Robust economic growth in Lebanon came to a halt last year as domestic political uncertainty and regional turmoil took their toll on key sectors such as trade, tourism and real estate.
This year is not shaping up to look much different as challenges translate into weaker bank profitability: slower capital inflows will moderate asset funding, softer trade and loan activity will impact fee generation, and regional unrest will drive loan loss provisions in subsidiaries that were meant to be the engine for growth.
This subdued level of profitability for Lebanese banks could represent a ‘new normal’ in the near term. Management teams are prudently placing their expansion plans on hold in order to preserve balance-sheet quality in the face of slower economic activity, heightened political uncertainty and an increase in regulatory capital.
This new normal contrasts with previous years during which the banking sector nearly doubled its profits, from $850 million in 2006 to $1.6 billion in 2010. This was possible by sidestepping the global financial crisis, attracting significant financial inflows and stockpiling record reserves at Banque du Liban (BDL), Lebanon’s central bank, all of which boosted Lebanon’s reputation back to the forefront of regional financial centers.
However, slower profit growth could influence the lending behavior of commercial banks, as well as their participation in government debt auctions and their redeployment of capital aimed at maximizing shareholder returns. It is unlikely, though, that there will be a material shift away from the existing business model, which has worked well for years.
The public sector will continue to finance its fiscal deficits with more debt, outside of enacting much needed reforms. BDL will continue to influence deposit rates to ensure that Lebanon attracts financial inflows, and will seek to reduce its intervention at treasury auctions. And banks will continue to participate at government auctions, at the very least maintaining their concentrated sovereign exposure.
Ultimately, the banking sector needs an avenue in which to continuously invest its excess liquidity; with a near-zero international benchmark rate in the interbank market, moderate private-sector demand and regional turmoil seen impacting asset quality in related subsidiaries, they don’t have many options left on the table.
With several headwinds on the horizon, the case between the banking sector, the Ministry of Finance and BDL is likely to be strengthened further as each major party shares a responsibility to maintain a healthy economy and a resilient banking sector. We have seen a concerted effort earlier this year on shorter-term local currency treasuries, which were auctioned at higher rates to ensure bank subscription, following the International Monetary Fund’s recommendations, but these higher rates were not enough to make up for the reduction in profit growth.
With tighter bank regulations, slower banking deposits, higher provisions caused by regional unrest, and cautious management focused on preserving asset quality, profitability for the banking sector could remain lackluster for now.
Although investors may have over-penalized the banks, judging by their very weak stock market performance on account of turmoil in Syria and Egypt, they will need to contend with a lower growth profile and less appetizing dividend payouts once visibility improves and their growth plans are back on track.