CommentEconomics & Policy

No growth without reform

by Nasser Yassin
written by Nasser Yassin

Within a period of six weeks last spring, Lebanon received an attentive treatment from the international community. On March 15 in Rome, an international meeting was held to support Lebanon’s armed and security forces. Afterwards in Paris on April 6, world leaders convened to offer Lebanon substantial foreign aid to bolster its economy at the CEDRE conference. Then on April 24-25, the international community reiterated its support for Lebanon’s efforts in hosting more than 1 million Syrian refugees at the Brussels II conference on “Supporting the future of Syria and the region.” These three occasions signal the world’s commitment to maintain Lebanon’s stability, but also signify the weak state of the country’s security and economy.

Lebanon’s economy has experienced a slowdown since 2011due to the eruption of crises in Syria and the region, and a resultant domestic political deadlock. Real economic growth has been subdued for the past six years while public debt has been on the rise with its share to GDP surging to reach a disconcerting 150 percent in 2017, according to the International Monetary Fund. Unemployment has been growing, and in refugee-hosting communities a noticeable and sharp increase in mostly low-skilled laborers has led to an approximate annual doubling of new entrants into the workforce. In the same vein, risks of spillover from regional turmoil, particularly in Syria but also in Yemen, are not far-fetched. Adding to this, the country is under strain from Syrian refugees, the vast majority of whom are destitute and reside in dire conditions among the poorest Lebanese communities in under-resourced and under-served cities and districts.

Despite recognizing the effects of regional turmoil and intense demographic pressures on society and the economy, as well as the need for international support and foreign aid to weather any potential storm, Lebanon is in urgent need of serious housekeeping.

Systematic challenges

Reforms are pressing, and have to go hand-in-hand with the plans to boost the economy—such as the Capital Investment Program (CIP) that was proposed at CEDRE. The Lebanese state needs to build a high-level political consensus for genuine reform, with commitments to tackle the systemic nature of corruption at all levels. New policies are needed to minimize graft and criminalize it. Implementing the Access to Information law, enacting policies to protect whistleblowers, and strengthening an independent judiciary are key in this reform drive. It is also clear that to stop the siphoning of state resources it is time to move away from the current clientelistic practice of using public sector employment to expand the electoral capital of politicians in office.

Equally pressing is the need to reduce inequalities. With 50 percent of population sharing only 5 percent of the country’s wealth, 10 percent of population sharing 70 percent, and just 1 percent sharing 35 percent, Lebanon has among the highest levels of unequal wealth distribution in the world. This necessitates an open, inclusive, and careful revision of current social and economic policies, which may lead to a new and comprehensive social and welfare strategy that could shift the focus toward more productive sectors in the economy, the integration of current social welfare and social protection programs, and more importantly, a high-level political commitment to reverse the increasing geographic disparities in Lebanon. This should be in alignment with Lebanon’s commitment to the UN’s Sustainable Development Goals (SDGs), specifically SDG 1, to end poverty in all its forms everywhere, and SGD 10, to reduce inequality within and among countries.

Inclusive development

Implementation of the proposed development programs and projects at CEDRE and Brussels II needs to be inclusive, in particular of women, the youth, and refugees. It is crucial that this should move from basic levels of participation to having the programs and projects attuned to the needs of women in society (including women in businesses), to the youth (particularly in refugee-hosting communities), and to the refugees themselves, both Palestinian and Syrian. Implementing an all-inclusive approach for development programs and projects would require new or modified government directives such as a quota system, a simpler work permit regime, and coherent and accessible ways for refugees to acquire residency papers.

It is also essential to have the planned programs locally-grounded, where municipalities can partner together in the design, implementation, monitoring, and later maintenance of development projects and initiatives. It is also key to prioritize areas and regions hosting highest numbers of refugees, and in particular the 251 most vulnerable localities (kadas) that host 87 percent of Syrian refugees while at same time encompass 67 percent of the most economically vulnerable Lebanese. Here, development projects would generate a social stability dividend with improved social relations and cohesion between hosts and refugee communities.

On May 17, a small event took place at the Beirut Port. Although not as grandiose as having world leaders gather around the table in Paris or Rome to show public support for Lebanon’s stability or pledge to boost its economy, it was a moment to celebrate as 20 tons of potatoes farmed in the plains of Akkar were exported to the Netherlands. A modest size of export yet a momentous improvement following painstaking efforts to revamp farming practices and enhance the quality of produce to make it eligible for EU markets. Lebanon can definitely benefit from more trade. Indeed, it needs to start reversing its trade deficit, which soared to $20.3 billion in 2017. Trade creates employment, particularly if it is geared toward boosting productive sectors in the country’s peripheral regions where agriculture (e.g. Akkar and Bekaa) and manufacturing (e.g. Tripoli) are predominant, as well as toward the export of services, such as those found in the budding tech-hubs in Beirut. Given the centrality of reforms, aid and trade should go hand-in-hand to put Lebanon’s economy on sustainable track.

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Economics & PolicyOil and gas

Aphrodite’s blues

by Mona Sukkarieh
written by Mona Sukkarieh

As the final preparations for the May 8 trilateral summit between the heads of state of Cyprus, Israel, and Greece were being laid out—the fourth such summit in just over two years, with so far, more words than actions—news broke that Cyprus and Israel might resort to international arbitration to resolve a dispute over Aphrodite, a gas field located in the Cypriot Exclusive Economic Zone (EEZ), with a tip extending into the Israeli EEZ.

In December 2010, Cyprus and Israel signed an agreement delimiting their maritime border. It was supposed to be followed up by a unitization agreement providing a framework for cooperation in the exploitation of cross-border natural gas and oil reservoirs, but the two sides have yet to agree to such a deal. A year later, toward the end of 2011, Texas-based Noble Energy announced the discovery of Aphrodite in Block 12 off the Cypriot coast.

When it was first discovered, Aphrodite was estimated to contain around seven trillion cubic feet (tcf) of natural gas, but a subsequent appraisal drilling in 2013 revised these estimates down to a mean of 4.5 tcf. Encouraged by this discovery, in November 2012 the holders of the Ishai license within the Israeli EEZ bordering Block 12 drilled a well that demonstrated that Aphrodite did partly extend into their license, though it only showed negligible quantities of natural gas. At the time, Eyal Shuker, CEO of Israel Opportunity, one of the Ishai licensees, declared: “We regret the results, and we would have been happy were they different.” Yet, much to the disbelief of the Cypriot side, in November 2015 the petroleum commissioner at the Israeli energy ministry classified these findings as a discovery, a term implying a commercial value.

Exactly how much of these natural gas resources extend to the Ishai license is unknown at this point. The Cypriots claim it is only a negligible fraction, possibly around 3 percent of the reservoir or less, while the Israelis, on the other hand, insist it is larger than that and have mentioned shares ranging from 5 to 10 percent of the reservoir.

Obstacles to development

The fact that Aphrodite extends to the other side of the EEZ border gives Israel a say in the development of the reservoir. In the absence of an agreement, Israel would likely refuse to allow the development of the gas field given that extracting gas from Aphrodite will lead to extracting gas from the Ishai prospect. However, this is not the only obstacle to the development of Aphrodite. Other factors explain why the gas field has not been developed yet, seven years after its discovery. As the local market is too small to justify the development of Aphrodite, the gas field’s license holders need to find export markets. So far, all options on the table are proving to be challenging from a commercial point of view. The high cost of development, combined with relatively low global gas prices, makes it hard for Aphrodite gas to be competitive, and that explains the difficulties in securing firm sales agreements to date. The absence of a framework to exploit joint reservoirs between Cyprus and Israel is an additional challenge that complicates development even further.

The issue was brought back to the spotlight with news that the negotiations between Cyprus and Egypt to connect the Aphrodite gas field to Egypt have reached their final stages and a deal is expected to be signed in the coming weeks. But this would be an inter-governmental agreement laying out the framework to facilitate possible gas transfers to Egypt in the future, and not a deal committing volumes of Aphrodite gas to Egypt. Indeed, the development of the Aphrodite gas field is still on hold with no real progress on this front since Noble Energy, the operator of the field, submitted a development plan in 2015. The company is focusing its efforts in the Eastern Mediterranean on developing Leviathan, the giant 22 tcf gas field in Israel, which at this time is its absolute priority in the region.

Disagreeing allies

The Cypriots have been disgruntled over what they perceive as an aggressive handling of the affair by the Israeli side, especially in light of the flourishing relations between the two countries in recent years. Ahead of the trilateral summit in Nicosia on May 8, Yuval Steinitz, the Israeli energy minister, made it clear that “the government of Israel cannot give up, not even as a gesture of friendship, on its territories or its natural resources.”

Ironically, the Israelis have interests on both sides of the border, with Delek Drilling, an Israeli company, holding a 30 percent stake in Aphrodite.

A matter of concern for Lebanon is one of the arguments the Ishai licensees are using to support their case in front of Israeli officials, whose support with regards to their share of Aphrodite they appear to perceive as fragile. Rony Halman, chairman of Israel Opportunity, was quoted as saying: “An Israeli concession to Cyprus and further development of the Aphrodite reservoir that ignores Israel’s rights in it will represent a dangerous precedent that in the future will affect additional reservoirs in the Mediterranean basin that extend across the maritime borders between Israel and its neighbors. Such behavior will lead to a significant loss of state revenue.” In any case, companies with stakes in the cross-border gas reservoir will continue discussions in the coming months. If they fail to reach an understanding, they will turn to an international expert, or possibly an arbitrator, to propose a solution.

Trilateral tracks have proven to be an excellent venue for discussions. This was the fourth trilateral summit for the three countries in two years, and a fifth is planned for later this year. Countless other lower-level diplomatic meetings have also been held, with few concrete results so far when it comes to some of the grandiose projects under discussion. Yet, there is a tendency to brandish these projects even though the commercial viability of, at least some of them, is hard to prove. In the meantime, more pressing issues, such as a unitization agreement, have seen slow progress.

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CommentEconomics & Policy

Securing our energy future

by Jamal Saghir
written by Jamal Saghir

Worldwide electricity consumption is estimated to grow from  around 20,000 terawatt hours (TWh) today to 35,000 TWh in 2030, putting energy security at the forefront of future planning. While in the past, energy security was largely focused on oil supply, and natural gas supplies were not globally integrated, today a global market in natural gas is linking countries, continents, and energy prices in unprecedented ways—fostering the need for a cooperative approach.

Securing the world’s energy future also depends on moving past traditional energy concepts, sources, and approaches. By 2040, 60 percent of the new production capacities are expected to come from renewable sources. Environmental sustainability is closely bound with future energy development in emerging and developing countries in particular, and renewable energy sources and storage have become critical for development and prosperity.

Energy security and development

The interdependence between energy-producing and energy-consuming countries is increasing due to the shift in the geographical sources of oil and gas supplies expected over the next several decades. More than ever, it is in the world’s common interest to secure a sustainable supply of energy. Enhancing energy security will require a far-sighted and cooperative approach internationally, one that builds on the value of interdependence.

This is especially true for developing countries, which are expected to account for more than two-thirds of the growth in energy consumption in the coming years. For these countries, energy security is also key to development. Economic activity and the economic growth necessary for job creation and raising incomes depend on adequate, affordable, and reliable supplies of energy.

The impacts of current unreliable energy supplies severely constrain businesses and hurt their competitiveness. In Sub-Saharan African countries, for example, production losses caused by power outages reach between 6 and 8 percent of sales. It should not come as a surprise that many companies in Sub-Saharan countries use their own generators, despite the fact that the cost of privately supplied power is two to three times higher than energy from public grids. As a consequence of unreliable grid supply, the percentage of companies with their own generators is very high in developing countries overall, as seen here in Lebanon.

Unreliable energy supplies in developing countries also come with an individual cost—some people can spend up to a quarter of their income on an energy supply which does not meet their needs.

Securing the energy future of developing countries is therefore vital to their future development and the needs of their citizens. One way in which to do this is to shift the focus of energy supplies to renewable or green energy sources.

The future is green

Here in Lebanon, there have been some attempts to foster the use of renewables as an alternative to conventional oil-based energy. One particular success is the use of solar water heaters, which have and continue to gain considerable interest in many parts of Lebanon.

By the end of 2018, it is expected that small-sized photovoltaic initiatives will have been implemented across the country, while a wind farm project in Akkar that would generate 200 megawatts has also been tendered, and another 200 megawatts of solar generation projects are planned. But overall generation from renewables is still a very small percentage of total energy sources in Lebanon (around 5 percent).

There is still much work to be done, compounded by the fact that what little success has been achieved so far is now at risk due to the potential of offshore oil and gas in Lebanon. The high levels of speculation surrounding these prospective hydrocarbon resources have inflated expectations of an oil and gas solution to Lebanon’s energy woes, putting the urgency of renewable energy development at risk.

It is true that extracting petroleum could be a potential solution to the electricity problem in Lebanon. However, this should not stop renewable energy development or impede Lebanon’s target of deriving 12 percent of its energy from renewables by 2020. In fact, the country should be aiming to double the percentage of renewables beyond this low goal.

Standing in the way of this, however, is the possibility of discovering oil and gas that could supply local power plants at a far lower cost compared to current prices paid by the government. Over-reliance on this outcome could create a tendency to see renewables as a secondary source of energy. If that occurs then there is little hope of Lebanon installing renewables past its near-term target. Even worse, it could stunt growth in the renewables sector for generations to come.

The stakes here are high. By reducing Lebanon’s reliance on conventional oil-based energy and accelerating a switch to renewables we would achieve a cleaner environment and a healthier country to live in, especially in places where private generators are running almost 24 hours per day and emitting harmful greenhouse gases. Securing our future energy supply requires bold action supporting the implementation of transformational renewable and storage power projects. Energy storage facilitates access to clean energy and acts as a buffer to stabilize the intermittency of renewable energies. It is an essential tool for enabling the effective integration of renewable energy and unlocking the benefits of a clean, renewable, and resilient energy supply.

This is as true for Lebanon as it is for developing countries the world over. The bottom line is clear—energy insecurity constrains economic growth and poverty reduction, and has environmental impacts that are increasingly detrimental to people’s health and well-being.

The big question is whether it is possible to expand supplies and access to energy in ways that enable the needs of the present to be met without compromising those of future generations.

The answer cannot lie in efforts to restrict energy consumption alone. We need to find ways to supply homes, farms, and factories with the energy they need, but with a smaller environmental footprint and much higher energy efficiency. Increasing energy supply and use, and decreasing the environmental footprint, therefore present a double challenge. If that challenge can be successfully met, the result will be a double dividend: an improved clean energy supply and an improved atmospheric environment that should, in the long term, lead to a more stable climate.

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2018 BudgetEconomics & Policy

Better to have than to have not

by Jeremy Arbid
written by Jeremy Arbid

A legal challenge of the 2018 budget law taken to the Constitutional Council, Lebanon’s highest court, threatened to cancel what was the country’s second state budget passed in the last six months, on the back of no budget at all for almost 12 years. Parliament ratified the 2018 budget without approving an audit of public finances, amounting to a violation of the constitution the court says, and inserted clauses to the law that the court deemed non-essential to budgetary matters.

In total, the court struck seven articles from the budget law and rebuked Parliament for its lack of oversight on government spending and collection, saying that by not approving an audit, they had left the door open to corruption. Given the weaknesses in Lebanon’s economy and the challenges facing the state’s coffers, however, the court decided against annulling the law in its entirety—instead ruling that it is better to have a budget than not.

The budget projects an overall spending reduction of nearly $9 million to $15.85 billion (LL23.89 trillion)—down 0.06 percent from the previous fiscal year, as Executive reported last month. As for revenue, the budget estimates $12.4 billion (LL18.6 trillion) for 2018. About 77 percent of this will come from tax collection, $9.5 billion—(LL14.3 trillion)—with the remainder projected to be raised from non-tax revenues and the profits of state-owned enterprises and public institutions—$3 billion in total (LL4.5 trillion). 

This year, Value Added Tax is estimated to generate $2.6 billion (LL4 trillion) after the rate was raised from 10 to 11 percent in last year’s budget law. Tax on interest income is estimated at $863 million (LL1.3 trillion). Customs duties could bring in $572 million (LL863 billion), real estate registration fees another $588 million (LL886 billion), income tax on profits $990 million (LL1.5 trillion), and income tax on salaries and wages some $517 million (LL780 billion).

Non-tax revenues include transfers from telecommunications surplus, expected at $1.4 billion (LL2 trillion), profits from Casino du Liban, $78.3 million (LL118 billion), and from the Port of Beirut, $142 million (LL214 billion). Banque du Liban, Lebanon’s central bank, is scheduled to transfer about $41 million (LL61 billion). Property held by the state is expected to generate around $70 million (LL105 billion), whiles fees paid for administrative services would add another $542 million (LL817 billion).

Government revenue has fluctuated over the past several years, according to figures published in the Public Finance Monitor (PFM) by the Ministry of Finance. In 2014 the government raked in $10.9 billion (LL16.4 trillion) before dipping to $9.6 billion (LL14.4 trillion) the following year, and rebounding to $10 billion (LL15 trillion) in 2016. PFM has not yet published full-year figures for 2017, but revenue estimates in the 2017 budget law came to $10.7 billion (LL16.2 trillion).

[media-credit name=”Ahmad Barclay & Jeremy Arbid” align=”alignright” width=”590″][/media-credit]

Authorization plus

Marwan Khatib, a senior associate at Kabalan & Associates law firm, says the budget law does much more than just authorize the government to spend money and collect revenues.  The law includes incentives for taxpayers to settle their dues and over the long-term might allow the government to improve tax collection rates and strengthen the overall public finance situation.

Article 55 of the law reduces customs duties and excise taxes on imported hybrid and electric vehicles. The new rule limits customs duties on hybrid vehicles qualified as personal use automobiles to 20 percent regardless of the value, and to 10 percent if intended for public use. Electric vehicles, meanwhile, will be fully exempted from customs duties. Owners of both types of vehicles will not pay registration and are exempt from their first “Mechanique” fee. Previously, vehicle purchases were levied customs duties at 20 percent for all vehicles valued at $13,300 (LL20 million) or below, and 50 percent on vehicles worth over $13,300.

Article 13 allows a treasury advance to Electricité du Liban (EDL) of nearly $1.4 billion (LL2.1 trillion) to cover the cost of fuel purchases, estimated to reach $1.38 billion (LL2086 billion), and to cover interest and loans which are projected to amount to  $9.3 million (LL14 billion). The article also states that EDL, with the Ministry of Finance and Ministry of Energy and Water, have six months from the date of publication of the budget law to come up with a mechanism to reimburse the treasury for the advance.

Article 15 delays capital expenditures on and maintenance allocations for state infrastructure by a year. Investments in infrastructure advocated by the article include: maintenance of buildings at the Lebanese University; increasing the capacity of drinking water delivery around the country; improving irrigation and sewage; construction of a tourist port in Jounieh; enlarging and maintaining the road from Sultana to Saida, and from Kfar Remen to Marjaayoun; removing landmines in the south; modernizing the Army’s IT department, as well as construction and maintenance of facilities and equipment; improving  school buildings, furniture and supplies; and upgrading and expanding the country’s fixed telephone line network.

Strained transparency

Article 16 allocates just under $500 million (LL750 billion) over five years for the purchase or construction of new buildings to house government offices, to provide  space deemed adequate through 2050. The article does not clarify which agencies would be prioritized nor does it say which regions of Lebanon would receive funding first. But it does show the allocation by year: $6.6 million (LL10 billion) in 2018, $133 million (LL200 billion) in 2019, $133 million (LL200 billion) in 2020, $110 million (LL165 billion) in 2021, and $116 million (LL175 billion) in 2022. It also stipulates that all government agencies renting space must end their leases by 2022.

Khatib added that many of the articles in the budget law 2018 may be crucial to the operation of government. Article 17, for example, decreased fines on taxpayers behind on their bills by up to 90 percent, providing an incentive for them to settle their unpaid tax bills by paying only a 10 percent fine instead of the full amount owed. This decrease will apply to delayed Mechanique fees, municipality fees, and NSSF contributions. Khatib suggested many taxpayers who had previously not paid in full may now pay up given the lower penalty, allowing the government to collect higher amounts in revenue than it otherwise would. Another example that Khatib points out is article 29, which updated property taxes applicable at different rates dependent on buildings constructed after September 1962. He also highlighted article 38, which amends fees for passports. A one-year passport now costs $40 (LL60,000), a five-year passport costs $200 (LL300,000), and 10-year passport costs $332 (LL 500,000). The Constitutional Council also struck down article 26 of the budget law, which would have offered waivers for companies behind on their tax bill, stating that it violated the spirit of the constitution, among other reasons.

In April, the Ministry of Finance published a document titled “Citizen Budget 2018,” offering greater transparency of high-level public finance figures that were previously buried in the budget law published in the Official Gazette (which, in mid-May, was put behind a paywall). A letter addressed to Executive and signed by the Minister of Finance, Ali Hassan Khalil, stated that the ministry “has pledged, as of this year, to regularly publish the Citizen Budget, in parallel with the adoption of subsequent budgets in the coming years, making it a permanent and ongoing tradition.” Inshallah.

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BankingCover storySanctions

The noose around Lebanon

by Jeremy Arbid
written by Jeremy Arbid

Over 300 days have passed since Saad Hariri, Lebanon’s prime minister, stood on the White House lawn next to Donald Trump as the US President promised an answer to the “menace” of Hezbollah within 24 hours. That answer did not materialize in the form of a comprehensive foreign policy or as diplomatic niceties, at least where the public is concerned, but now in mid-2018 we indeed have the answer—namely that actions speak louder than words. With that principle in mind, Trump’s politics vis-à-vis Hezbollah and the region has been made clear.

American focus appears to follow that of Israel. In other words, their focus is on Iran. This leaves Syria, as of right now, as a tertiary concern to the Americans. Meanwhile the month of May saw escalations from the Israeli side over what it perceives as Iranian encroachment, escalations that risk further inflaming the Syrian war. These included Israeli airstrikes on Iranian military facilities in Syria, the American withdrawal from the Iran Deal (formally known as the Joint Comprehensive Plan of Action), moving the American embassy in Israel to Jerusalem, and American sanctions that targeted Iranian central bank officials, leaders of Hezbollah, and Hezbollah’s alleged illicit global financial network. All of these could increase the risk of a new war in the region. But what could happen to Lebanon and its economy, including the financial sector?

Wider consequences

On May 8 Donald Trump abandoned the Iran Deal, fulfilling a promise made on the campaign trail. The US president offered no strategy or alternatives, with a list of demands only later fleshed out by US Secretary of State Mike Pompeo. The Iranians have a list of their own that they have sent to the European parties to the deal who wish to keep the agreement in place. These include European protection of Iranian oil sales and a continuation of purchases. The Americans have threatened sanctions on European companies if they do business with Iran, and so far Total, an international oil company, announced it would freeze its $1 billion investment in an Iranian gas field if the Americans reaply sanctions on Iran later this year. Other global companies have also said they would wind down business in Iran.  In the 1990s the United States threatened sanctions against European companies for trading with Cuba, but the European Union was able to neutralize the threat by suggesting retaliatory sanctions. Right now it is anyone’s guess how this chapter of the saga might play out, and at this point it is unclear how wider American actions will affect the regional economy. We also do not yet know what sanctions targeting senior officials connected to Hezbollah will do to Lebanon, its banking sector, or the local economy.

Economic woes

What we do know is that the risk of a regional war that could engulf Lebanon has already had implications for the country’s economy.

Moody’s, a credit agency, reported in mid-May that global financing conditions will tighten gradually but also said that Lebanon, as one of several sovereigns, could be vulnerable to an interest rate shock. In the event of such an episode, the Moody’s report concludes that “the most exposed emerging market and frontier market sovereigns would see fiscal strength weaken. Absent a policy response that effectively mitigated the erosion of fiscal strength, these shifts would strain ratings, even for sovereigns we already assess with the lowest fiscal strength.” Their announcement does not directly address war risk, but Lebanon’s vulnerability to an interest rate shock could be due, as they put it, to “high debt burdens, eroded revenue bases after the commodity price shocks, and an untested capacity to refinance sizable maturities in an environment of tighter financing conditions.” The indirect effect of oil prices, which now hover around $80, will heavily impact the Lebanese economy, putting pressure on exchange rates and the international interest rate environment. There is also speculation that Brent Crude trading could reach $100 per barrel next year, in part due to US sanctions on Iranian oil.

Lebanon has one of the world’s highest debt-to-GDP ratio, estimated above 150 percent in 2017 by the International Monetary Fund (IMF), and the government recently swapped Eurobonds with Banque du Liban (BDL), Lebanon’s central bank, worth $5.5 billion in Lebanese treasury bonds, according to a Ministry of Finance statement. The swap is meant to finance the government through the end of the year and to reduce debt-servicing costs.

Challenges ahead

The Eurobond fell to 94.67 points as of May 14 according to the BLOM Bond Index, a measurement of the performance of the Lebanese government in the Eurobond market, a decline of 8.5 percent from its peak of 103.42 points on January 17. Dollar-denominated bonds have also tumbled, according to the May 14 Weekly Economic Commentary published by Nasser Saidi, a former Lebanon economy minister: “Lebanon’s dollar-denominated bonds fell to multi-month lows after Trump pulled out of the Iran deal: the $1 billion bond maturing in 2022 tumbled to 90.66 cents (the steepest loss) – its lowest level since Nov 2017.” In a message to Executive, Saidi explained the drop as investor uncertainty by stating that “investors consider Lebanon at risk of war as a result of potential Iran confrontation.”

Lebanon’s fiscal standing is, in polite terms, very challenging. Saidi, responding to an Executive email, summarized the choppy strait that Lebanon must navigate, while also considering the external pressure points: “Given the high and growing risk premium, the spread on sovereign debt and interest rates are likely to remain high and rise further in Lebanon. This will be further exacerbated by the rise in US interest rates as part of monetary policy normalization and higher inflation. Given the peg of the LBP to the USD, there will be upward pressure on Lebanese interest rates. The impact of rising rates is substantial. It is estimated that a 1 percentage point (100 basis points) increase in interest rates would raise the cost of debt service by 7 percent of government revenues, from an already unsustainable 49 percent. However, BDL indicated in March this year that there would be no further rate hikes in spite of the [US Federal Reserve’s] anticipated hikes later this year, indicating monetary accommodation of budget deficits by the central bank. Trying to lower spreads will hamper the nation’s ability to attract inflows, thereby raising risk premiums further.”

Internal dynamics, coupled with some external factors, hold the possibility to trip up Lebanon’s economy, rather than indirect pressure of sanctions which at this point really do not look like an economic instrument but more like a political one that makes noise and headlines but does not change the economic equation fundamentally. Yes, there are sanctions on Lebanese individuals and companies and that does pile on political pressure on the country, but the standard answer from Lebanon’s central bank is that it complies with international standards and foreign and local legislation, while the banking community is in compliance with global anti-money laundering and counterterrorism financing requirements.

Riad Salameh, governor of BDL, does not seem so fazed by the myriad challenges piling on the country. He has, afterall, guided Lebanon through similar rocky periods over his 25 year tenure. “The challenges are true challenges and we will be facing them, whether the increase in interest rate because of the world increase in rates, or whether the higher oil prices. [It is also true that] the geopolitical risks will be influencing the economy,” Salameh said in a recent interview with Executive.

Past experience has demonstrated the vulnerability of Lebanon’s economy to external shocks and maybe it is so far positive that there has been only limited military action in the immediate period following America’s JCPOA withdrawal, embassy move, and targeted sanctions. How Lebanon plays into these geopolitical issues we still do not know, but the sound of the Trump administration’s war drums grow ever larger and the latitude afforded to Israel to do as they may in the region widens.

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BankingCapital banking solutionsCover story

IT in banking

by Thomas Schellen
written by Thomas Schellen

Some business success stories surprise like new gourmet recipes. It occasionally happens that culinary innovations start with ingredients which by and in themselves do not appeal to everyone as superb delights for the senses—for example liverwurst and artichokes, or Brussels sprouts and tofu—but make a winning dish when combined. Likewise, hardcore banking and software development might, each on their own terms, be perceived as stale, boring, and tedious activities. But when the two ingredients are being composed into a menu of refined products in a company like Beirut-based Capital Banking Solutions (CBS) they can excite not only their cooks, but also make money in global markets and entice investors.     

CBS is an 11-year old company that according to CEO Samer Hanna has around 270 employees, half of whom are in Lebanon. He tells Executive that the other half are located in offices in Monaco, Paris, Geneva, Abidjan, New York, and Miami. According to him, the combination of local and global was by design. “Capital Banking has always had the aim to be a global company while relying on Lebanese developers and Lebanese minds,” he says.

Core banking

In terms of its product and services lines, CBS addresses very specific software needs in the banking and financial industry. According to Hanna, CBS is no Fintech player in the sense of the word’s present day usage but “100 percent a software company” that develops its own software, distributes it in the form of software modules and bundles through their own sales team (as well as some third-party channels), and also provides implementation and maintenance. The product scope ranges from a core banking system—the flagship product—to modules/bundles for corporate banking, compliance, risk management, anti-money laundering, digital banking, private and investment banking, Islamic banking, and capital markets.

A core banking system can broadly be defined as the software with which banks in the last 50 or so years increasingly use to support their most common transactions. The system usually entails capabilities for deposit, loan and credit processing, opening and maintaining accounts, and keeping financial records, as well as various interfaces such as those for general ledger systems and reporting tools.

Such a system often represents a very substantial IT investment for a bank, and replacing it involves very lengthy IT procedures and extensive employee training. The life cycle of a core banking system is very sensitive to technological innovation and regulatory change, but high cost and other barriers to change often lead banks to rely on their legacy core banking system for many years, and even decades. Moreover, implementation of core banking is so demanding that successful migrations to a new system are by no means guaranteed. Hanna acknowledges that in the CBS experience there were instances when a project was more challenging than expected and had to be implemented at a financial loss to the company, but he proudly says, “We have not failed in one single implementation in the last 10 years, even if it cost us money, and we had to take it on ourselves to succeed.”     

According to him, CBS serves mostly small to medium-sized banks and sells a core banking system often for $1-1.5 million (which is not a high price, as such systems go). Core banking systems do not account for the largest sales in terms of deals—these are from sales of software modules like anti-money laundering and compliance—but overall are the company’s top revenue generator. CBS released a new version of the system at the end of 2017 under the name CapitalBanker, a version which makes Hanna enthuse that “this system is gorgeous.”

He is more reserved when the question turns to the financial performance of CBS, declaring “I can say that we are a profitable company and growing in double digits every year, by around 15 percent on average, which is very acceptable to us and to our board.” As he does not disclose current performance figures, he only allows that the company holds a “tiny” share of the global core banking software market when compared with leading providers such as Switzerland-based company Temenos, or Oracle Financial Software Services and the EdgeVerve division of Infosys, which are both based in India. Temenos, which claims to be international market leader in software for banking and financial institutions, reported revenues of $735 million and $138 million in net profit for FY 2017. Market research vendors put the global market size and outlook for core banking software as growing toward $10 billion annually.

Global outlook

Hanna reveals, however, that the firm has revenue targets of $50 million in annual sales over the coming few years and is not too far from that point. Moreover, there can be no question that CBS has taken to the global market for making its fortune. As Hanna says, the company derives 8 percent or less of its annual revenue from sales in the Lebanese market and shows no sign of having prioritized its home market for acquisition of new clients, increase of its sales, or even presence in local trade shows. Hanna says, “We did not have a need [to perform in the local market], and still do not feel that the return [from the Lebanese market] is important [enough] to invest the effort, time, and people into exhibiting in the local market. Most of our sales and revenues are generated in Europe, the Middle East, and Africa.”     

As to the background of relative reticence in Lebanon, it also seems conceivable that the company’s connectedness with Bank Audi Group, which is no secret, would discourage some other banks in the local arena from seeking a client relationship. According to Hanna, two of the six board seats at CBS are held by Bank Audi Group, which he explains is a 45 percent shareholder (another seat is held by Berytech Fund II, or BTF II, which was, at time of writing, about to declare a $5 million equity investment and participation in CBS; the three remaining seats are with Hanna and two other executives of the company).

Notes in Bank Audi’s Annual Report for 2016 say under the header Other Operating Income that the group derived $25.1 million in revenues from nonbanking activities, attributed to “Capital Banking Solutions Ltd., a subsidiary.” Another note to the Annual Report states CBS Ltd. to be a company with a registered office in the Dubai International Financial Center in which the group acquired an additional 33 percent share in September 2015, bringing the total ownership stake to 70.5 percent. According to Hanna, the corporate structure of CBS includes, under a Lebanese holding, offshore and onshore corporate units in Beirut, besides the Dubai unit, which was established for the handling of international billing.

A twofold rationale drove CBS to seek an injection of fresh capital from BTF II, which is a venture capital fund that confirms on its website that its funding is sourced from Lebanese banks under the terms of central bank Circular 331. This was, on one hand, the desire to create an extensive sales department in support of CBS’ global footprint. The other aim was to create new products, from investing into an Islamic banking module to developing its cloud-based services. According to Hanna, the state of the Islamic module is about 70 percent of where CBS wants to take it, but the company already achieved sales to banks in Iraq, and the migration to offering banking software as a service in the cloud context is progressing, besides which, he says, “We went crazy on digital; we have a great digital banking module and are now finalizing our mobile banking app.”  While CBS wants “to stay as far away from Bitcoin as possible,” Hanna concedes that the company has tasked a very small team with investigating blockchain and probably creating a process using the distributed ledger concept. As the digital frontier of banking will not wait for the timid, it appears encouraging that a Lebanese software company is standing its ground in technology development markets that, by all rational expectations, will have great importance in the future of banking.

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BankingCover storyNumbers & Figures

The breakdown

by Dany Baz
written by Dany Baz

It has been one of the most reassuring factors in the Lebanese economy—some might be inclined to say nearly the only one—that local banks maintained their strong financial standings during the past years and have been perfectly assuming their role in financing the economy. Beyond their financial performance, which is highlighted in the analysis below, banks have also been implementing adequate corporate governance standards and nurturing good transparency and disclosure practices. The Lebanese have every reason to conclude that the robust financial fundamentals, rigorous adherence to standards under supervision by the central bank, and solid risk profiles put Lebanese banks in a good position to reap the benefits of an economic upturn locally and regionally.

The analysis below is based on the consolidated performance of 26 banks that account for 97 percent of banking activities. Fifteen of these 26 banks are defined as comprising the Alpha banking group with deposits above $2 billion (per bank) and the other 11 banks are classified as the Beta banking group with deposits between $500 million and $2 billion. The number of Alpha banks increased from 14 to 15 as of December 31, 2017.

[media-credit name=”Ahmad Barclay & Dany Baz” align=”alignright” width=”590″][/media-credit]

Banking activity

Total assets stood at $241 billion at year-end 2016. Customer deposits, which represent more than 80 percent of consolidated assets and have increased by 15 billion over the past two years, totaled $193 billion, while consolidated loans represented $74 billion in 2016. A second look shows that domestic deposits have increased by $18 billion while foreign deposits decreased by $3 billion. In parallel, domestic loans to customers have increased by $5 billion over the period while foreign loans have remained at the same levels since December 2014. Based on the figures of Alpha and Beta banks, assets could reach around $260 billion at year-end 2017, deposits could surpass the $200 billion mark, and loans could reach $75 billion for the sector at year-end 2017.

The breakdown by currency reveals that the dollarization of domestic deposits remains steady at 64 percent while dollarization of domestic loans decreased substantially from 74 percent to 71 percent during the period under study, further reasserting the Lebanese Lira (LL) as a lending currency. Much has been said and written on the impact of the central bank’s stimulus packages and the fact is that banks have injected more than $3 billion worth of loans denominated in LL in the past two years with a growth of 13 percent compared to a 4 percent growth in total domestic loans.   

In the light of growing regional and local tensions, 2014 was the last year where activity growth registered double-digit figures. Since 2015, overall activity dropped to an average growth of around 5 percent and the domestic/foreign breakdown reveals that the slowdown is due to foreign aggregates that were hit by the devaluation of currencies in major markets of presence, namely Egypt and Turkey. In addition, some banks have deconsolidated their foreign entities in Armenia, Russia, Cyprus, Syria, Iraq, and Sudan, further translating into a decrease in balance sheet aggregates.

[media-credit name=”Ahmad Barclay & Dany Baz” align=”alignright” width=”590″][/media-credit]

Foreign activity represents around 16 percent of deposits and 27 percent of loans. It is interesting to compare the ratio of deposits and loans per branch locally and abroad. In fact, Lebanese banks are able to replicate their local pace of circa $50 million per year per branch in terms of loans, but foreign branches are collecting only half the deposits of domestic branches, respectively circa $75 million and $150 million per branch per year. Lebanese banks operated a network of 1,427 branches at year-end 2016. Of these, 359 branches were located abroad after the closure of 52 branches in foreign markets in a development linked to the deconsolidation of foreign entities mentioned previously. The domestic network of 1,068 branches grew by 29 new branches in the past two years.

Liquidity and asset quality

Liquidity is on the rise at 35.15 percent, well above regional averages, with liquidity in LL rising to 37.55 percent and liquidity in foreign currency (FC) registering 34.08 percent. In parallel, the loans to deposits (LDR) ratios remained stable throughout the period under study and well below regional and international benchmarks. At end of 2016, the latest observation currently available for this analysis, LDR stood at 38.36 percent overall, broken down into 27.11 percent in LL and 43.32 percent in FC.

The persisting regional and local challenges have slightly impacted asset quality with an increase in the ratio of doubtful loans to gross loans that rose to 6.55 percent at end 2016, similar to its 2014 level but slightly higher than the 6.37 percent registered in 2015. In parallel, the coverage of doubtful loans stood at 75.52 percent, up from 75.44 percent in 2015 and well above the world average of 68.70 percent in 2016. In addition, Lebanese banks increased their collective provisions to a new high of 1.55 percent at year-end 2016.

[media-credit name=”Ahmad Barclay & Dany Baz” align=”alignright” width=”590″][/media-credit]

Profitability

Net profit increased by around 13 percent to $2.5 billion at end 2016 with domestic profit dropping from the mid-80s to low-70s as a percent of total net profit. Return ratios followed suit with return on average assets (ROAA) and return on average equity (ROAE) nudging up to 1.06 and 11.23 percent respectively. In comparison, the MENA average ratios stood at 1.50 and 11.40 percent respectively in 2016. It is worth noting that Lebanese banks have increased their equity by around $3.5 billion over the last two years under study.

[media-credit name=”Ahmad Barclay & Dany Baz” align=”alignright” width=”590″][/media-credit]

The analysis of components of return ratios show that margins and spreads remained stable throughout the period under study at around 2 percent and 1.90 percent respectively. In parallel, the net operating margin was equally steady at around 34 percent while cost to income improved, dropping from around 50 percent to 44 percent over the period compared to a world average of 55 percent at end 2016.

[media-credit name=”Ahmad Barclay & Dany Baz” align=”alignright” width=”590″][/media-credit]

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BankingCIPCover story

Strongest linkage or missing links?

by Thomas Schellen
written by Thomas Schellen

The list of infrastructure needs is long, yet the wish list of these projects for Lebanon is still very rough, and as Executive noted last month, looks methodologically as messy as a disorganized teenager’s room waiting for an encounter with neatness. As the projects in the vast national infrastructure file may contain some old and technologically obsolete plans or plans of dubious national economic value, any realistic outlook for upgrading Lebanese infrastructure to the levels required for economic sustainability, plus social and environmental compatibility, is clearly more in the mid and long term than in the immediate or short term.

This is without even starting to talk about the systemic challenges of managing projects in public-private-partnerships (PPPs) wisely and with great efficiency, nor about the prioritization, selection, and determination of time frames for specific projects. But within this general perspective, what is the outlook for Lebanese banks’ participation in the finance of the great effort?     

From the perspective of invigorating the Lebanese economy and finance on the macro level through the CEDRE process, the question to the role of local contributions gets a clear answer from Banque du Liban Governor Riad Salameh. “The idea about CEDRE is to fund the projects with international funds, not local funds,” he tells Executive. In his view, the sourcing of funds through local capital market platforms should thus be an exception.

The international angle in the CEDRE context is of primary importance for the economic equation in the country, emphasizes Alain Wanna, deputy general manager and head of group financial markets and institutions at Byblos Bank. “[Lebanese] banks will play a role, but the funding for the infrastructure projects will come from outside of Lebanon, and it is very important that Lebanon receives new funding from outside. For the balance of payments, for currency reserves, [and] for stimulation of growth, it is very important that the money comes from outside the country, and comes at subsidized interest rates,” Wanna says.

financing ppp

He clarifies the expected division of labor between the external funders and the local commercial banks, saying, “International donors and funders will follow the projects [organized under CEDRE] very closely, and they have a key role in this. They will observe the bidding process, study the costing, and monitor the development of the projects. This is important to avoid any notion of corruption. Lebanese banks, within their available liquidity, will be involved with activities such as extending credit lines and providing financing deals to contractors and companies involved in the [infrastructure] projects.”

For Saad Azhari, chairman and general manager of BLOM Bank, Lebanese banks will have a definite role to play in PPP infrastructure projects but he says this must be put into perspective. “In Paris [at CEDRE] they were able to secure long-term financing for those projects. Long-term financing is coming from those specialized international institutions that can give those loans for 20, 25, and 30 years. This is provided.

“When those projects come to be executed, however, private sector involvement will be large. The role of the banks is in this area. The private sector will need [Letters of Credit and] open overdraft facilities, or they might need to get loans, for example for buying a piece of equipment or construction machinery with a three to four-year loan. Thus our role [as commercial lenders] will effectively be in supporting those who are going to execute the projects,” Azhari says, adding that local banks on one hand will benefit in this way from the CEDRE process and on the other hand will be able to ensure that local companies will have the ability to execute infrastructure projects under the plan.

Bank Audi also leaves no doubt that it is ready to be involved in the finance of PPP infrastructure projects in Lebanon, and that participation in the scheme is a no brainer for a large local bank. “Let me start by saying that we have participated in similar deals in other countries in the region. Why would we not be doing this in Lebanon?” Group Chief Strategy Officer Freddy Baz asks rhetorically. As he tells Executive, Bank Audi has already participated in infrastructure projects elsewhere in the Middle East, for “important projects involving electrical central plans, port facilities, etc.” While he refrains from going into greater details regarding these projects “for reasons of confidentiality,” he makes it clear that the bank would look at projects in Lebanon with both great interest and with the eye of a financier. “We will only be driven by financial considerations. We will be looking at the file [of infrastructure projects] as we do for any other corporate file and any other project financing file,” Baz explains.

“What we look at and stress-test and where we challenge our counterparties is the feasibility of the project, and the capacity of the project to generate the cash required for the project to reimburse itself [from operations and operating revenues],” he elaborates, emphasizing that this is not on the basis of any financial guarantees, as requisite as such are for completion of a financing arrangement. “We are never driven by guarantees on our loans even though these guarantees are essential and we never give final approval for a financing arrangement if the guarantees are not adequate. But this is the last part that we look at [in discussing the project],” says Baz.

He explains further that Bank Audi could either get involved directly in projects, by taking an equity stake, or less directly, through financing the contractor or the investor. This does not involve looking through the project list for something that might be to the bank’s taste, however. “We wait until the investor or the contractor comes [to us]. What is requested is for banks to be available and open,” Baz clarifies. He notes that today much confusion remains regarding the Capital Investment Plan espoused at CEDRE, and PPP projects and the PPP law, given that what was presented was a list of projects which the Lebanese government considered to be priorities and are assumed to be capable of generating profitability for the private sector.

The reckoning

From the perspective of FFA Private Bank, the issue of investments under the proposition set forth in the CEDRE conference involves a macro-economic risk for a GDP contraction in the coming few years, given that the Lebanese government’s promises of reform and deficit reduction require a totally new exertion of fiscal discipline. “Should we decide to abide by that discipline, it is likely to push 20 to 30 percent in the weakest segment of the population into deep poverty. This might be a cost that we would be socially unable to bear and that would come with its own social unrest,” warns Iyad Boustany, managing director and head of investment banking at FFA.

This could translate into one of three rather unsavory options, the first being eruption of heated social debates and top-down attempts to have the burden of the economic and administrative restructuring process be borne collectively—which probably would mean an unequal distribution of burdens from rich to poor. Another option—unwise from a banking perspective—would be if attempts were made to use banks as the donkeys for carrying the cost burden related to reforms. This, says Boustany, could happen under a mistaken presumption that banks were the main financial beneficiaries of the past period when fiscal discipline was lacking, with the consequence of society saying that banks should write-off 20 or 30 percent of the Lebanese government’s debt. The third alternative, of not initiating reforms and trying to continue with the unsustainable pre-CEDRE status quo, would be no solution at all. Thus, a period of reckoning, in Boustany’s view, is very likely as result of the fact that Lebanon has been living above its means for a very long time.

To tap into the economic saving potential of infrastructure investment flows and PPP projects, it would, according to FFA Private Bank, be prudent to broaden and deepen the direct flow of investments of all sizes from the Lebanese population and the diaspora. Banks, which have barriers against participation in PPP finance because of the long tenors—infrastructure projects typically require financing for durations upward of seven, 10, or more years—should be disintermediated from the process of direct infrastructure finance, i.e., the middle man should be removed when it comes to financing these projects.

“We are very strongly advocating something that the government should be advocating, [namely] a totally disintermediated, capital market driven infrastructure financing. [This route] could achieve several benefits in one strike, one of them being that it would give small investors equal investment opportunity, something that the World Bank is very vocal about,” Boustany proposes.

Transparency and ppp

He acknowledges that moving to such a model would imply a total shift in the prevailing economic model of Lebanon, away from issuances of debt instruments that channel income to banks and a minimal privileged strata of society. Boustany argues that the present time would be the right moment to change the business model that the Lebanese economy has been operating for three decades and switch to a model where that the vast majority of the people—who have been paying for the party that others were having for the past 20 years—will be enabled to participate and profit directly from buying infrastructure finance instruments with diversified risk profiles and yields.

This, by his reasoning, would also act as support factor in the fight against corruption as people with stakes in project bonds etc. will have incentives to demand greater transparency and improved governance from infrastructure project managers. Despite imperfections, the new PPP law, according to Boustany, supports the development of transparency and governance. 

According to him FFA Private Bank would seek to play a role in promoting investments in infrastructure PPP projects that are carried out through capital markets instruments with ticket sizes that are as small as possible. He says: “We are positioning ourselves toward very strongly advocating the disintermediated model of public finance and PPP financing, creating all the elements and using all the existing tools in order to give life to this model, which we believe for the time being to be the only one viable for channeling vast needed funds into infrastructure projects.”

Open and equal investment

“Money is available in Lebanon. All that is needed is to agree on an arrangement that isn’t one where the [elites] take most of profit and throw a few morsels to the people. [This means that] we have to ensure that all projects will be open to wide and equal investment to the general public, not just the more questionable ones while the political establishment picks and chooses [profitable projects] for themselves. Everybody needs to be provided the legal ability to access and finance projects, whether they look difficult or promising,” Boustany asserts.

Whereas the disintermediated capital markets strategy advocated by FFA would with high probability run against the current interests of many financial players in Lebanon, the viewpoints of other bankers focus on highlighting areas where disruptive market impulses and established models can mesh. Bank Saradar’s Head of Strategy Sami Abou Jouma seeks to balance the reward expectations and risk potentials that relate to the CEDRE scheme. “Implementation of the agreements in the CEDRE initiative will change the equation in the Lebanese market in a positive way, whether in terms of liquidity, corporate lending, or project finance. PPP projects with support from multilateral institutions and international donors will have a spillover effect on the Lebanese economy, and local banks, especially the big banks, will have a role to play in the financing of the wider ecosystem created by PPP [projects], but it is difficult to say today at which level and in which form and amounts,” he explains.

“The three elements needed for the success of the CEDRE concept and PPP are fulfillment of the right reforms, the right governance framework, and the putting in place of checks and balances. If these three things happen, then I think, yes, PPP will be very positive news for the Lebanese economy,” he concludes.

BLOM’s Azhari, who by his own characterization is a perennial optimist, believes that the impact of CEDRE will be reflected in the national GDP and that the country could see a return to growth rates from the strongest upward periods of post-war Lebanon. He concedes that it is currently difficult to anticipate the GDP impacts of different PPP infrastructure projects or the multiplier effect of inflows expected under CEDRE. He would not join speculations, put forward by some in the financial industry, about rates of increase in the lending activity of banks, though he asserted the view that “overall, the impact is definitely going to be positive and the GDP growth is going to be larger than the amounts that are being received.”

Coming to the provisional bottom line on the views and approaches of top bankers in Lebanon (as far as those responsive to Executive) vis-à-vis the value proposition of infrastructure PPP financing, it emerges that a plurality and a possible majority are leaning to the optimistic point of view on CEDRE and the financing of PPP with participation by local banks. This is notwithstanding their awareness that the prospects of the whole endeavor are yet only visible as if through a murky glass. 

As Audi’s Baz views the many vagaries of prospects for anything from deficit reduction to reforms and finance for investments and PPP, he notes, “Markets are tolerant. They do not need ultimate solutions; they need signals that you are again on the right track.” He summarizes his personal outlook from a banker’s perspective by saying: “Our expectations [related to the new Parliament] are not very high but if all of what has been talked about at CEDRE and in the last Councils of Ministers [meetings of the previous government], 50 percent is achieved, it will in my opinion be more than enough to provide sustainability and stability again in the country.”

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BankingCover story

News on the house of Saradar

by Thomas Schellen
written by Thomas Schellen

Over the past three to four years, Saradar Bank was being developed as a universal bank with a full range of services in corporate, private, and retail banking. The process was aimed at engineering one differentiated banking entity out of two smaller banks, Near East Commercial Bank and Banque de l’Industrie et du Travail. Although, or perhaps because the procedure entails the creation of a new three-to-five year vision and strategy (implementation of which is currently ongoing) on top of the refurbishment of the bank’s brand and network, since 2016 Saradar Bank had been anything but forthcoming with information about its state of affairs and plans for further development. Until now.

“By end of 2017, we grew our assets by 26 percent versus a market [growth] of 6 percent and our deposits grew by 26 percent versus a market [growth] of 3.5 percent. Also, at the end of 2017 we became an Alpha bank [with deposits above $2 billion]. The growth in deposits was an ambition and objective because we wanted to reach Alpha bank [status],” says Sami Abou Jamous, Saradar Bank’s chief strategy and planning officer.

“In 2017 our focus was to implement a new strategy, improve efficiencies, optimize cost structures, [and] invest in technology and people. Moving forward, our focus is on profitable growth. Our ambition is to continue growing fast but claiming that there will be the same high-paced growth [as in 2016 and 2017] would be an ill assumption,” he tells Executive in an interview on the eighth floor of the bank’s head office building.

On the corporate side, the positioning of Saradar Bank is targeted toward a segment that Abou Jamous calls “mid-corporate.” The competitive edges of the bank in this business line include its factoring service, as well as project finance and corporate lending approaches with a strong emphasis on long-term and personal relationships with their client base that extends beyond mid-sized corporates to small and medium enterprises (SMEs).

In private banking, which is the bread-and-butter business of Saradar Bank as it had been the primary strength of the previous Bank Saradar (before a merger into a joint group with Bank Audi in 2004), the bank pampers its clientele with investment advisory, wealth management, and “premium services” that appear to be a banking equivalent of ‘I want to read every wish from your eyes.’   

Most innovative, however, might be the lender’s new approach to retail. The bank is surprisingly more than content with the size of its physical network in Lebanon, which currently entails 17 branches. This number is puny when measured against the what Bankdata states is a total of 1,037 domestic branches operated by Alpha and Beta banks at end of 2017, and is negligible when compared with other contenders in the Alpha group of banks (ranked 14th by deposits, its peer Creditbank, for example, has 25 branches while branch networks at the ten largest banks easily run into counts above 50). However, the small geographic footprint of Saradar Bank is the foundation for shaping the retail line of business into a digital bank that is close to being as “digital native” as possible (see overview piece for more).

In the structural organization context of the family-owned Group Saradar, the bank is not a top-level corporate entity, but rather a unit of Saradar Finance House (SFH), which in turn is one of three units that comprise the group. SFH, according to Abou Jamous, bundles partial or full ownership interests in several financial enterprises, such as micro-lending provider Vitas, money transfer operator CashUnited, and asset management arm Saradar Family Office (SFO). Of the two other units in Group Saradar, the first organizes all property investments and real estate development activities in Lebanon and abroad; the second unites under its umbrella what internally is called other investments, which include postal services provider LibanPost as well as ventures that, according to Abou Jamous, range from artistic enterprises to some that are not-for-profit.

Abou Jamous, who besides his position in Saradar Bank is also is chief operating officer of Group Saradar, reveals that strategic plans on group and bank level include investments into at least one Fintech-oriented startup fund, acquisition of an insurance company, the possible creation of sister banks to Saradar Bank abroad (most likely in Europe and Africa), and expansion of real estate investments in Europe and the United States.

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BankingCover storyOverview

Buoyed by banks

by Thomas Schellen
written by Thomas Schellen

The relationship between the Lebanese economy and its banks is not quite as simple as the numbers suggest. Banking aggregates are improving every year. But the economy in Lebanon cannot be assumed to be sturdy just because the banking sector is jogging on and on. There are far too many risks and alarm signals on the macro level. To name a few beyond the often-cited debt to GDP ratio (now somewhere above 150 percent), seemingly perennial current account deficits (nearly 20 percent in 2016 according to World Bank Group data), and the deficit to GDP (last above 8 percent), the burdens of inequality to society keep increasing—there are weaknesses in factor productivity, poor capital stock formation, lack of competitiveness of manufacturers, an anemic middle class, and arguably not enough energy in the entrepreneurship ecosystem and knowledge economy.

This only can serve to emphasize that banking can supply financial nourishment that a society needs to solve its economic problems—but cannot on its own cure an economy. A society’s economic health is unachievable without banking sector health. When viewed from this perspective, it is more than a simple comfort that banking in Lebanon is still doing astoundingly well. But can one assume that the sector is of overall convincing health, especially when considering the degradation of the regional environment?

Freddy Baz, vice-chairman and group strategy director of Bank Audi, the largest bank in Lebanon by assets, views the health of local banking in context of an economic environment that is marked by tightening conditions, both nationally and regionally. He tells Executive, “As to the health of the banking sector, the quantity effect and the price effect have obviously impacted the bottom lines and internal capital generation of banks because of these deteriorating macro conditions. This is the case in the region as a whole, where one could see decelerating inflows affecting the foreign positions of countries and domestic liquidity. It is true that banks in Lebanon are today facing more challenging macro conditions, but not to the detriment of their asset quality and liquidity, which are still among the best in the region.”

Baz acknowledges that the inflows to Lebanon are down in absolute terms, but “not dramatically so.” According to him, when seen in relative terms, that is when comparing the share of inflows that are attracted to Lebanon with the rest of the Middle East and North Africa (MENA), Lebanon’s slice of the inflow pie was about 15 percent in the past two years. This was down from a previous peak share of 18-19 percent but still a sign that the country in terms of inflows is boxing far above its weight in GDP where the national contribution to consolidated regional GDP is 1.5 percent.

Saad Azhari, chairman and general manager of BLOM Bank, points to the existence of growth and positive profit performance reported by top banks for the first quarter of 2018 despite having borne the impact of increased tax burdens. “I think that the health of the banking sector, even with the difficult environment, is still good. We are witnessing reasonable growth of deposits. The situation in Lebanon is one of challenges, but the banking sector is still in a good shape,” Azhari tells Executive.

According to Alain Wanna, deputy general manager and head of group financial markets and financial institutions at Byblos Bank, the first quarter in 2018 was satisfactory for the sector. “The top four banks, by their published figures, were able to achieve stable profits or small increases, which is very acceptable if we consider that it was after the introduction of new taxes with the involvement of double taxation. Parliamentary elections are behind us, and they were conducted smoothly, CEDRE finished and results were very good, so if the new government is formed quickly, and we have the implementation of reforms that the [previous] government promised, we can expect that acceptable deposit growth will be maintained in 2018,” he says.

Also for Sami Abou Jamous, chief strategy and planning officer of Saradar Bank—the latest entity to ascend to the Alpha group of banks in Lebanon—the good run of Lebanese banking will continue despite turning more uphill. “The banking sector in Lebanon has been resilient and will hopefully continue to be resilient since banks are strongly capitalized. As we at Bank Saradar see it, the pace of this growth will be slower, competition will intensify, and costs driven by mounting regulatory requirements will increase—hence squeezing margins for banks in the years ahead. However, there will continue to be growth. All this means that we [as banks] have to start operating differently, hence our differentiation and our using of digital means to optimize cost,” Abou Jamous says.

Bankable health and harmony

When it comes to preservation and improvement of individual health, the importance of lifestyle choices and influences from the living environment cannot be overestimated. With smoking, drinking, poor diets, and weak control of stress factors, health professionals see the presence of four factors responsible for the development of health problems.

There are some, who in this figurative sense, would regard Lebanese banks as having long been addicted to junk food diets, due to banks’ over-reliance on a single “nutrient group” for fueling their activities—namely the financial food group of treasury bills and sovereign Eurobonds. At present, however, there are added possible detriments to the Lebanese banking sector that must be considered, from taxation pressures to stress-inducing uncertainties over the national outlook. Practically all of these possible impediments to the health of the banking sector are related to political developments, if not in Lebanon, then in the region and world. 

This exposure to political influences on various levels increases the value of having a reliable political outlook in Lebanon. The experience of having had successful elections is a good base, Baz notes. The important issue in his view was not the voting outcome of the elections but the process itself. “Going back to the democratic process is something that is positive. The conclusion of the electoral process was needed by itself and is a reflection of an improvement in the political governance process in the country,” he says.

For Azhari, (who spoke to Executive on the eve of the parliamentary elections), a fast formation of a new government would send a very positive signal to the economy and the banking sector. “The sooner a new government will be formed and the sooner that the government will be able to benefit from the CEDRE package, the better for the overall economy. I was positively surprised by the success of CEDRE as I wasn’t expecting that they would be able to reach what is effectively $11 billion of subsidized loans. [This amount] was beyond my expectations and when disbursed over the next five years is really a big number. I think the government’s priority should be to [do everything to] benefit from those loans,” he advises.

While all bankers asked by Executive about the issue of the government formation said that speedy progress to a new Council of Ministers would be highly welcome and provide encouragement to the banking sector, Baz emphasizes that it should not be interpreted as a detriment to the next government’s effectiveness if negotiations over it were to be marred by laborious and time-consuming elements of the type that often characterize processes in Lebanese politics, adding that he was hedging for this risk.

Equally, he says, it will be more important for the government to demonstrate its collective awareness of the nation’s existential needs for structural reforms—reform of the tax system, reduction of waste in the public sector, combating corruption, expanding provision of efficient public utilities, and the creation of better social buffers in areas such as education and health. Agreements among the government’s constituents would count for much more than the government achieving contentious numerical targets such as the exact implementation of an annual deficit reduction by precisely one point. “In top-down analysis we are not driven by figures and numbers—we are bankers and we are managing very large institutions with risk cultures that go beyond what exist in other business. One can question the 1 percent annual reduction in deficit that has been proclaimed but in my opinion this is a false debate. The right debate is to be conscious as Parliament and cabinet about the urgency of reducing the deficit,” Baz says.

For Wanna, an accurate understanding of the banking sector’s health prospects has to include a perception of risks and outlooks for banks. “If you want to look at the main risks, I can summarize these as the mismatching in the balance sheets of the Lebanese banking sector, the level of liquidity in the sector, sovereign exposure, and the quality of the loan portfolio,” he explains. “Going forward, I think that consolidation in the banking sector will, in the short to medium term, be one of the major drivers of growth in the sector. To merge with larger banks will be the only way out of their situation for smaller banks with limited capital and limited ability to introduce new technology or [those] who face problems to even finding a correspondent bank for their dealings with international markets and who also have to invest in compliance and other key areas. It is my view that it is better for smaller banks, and for the country, if they merge with larger banks,” he says.

Digital body builders

The latest movement in the international industry is the rise of digital. There is some chance that banks of the next generation might be unrecognizable to banking customers of today. But while it is actually quite likely this does not negate the possibility that it will be an autobahn to perdition if banks ignore or underestimate the digital future.

Awareness of the importance of digital offerings for banks is arguable near universal, if one goes by their rhetoric and marketing efforts in pushing digital services. Digital native banks cannot at present be established in Lebanon and it is likely that consumers will still be able to recognize a bank when they see one in 10 or 20 years. Still, it is of interest to see that a bank now talks about the digital over the physical as Saradar Bank’s Chief Strategy Officer Sami Abou Jamous tells Executive when explaining why the bank is more likely to keep its network small and is working to create a “tailor-made hybrid digital bank.”

Beyond the political risks to banking sector health and risks related to the Lebanese market regardless of any political factors, keeping the sector healthy will require countless other considerations that would go beyond what can be addressed in this story.

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