The striking thing about the latest consolidated balance sheet of the Lebanese banking sector is the lack of change in its structure. After a period of ten to twelve years at least, assets are still split between cash reserves and deposits at the Banque du Liban (BDL), Treasury bills and other government debt securities, and loans to the private sector. As at the end of 2005, government securities accounted for 25.2% of total consolidated assets, while cash reserves and BDL deposits accounted for 29.2% and loans to the private sector for 23.1%. Foreign assets, which principally include inter-bank deposits with banks abroad accounted for 18.8% and fixed assets for 3.3%.
Funding, as has always been the case for the last 15 years, came principally from customer deposits, which accounted for 72% of total liabilities or interest-bearing funding. Total customers’ deposits, excluding deposits from non-residents, amounted to almost $48 billion by the end of 2005 and to $48.2 billion by the end of February 2006. The customer deposits figure has not increased significantly in the last three to four years, reflecting a sort of optimization of the consolidated balance sheet. Indeed, banks have slowed down their race to attract deposits by offering high interest rates, as placement of funds opportunities are scarce in a very difficult and deteriorating domestic operating environment. Moreover, the Paris II donors’ conference in November 2002 forced interest rates on both assets and liabilities to be decreased. Today, many of Lebanon’s larger banks are offering interest rates on customer deposits which are almost on par with what’s being offered by large international banks in AAA-rated countries. This is mainly due to the gradual rise in US dollar interest rates since 2002, which have today reached 4.75%.
Dollar accounts lose edge
When Lebanese banks offered 4.75% on US dollar savings accounts, the US dollar Libor (London inter-bank offer rate) was slightly below 4% at around 3.5%-3.75%. When the US Federal Reserve raised the US dollar Libor rate to 4.75%, Lebanese banks did not react and kept their own deposit rates relatively unchanged plus or minus a quarter of a percentage point. The compulsory tax on interest rates of 5%, which is imposed by the Lebanese government on both residents and non-resident depositors, brings any rate offered on deposits with Lebanese domiciled banks down to the same level as international rates.
Given the above considerations, a dangerous conclusion for the banks and the country can be drawn: why would anybody keep his savings in a bank domiciled in a B- rated and volatile country, and pay taxes on his interest receipts, when he or she could easily place his/her savings in an international AAA rated bank domiciled in a AAA rated country, get world class service and the same level of interest rates, and not pay taxes? Were a critical number of depositors to realize such a state of affairs, it would be highly likely that the liquidity of some banks may be tested again.
Relying on customer deposits
Lebanese banks seldom diversify their funding and continue to rely on customer deposits, which are nevertheless recurrent in nature despite having on paper an average maturity of 1.5 months. The maturity mismatch that characterizes the Lebanese banking sector does not appear to be a problem, as banks succeed in maintaining and even increasing their deposit base year in and year out. The only problem is that if the country is downgraded or there is a major external blow, such as last year’s assassination of former Prime Minister Rafik Hariri, then interest rates on both assets and liabilities may go up. Given the maturity mismatch, the higher rates on deposits, which have a much shorter maturity than assets, would then have to be implemented immediately, while valuable time would pass before the higher rates on longer assets are received. The ultimate price for Lebanese banks would be to see their profitability affected in the short term, and to witness depletion in equity and provisions, which would be difficult to compensate at a later stage if the interest rate hike is significant.
Straight, plain vanilla bonds accounted for 0.08% of total assets and amounted at year end 2005 to a measly $58.7 million. This is surprising, given the previous success banks had in the international capital markets when they last issued large size bonds back in the late 1990s. It is worth noting that the fact that the Lebanese government is still a frequent issuer of Eurobonds should make the banks equally attractive amongst local and international investors when issuing bonds. Issues of medium to long-term bonds would improve the maturity mismatch of most banks, while this other form of funding could be placed in new, but badly needed projects and/or products.
Medium and small banks clearly lack sufficient capitalization. They have been warned.
The Lebanese banking sector’s equity base has increased by a little bit more than 10% from the end of 2004 to the end of 2005, reaching a consolidated figure of almost $4.3 billion. The same figure has increased by almost 7% in just two months since the end of 2005 to reach $4.6 billion at the end of February 2006. The reason for this rise in equity is partly due to a frenzy of preferred share issues and to capital increases, which were mostly subscribed to by wealthy Gulf investors. Shareholders’ equity also rose because of better than expected profitability for the larger banks which were able to allow for an organic growth of their equity.
Insufficient capitalization
The consolidated equity figure for the banking sector is still regarded as barely sufficient, as reflected by an equity/assets ratio for the whole sector of 6%. With the implementation of Basel II requirements starting in 2008, the domestic banks’ current economic and regulatory capital would not be enough, as Basel II promises to hike risk weighting on assets significantly. For the moment, risk weightings are excessively generous and do not reflect the reality of credit risk in a volatile country such as Lebanon. It is also worth mentioning that from the consolidated figure of $4.6 billion of February 2006, at least $1 billion was accounted for by one bank, BLOM, which is the largest bank in the country. That particular statistic should be considered alarming for the medium and small banks, which clearly lack sufficient capitalization. They have been warned.
