid a direct exposure to B– rated debt securities. The upshot is that they have been left handicapped in terms of profitability compared to their local competitors and have significantly limited their treasury capabilities.
Some positives
There are opportunities in the wake of the foreign exodus. It has in theory opened the way for local banks to develop their own capabilities as well as tailor-finance tools that fit the domestic environment, such as lending to corporate departments – still underdeveloped in Lebanese banking – and bespoke retail products. However, it is hoped that local banks and the national regulator would also sit up and take notice and work to make the Lebanese financial system more attractive and efficient. It is also hoped that local officials will recognize that the country’s risk is too high to attract foreign and Western investors, and that they need to take action sooner than later.
The downside is that local banks are no longer exposed to international standards, which increases the chances of them getting deeply ingrained in old habits. There would also be fewer opportunities for local companies and individuals to benefit from more sophisticated financial engineering and more diversified banking products such as those provided by international banks. But the most important and immediate negative consequence is that of image. The departure of such blue-chip names looks bad and will not help Lebanon’s quest to attract Western investors.
The politics of it all
The issue of bringing back foreign investors rests entirely in the hands of the Lebanese government, which has to resume economic reforms, eradicate bureaucracy, and provide incentives for foreign investors (mainly on the fiscal side). The government could also attract Lebanese expatriate bankers by providing them with a direct tax incentive, in a similar vein to what other emerging market countries have been doing for the last decade. It is also crucial to provide foreign investors with comfort as regards to the political environment, and develop a wise and stable political and social policy. One can only hope that the current decision makers realize what is happening and mobilize to rectify the situation.
