In July, I authored a report for FFA Private Bank titled “The Lebanese banking sector 2008,” which examined the Lebanese banks’ fundamentals, performance, financial strength and the challenges the sector faces going forward.
The report pinpoints that the Lebanese banking sector has steadily grown over the years relative to the size of the domestic economy, having amassed assets in excess of 327 percent of Lebanon’s gross domestic product amidst ongoing deposit inflows. The increase was driven by several comparative advantages, including a banking secrecy law, a skilled workforce, a relatively stable currency and high yields on local and foreign currency compared to peer countries. The strict regulatory framework and conservative policies set by the central bank that shielded Lebanese banks from exposure to toxic assets and structured products also helped considerably.
Over the past decade, the Lebanese banking landscape has changed significantly, moving from a highly competitive and fragmented environment to an asset consolidation environment. The period also witnessed the expansion of Lebanese banks on the regional scene.
Banks’ balance sheets suggest that Lebanese banks are “deposit-rich banks,” as they are funded mainly through customer deposits, which accounted for about 83 percent of total liabilities and shareholders’ equity during 2008. But the asset allocation also reflects the large exposure to sovereign debt, with more than 50 percent of the assets made up of government and central bank paper, mirroring the fact that the Lebanese banking sector is acting as the backbone of the economy, providing funding for its sovereign debt by accumulating customer deposits.
The report noted that the Lebanese banking sector has demonstrated remarkable growth over the years despite the persistent political instability and the global financial crisis that surged in 2008, proving its resilience to external turmoil. Initially, customer deposits were bolstered by the inflow of wealth following the civil war and by the ample petrodollar liquidity in the region that flowed into the sector in the aftermath of the September 11, 2001 events in the United States.
More recently, deposit growth was triggered by the Lebanese banking sector emerging as a safe haven for depositors in light of the prudent policies set by the central bank and the attractive interest rates on deposits compared to regional peers. In 2008, the sector added $10.5 billion in deposits, implying a 15.6 percent year-on-year growth rate. The dollarization rate dropped from 77.3 percent in December 2007 to 69.6 percent in December 2008, highlighting the renewed confidence in the Lebanese currency and the economy as a whole. Supported by solid economic activity and steadied by a stable political situation, loans growth recovered in the last two years and lending grew at a compound annual growth rate of 17.3 percent between fiscal year 2007 and fiscal year 2008, compared to a rate of 0.63 percent between 2000 and 2006.
The Lebanese banking sector has reported regular growth in profits across a seven-year track. In recent years, profitability was favored by an increasing contribution of regional entities to the sector’s income, a recovery in lending activity and improving cost-to-income ratio. As a result of a further diversification of the Lebanese banks’ business lines, non-interest income has witnessed significant growth in the past few years, but remains underdeveloped relative to the net interest income, which accounts for 69 percent of the sector’s total income.
Thus, the performance of Lebanese banks is closely linked to the interest spread between the cost of funding and yields on uses of funds. Prospects for sustained profitability will depend on the maintenance of growth in earnings within the context of international interest rate contraction. The banking sector will also need to attract additional deposits from operations abroad as regional economies slow.
But the FFA report also states that the Lebanese banking sector is growing without any detriment to its financial position and asset quality. Banks’ asset quality improved during the political and security difficulties of the last few years; loan portfolios also showed strong growth. The Lebanese banks also enjoy very high liquidity levels, while banks around the globe suffered from the severe liquidity crisis. But most importantly, Lebanese commercial banks are solidly capitalized, as witnessed by their capital adequacy ratio standing at 11.23 percent, significantly above the 8 percent required by the Basel II committee.
The immediate risks facing the Lebanese banking sector remain limited given its ability to counterbalance the adverse effect of the global financial crisis. The positive factors include ongoing deposit inflows, increasing oil prices and the political and security improvements following the parliamentary elections in June.
But the FFA report notes that Lebanese banks are faced with two key risks. First, their high exposure to the sovereign debt in light of the fragile political environment. The second risk is the highly uncertain political and security environment in which they operate. According to the report, the immunity of the Lebanese banking sector is correlated to the consolidation of the recent domestic achievements; they include the economic growth recovery and the decline in government debt ratios.
Marwan Salem is head of research & advisory at FFA Private Bank
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