In mid-September, Arab media reported that the Gulf Cooperation Council countries were in talks with the World Bank about raising their capital contributions. This was confirmed by Senior Vice President and World Bank Group General Counsel Anne-Marie Leroy, who said the talks were meant to secure additional capital and would therefore increase the voting rights of the GCC, and that an announcement to this effect would be made in October.

But no announcement came. The World Bank may be in dire financial straits, according to statements made at the October World Bank Group and the International Monetary Fund meetings in Istanbul, but there is disagreement between developing countries and the bank’s biggest donors as to how soon more capital is needed, and where it should come from.

Representatives from both France and Great Britain, two of the bank’s largest contributors, said that they believe lending increases can go forward without additional capital. But World Bank President Robert Zoellick and representatives from many developing nations sounded the opposite note, predicting that without expedited gains in capital, the World Bank would have difficulty maintaining its current lending by the middle of 2010.

“The distribution of quotas should reflect the weights of its members in the world economy, which have changed substantially in view of the strong growth in dynamic emerging markets and developing countries,” said the G-20 leaders in a joint concluding statement after their Pittsburgh meetings in September.

Accordingly, capital increases would have to come from middle-income countries and not the now dominant West. In fact, the G-20 countries recommended that funding for the World Bank should shift by a measure of three percent toward credit-worthy developing countries and away from developed ones.

As it stands, the GCC voting block holds 3.88 percent of the total votes in the International Bank for Reconstruction and Development (IBRD), the oldest and largest lending arm of the World Bank Group, which provides relatively low interest loans to developing countries. It is these countries that were the most vocal in their call for more donor-money at the Istanbul meetings and it is this fund, the IBRD, that World Bank officials say needs new capital, and quickly.

A question of motivation

Both expert opinion and rhetoric from October’s World Bank Group-IMF meetings may point to the reasons why the GCC’s role in the World Bank will remain fixed while others’ will increase. Ibrahim Saif, secretary general of the Jordanian Economic and Social Council and expert in political economy, believes that GCC capital in the bank is holding steady, in part, because the countries themselves are not interested in playing a larger role in the global political scene.

“They are quite happy to just work while it’s happening and not get engaged with the rest of the world,” he said. “The BRIC [Brazil, Russia, India and China] were quite aggressive. I think they were very clear that they really wanted to increase their shares.”

Saif said that no such desire came from the GCC and thus no increase was made.

In November 2008 British Prime Minister Gordon Brown saw a “lukewarm reception” when he visited the Gulf and suggested that the GCC contribute “hundreds of millions” to IMF bailouts, said Gulf Research Center Chairman Abdulaziz Sager in an analysis piece. He said that any humanitarian or geo-political aspirations that the GCC may have held evaporated with the credit crisis.

Total World Bank lending by region: fiscal 2009

Share of $46.9 billion total

Total World Bank lending by theme: fiscal 2009

Share of $46.9 billion total

Total World Bank lending by sector: fiscal 2009

Share of $46.9 billion total

Singular ambition

On this issue of international contributions however, the GCC is not completely in agreement as Saudi Arabia’s role in both the World Bank and the IMF far exceeds its Gulf neighbors. GCC capital in the IBRD totals approximately $7.5 billion, and $5.4 billion of this, or 72 percent, comes from Saudi Arabia.

“Saudi Arabia wanted to play a role but Saudi Arabia is like a single player,” said Saif. “The other GCC countries are small and they don’t see the benefit of having more stake in the World Bank. It seems that they are quite satisfied with their current role.”

Saudi Arabia has been negotiating a sizeable additional contribution to the IMF, rumored at $10 billion.

“If you look at the track record of Saudi since the 70s you’ll see the willingness to support the IMF when others were unwilling or unable,” Muhammed al-Jasser, governor of the Saudi Arabian Monetary Authority, told The Wall Street Journal last month.

Al-Jasser also argued that contributions to the two international lenders should not necessarily be determined by GDP, as global financial prominence is a better gauge, which is particularly relevant to Saudi Arabia, as it is the most over-represented country in terms of the ratio of international donations to GDP.

Cool wind from the West

In addition to the speculated lack of desire for greater geo-political influence on the part of the GCC, large Western donors have also hinted their objections to a capital increase originating from the Gulf.

At a meeting of the World Bank’s development committee, United States Treasury Secretary Timothy Geithner said, “We will be seeking critical institutional reforms in any consideration of additional resources.”

Saif believes this statement would definitely apply to the GCC.

“It’s not new that the GCC countries over the last few years came under huge pressure to become more transparent about their budgeting and about their oil revenues and how they distribute them,” he said. “Secondly, they also came under pressure as far as their investments. They are not really willing to open their books.”

In fact, a lack of transparency in the Gulf’s financial sector has been blamed for the falsely high credit ratings given to the countries’ financial institutions, leading up to and even after the start of the global financial crisis.

More green in the spring

At the suggestion of the World Bank’s biggest donors, a formal review of the bank’s financial needs will take place in the spring of 2010 in order to address the World Bank’s proposal of an overall capital hike of $3 billion to $5 billion for the IBRD.

Saif, however, has doubts that this will change the role of the GCC.

“I think it will remain the same. I think that the GCC countries are not very eager and not very aggressive about increasing their weight in the World Bank,” he said.

World Bank officials declined to comment for this article.

With deposits flowing in unabated, banks in Lebanon find themselves in an almost singular global position — they have an overabundance of liquidity.

“We definitely have an excess,” said Marwan Barakat, head of research at Bank Audi. “But this liquidity pays in difficult times, such as [those] we are passing through nowadays. Excessive liquidity has been paying for Lebanon.”

The Central Bank of Lebanon reported $14 billion in capital inflows for the first eight months of 2009, though some analysts contest this number. Bank Audi estimated that $5 billion of this amount were converted into Lebanese lira (LL) during the first half of 2009, gaining on the $8 billion worth of conversions for the whole of 2008.

Though total liquidity is not at its record high, it is the massive conversions into LL that have created an excess of liquidity in local currency, which could, eventually, become a burden if not properly handled.

“This is what I call an enviable problem for Lebanese banks,” said Nassib Ghobril, head of economic research and analysis at Byblos Bank. “Since the crisis started, banks around the world have tried to attract liquidity and they haven’t all succeeded. They’ve had to use government intervention and bailouts. [In Lebanon], the banks are the ones who have supported the government for a long time.”

Deposits have been converted into LL at unprecedented rates in recent years, with dollarization of deposits dropping from 77.3 percent in 2007 to 69.6 percent in 2008. That number is down to 65.5 percent today, according to Ghobril.

The sharp increase in LL deposits led to an overall increase in LL money supply of 8.8 percent for the first half of 2009, with the majority of this increase coming from LL savings deposits, which increased 18.5 percent during the same period.

Lebanon’s primary liquidity ratio at the end of 2008 was 51.5 percent of total deposits, which — compared to an average of 28 percent in the Middle East and North Africa region, 34 percent for emerging markets and 30 percent globally — puts Lebanon in a unique fiscal position.

“More than the number of inflows, the important thing is the balance of payments surplus — the difference between what is coming in and what is going out of the country,” said Barakat. According to the central bank, the balance of payments surplus was $4.8 billion over the first nine months of 2009, which is a record high for Lebanon.

Confidence into cash

These figures are the product of famously conservative practices on the part of Lebanese banks and prudent regulations by the central bank banning high-risk investments such as structured products and derivatives, which have kept the Lebanese banking sector relatively unaffected by the global credit crisis and spurred confidence in the local currency.

Increased confidence in the local currency has also been aided by an attractive interest rate spread. Interest rates on deposits in LL have hovered around 7 percent for the past two years, dropping from 7.23 percent in August of 2008 to 7 percent for the same month in 2009, while US dollar rates have dropped from the already low 3.55 percent in August 2008 to 3.18 percent in August 2009. In order to keep the spread from growing any further and to slow the rush of local currency conversions, the Association of Banks in Lebanon has recommended that banks cap their LL deposit rates at 7 percent.

“The trend was liquidity over profits, liquidity over expanding the balance sheet, liquidity to be on the safe side,” said Ghobril of the banks’ practices during the financial crisis.  

And Lebanon’s top banks have managed to turn a profit this year, a relative anomaly in today’s financial landscape. BLOM Bank has reported $138 million in profits, a 5.8 percent year-on-year increase. Bank Audi’s profits increased 1.9 percent from last year, totaling $133 million, and Byblos Bank saw 2 percent growth from last year with $64 million in profits.

But despite praise coming from international organizations and the media, this growth has slowed, and is predicted to continue on that declining trajectory without profitable outlets for capital.

Banking sector deposit rates

Banking sector dollarization ratios

Too much of a good thing

Though most bankers and economists would argue over the syntax of the situation — “It’s a challenge not a problem,” said Ghobril — the fact remains that Lebanese banks need to find a way to turn the staggering amount of liquidity into profit in order to afford the expense of such abundant deposits, given the high interest rates offered on them.

“Because so much of it is converted into Lebanese [lira] and there are no outlets, now the banks are rushing to buy treasury bills,” said Ghobril.

But treasury bills are becoming a less attractive outlet as yields steadily decrease. In fact, despite the stacks of capital stored at the banks and the few opportunities to capitalize on them, the treasury bills portfolio of Lebanon’s commercial banks decreased in the first half of 2009 by the equivalent of $1.09 billion.

The simple solution is for banks to lend more in LL. However, due to Lebanon’s unique financial nexus, increasing local currency lending is easier said than done.

“Interest rates cannot decline on their own because we have a high fiscal deficit, a high public debt and we have not done anything to reduce the public debt or the fiscal deficit,” said Ghobril. “As long as we have these structural deficits in addition to the lack of long term political stability, there is no way to reduce interest rates much further.”

Short-term fix

The Central Bank of Lebanon has made several efforts to provide the banks with outlets for their excess liquidity, but none have yet proved a lasting remedy.

Until early July, the central bank was issuing LL certificates of deposits (CDs), with banks particularly taking advantage of the high-yielding five-year variety. The return rate on the CDs dropped from 10.9 percent at the end of 2008 to 9.25 percent at the end of June 2009. After issuing the equivalent of $6 billion in CDs, issuance of the popular five-year category was suspended, possibly because the program became too expensive, with demand in 2008 doubling in only the first half of 2009.

The central bank then shifted its efforts and is now attempting to spur lending in local currency. With 57.8 percent of the public debt held by domestic commercial banks as of August this year, lending in local currency continues to be expensive and banks have struggled to lower interest rates in order to spur LL lending.

As of August, the LL lending rate was down 69 basis points from the same time last year, at 9.27 percent. US dollar lending rates stood at 7.05 percent in August, which is 12 basis points lower than August 2008.

Furthermore, banks are working against usual practice. As of June 2009, lending continued to see a dollarization rate of 85.4 percent, which has been the case since the beginning of the decade.

In addition to the unattractive LL lending rates, some argue that the worldwide tightening of purse strings has affected loan requests.

“It’s a demand problem. We have enough liquidity for sure. But, you need two people to dance,” said Makram Sader, secretary general of the Association of Banks in Lebanon.

In order to encourage banks to lower LL lending rates, the central bank lifted reserve requirements on certain loan categories beginning in late June. The reserve requirement exemptions mostly affect housing and education loans and represent what Bank Audi said is the central bank’s only remaining option to spur lending.

“Within this environment, the policy of subsidizing debtor interest rates in LL rises as the only plausible exit for the current distortions within the context of massive capital inflows and currency conversions,” said Bank Audi in a recent report.

“The initiative is to exempt Lebanese [lira] lending from reserve requirements to the extent of 60 percent,” said Barakat.

And the banks have responded with housing, personal, car and education loans in LL with interest rates around 5 percent for the first year.

Treasury bills yields

Looking to the long-term

In September, an International Monetary Fund working paper on the “Determinants of Bank Deposits” said that Lebanon’s “domestic commercial banks which, given their large existing exposure to government, are de facto captive in this system, in the sense that the viability of government finances and that of the banks’ balance sheets are mutually dependent.”

Analysts expressed confidence in the forecasted success of the central bank circulars to increase LL lending, but the limited categories for which reserve requirements have been lifted don’t allow for private sector development.

“It is yet increasingly wished that the central bank expands the relatively limited scopes of the circulars, said Bank Audi. As the aggregation of all such categories does not constitute the bulk of lending growth requirement in the coming couple of years,” said the report.

Ghassan Moukheiber is a member of the Lebanese Parliament and president of the Lebanese chapter of the Global Organization of Parliamentarians Against Corruption. Moukheiber headed the legal drafting committee for the Bill on the Right of Access to Information, which was submitted to parliament before the June elections. He spoke with Executive about the bill’s philosophy and financial implications.

E  What rights of access to information do Lebanese citizens currently have?

Access to information exists in a number of scattered regulations. However, there are a number of areas that we [are] try[ing] to improve in the bill we submitted. There has been a publication issued by the Lebanese Transparency Association, mapping the various rights that already exist, which can be found in a multiplicity of laws. However, there are many hindrances because there is no clear understanding in the actual regulation that access to information should be ‘the principal’ and secrecy ‘the exception’, which was clearly stated in the bill.

To make access to information more practical, we have mandated automatic publication of information, which is not the case now. Except in very rare instances, we don’t have automatic publication of reports. The most important thing is that the law, as it currently exists, does not provide remedies if a civil servant of an administration does not provide the information. It remains a theoretical right. Therefore, it was very important to act on these various loopholes in the law, and to provide Lebanon with a new statute. But we need to complete the legislative work with whistleblower protection. And there, we have nothing. There are no provisions that promote the disclosure of facts and evidence related to corruption, and there’s nothing that can really protect whistleblowers.

E Under the bill, information that jeopardizes “financial and economic interests of the state and safety of the national currency” cannot be accessed by the public. How much will this restrict the public’s right to know about its financial institutions?

This drafting reflected a discussion within the drafting committee about information related to the reserve that is kept by the central bank. Whenever the disclosure of information can damage the financial economic interests and the integrity of the Lebanese currency, then it may not become subject to disclosure. And even such a determination is subject to scrutiny and appeal before the independent authority. It was felt by the drafting committee, and apparently also in line with international practice, that the principal is access. The exception is limited or non-authorized access and this is the case of limited access. We are introducing here a level of assessment and again, that is subject to appeal before the [proposed] independent anti-corruption authority.

E  Since the government’s finances in Lebanon are so closely linked to commercial banks, how can we combat banking secrecy on a public level?

It [the bill] cannot combat banking secrecy because banking secrecy is still something that is held by all Lebanese as something almost sacred. There has been a deviation from this secrecy by special provisions that relate to money laundering. Money laundering is covered by appropriate Lebanese legislation, albeit differently from whatever is done elsewhere. However, there is specific information from private banks that is public. Their statements of accounts must be published. The overall assets of the banks are also published.

I believe that in the particular area of banks, the bill has provided for the appropriate balance between the requirement to maintain banking secrecy and the requirements of the law to combat money-laundering, and the needs of the public to have the maximum information about everything, because this document applies mostly to the public sector.

E  What about campaign finance?

Campaign finance is regulated by the electoral law. Campaign finances are for individuals and therefore are not covered [by the bill]. Electoral law covers that and it has waved banking secrecy on special accounts, but I still believe that the electoral law is incomplete and insufficient to cover all the needs of campaign financing. But this is not to be covered here. I am of the opinion that the law as it was drafted is still incomplete, because a lot of its provisions could be circumvented by banking secrecy. We only lifted banking secrecy on the campaign account, which is insufficient because it is very easy for a campaigning candidate to circumvent that regulation. The second thing that needs to be regulated is party finance. But not everything can be covered by this particular bill, which focuses on the public sector and private institutions that are assimilated to the private sector.

E  The bill says that annual reports from government administrations must contain the costs of their activities. What about the financing of these?

No, because their purpose is to make available information without request. This particular article is relatively unusual in classical ‘access to information’ bills. But this follows an international trend and definitely a need that we have in Lebanon, and this is something that I have particularly pushed to include in the bill:  annual reports. In annual reports, the provisions are there to make sure that you don’t only have propaganda reports, because a number of ministries and independent authorities do publish annual reports, but they are used for their own public relations so they only show the nice side of what they did. But they never show the downside. What is it that they could not accomplish and why? These provisions are to make sure that not only do they publish reports, but this requires the reports to be candid. Private companies that are handling public services must come under public scrutiny. These privatized companies will still be required to publish annual reports made available to the public, including municipalities. What is important here is that we are also making municipalities subject to public scrutiny. Take, for example, a huge municipality such as Beirut, which is under no scrutiny whatsoever from the public at large. Their meetings are private. It seems that municipalities are black boxes.

E  How will the candidness of these reports be enforced?

Enforcement of the whole law is through appeals to the independent anti-corruption authority. The independent anti-corruption authority is granted the power to oversee and implement the bill through appeals, which are submitted by individuals. So an individual who feels that the bill was not implemented or feels that his right of access to information was violated can appeal to the authority and that authority could direct the administration to do its job. The independent authority is not a court, but in extreme cases, you could appeal to a court of competent jurisdiction to force an authority to do it.

It empowers citizens to act because they know. It is making information available. If a ministry, a privatized company or the central bank do not publish the reports according to standards first, they could be held to account by the independent authority. They could be reprimanded, named and blamed. Citizens could name them and blame them and politicians could use that because… we [would] have an obligation.

Today there is no such obligation. When you go to any ministry that publishes such reports you only see the good side of what they do: the rosy propaganda type of information. And what we try to understand in parliament, with little success, is really getting these public authorities to tell us why they could not do what they promised. Or why they could not implement their action plan for the year. So I believe that this bill is a beginning. It is not the end of the story.

E  The administration has the power to dismiss a request as arbitrary. How will this be determined?

It will become practice. If you can go and ask the government to provide you with a complete list of all the employees of the state, with their addresses and phone numbers, that could be legitimate, but there are things that could be abusive. Abuse is to be assessed on a case-by-case basis, and in all instances abuse will still be qualified by the independent authority. The quality of abuse is in my opinion directly related to what you will use the information for. As this is a case-by-case situation, it can only be left open. You cannot keep on asking for things just to clog up the administration with requests for information. It is a general principal of law that the access to any right is always limited by its abuse, whether it is by individual citizens or by the state.

In a recently released report, FFA Private Bank initiated coverage on Bank Audi with a hold recommendation and a fair value estimate of $73.9 per share, implying a price-to-book ratio (P/B) 2009 of 1.39 and a price-to-earnings ratio (P/E) 2009 of 9.83.

The report pinpoints that Bank Audi has pursued an ambitious expansion strategy based on significant organic growth coupled with a series of mergers and acquisitions in light of the wave of consolidation witnessed by the Lebanese banking sector from the mid-1990s onwards. Thus, Bank Audi has rapidly grown to become the largest bank in terms of deposits, assets, loans and shareholders’ equity in Lebanon, where it operates the widest branch-network throughout the country.

Expansion

On the international front, Bank Audi, in the late 1970s, expanded its activities to Europe by establishing entities in Switzerland and France. In more recent years, Bank Audi has started building a strong regional franchise, as witnessed by 71 operating branches, 185,000 accounts and $3.3 billion in assets accumulated in only the last three years of activity. Currently the bank’s regional presence covers Jordan, Syria and Egypt where it provides comprehensive retail and commercial banking products, Qatar and Saudi Arabia where the bank is specialized in capital market activities and corporate and private banking, respectively, as well as Sudan and the United Arab Emirates. While Islamic banking is the core business of the bank in Sudan, Bank Audi operates in the UAE out of a representative office.

In the late 1990s, Bank Audi consolidated its universal banking profile, covering a large spectrum of banking services ranging from retail, commercial, investment and private banking to capital market activities, insurance and Islamic banking.

Looking ahead, Bank Audi’s strategic orientations on the domestic front revolve around strengthening its domestic franchise by consolidating its commercial banking franchise and corporate business relationships, further strengthening the retail banking coverage and franchise as well as developing private banking towards asset management. On the international level, Bank Audi aims to build a strong franchise in the Middle East and North Africa region, consolidating its presence in Europe and strengthening its existing coverage of the Lebanese diaspora in West Africa, Australia and Latin America.

Regarding the bank’s financial results, the report notes that Bank Audi demonstrated a strong performance in 2008, as well as during the first half of 2009, in spite of a severe downturn in global markets. Proving its resilience to the global financial turmoil, Bank Audi managed to increase its assets, customer base and earnings by 17.9 percent, 21 percent and 19 percent, respectively, in 2008 while maintaining adequate capitalization and liquidity levels. Results from the first half of 2009 reveal a growth of 3.4 percent in the loan portfolio and a substantial 11.6 percent increase in the customer base, sustaining the bank’s leading position in terms of loans and deposits. Net profit of $132.9 million was declared for the first half of 2009, indicating a 1.9 percent year-on-year increase in the bottom line results.

Spanning five years, forecasts predict Bank Audi will  witness strong growth in its balance sheet and will continue generating strong results, while capitalization levels remain sound. With an important part of total growth originating from the bank’s international expansion strategy, Bank Audi’s deposit expansion will remain sustained as mirrored by a compounded annual growth rate (CAGR) of 12.7 percent over the projection period, and will be the main driver behind the group’s balance sheet growth. As for the group’s lending activity, it is noted that loans and advances will increase by a CAGR standing at 12.38 percent for the whole projection period. This sustained growth pace is expected to be triggered by a significant rise in the contribution of newly established regional entities to consolidated activity, as well as by steadier economic environment on the domestic scene which would, in turn, lead to a surge in demand from the private sector.

Loans-to-deposits ratio

Also, the report highlights that potential pressure on the economic environment could lead to a slight deterioration of asset quality in the context of a significant growth of the loan portfolio. However, this risk should be mitigated by the bank’s strict risk management.

Despite a substantial improvement in the bank’s cost-efficiency in 2008 and the first half of 2009, the report noted that Bank Audi’s cost-to-income ratio is still considered high, owing to the bank’s aggressive expansionary policy in addition to a heavy cost structure. The analysis concludes that Bank Audi will witness a faster pace in revenue growth compared to cost growth, which would lead to a gradual decrease in the cost-to-income ratio from 54.96 percent in 2009 to 45.72 percent by the end of the projection period.

Cost-to-income ratio

Triggered by solid growth in the bank’s balance sheet and a tighter cost control policy, and supported by a potential improvement in the overall market conditions and higher interest spreads, as downward pressures on the London interbank offered rate (Libor) ease, the net income figure is expected to move from $238 million in 2008, to $497 million in 2013, underlying a CAGR of 15.9 percent.

This surge in earnings will have a direct impact on profitability ratios. Thus, the return on average equity is expected to move from 12.9 percent in 2008, to 16.8 percent in 2013, while the return on average assets, which stood at 1.24 percent in 2008, should move towards 1.38 percent by 2013. 

Net income and growth rates

Marwan Salem is the head of research & advisory and RAYA FREYHA is a financial analyst at FFA Private Bank