Executive Magazine

Neuro-leadership

by Samah Karaki June 19, 2018

written by Samah Karaki

In numerous reports questioning the gender gap in the workplace, particularly the gap further up the leadership ladder, one persistant argument points to differences in men and women’s confidence. This has led many to address how women can be empowered in the workplace. Such steps are necessary at all professional levels, as even some very high-powered women can feel as if they do not deserve their positions, having the so-called “imposter syndrome.” But confidence is not a panacea; solving the gender gap is a complex issue requiring an equally complex approach.

In a report published recently in the Harvard Business Review, data analysts from management consulting company McKinsey & Co. and workplace analytics company Humanyze tested the argument that women’s behavior is to blame for the dearth of female leaders. For this landmark study, researchers spoke with 70,000 workers from 222 companies that employ more than 12 million people. Of those, 44 percent said that unconscious bias among male managers is a significant barrier to gender diversity in the workplace. This indicates that arguments about changing women’s behavior wrongly place the onus on internal rather than external factors. Based on the results of this study, one cause of gender inequality is the unconscious bias that men are more creative, smarter, and better leaders. Which raises the question: Are they? What does the science actually say about gender differences in leadership? Do men and women have different brains that could reflect different abilities? If so, whose is better suited for the workplace?

Some are uncomfortable with a biological account of human behavior, feeling it underestimates the influence of the social and cultural forces that shape who we are. It is almost certainly true that our personalities partly develop from cultural expectations around traditional gender roles. But over the past 15 years or so, new technologies have generated a growing pile of evidence that there are inherent differences in how men and women’s brains are wired and how they work. We do know now that some differences are innate: at seven months female babies focus more on faces than male babies, and even male baby monkeys prefer playing with cars.

The left side of the brain stores and uses what is known and deals with facts, with information in isolation, while the right brain is constantly on the look-out for what is new and engages with emotional information, with concepts as a whole. Sometimes the left side is referred to as “the male brain,” and the right side as “the female brain,” but this is a misleading oversimplification. A 2014 study found that the two hemispheres of a woman’s brain talk to each other more than a man’s do. Women’s brains consistently showed more strongly coordinated activity between hemispheres, while the men’s brain activity was more tightly coordinated within local brain regions.

There are a number of conclusions crucial to women being valued in organizations that can be drawn from these observations. Men, because of their brain activity, focus on problem-solving and outcomes, not readily taking the broader picture into account. Women may appear to lack focus, but the suggestion here is that they are scanning wider horizons. When applied to the workplace, this ability would be “big picture thinking,” seeing the impact of decisions on a large number of stakeholders, and taking relationships into account when solving a problem. This way of thinking is not lacking in focus, but rather a strength that can bring huge value to a team.

If the future of excellence in organizations and their capacity to retain talent lies in the quality of relationships and trust among employees, then it could be that women have a more intuitive understanding of such processes.

Power and testosterone

Dominance and power are often connected with the hormone testosterone. It is true that high-power alpha males in primate hierarchies have high levels of testosterone, and powerful and effective leaders also have high testosterone that makes them more motivated by competition and more optimistic when it comes to risk-taking. Women, on the other hand, have less testosterone, and a large number of studies have concluded that they are more risk-averse than men. Women approach risk while paying attention to facial expressions, body language, and unspoken words. In other words, they have more empathy when they take decisions.

In challenging times, however, high testosterone can actually undermine leadership by reducing this empathic accuracy and driving men toward over-optimism, most notably during the 2008 global financial crisis. A recent study used experimental games to examine how power and testosterone levels affected leader corruption over time. The study showed that those who had high levels of testosterone were most corrupt when they had high levels of power. In other words, power interacted with endogenous testosterone in predicting corruption. As you might suspect, women, who have lower levels of testosterone, were more resistant to corruption than their male counterparts.

This is not to say that any conclusions on whether women are “better” than men in leadership roles or vice versa should be drawn. Challenging situations demand leaders that have the flexibility to utilize an array of leadership qualities that includes risk-taking and high confidence, but also reading other people, listening to employees’ concerns, and then making one’s own decisions, along with guiding, inspiring, and protecting the group.

This points to the need for women to stay true to their own skills and values to be authentic. When we hear about empowerment in the workplace, what is often suggested is that to reach these levels of power women must act more like those who have long been historically empowered: men. Women are expected to embody the characteristics we often attribute to men in the workplace, as if these are the only characteristics that can contribute to professional success. But diversity in leadership is key to business success. Globalization has intensified the pressure and demands for competition and change, so companies that want to survive these challenging times need to find the way to spark innovation by harnessing the power of different ideas from diverse groups of people and tapping into a range of opinions, ideas, and experiences.

The final thing to remember is that it is very easy to hold gender as the marker for diversity within an organization, but it is not the only form of diversity. There is also cultural background, age, sexuality, disability, and most overlooked, diversity of thought and experience.

June 19, 2018 0 comments

Inside the global economy

by Riad Al-Khouri June 12, 2018

written by Riad Al-Khouri

In publishing a “practical guide” to the global economy, American economic researcher Andrew Vonnegut provides a toolset for better understanding the ways in which it is prone to be influenced by “big shifts.”

According to Vonnegut, such shifts can be demographic or ecological, but can also involve issues related to inequality, information technology, and emerging markets. Viewing some or all of these shifts through a unified global economy lens can beneficial in analyzing the present geo-economy or preparing for future movements in it.

The book would be of interest to readers in countries that cannot shape the world to satisfy their particular national economic interests—a reality faced by most, if not all. Other approaches often use individual (national) economies as their starting point and then model the global system as interactions among them. Vonnegut considers the global economy as a whole, not simply a sum of national parts, providing a framework that is not extrapolated from national perspectives of international economics.

Vonnegut’s writing drew on his academic expertise teaching a course on global economics at the University of California Santa Barbara (UCSB), and his practical experience as a consultant working in emerging markets finance and policy (with a stint in the Middle East, where this author met him).

Contemporary economic phenomena in my view can be explained using Vonnegut’s approach. An example of this is the global impact of the United States tax reform that was adopted by the Congress at the end of last year.

According to a report released in February by UNCTAD (the United Nations Conference on Trade and Development), US corporations may bring in up to $2 trillion under the new tax regime by repatriating cash from foreign affiliates. As analysts describe it, the reform ends a system whereby companies defer tax on foreign earnings until the repatriation of funds. Instead, the new measure treats those earnings as if they were being repatriated, with an 8 percent tax on non-cash assets and a 15.5 percent tax on cash.

UNCTAD noted that the last similar US tax move—the 2005 Homeland Investment Act—resulted in the repatriation of $300 billion from abroad, and that funds available for repatriation in 2018 are seven times larger than in 2005. With $3.2 trillion in US overseas retained earnings, including about $2 trillion held in cash, this amount is today equal to half of US-owned foreign direct investment. Consequently, the UN body said, “repatriations could cause a large drop in the outward FDI stock position of the United States.”

Such a shift in FDI stock is expected to have significant effects on global investment patterns. The implications for developing economies are not wholly clear as they comprise a wide range and also depend in part on the reactions of other countries. Using the tools provided by Vonnegut would be of value in assessing these inter-relations and the ramifications of US and others’ policies beyond their borders.

However, Vonnegut’s analysis of the global economy as more than a grouping of domestic economies could fruitfully be taken even further by adding a geopolitical framework. Andrew Vonnegut’s famous cousin, the novelist Kurt Vonnegut, once wrote that US President George W. Bush had “gathered around him upper-crust C-students who know no history or geography.” Inside the Global Economy, as it stands today, could do with a geopolitical component and would benefit from being beefed up with perspectives on history and geography. Regardless, the world is changing so fast that a second edition of this book should not be far off. I give the current global system another decade before a very different world starts to replace it.

Also, it has to be mentioned that Inside the Global Economy pays little attention to Arab countries. This is deplorable because this otherwise fine book could have much to say in clarifying the context of regional turmoil in this part of the world. Introducing, for example, the case of Qatar’s dispute with Saudi Arabia, within the context of the Iran-US clash, would provide a more shrewd analysis of energy markets. If the geopolitical element is woven into Vonnegut’s analysis, this comprehensive book will be of even greater value to readers seeking to understand the global economy, from the Arab world and beyond.

Khouri was assisted in this book review by Emily Silcock.

June 12, 2018 0 comments

Banking Cover story Q&A

The essential view

by Thomas Schellen June 11, 2018

written by Thomas Schellen

Executive sat down with Riad Salameh, the governer of Banque du Liban (BDL) to discuss the prospects for the country’s GDP, the role of the central bank, and the external and internal challenges that lie ahead.

E Thank you for sitting down with Executive at this crucial time for Lebanon. I understand that you very recently discussed the country’s economic outlook and the positive impact of the elections on the financial situation with President Michel Aoun. In the current context, how do you see the perspectives for Lebanese GDP in the next two years, or perhaps even in the longer term?

Lebanon is a volatile country and there always are unforeseen events. The central bank has taken it as its policy not to announce estimates for growth prior to July of every year. In general, the Lebanese economy will profit from the implementation of the resolutions at the CEDRE conference. On one side, we estimate that the growth can increase—[in excess of] the normal growth of the country—by 1 percent on every $1 billion invested. On the other side we think that the reforms, which have been announced or promised by the government, will increase confidence and will therefore contribute to positive growth as the government has announced that it will decrease the deficit to GDP by 5 percent[age points] over the next five years.

E How about the risks related to the reforms in the current geopolitical environment, in which we have just seen the oil price go above $80, or if we look at the interest rate environment in the United States and many concerns about the Middle East in Europe and the US? How much of a risk exists that the reforms and fiscal discipline needed to reduce the deficit by 5 percentage points of GDP over five years would lead in the short term to negative developments in the economy, specifically in the perception of their situation by the people?

The challenges are true challenges, and we will be facing them whether the increase in interest rates because of the world increase in rates, [or] whether the higher oil prices. [It is also true that] geopolitical risks will be influencing the economy. But I believe that if there is realistic political will internally [in Lebanon] to undertake reforms, that these reforms will be executed. I don’t want to speculate. We have to wait to see the new government, and it will be their [responsibility].

E Some bankers expressed views that beyond GDP growth and employment creation because of the CEDRE inflows, it could also create a possibility to lower interest rates. Do you see any room for lower rates in Lebanon?

Interest rates are going to be stable. You cannot talk about lowering interest rates in a global environment where rates are going up. We have seen that emerging markets in the world are now practicing higher interest rates. The banks and the economy will have to adapt to this new level of interest rates. The only way to moderate this increase is to improve on the fiscal [situation], which will improve the rating of Lebanon and lead to an equilibrium in our market with lower spreads when we compare our rates to the international markets.

E So the risk premium on Lebanon could be reduced by measures of reform and fiscal discipline?

Yes.

E Was there any reason for concern in the recent widening of spreads in Credit Default Swaps (CDSs) for Lebanon, which reflect the cost of insuring debt?

This is temporary and not linked to Lebanon as such. As yields on the 10-year [US treasury] bond went above 3 percent, we have seen a sell-off in all emerging markets. Lebanon also has seen its [bond] yields pushed higher, which normally pushes CDSs higher because of technical reasons. There are no new credit events in Lebanon from us which would justify any reaction.

E If we turn to looking at the role of the central bank in Lebanon, BDL has been, of course, the guardian of the monetary policy and of banking but also, especially in recent years to a large extent, of the entire economy, talking about the stimulus packages initiated by BDL. Do you see a possibility that under a reform paradigm, the economy could shift and see the government take a more determined role in fiscal policy?

We will welcome such a move. It is our hope and our aim to depart from non-conventional central bank activities, provided that the government fills the gap. During the past years, this [stimulus from BDL] was needed to maintain the stability in the economy and the social stability, but our main [area of] concern is the monetary stability and the banking sector, and also keeping Lebanon compliant with the international laws.

E Wouldn’t the government and specific ministries be hard-pressed in finding the cash to create incentive programs such as the housing loan incentive?

This will depend on the budget which [the government and Parliament] will adopt. Of course, all these initiatives need to be funded and need to be subsidized. Thus, if the policy of the government is to take over these activities, this will be shown in the next budget, because in the present budget there is no allocation for such subsidies.

E The story of BDL over the past 25 years cannot be separated from your story as its governor. When you were inaugurated on August 1, 1993, what was your expectation on how long you would be in this post?

At that time, I thought it would be a one-term operation, but events in Lebanon have put the central bank and my presence here as a matter of consistency for the country. Various governments have therefore decided that I should continue.

E With the effect that it looks today as if you might on one not too distant day, namely in about one year, enter the record books as the world’s longest continuously serving central bank governor of all times up to this point in history.

[Laughs] I don’t know what the terms of the other central bankers are, but I did not do it on purpose.

E As you have the benefit of being able, from personal experience, to review the challenges of the central banker’s role as they evolved over many years in the international development of the financial economy, how in your view does the current phase of 2017/18 compare to previous phases in the role of central bank governor of Lebanon?

Well, the banking sector has improved, and the confidence in the currency has improved. Our concentrations and concern now are on the implementation of the new rules and regulations and accounting standards that have been decided through the Basel III agreements. Challenges that did not exist when we started are now important risk factors for the stability of the country, and I mention here what we have to face in terms of compliance and in facing the sanctions that are part of our daily business. The challenges have changed from the time when it was our objective to create the confidence in the currency, decrease dollarization, and strengthen the capital of banks. Of course, we have to keep these objectives, but we are now in another world of the added challenges that I mentioned.

E The IMF has recently used the term “unsustainable” in describing Lebanese debt to GDP ratios and the current account deficit, but one could argue that these ratios have, for many years, been far from positive and indeed worrying. Is Lebanon’s situation today worse than in previous periods?

We differ with the IMF with their estimate of growth for 2017, and these differences can influence all the feasibilities in projections that can come after. We think the growth in Lebanon was about 2.5 percent in 2017, and they put it at about 1 percent. The realities come from the market. Lebanon’s stability depends on confidence and on the inflows that come to Lebanon every year. This is what we look at more than at economic data, especially since, as you know, the GDP in Lebanon is undervalued as we are in an economy where not everything is really billed.

E What do you tell bankers, especially bankers from international markets, who would say that the Lebanese pound is overvalued?

You cannot maintain an overvalued currency for so many years. This is the best answer. We have seen a live stress-test [of the currency] in November when Prime Minister Hariri resigned. It created demand on the dollar where depositors were converting and it also created outflows. But the system remained stable and things reversed as the political event finished, which was a political and not a monetary crisis. That this reversal happened means that markets are looking at the value of the pound and being realistic. On the other hand, nobody in the world could really determine what the value of the pricing of a currency is. It is [determined by] supply and demand.

E It seemed from a recent conference sponsored by the Bank of International Settlements that the view on exchange rates in small open economies is shifting from a focus on such countries’ independent stances on monetary policy to greater understanding of inescapable dependencies through policy spillovers from globally dominant central banks. Research papers thus appear to put more emphasis for central banks to know if their currency is close to its long-run equilibrium value rather than using other metrics for assessing the real exchange rate, which seems to indicate that that the impact of external influences on small economies and your positions on the exchange rate are increasingly being validated.

Yes, and our policy is derived from the realities of Lebanon. We have a dollarized economy in Lebanon today, and there is no value added to this economy if we do not maintain a peg on the pound. On the contrary, the peg on the pound creates demand for consumption and also stable purchasing power, thus social stability.

E But from your perspective, how could the competitiveness of the Lebanese economy be increased vis-à-vis strong manufacturing nations which have exchange rates that make their products more competitive in global markets, when looking for example at regional behemoth Turkey where the exchange rate just this spring reached 4.6 TRY to the USD, down from about 3.5 a year ago and from 2 in 2014?

The higher costs that are linked to production in Lebanon are essentially due to the absence of a proper infrastructure. Once you have this infrastructure, you are going to be able to produce and be competitive. Cost is on the other hand also due to lack of efficiency, which means that you need a more serious approach at work[places] in terms of working hours and having fewer holidays. This would also help increase salaries in the private sector by way of an increase in demand [for labor].

Lebanon is competitive in many sectors, but our infrastructure is today really very backward. We are talking here not only about roads and transportation, but also about the environment, about fighting pollution [and] exploiting the sea. The resolutions of the Paris conference are important to create a base for a productive [and] competitive economy, and the internal reforms are important for effectiveness. Our view is that the public sector growth as share of GDP should stop, and we should encourage the growth of the private sector to have a greater part in our GDP. That will turn out to give leverage to Lebanon.

E Which brings us back to the CEDRE process and the importance of international support for Lebanon. One of the issues in this regard is the refugee issue that was the main topic at the Brussels conference held in April. Is the drain on the Lebanese economy and society from your perspective a component that needs more international humanitarian and development assistance, beyond what was pledged in Brussels or at earlier such refugee aid conferences?

[The refugee issue] is a cost on Lebanon and has been stated as such by the World Bank and the United Nations. [In the presence of] such a cost, whatever reforms you do, there will be pressure on the government. The increase in the security forces, for instance, and the cost of that increase is due to the fact that you need more people to assume security [functions] when you have such a number of refugees. And so on.

On another side, the Syrian war also has hurt Lebanon because residents from the Arabian Gulf countries are not visiting Lebanon as before and because our exports are almost impossible to achieve. So whatever you do in terms of [improving] productivity, whatever you do in terms of [achieving] reform, these [economic restraints due to the refugee issue] are realities and currency devaluations are not going to solve these realities.

But returning to the relation between competitiveness and the exchange rate, I take you to the Italian example, where [Italy] used to devalue the lira to improve the economy [before the EU’s establishment of the economic and monetary union]. They realized that [this approach] was not working and that is why they joined the euro, which is a stable currency. The currency can play as long as it does not create inflation.

E Could then inflationary pressures on Lebanon arise from the CEDRE inflows of money, if the equivalent of more than 20 percent of the country’s GDP in one year are to flow in over the course of five years?

The investments are spread over 10 to 12 years, so the issue of inflation can be mastered.

E And the central bank will play a strong role in this?

Of course.

E If we turn to the banking sector, where you mentioned the need to comply with international rules and also apply new accounting standards. One of the goals of the unconventional measure initiated by BDL in 2016—often called the swap—was to enable banks to build up profits that they would retain for the purpose of switching to the more demanding International Financial Accounting Standards, or IFRS 9, if I understood correctly. The migration to IFRS 9 was mandated for the first quarter of this year. Can you tell us anything about how it was achieved, if it was smooth or if there were any hitches?

It was smooth. It has delayed the publishing of our usual statistics by two weeks, but, as of now, all banks are taking IFRS 9 as the reference in reporting. There are also other circulars which were considered positive like the issuance of the liquidity cover ratio. One can say today that the banks are properly capitalized because when we did the engineering [of 2016] and we also asked the banks to have a solvency ratio of 15 percent, based on Basel III. Today, they are at over 15 percent [solvency].

E Is this the case all throughout the sector?

It is the average of the sector. You always have one or two banks which are behind, and we follow their cases, but you have to admit that what we are asking [of Lebanese banks] is beyond any level of what is required worldwide.

E As one always hears rumors about new developments and pairings in the Lebanese banking industry, is there any change in the BDL policy on mergers of banks in the top tier of now 15 banks, the so-called Alpha group with deposits of over $2 billion each?

We have not introduced any change so far. We are, of course, flexible, and will adapt to the realities, adapting our policies to what is required to be able to keep Lebanon financed properly. For the time being, we do encourage mergers but not among the top 12 banks. We think that the consolidation that has happened by market forces has also improved the confidence in the banking sector in Lebanon.

E If I may ask in this context about another financial sector, namely insurance. Insurers have spoken for some time about having appealed to you for subsidized soft loans from BDL that would encourage consolidation in this industry which according to the World Bank’s Financial Sector Assessment is beset with over-crowdedness and unhealthy competition on pricing. Is there any outlook for the insurance sector to get soft loans from the central bank or any other form of support toward consolidation?

The insurance sector is not in our jurisdiction. It is controlled and regulated by the Ministry of Economy [and Trade]. We have no project for putting any subsidized loans [at the disposal of] the insurance companies in the country.

E What can we expect for 2018 as far as Circular 331 and its process, as far as the Beirut Stock Exchange (BSE), and as far as the electronic trading platform (ETP) and the transformation of the current capital markets environment?

On 331, we are committed to pursue implementation of this circular as we believe that it is going to contribute to the creation of a productive sector for Lebanon, productive like we see it in the modern world, and that would play an important role in improving efficiency and competitiveness in the country. [Regarding the BSE], we are still waiting for the government to designate board members so that the process of privatization of the Beirut Stock Exchange can be pursued as the law requires. On the electronic platform, we are getting there. It is a matter of one or two months that we will have the clearing system in place. We are presently testing it and want to operate [the ETP], even if we will not sell it for the time being because we are waiting to sell it at the same time as the Beirut Stock Exchange. We believe [the ETP] will create liquidity in the country.

E Is it correct that an ETP is usually especially beneficial for the trading of government securities on basis of certain volumes?

Such a market gives you the freedom to list all types of papers after getting the approval of the [Capital Markets Authority]. There are no restrictive measures such as on a classic stock exchange. We anticipate seeing trading not only in government securities [but also] in currencies, except for the Lebanese pound, [and] in shares when these shares cannot be listed on the stock exchange. We hope that [the ETP] will [provide] exits for startup companies and funds, and also hope to see commercial paper and debt paper traded there. Trading should be possible from all over the world, so this is another way to integrate the Lebanese diaspora with the local economy.

E How about things like bonds for financing parts of the PPP projects in infrastructure? Would the ETP be a possible avenue for trading such bonds as financial papers with small minimum tickets in Lebanon?

The idea of CEDRE is to fund the projects with international funds, not local funds. Therefore, apart from certain exceptions, this should not be a place to use in order to fund these projects.

E When multilateral institutions such as World Bank and European Bank for Reconstruction and Development, which have committed to roles in the financing of Lebanon’s infrastructure projects, will come to Lebanon, will BDL have an advisory role on the evaluation of projects or in some other form sit at the table when projects are being negotiated?

The central bank has no role in this. These are international funds, and the follow-up should be done by international bodies. [The process of discussing the infrastructure investments] is between the government and the lending institutions or countries, but whenever our contribution is required we will not hesitate because we think that the project is beneficial for Lebanon.

June 11, 2018 0 comments

Last word Opinion

The impact of GDPR on Lebanese businesses

by Jihane Abi Saleh June 11, 2018

written by Jihane Abi Saleh

With the continuous digitization of human life and economy, questions around the ownership and privacy of our personal information need urgent attention. From June, it will be crucial for Lebanese companies to understand the implications of new European regulations on the ownership and limits to exploitation of personal information, which came into force at the end of May.

As of May 25, two years after the adoption of the General Data Protection Regulations (GDPR) by the European Union, organizations who are registered in the EU, or selling products and services to EU residents, have to apply GDPR. This can range from large international manufacturers and online retailers, to small enterprises and commercial bloggers. But many in Lebanon assume that this new regulation will not affect them.

This could be mistake, and a costly one, for companies that offer products or services online that are purchasable by EU residents. All local companies with a strong digital presence outside Lebanon should determine whether they need to initiate compliance with GDPR.

GDPR is a landmark European Union regulation that prescribes the rules and regulations for the collection, processing, use, storage, and destruction of the personal information of EU residents. The main aim of this piece of legislation is to protect consumers by giving them greater control over their personal data that is transmitted via the internet, and to compel businesses to be more accountable and transparent in their use of customers’ personal data.

As an EU regulation, GDPR is not a priori applicable outside of the bloc, however, one of the considerable changes introduced by GDPR is in its extraterritorial scope, which allows it to reach non-EU organizations performing transactions with EU residents. Under article 3 of the GDPR, a company may still have to abide by its rules even if it is incorporated outside of the EU and has no physical presence within the EU.

Compliance with GDPR is thus required of companies anywhere, as long as their activities entail the offering of goods or services to European residents, the processing of data from such persons, or the monitoring of users’ behavior that takes place in the EU. GDPR will likely apply to a Lebanese business even if it has no employees or offices within the EU, but is selling a product or service to EU residents, or even simply offering to sell, irrespective of whether a payment is made or not. Likewise, abiding by GDPR is a necessity for any Lebanese company that monitors the behavior of European residents, for example, if it processes information about consumers in an EU country to predict their behavior, or does surveys on the behavior of EU residents. In addition, GDPR is applicable to a Lebanese company if it has EU-based employees and is processing information related to these employees.

GDPR would not apply if the Lebanese company is undertaking regular marketing of goods and/or services. This means that if the company has a website offering goods and/or services but does not have a physical presence in the EU and shows no indication of targeting any EU residents, it is not required to comply with GDPR rules simply on the basis that an EU resident can somehow stumble upon its website—what this means in practice will emerge over time.

However, the GDPR likely will apply to a company, irrespective of its country of incorporation, if its website targets EU residents, if it accepts the currency of an EU country, has a domain suffix for an EU country, offers shipping services to an EU country, or provides information in a language that is predominantly spoken in an EU country such as Italian, French, and German.

Violating the GDPR and failing to report any infraction of personal data rights of EU residents can result in hefty fines; in serious cases, regulators can penalize businesses 20 million euros, or up to 4 percent of their previous year’s worldwide turnover, whichever is higher. For smaller infringements to the GDPR, regulators can impose fines amounting to 10 million euros, or up to 2 percent of the companies’ worldwide turnover, again, whichever is higher.

Lebanese companies, thus, would benefit from informing themselves about the provisions and requirements that are coming into force with the GDPR. If uncertain as to whether GDPR applies to a Lebanese business, it may be a good idea to contact an auditing or consulting firm with expertise in doing business in Europe, or approach a specialized adviser to make sure that its privacy initiatives are in order. This will not only avoid legal proceedings and painful fines, but also express a will to protect fundamental rights and freedoms of individuals, and in particular, the right of consumers to the protection of personal data.

June 11, 2018 0 comments

Comment Economics & Policy

No growth without reform

by Nasser Yassin June 7, 2018

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.

June 7, 2018 0 comments

Economics & Policy Oil and gas

Aphrodite’s blues

by Mona Sukkarieh June 6, 2018

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.

June 6, 2018 0 comments

Comment Economics & Policy

Securing our energy future

by Jamal Saghir June 6, 2018

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.

June 6, 2018 0 comments

2018 Budget Economics & Policy

Better to have than to have not

by Jeremy Arbid June 6, 2018

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.

June 6, 2018 0 comments

Banking Cover story Sanctions

The noose around Lebanon

by Jeremy Arbid June 6, 2018

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.

June 6, 2018 0 comments

Banking Capital banking solutions Cover story

IT in banking

by Thomas Schellen June 6, 2018

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.

June 6, 2018 0 comments