There is no doubt that the recent violence between Israel and Lebanon has dented the Lebanese economy to the tune of roughly $4 billion and counting. And even though it is likely that funds for repairs will be made available, the cost in terms of morale – the years repairing damaged homes, factories, roads and bridges – will also be considerable.
The banking sector had counted on a bumper tourist season. However, it is now expected that the country’s GDP, which experienced solid growth of around 6% by the end of June, will probably experience negative growth, or stagnation at best.
Like other sectors, Lebanese banks have been directly hit by the crisis. Not only have they lost potentially significant business as a result of a spoiled summer season – the sector had wanted to use the summer to add deposits, increase the number of expatriate and foreign customers, and increase non-interest revenues – but they are now witnessing the effect of a deteriorating political and economic situation on economic capital.
Many banks, including the larger ones, were heavily exposed to small and larger businesses which were annihilated during the early days of the fighting, while other banks are starting to provision against non-performing housing loans, initially granted to individuals whose homes have been flattened in previous fighting. Such factors are likely to push risk weightings upwards, and increase the need for additional capital, at a time when capital is almost impossible to find. Forced provisioning against unexpected non-performing loans are also likely to affect a rising profitability for the banking sector as a whole.
For those banks listed on the Beirut Stock Exchange and other exchanges across the world, such as Audi, Byblos, BLOM, Bank of Beirut, Bemo, and BLC, the loss in market capitalization has been estimated at around 15%-20%. Local and international investors are in a situation where the liquidation of their holdings, albeit at a loss, is the absolute priority, as it is difficult for them to draw up a vision of what the economic and political future of Lebanon will look like in the short or long-term.
Deposits are also fleeing the country, although at a lesser rate than during the period following the assassination of Rafik Hariri. The smaller banks are the worst hit, as they do not have foreign subsidiaries or branches to which they can divert their customers, while others – small and medium-sized banks – with no international presence are losing valuable deposits to other larger banks which do. Elsewhere, the larger banks that decided to expand geographically now realize that it is precisely situations like these that vindicated their decision to do so.
Then there is the dollar. The Banque du Liban (BDL) was quick to alleviate fears of a lack of liquidity by announcing that it had sufficient foreign currency reserves ($13 billion) to counter the panicky conversion of Lebanese pound deposits into US dollar deposits. In three weeks of hostilities, around $1 billion of these reserves are believed to have been spent. The recent announcement that Saudi Arabia had deposited $1 billion at the BDL came as a welcome relief and is regarded as a substantial morale boost, as it reflects the level of support Lebanon continues to enjoy from friendly Gulf nations.
The hostilities have come as a painful reminder to banks that an economy cannot prosper and profits cannot be sustained when the political environment is unstable. For some banks, particularly the larger ones, a policy of geographical diversification has been on the cards for a while now, as their management and shareholders rightfully concluded that the Lebanese operating environment was not particularly conducive to efficient business.
So far, the banks’ profitability has come mainly from interest income, which itself is more than 50% accounted for by interest received from government debt securities. Non-interest income, such as fees, commissions, selling savings and investment products, foreign exchange and money market dealing, still make up less than 20% of total operating income, whether you are looking at a large or small bank. The banks lack significant diversity in their revenues, given that they operate in a constrained and difficult environment. The recent military crisis is unlikely to encourage or allow the further diversification of revenues and may, on the contrary, push Lebanese banks to expand geographically in order to move away from Lebanese risk, which could be expected to worsen at the end of the hostilities. Some of the larger Lebanese banks have already started their geographical expansion into countries in the Arab region, which offer significant long-term potential and where sophisticated and efficient banking regulations are still at an under-developed stage. These countries include Sudan, Algeria, Iraqi Kurdistan and Syria.
Geographical expansion is probably the most efficient way for Lebanese banks to diversify revenues and build up a recurrent income stream. By developing foreign franchises and focusing on activities that are the most in demand inside these foreign markets, Lebanese banks would assure their profitability for years to come, as well as hope to outgrow the Lebanese domestic market revenue base, which should have reached its peak by now. An efficient geographical expansion would also diversify risk and reduce the burden on regulatory and economic capital.
Although some Lebanese banks are concentrating on developing their activities in under-developed countries such as Algeria, Sudan and Syria, others are following a more conservative and cautious route. Indeed, this latter group of banks is focusing instead on fast-developing and developed markets such as those of the Gulf (Saudi Arabia, the UAE, and Qatar), due to these markets’ less risky nature, greater political stability and more diversified economies. This approach could be regarded as wiser, since revenues and assets emanating from more stable markets are likely to have a much lesser constraint on capital. In fact, many Lebanese banks are keen to emulate the Arab Bank model, where more than 80% of assets and revenues are derived from developed markets such as the UK, France and Switzerland. Arab Bank is one of the rare banks in the world to be rated above the investment grade level and well above the sovereign ceiling of Jordan, whilst it remains the largest bank in Jordan and the most significant stock on the Amman Stock Exchange.
With Basel II looming and the political situation worsening, Lebanese banks are aware that they need to diversify their assets and revenues away from the Lebanon risk and the low sovereign rating (B- until further notice) of the country, which constrains all borrowers and issuers in the same country to the same rating. A geographical and product diversification of banking revenues is the only way to build a stable and constant income base, which in turn would help capital increase internally, without having recourse to frequent capital raising. However, Lebanese banks’ shareholders must realize that to become another Arab Bank, there must be a firm commitment to recruit and adequately compensate qualified and experienced personnel, as well as develop detailed and realistic strategies that would be implemented by a management force with the right rack record and approach. The corporate governance issue would also have to be tackled seriously.
With the future of the Lebanese economy remaining extremely uncertain at this stage of the political-military crisis with Israel, Syria, Hezbollah and vis a vis the rest of the geopolitical context of the Middle East, Lebanese banks must start applying plan B. A contingency plan which consists principally of diversifying products and activities away from Lebanon could become a blessing in disguise and the trigger for the process of internationalization of Lebanese banks to finally take place.