A real future for Beirut’s financial center potential

Arab banks believe that Lebanon offers a potential (particularly human) which is worth developing and trusting

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During the 1960s and 1970s, Beirut was globally acknowledged as the banking center of the Middle East. Lebanese banks flourished and built up strong franchises by picking up petro-dollar deposits from Gulf investors – particularly after the 1973 oil crisis. Foreign banks increasingly chose Beirut as a regional hub.

Beirut, with its cosmopolitan outlook, was considered a democracy with significant potential; it was located only a few hours’ flight from Europe and had embraced European and Western culture. The city was politically neutral in a turbulent region, had a growing economy based on trade and intermediation with Gulf countries, and had sophisticated (for the time) banking regulations and one of the few banking secrecy regimes in a world in which any country (apart from the US) was in danger of falling into communism, extreme socialism and state economic control.

The days of Lebanese excellence

Lebanon was also very well equipped in terms of telecommunications and infrastructure, having both an airport and a sea port that were included in the list of the world’s main transport hubs. These were the days of Lebanese excellence, when MEA was “airline of the year,” TMA was “cargo airline of the year” and Georgina Rizk was Miss Universe. Singapore publicly stated that it hoped to become Asia’s Lebanon by the end of the 1970s.

MEA is no longer airline of the year (but is heading in the right direction), TMA is bankrupt, the economy is burdened with the highest debt-to-GDP ratio in the world, a third of the educated population has long since departed for greener pastures, and democracy has never looked more fragile. Infrastructure has been “updated” at great cost but is still inefficient. Our current Miss Lebanons never seem to progress beyond the first round of the Miss Universe pageant.

Major Western banks which had been present in Lebanon for decades have left the country, finding it too risky and too small a market. These include ABN Amro and ING Barings, which both sold out to Byblos Bank, Crédit Lyonnais, which sold to CreditBank, and Crédit Agricole, which sold its 51% stake in Banque Libano-Francaise to local and regional investors.

In 2006, there are five major Western banks still present in Lebanon: HSBC, BNPI (or BNP-Paribas), Société Générale, Citibank and Standard Chartered. Other western banks such as Banca di Roma have representative offices. Among the surviving Western banks, Société Générale has already reduced its stake in its Lebanese subsidiary.

Too much risk for too little return

Lebanon has a low credit rating (B- by Standard & Poor’s), which implies that foreign banks have to capitalize their Lebanese outfit heavily in order to cover the significant risk it carries on its balance sheet. Given the low return from lending to the Lebanese private sector and the high level of doubtful loans in proportion to the outstanding loan portfolio, Western banks have long decided to reallocate the high level of capital they used to invest in Lebanon to other less risky, more diversified and higher-yielding economies. Since the Basel II regulations, which require banks to allocate capital commensurately with the risk they carry on their balance sheet, have to be implemented in Western Europe and the US by January 2007, it is understandable that Western banks with large operations in Lebanon are leaving. For them, staying in Lebanon would be too expensive in terms of capitalization and make little economic sense, especially as most Western banks are feeling increasingly out of touch with the economic and business culture of Lebanon and the Middle East.

This difference in culture has created a gap in the Lebanese domestic market which is gradually being filled by Arab and Gulf banks. The latter are showing an increased interest in Lebanon, particularly since 9/11 and the rise in oil prices. With much greater wealth at their disposal, Gulf investors and banks have been concentrating on markets closer to home, where the general and business culture is similar to their own. Moreover, Lebanese risk is well understood by Arab investors and bankers, who have more trust in the Lebanese economy for its solid track record in meeting obligations. Although Arab banks are putting more weight on fundamentals in their investment decisions, they continue to believe that Lebanon offers a potential (particularly human) worth developing and trusting.

While Western banks take a pragmatic view of the markets they believe they should get into, and rely on fundamental analyses to make their final decisions, Arab banks rely more on trust and track record, as well as on the belief that their natural markets should be the neighboring non-oil Arab countries. What Lebanon is experiencing at the current moment is not dissimilar to what happened in the last decade between Western and Eastern Europe. German, Swiss and Austrian banks thought that central Europe was a natural market for them given cultural affinities and geographical proximity. Likewise, Greek banks considered the Balkans (Bulgaria, Macedonia, Albania and Romania) to be their natural back garden, with the Greek banks purchasing many newly privatized state-owned banks.

In the last six years, Lebanon has consistently been the non-oil-producing Arab country to attract the highest level of Gulf investment. Apart from cultural affinities, the reasons for Lebanon’s attractiveness include a well-regulated banking system, a solid track record for banks and for central bank support to banks in difficulties, and an educated, multi-cultural and experienced workforce. Lebanon is one of the few countries in the Arab region with highly educated youth as well as professionals with long experience working in Western banking and financial centers such as London, New York, Paris, and Geneva. The fact that a significant number of Lebanese bankers contributed to the development of the Gulf banking sectors a few decades ago has contributed to the credibility of the Lebanese banking sector and its workforce.

Attracting Gulf Arab investment

The purchase of Lebanese banks by Gulf banks cannot be considered a recent trend. Gulf banks have been keen on the Lebanese market and its banking system since the early 1990s, particularly since Rafik Hariri became prime minister towards the end of 1992. The emergence of a dual Saudi-Lebanese national as the head of a government that had developed a major reconstruction program could not have been a better trigger for Gulf investments in Lebanon. It began with Gulf banks subscribing to Lebanese Treasury bills, followed by the opening of branches or subsidiaries of some Gulf banks, such as the National Bank of Kuwait, and culminated in the purchase of Crédit Libanais by the bin Mahfouz family (who owned National Commercial Bank in Saudi Arabia and part of Jordan’s second largest bank, the Housing Bank), and of Banque Libanaise pour le Commerce (BLC Bank) by the Qatar Central Bank.

The latter is the most significant both in terms of size and operational importance. The purchaser is not a private banking institution but a central bank, which clearly has plans to develop its acquisition into a major investment vehicle and a banking product development and processing center. By purchasing a local bank, Gulf investors can shift part of their rising wealth into Lebanon more efficiently and hope to attract a greater number of qualified employees to work on banking product development and the processing and settlement of transactions carried out in the Gulf.

Buying banks in Lebanon is an attractive proposition for many Gulf banks. Not only do they expand regionally and strengthen their control in a neighboring and easy-to-access market, they also benefit from the Lebanese workforce, which has a solid track record in the management of offshore banking. Lebanese bank professionals, of whom plenty are still around (or have taught their successors the job), have already carried out processing, back-office and settlement work, as well as classical banking activities on behalf of Western banks. The switch from Western to Gulf banks is a natural one, and the development of Gulf banking and finance should have led the Lebanese to expect this change sooner or later.

Gulf banks can easily afford to take on the risk of having subsidiaries in Lebanon. The rising wealth of Gulf investors due to the rise in oil prices and the transfer of billions of dollars of funds back from places like the US have led Gulf banks to realize that investments in risky and undercapitalized countries like Lebanon can have a beneficial effect and ultimately reduce risk. By investing in one of the most educated and professional banking workforces in the region, to handle the processing of, say, retail products such as credit cards, Gulf banks cannot go wrong.

Opportunities in wealth management

Apart from the processing of retail banking products and back-office activity (in a similar vein to India), Gulf banks are pinpointing Lebanon and Beirut as a future center for wealth and fund management. Lebanese fund managers enjoy a good worldwide reputation and have a strong track record in advising high net worth Gulf individuals. Over time, Lebanese wealth management advisors have grown significantly in numbers and sophistication and have become more demanding in terms of where they will live. They are keen to live in Beirut, where they are closer to their families, where the weather is kinder and the culture is familiar. Through a subsidiary in Beirut, a Gulf bank would be able to benefit more efficiently from the expertise of Lebanese wealth managers, while combining business with pleasure.

The tourism potential of Lebanon is also linked to the interest of Gulf banks in Beirut. Gulf banks would be able to develop tourism-linked projects for their own holiday-makers and benefit from a strong Lebanese project-financing expertise as compared to regional standards. Lebanon’s banks have always suffered from being too many and too sophisticated for their own marketplace. The arrival of Gulf banks should be seen as a factor adding significant dynamism to the local economy.