Banking economists on the Lebanese banking sector

Talking bankers

Photo by Greg Demarque
Reading Time: 14 minutes

Bankers are people. Brothers, sisters, mothers, fathers, spouses, children, cousins, clients, business advisors, financial partners, and friends of other Lebanese people. Given that over 25,000 individuals are employed in the local banking sector, with high percentages of them being women (in comparison to most not “traditionally female” professions) in a banking workforce that is composed overwhelmingly of university graduates in their most productive years, it would be strange if most Lebanese were not either connected to a banker themselves or by one or a few degrees of separation to someone else who has a personal connection to someone in the banking industry. Young bankers with positions of responsibility were among the peaceful and cheerful Martyrs’ Square crowds shouting thawra (revolution) last November that today seem like a distant dream of hope of a reformed Lebanon that belongs to its people. 

But in the public discussions that have been raging for many months—a period in which bankers have and continue to be publicly blamed for their roles—the Lebanese banker has been reduced from a living and breathing human being to a cutout figure in a shadow play. 

Mistakes have been made in Lebanese finance over the past three decades. Honest mistakes. Undeniably things need to change. To facilitate and spur on productivity-enhancing behavior and the migration of banking culture into a new and more socially beneficial pattern, better interpersonal communication is needed. Even in normal times, the personal connection between average retail customers and local finance houses are subjected to pressures that easily can make them drift apart. Much worse impairments of trust and increases in the emotional distance between Lebanese citizens and their banks, though, have been the result of the financial and economic crisis of 2019/2020. One collateral impact of the crisis and the, at times, overheated animosities affecting banks and their customers was an unprecedented reticence of banks to communicate.

In response to our outreach to banks since early May 2020, however, two major Lebanese lenders, Bank Audi and Byblos Bank, directed Executive to their lead economists to ask our questions. Both chief economists preferred to answer our questions in writing. In the following we present the answers of Marwan Barakat, group chief economist and head of research at Bank Audi, and Nassib Ghobril, chief economist and head of the economic research and analysis department at Byblos Bank Group.   

Presenting our list of questions, we noted, by way of introduction, that a central pillar in the government’s financial rescue plan famously calls for a comprehensive restructuring of the banking sector to decisively address the accumulated “FX mismatches at the central bank,” reveal embedded losses, and refocus “a resized banking system on the distribution of credit to the private sector.” Noting the obvious political economy and economic policy implications in this narrative, stretching from a need and form of a “haircut” to issues of state intervention in the design of the Lebanese economic system for the coming 20 years or more, led Executive to ask about banks’ views regarding the real size of impairments of their assets, the issue of recapitalization of banks, and the acceptable levels of debt that Lebanon can shoulder. Below are the questions posed and the answers received in writing. 

What are your views with regards to the size of the hole in the banking sector and your views on the need and optimal available means for sanitizing balance sheets?

MB: While the economic recovery plan contains some positive points and tangible public sector soft landing measures, it also contains some weaknesses in our opinion, mainly at the level of the banking system restructuring. The figures provided are of course estimates, and might be exaggerated. For instance, one should not forget that the losses attributed to banks’ credit portfolio to the private sector do not at all take into account that when and if borrowers fail to repay banks their dues, banks themselves already have collateral and real guarantees, such as property assets they could seize and monetize. Hence, losses might very well be lower than envisaged in the government’s plan.

It would be wrong to restructure banks without knowing the real amount of losses, and, even more so, wrong to penalize depositors in one way or the other based on inflated or inaccurate loss estimates. Speaking of depositors, it would also be wrong for banks and depositors to bear the burden of the state’s default. When a borrower defaults, lenders seize their assets rather than the borrower (in this case the state) seizing banks’ and depositors’. On another note, looking at the plan put forth by the Association of Banks in Lebanon (ABL) shows that it is possible for the central bank, Banque du Liban (BDL), to avoid losses thanks to a defeasance fund valued at $40 billion, and that would avoid banks having to incur losses related to their exposure to BDL. Sanitizing balance sheets should take place in close coordination with the BDL and banks themselves and would be in the interest of all stakeholders.

What would be the best mechanisms of asset protection in the interest of future generations and for banks’ recapitalizations?

MB: If all means to protect depositors’ money prove to be insufficient, the best mechanism would be to establish a sovereign fund where part of large depositors’ money is transferred against shares or stakes. Privatizations and selling of state assets would help depositors recoup those funds. We do not believe that all banks’ equity should be wiped out as suggested by the government plan. In line with the ABL’s own plan that is being currently discussed, banks can save part of their equity and thus continue to operate in the future. Once a consensual plan is put in place, and an International Monetary Fund (IMF) agreement is underway, the economic cycle can start again, confidence can resume, and fresh funds inflows might follow from existing and perhaps new shareholders, thus ensuring banks’ recapitalization. The ABL plan mentioned a voluntary deposit-to-capital conversion for those large depositors who believe that banks that are equity-positive once the restructuring is over can ensure share appreciation for them in the future.

NG: Lebanese citizens lost confidence in the ability and willingness of the executive branch and of political parties in power to deliver public services and to improve their standards of living, as reflected by the Byblos Bank/AUB Consumer Confidence Index. Amid these developments, it is normal that confidence in the banking sector gets affected, as banks are a key part of the Lebanese economy and are the most affected stakeholder of the Lebanese economy by developments, due to the fact that it is the only sector that lends to the entire economy. So it was expected that banks will be impacted by the crisis more than other sectors. However, the perception about banks was affected by a massive campaign that started in November 2019 to put the blame of the crisis on the banking sector in order for political parties in power to evade responsibility. This campaign, which is still ongoing, has affected the perception of citizens toward banks.   

Therefore, confidence in the banking sector is closely tied to confidence in the ability and willingness of the executive and legislative branches to implement much-needed structural reforms. The best way to restore confidence is for a government reform plan with sequenced priorities that would create a positive shock in the market, prioritize growth, tackle the size of the public sector, and address the liquidity shortages in the market. The plan that the government issued at the end of April has faced significant criticism from various stakeholders, and did not result in the positive shock that citizens, the private sector, and the diaspora have been waiting for. But an agreement with the IMF on a funded program will be the start of the long road to restoring confidence.

What do you see as the best way forward in terms of recovering or rebuilding trust in the banking sector and how much time do you anticipate will be needed until a working level of trust with banks is restored locally and among Lebanese expatriates?

MB: Building back trust will take time; that is for sure. In order for that to happen, the government must implement an economic recovery plan ensuring an equitable distribution of losses among economic agents. Burdening depositors is certainly not going to bring back trust, on the contrary [it would] damage it for a long period of time. Once a credible plan is put in place, and IMF and perhaps CEDRE funds are on their way, restrictions on withdrawals and transfers might be lifted and trust restored gradually.

There seems to be no large disagreement that the banking sector will lose some players by market-driven consolidation or under some form of merger policy that could be implemented in various ways—for example imposed through new laws or guided by the central bank under use of its regulatory toolkits; the government mentions a downsizing of 50 percent in the number of banks and quite a few independent analysts also seem to think that up to half of the banking sector is slated for a rational reduction in terms of total assets. What do you think?

MB: With a banking sector nearly 5 times larger than pre-crisis GDP, it is normal to say that the local banking sector is overcrowded. The BDL Governor [Riad Salameh] has long advocated that the number of banks should be reduced. In the current conditions, banking institutions more hit than others and/or unable to raise capital in accordance with BDL regulations, might be forced to merge with others. This would ensure the reduction of the number of banks in the market. Only a handful of larger banks would remain, although it is difficult at this point in time to say how many.

NG: There is a large difference between a market-driven consolidation of the banking sector and the imposition of consolidation as stipulated in the government’s financial plan. It is market dynamics, economic conditions, and competition among banks that determine the size of the sector and the number of banks, not government interventionism. There are several factors that are having an impact on the banking sector. First, the current government’s decision to default on the foreign obligations of the Lebanese state in March will inevitably result in heavy losses for banks. Second, deposits have declined by $25 billion between the end of August 2019 and the end of April 2020. Third, loans to the private sector have regressed by nearly $6 billion in the first four months of 2020 and by $15.5 billion since the start of 2019. Fourth, the severe economic contraction and very low level of household confidence have put on hold any prospects of demand for new loans.

Three of these factors are putting pressure on banks, but three of them are market-driven factors that will push the boards of directors of banks to examine the value-added of merging with or acquiring other banks. Also, historically, the banking sector has seen a gradual and orderly consolidation under the supervision of BDL. In the early 1990s, there were about 82 banks in the country. So BDL provided incentives to banks to merge, acquire other players, be acquired by another bank, or exit the market altogether. There are currently 47 commercial banks in the country, in addition to 16 medium- and long-term banks, also known as “investment banks,” that are owned by the commercial banks. Market factors and BDL incentives are the only logical and healthy way to determine the size of the banking sector and the number of banks. And it is up to boards of directors of banks to explore, examine, and determine the best course for their bank, and it is up to the shareholders through general assemblies to vote on these measures. Therefore, some of the other ideas that have been suggested sound obsolete and out of touch with realities, and have already negatively affected confidence.  

Global risks are coming

In the long term, the current Lebanese crisis will by all historic experiences of other jurisdictions be a traumatic memory but a memory nonetheless. However, the financial landscape for the remainder of the 21st century is likely going be informed by the impact of the combination of what the International Monetary Fund (IMF) has called “The Great Lockdown” and the impact of new risks that have been highlighted in 2020 and led to what will be remembered as the deepest correction to developed world financial overconfidence and shakedown of socioeconomic complacency in the annals of Western-dominated capitalism.

In assessing global macro-financial reality, the Bank for International Settlements (BIS) has very recently expanded its perspective on predictable but immeasurable global risks that originate in humanity’s overlong dismissal of natural risks. Specifically, the risks labeled Green Swans—a term that was the title of a joint publication of BIS and Banque de France, the French central bank, in January 2020—have now been expanded to prominently include the COVID-19 pandemic, adding to the previously identified Green Swan of climate risk.

Green swans are “highly likely” but unpredictable in terms of time and “too complex to fully understand,” the deputy general manager of BIS Luiz Awazu Pereira da Silva emphasizes. To address the new, radically altered global risk landscape, BIS sees the need for proper measurement and pricing of emerging global risks and the need for strengthening resilience of systems and institutions for avoiding/mitigating Green Swans.

As already established in climate risk scenarios, such risk management involves multilateral development banks (MDBs), regulators, and the financial sectors of countries around the world. Collaboration between local and international banks has become instrumental in moving economic agents in less developed countries in direction of adoption and promulgation of the environmental, social, and governance (ESG) standards that can contribute to increased efforts in managing environmental risks. In recent years, Lebanese banks that entered SME financing partnerships with International Financial Institutions and MDBs have begun to steer their SME loan applicants toward prudent climate practices and environmental standards.

Thus the following question by Executive was posed to 15 banks via email, with the option to respond anonymously. Bank Audi’s Marwan Barakat answered. 

How much of a role does the Lebanese banking sector play in contributing toward the creation of not just more short-term productive but long-term sustainable economic sectors in Lebanon that are viable under increased Green Swan risks, and how can the banking sector’s functioning be improved for the development of the productive sectors in a sustainable economy under new macro-social paradigms and trade-offs between economic efficiency and societal resilience that are being anticipated by leading global banking institutions such as BIS?

MB: Of course banks operating in Lebanon have a big role to play as they are the ones ensuring financial intermediation and channeling liquidity toward productive sectors of the economy in order to contribute to their growth. What is required is for the public sector authorities to ensure a conducive investment climate, a proper macroeconomic background, and, above all, political stability, in addition to implementing a credible economic recovery plan, in order for investors to come back to the country and have faith again in its financial system. Once this is ensured, and the public sector has lower financing needs, banks can benefit from more opportunities to lend to the productive sectors of the economy and contribute to their development.

Noting that the discussion over this topic of the optimal number of banks in the country has seen a wide variety of views for the last 20 years, how many banks are appropriate for Lebanon when considering all future expectations from our local economic outlook to the global recession, goals of financial inclusiveness and open-banking-related trends of digital disruption?

MB: See [answer to previous question] above.

NG: There is no need to venture onto this obsolete path, as there is no such thing as an “optimal” number of banks. Market forces determine the number of banks in any economy, not theoretical assumptions and abstract notions, and certainly not pervasive opinions about the redistribution of income and about punishing banks because they generate income. A small economy can absorb a large number of banks if it is posting healthy growth rates, if it is attracting capital and investments, if it is transparent and has a developed statistical system, if it has an efficient legal system and its political parties respect and abide by the rule of law, and if it provides the proper investment climate and business environment to encourage investments, risk-taking, and expansion by the private sector. Conversely, a large economy that lacks transparency, that suffers from the government’s intrusion and meddling into the private sector, that endures from a large and costly public sector and inefficient bureaucracy, that applies laws arbitrarily, will not have a developed banking sector and will not attract foreign banks or expertise, and, most importantly, will not gain the confidence of potential depositors and borrowers.

How large do you think the banking sector asset base will be in relation to Lebanese GDP at the end of this year, next year, and five years from now? How many large banks will remain, and how extensive do you expect the branch networks of the largest banks to be by 2025?

NG: It is very ironic that the asset base of the Lebanese banking sector will be large relative to the size of the Lebanese economy at the end of 2020. The banking sector’s assets-to-GDP was about 382 percent at the end of 2019. But despite the ongoing decline in deposits and in credit to the private sector in 2020, and despite the “netting” operation on the assets and liabilities’ sides of the consolidated balance sheet of banks as part of the implementation of international accounting standard IFRS 7 that reduced the assets of banks by about 19 percent year-on-year as at April of this year, the economy is shrinking at a much faster rate.  The sector’s assets have declined by 5 percent in the first four months of this [year and] deposits regressed by 7 percent [whereas] loans shrank by 12 percent in the first four months of 2020. However, preliminary projections show a contraction in real GDP of about 14 percent for this year, but I believe the economy will contract by 18 percent based on the current trends. Still, even with a contraction of 14 percent, nominal GDP will shrink from $52.3 billion in 2019 to about $33 billion in 2020. As such we estimate the assets-to-GDP ratio to reach about 270 percent of GDP at the end of 2020.

Therefore, these facts and figures discredit the theories and statements by some public officials about the large size of the banking sector relative to the size of the economy and of the need to downsize it through a centrally-planned process. Instead, they should spend their time producing a blueprint for downsizing the size of the bloated, inefficient, unproductive, mismanaged, overstaffed, and costly public sector. This is the most important factor and a sine qua non condition to restore the confidence of Lebanese citizens, of the private sector, of the banking sector, of the Lebanese diaspora, and of the Arab and international community.

How do you see the idea that banks should strengthen their “distribution of credit to the private sector”? What needs to be changed in the risk approach to productive sector lending?  

MB: Banks have indeed contributed a lot to supporting the economy and its private sector in difficult times by extending credit. No need to expand further on that, you are right. The government seems to believe that banks have a lot of exposure to BDL, which is an indirect exposure to the state itself. They believe that part of such funds should be allocated to the private sector. However, banks have been very cautious with regards to extending new loans to the private sector in the past couple of years due to the accentuated economic slowdown from 2016 to 2019, and private sector borrowers themselves reduced demand for new loans as they scaled down their expansion plans amidst the prevailing conditions. At the same time, political bickering took a toll on reforms and policy-making and BDL and banks had to come to the rescue of the public sector once again, hence the increased sovereign exposure lately. Once the economic cycle starts again, we would like to lend more to the private sector, but the government needs to create the proper macroeconomic conditions for that.

NG: The notion that Lebanese commercial banks do not lend to the private sector is politically-motivated and displays a deliberate lack of knowledge about the functioning and operations of Lebanese banks, as the numbers speak for themselves. Figures issued by BDL show that utilized credits by the private sector totaled $59.6 billion at the end of 2019, despite a decrease of $10 billion, or 14.3 percent from $69.5 billion at end-2018.

Further, lending to the private sector exceeded 100 percent of GDP, which shows that banks have reached the prudential limit to lend to the private sector relative to the size of the economy. Still, banks would have liked, and still want, to lend even more to the private sector. But the very large size of the informal economy has prevented such lending. According to the IMF’s estimates and to the Central Administration of Statistics’ national accounts, the size of the informal economy is about 30 percent of nominal GDP or about $15 billion based on the size of the economy in 2018.

Last but not least, the executive branch and the political class should realize that they are the reason for the increase in interest rates through politically and electorally-driven decisions that widened the fiscal deficit and increased the borrowing needs of the government. Therefore, a sustained effort to reduce public expenditures drastically is the fastest way to produce market-driven low interest rates, as the current forced and administrative measures to have reduced rates are artificial, temporary, and will not restore the confidence of borrowers.

The vision for the Lebanese economy is to return to growth. Banking has not been mentioned as much as agriculture and industry in this context. In the past, banking had a big role not just in financing of the public and private sector but also in terms of contribution to taxes and employment. How large do you estimate can the contribution of banking to GDP and fiscal revenue be in the future and how does this compare to the average of the five years until 2018? How many jobs will a restructured banking sector provide and how many new hires can be expected from the sector per year between now and 2025?  

MB: A downsized banking sector in a smaller-sized economy will definitely bring some changes. While efforts to promote the primary and secondary sectors of the economy are welcome, and we have been calling for supportive government policies for those sectors for a long time, Lebanon will remain services-oriented to a large extent. Hence, banking and financial services will continue to play an important role in economic activity. However, with much lower banking sector activity and higher corporate tax rates, [the] earnings generation capacity of banks will be affected and their contribution to government revenues will unfortunately be much lower than in recent years. Banks have been one of the most important taxpayers and perhaps because of their transparency, they have been penalized by the government that saw an easy way of raising revenues. Government efforts should be geared toward raising tax collection and fighting tax evasion.

Thomas Schellen

Thomas Schellen is Executive's editor-at-large. He has been reporting on Middle Eastern business and economy for over 20 years. Send mail

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