The merger of Banque Audi and Banque Saradar was the best thing to happen to the Lebanese banking sector for many years and the biggest merger/acquisition since the Byblos-Banque Beyrouth pour le Commerce and Bank of Beirut-Beirut Riyad Bank deals in 1995 and 2001, respectively. Although the banking sector has been consolidating for the last ten years, albeit at a slow pace, this consolidation has mainly been characterized by acquisitions of weak smaller banks by larger institutions.
The Audi-Saradar merger, on the other hand, has produced the first really institutionalized banking group in Lebanon with very little control by one single family and the widespread dilution of responsibilities and decisions among a complementary and relatively efficient management team. With such an institutionalization of ownership, the Audi-Saradar venture is likely to have positive developments on the overall competitive environment in Lebanon. It is also expected to influence other banking groups to improve corporate governance, as well as underwriting skills and risk management. Not only will the capitalization of the new venture be improved as a result of the combination of the two equity bases, but other banks are also likely to feel the peer pressure and step up their efforts to increase shareholders’ equity as well. There will also be improved banking products available to customers, reduced related party exposure as a result of family ownership dilution, increased financial flexibility and importance vis-à-vis the regulator and enhanced shareholder value. All of which will enable the new bank to meet Basel II requirements more easily and eventually offer greater support to the Lebanese domestic economy.
But it is what it may do for the cause of corporate governance that is most interesting. Lebanese banks desperately need to move away from family ownership towards a wider distribution of share ownership among passive and strategic investors or shareholders. Although some banks (such as Audi-Saradar and Bank of Beirut) have already followed the institutionalization path, a large number still remains in the hands of families and family ownership throughout the world has proved to have flaws. These include the lack of adequate resources to assist a bank in times of need and the unwillingness to dilute ownership to support growth. When families are present in management, there is the risk of credit and personnel decisions not being based on merit. Business decisions are often made purely for political or social reasons rather than economic ones, whilst the risk of connected lending is high and affects the image and creditworthiness of the bank (many Lebanese banks still claim though that they prefer to lend to companies they control, since they know them better).
To be fair to some family-owned banks, many family shareholders have already demonstrated their financial support to the business by taking minimal dividends (this was a Central Bank rule during the war years) or increasing the bank’s capital. Many families have also opted for a sale or a merger when they realized that they did not have the means to inject further capital and that they were better off joining hands with larger, better-equipped banks (such as the acquisition of Crédit Commercial du Moyen Orient by Banque Audi in 1996).
Family ownership in the Arab world has a different meaning than in other regions such as Europe or North America. Arab individual owners are often very wealthy in their own right and are more than able to support their business interests. Indeed, in Lebanon, the Central Bank considers family ownership to be a positive factor as it guarantees the conservatism of each individual bank and the heavy involvement of families in the daily management of the local banks has been a major factor behind the survival of most banks during the civil war period.
But this policy has its limitations. It can give rise to serious corporate governance and succession issues, and many banks, particularly smaller ones (below the top fifteen) are still run by forceful managers/shareholders (often carrying the two contradictory and conflicting titles of general manager AND chairman), who constrain or hinder the future development of their banks and add considerable stress on the already fragile and often weak financial structure.
It would be worth noting that many larger banks (as demonstrated by the recent Audi-Saradar venture) have been busy addressing corporate governance issues by taking significant steps towards institutionalization of management decision-making. The larger banks have been proactive in this area, as reflected by the setting up at various institutions of committees and executive management teams responsible for operational and financial (but rarely for strategic) decisions on a daily basis. The Central Bank, through its Banking Control Commission (BCC) has also been busy guiding the banks in their efforts to dilute the influence of particular senior managers or shareholders influence in managing the bank.
Today, the viability of many banks in Lebanon is in doubt. Those banks that still swim against the tide of consolidation typically have a very narrow franchise base, lack the necessary technological sophistication and operational capabilities that would lead to growth and long-term profitability. Most of these banks are vulnerable to the volatile external environment and would not be able to defend their franchises in the long-run. The forthcoming Basel II regulations, which are due to be forced upon banks all over the world, will put the final nail in the coffin, as they require a significant upgrade of risk management capabilities and a change of banking culture along Western European and North American ones, which are focused on credit and other risks.
While the Audi-Saradar merger will hopefully accelerate the pace of the consolidation process within Lebanon’s banking sector, the recent decreases in interest rates on government debt securities and the squeezing of margins should also change the thinking of many bankers, as they realize that organic growth is now increasingly difficult to achieve. The changing interest rate environment is likely to push all banks to become real lending banks, more focused on risk management, greater corporate governance, and on developing a strong credit culture within each institution. Greater consolidation of the banking sector in Lebanon would result in a more efficient banking system that is less vulnerable to shocks in the economy.
A sound and dynamic banking system is key to the future prosperity of the Lebanese economy. In order to achieve this higher level of creditworthiness, Lebanese bankers need to strike a balance between risk taking – financing economic growth – and prudent investment of national savings (deposits). Success in the key areas of risk and capital management, cost control and product diversification and distribution, will distinguish the healthy and profitable banks from the rest. However, given the current skepticism among some bankers, the sector may sadly still need a certain number of high profile collapses or failures to highlight to the rest of the sector the importance of robust risk management and rigorous corporate governance. Banque Audi and Banque Saradar have spectacularly shown the way to the banking sector. Emulation should now follow, while the wait for peer failures should not be an option for most banks.
Nicolas Photiades is an independent financial adviser on financing, capital optimization, and strategy.