The banking sector in an economy is an important determinant of economic growth. It raises funds from those who have an “excess” of capital and lends them to those with a shortage. In this process of transferring funds, banks collect information, evaluate alternative investment projects, and monitor borrowers to ensure that loaned funds are efficiently utilized. Generally, the more effective the function of screening and monitoring, the more productive the financed investment and the higher the economic growth rate in the economy. It is through this role that economists find a statistically significant link between commercial banks’ allocation of credit to private firms and real per capita GDP growth.
In the post-war period, Lebanese banks have made major improvements. Their ability to mobilize savings went up; that is, the deposit-to-GDP ratio is 170%, exceeding that of developed countries, whose ratio ranges between 70% and 130%. Additionally, the banks’ total assets are around 200% of GDP, while profitability in terms of net return on average equity is 28% in 1997. Nevertheless, the growth rate in the economy has been declining. So the question remains: Why, despite the rosy numbers, has the banking sector failed to reverse the economic decline? There are four reasons.
First, while enjoying high returns and low risk on government treasury bills, the banking sector initially found little incentive to develop its credit assessment technology, which would allow banks to identify, assess, and finance projects. Its lending to the private sector has been confined to areas where credit can be easily assessed and monitored. It should come as no surprise, then, that trade, services, and construction absorb two-thirds of the banking sector’s credit. The majority of the loans are short-term, which allows the banks to closely monitor their performance.
Lending on such a basis can be detrimental to the economy since it may discriminate against sectors that require closer credit assessment and monitoring on one hand and medium- and long-term credit on the other hand. The most obvious victim is the agricultural sector, whose contribution to GDP was 12.4% in 1995 and yet whose share of credit was a dismal 1.6% in 1997.
The second major problem is a lack of reliable information on borrowers. The majority of private sector firms in Lebanon fail to publish accurate balance sheets. To avoid such risks, banks have concentrated lending to known, trustworthy clients, who are generally large borrowers. Credit in Lebanon is concentrated in the hands of very few people: 81% of the total credit goes to 9% of borrowers. In other words, roughly 4,500 people absorb four-fifths of credit. These are the well-known clients of the banks with large assets and/or who have been doing business with banks for many years.
Another consequence of the paucity of information is simply a lack of lending. Although the Central Bank of Lebanon allows banks to lend up to 70% of their foreign currency deposits, many of the large banks have lent much less than that. In fact, the average for the top 17 banks in Lebanon is 52%. A rough calculation shows that in 1997, an additional $3 billion could have been lent to the private sector. Such low lending and high liquidity are damaging to the banks’ profitability. And they deprive unknown and particularly small firms, generally the source of employment opportunities, of access to capital.
A third problem is collateral. A study shows that countries with a legal environment emphasizing creditor rights and enforcing contracts have better-developed banks and higher per capita growth. The absence of these two ingredients may discourage lending by banks in the first place. In Lebanon, although creditor rights are ensured, collection and enforcement are more problematic. Banks consider court procedures too complex, time-consuming, and uncertain.
According to a survey conducted by the Lebanese Center for Policy Studies, over 45% of banks consider the unpredictability of the judicial system a major problem for business. This is in contrast to a lower level of dissatisfaction expressed by other sectors. Banks also seem to want to avoid going to court as much as possible; it was cited as the last option for solving a dispute. They are discouraged from using the formal appeal process since it is considered to be time-consuming by fully 90%. Furthermore, the high formal and informal costs of property and mortgage registration unnecessarily increase the cost of borrowing for entrepreneurs.
The final problem is that despite the fact that banks have mobilized savings, the average maturity of deposits is too short, around 45 days. This has negative repercussions on the banks’ ability to lend to firms on a medium- and long-term basis.
One of the things that could be done to get the economy out of the recession is to work on building a stronger link between the banking sector on one hand and the productive sectors on the other hand. The objective of this is straightforward: get the money stacked in the banks’ coffers into the cash-strapped productive sectors. But for this to happen, the private sector must publish transparent and accurate balance sheets and income statements. The government could streamline bureaucratic procedures to facilitate collateral collection. In addition, it must prepare coherent strategies for the productive sectors to become competitive and hence profitable enough to pay back the loans. And finally, the banks should develop loan technology that can better assess and monitor loans to these sectors. Some have already begun doing this. At least it is a start.
