Tough sell

Wary Lebanese banks are shying away from corporate lending in an increasingly unstable corporate environment

Recent data suggests that commercial banks and financial institutions in Lebanon are increasingly shying away from corporate lending. In fact, most major banks remain wary of the Lebanese corporate environment, as they still attempt to mend their existing portfolios of corporate debt, to the extent of actually reducing the size of their portfolio of commercial loans. BLOM Bank, Banque Audi, and Banque Saradar saw their portfolios of commercial loans shrink anywhere between 1% and 8% over the past year. Typically, and perhaps oddly, the bulk of non-performing loans held by most banks fall into the corporate lending category, as opposed to retail lending to consumers. Corporate banking – including corporate loans and financial assistance – thrived in the mid 1990s as the economy was perceived to accelerate its post-war recovery with a GDP growth of 8.8% per year. Banks were typically more eager to help finance business ventures in Lebanon, coupled with equity capital being contributed by domestic and regional investors alike. New companies were being established, consumption was high, real estate prices were soaring, and the overall outlook for the economy was rosy, to say the least.

In 1996, as banks continuously enlarged their portfolios of corporate debt – typically of a long-term nature – things rapidly took a turn for the worse. Economic growth slipped into reverse, consumer confidence, and consequently consumption, toppled. As businesses saw their margins squeezed by high interest rates on their financing and lower revenues, bankruptcies thrived, creating a substantial burden to anyone and everyone with any kind of exposure to the Lebanese corporate environment. Despite the promising signs of an economic recovery observed over the past few months, and the increased consumer and investor confidence pursuant to Paris II, Lebanese banks are not likely to expose themselves to additional corporate debt until they improve the status of their existing portfolio to a point where they can take on additional exposure, a task typically of a high risk nature considering the unpredictability of the Lebanese economic and business environments.

While no bank has categorically ruled out any form of lending, credit assessment is stringent at most institutions, and conditions for acceptance are as such because only large, well-established businesses are eligible to apply. Many Alpha group banks are extending corporate loans, albeit on a very conservative basis, requiring substantial due diligence and a number of guarantees.

Smaller banks, on the other hand, seem perhaps more eager to venture into corporate lending. Typically, smaller banks have less balance sheet exposure to corporate loans from their past activities. This, coupled with an increasingly competitive environment in retail lending, has prompted a number of medium sized banks to draft strategies that would focus on business loans. As such, conditions are less stringent, interest rates are more flexible, and leniency is more commonplace.

However, the major factors behind the reluctance of banks to finance businesses in Lebanon are being exacerbated by their own policies on the matter. Small and medium sized enterprises have always been the backbone of the Lebanese economy. In fact, SMEs represent around 95% of total industrial enterprises, and employ up to 65% of the total industry labor force. Moreover, SMEs contribute over 40% of the country’s industrial output. Unfortunately however, most SMEs are foregoing profitable business opportunities and are operating below full potential. Production is being limited by the overall reluctance of major banks to provide fairly priced financing facilities to expand production.

While the Lebanese government is attempting to nurture this appetite for small enterprises through subsidies, it does not do so for all sectors, as many promising entrepreneurs are facing difficulty in obtaining debt financing for their projects.

A significant level of risk is typically inherent of small businesses, whose operations are of a typically high volatility. Such a factor is deterring banks from extending to them the much-needed facilities, to the benefit of large and well-established institutions. Such an attitude is somewhat detrimental to the overall growth of businesses in Lebanon, since large institutions typically make use of credit facilities to maintain their operations; whereas small businesses make use of funds made available to them to open up to new markets, increase their product lines, and focus on promotion and advertising.

It should be noted, however, that banks are not the only ones shying away from corporate lending. While Lebanese banks are typically reluctant to offer financing services to local companies, such companies themselves often find it detrimental to make use of such services if and when they are provided. In fact, the cost of debt on corporate loans is so high that it significantly eats into profit margins and forces companies to forego promising investment opportunities. According to Central Bank statistics, interest rates typically charged by Lebanese banks do not fall below 10% p.a. on average, a drastically excessive figure given the typical returns on investments in the country.

A high cost of equity resulting from the geo-political and economic risks associated with the country, coupled with a high cost of debt, are severely undermining appetite for investments in Lebanon. Sought after investments should currently achieve returns in excess of 15% in order to marginally exceed their cost of capital. The issue has been raised numerous times recently, namely in the industrial sector. A number of Lebanese industrialists are reducing output, moving production to other countries, or outright shutting down their operations due to – among other reasons – the high cost of financing their working capital.

It appears then that would-be entrepreneurs should shift their focus towards a perhaps more expensive source of financing: equity capital. Equity capital for new innovative businesses often comes in the form of venture capital, especially in the West. A solid equity base would provide a newly established company with a solid base to launch and expand its operations. Moreover, the ability of a company to attract regional strategic partners would assist in expanding across borders, a critical factor given the limited size of the domestic market in Lebanon.

In addition, a well-capitalized company offers an added incentive to banks to provide debt financing, as the perceived risk to the banking institutions is reduced by the availability of a solid capital base.

It appears then as though the Lebanese business environment suffers from a basic flaw, which severely reduces its ability to promote investments and attract foreign investment capital. Bank’s preferences towards government bonds instead of loans severely limits the sector’s ability to play its basic role of channeling funds from depositors into investments. Several steps should be undertaken, and promptly so, to remedy the situation. It surely does not suffice to attract Arab funds into Lebanese banks if their primary use is lending to the government, and consequently crowding out the private sector. In fact, the government itself should promote corporate lending by reducing interest rates to spur investments, offering subsidies, and encouraging banks to open up their vaults.