When implemented sometime during 2008, the Basel II Capital Accord will demonstrate that the entire Lebanese banking sector will be in need of extra capital to cover up the underlying risk of their assets. Most banks are expected to see a drop in their capital adequacy ratio (equity divided by risk weighted assets) from an average of 21% for the sector to a level below 6%-5% (for some banks even more). Lebanese banks’ capital adequacy ratio will then be below the minimum regulatory capital ratio of 12% as established by the Banking Control Commission (BCC) a few years ago. In other words, the entire Lebanese banking system will need a whopping $5.7 billion (current equity is $4.3 billion) of extra capital in order to reach the minimum regulatory capital adequacy ratio of 12%, or $2.6 billion if the BIS CAR is to reach 8%.
This sudden drop in capital adequacy will make local banks realize, not only that they need to increase capital significantly but also that they need to assess risk in more details and more professionally, and that they will need to obtain capital funding flexibility. Under Basel II regulations, capital is expected to fluctuate constantly at first, as banks try to find optimization of their assets in terms of credit risk and risk weightings. This capital fluctuation would crucially require an equity funding flexibility that can only be obtained through a listing on a recognized stock exchange, which also enjoys strong liquidity in a developing secondary market.
A listing, which would be an initial public offering (IPO) for most banks (only a few are already listed) would also force transparency and a certain operational and market discipline for all new entrants. Any CEO of a bank facing a capital shortage as a result of Basel II should not only seek to increase capital in order to meet regulatory requirements. He or she must be asking him or herself whether they have the right stuff to go through an IPO. Taking a company or a bank public is a grueling affair, even in Lebanon, especially that the CEO will have to manage the process in tandem with day-to-day work, which is already hard enough. The senior management team may need strengthening, replacing or overhauled. Products and revenues will have to be diversified to create long-term, healthy and recurrent profitability. Investors would never look at a Lebanese bank IPO if all these criteria are not met.
Sooner rather than later
Even if internal and operational issues are covered, banks must be able to time their IPOs correctly. They must start increasing their capital today or at least enquire about conditions for a listing with the BSE. Increasing the capital through an emerging market bourse takes double the time it normally takes in a developed market. The idea of gradually increasing capital after thoroughly preparing the IPO, starting from today should be taken seriously and constitute a major strategic challenge.
However, if all banks carry out their IPOs at the same time, especially if it is soon after Basel II regulations are implemented, then there will be a few winners and a lot of losers. The Lebanese and regional market has no room for 40 Lebanese banking IPOs at the same time and the BSE will certainly not be able to cope with such a bottle neck. In general, most IPOs worldwide are carried out earlier rather than later. In Lebanon, banks could set a first by trying to list too late, a result of sheer desperation in the face of a forceful set of international capital adequacy regulations.
Banks should not only think about increasing their own capital. They should also be advising their corporate customers to get themselves more equity funding flexibility, particularly those corporates which have established successful franchises. By increasing their capital through the local equity capital markets, Lebanese corporates would enhance their credit strength and debt capacity significantly, as they would become more transparent, be forced to follow a strict market discipline that normally accompanies a listing, and be able to finance their development with capital rather than debt. The end result would mean a much better risk weighting of their credit exposure with their bankers, and consequently less capital for the latter.
Basel II is regarded as a constraining evil by bankers worldwide. For Lebanon, it could be the trigger for a healthier economy and exponentially greater competitiveness. From 2008 onwards, no Lebanese bank should have the right to look back. As Brutus says in Julius Caesar, “There is a tide in the affairs of men, which taken at the flood, leads on to fortune. Omitted, all the voyage of their life is bound in shallows and in miseries. On such a full sea are we now afloat. And we must take the current when it serves, or lose our ventures.” Enough said.