Bad loans threaten finance sector in Syria

01 August 2013

Syria’s banking sector is confident of survival in the short term, aided by a sympathetic central bank and adequate levels of liquidity, but non-performing loans are rising sharply

Just a few years ago, as Syria’s financial system gradually opened up, Lebanese and Gulf banks were ploughing into the market in search of lending opportunities in a largely immature market, resulting in 11 of Syria’s 20 banks having substantial overseas holdings.

Now, these same banks are having to write down huge losses on their Syrian exposures, as more than two years of intense civil conflict exact a painful economic price. The Syrian pound has plummeted in value, economic activity is stagnating and few firms are daring to make any long-term investments in the country. With the economy in virtual lockdown, banks are feeling the impact as keenly as anyone.

The depreciation of the currency, which in late July was averaging £Syr200 to the dollar, compared with £Syr50 at the start of 2011, is symptomatic of the economic crisis confronting Damascus. However, the Syrian pound’s slide has actually provided some respite from the gloom for the country’s financial sector.

Unrealised gains

Estimates suggest the continuing depreciation of the Syrian currency has led banks to record more than £Syr14bn in unrealised foreign currency revaluation gains, helping to mask the difficulties and losses they faced in 2012.

“With a sympathetic central bank, lenders can survive for a very long time even though they are clearly insolvent”

Andrew Cunningham, Darien Analytics

“When the pound devaluates, banks record unrealised gains on all their foreign currency assets,” says Joude Badra, deputy head of investment banking at Bemo Saudi Fransi Finance (BSFF), the investment arm of Syria’s second-largest private bank by assets. “So, whatever dollars they have, they multiply them by a higher rate and profit on the difference that is recorded. However, this is all paper profit. Take out those gains and the 14 private sector banks lost £Syr10bn in 2012.”

If the currency gains are excluded, the picture is indeed far bleaker for lenders. Of the 14 private banks, only Syria International Islamic Bank (SIIB) – founded by Qatar International Islamic Bank – broke even in 2012. Aggregate losses totalled almost £Syr10bn, notes BSFF in a report on Syria’s banks issued in June.

The evisceration of the economy is the driver behind these losses. According to the Washington-based World Bank, gross domestic product contracted by 30 per cent last year, and it anticipates another 10 per cent drop in 2013.

“Banks are posting losses and that is primarily related to minimal lending opportunities and high provisions associated with non-performing loans (NPLs),” says Badra. “They aren’t willing to lend, but are still paying higher interest rates on their deposits, after the Central Bank of Syria (CBS) raised the rates in 2011 to encourage people to keep Syrian pounds.”

In May 2011, as the uprising against President Bashar al-Assad’s regime gained traction and the sanctions noose on Syria tightened, the CBS raised the interest rate on term deposits by 2 percentage points to 9 per cent. This may have prevented a more devastating loss of confidence in the pound, if only temporarily. By mid-June of this year, the pound had slipped to a new low of £Syr220 to the dollar, as Syrians desperately tried to sell down their holdings of local currency. After two years of war and reduced earnings, the government lacks the foreign exchange reserves to prevent damaging runs on the currency.

With banks forced to pay more on deposits while enjoying fewer lending opportunities – and receiving lower fee and commissioning income due to weaker economic activity – their finances are feeling the impact.

Furthermore, the costs of doing business in Syria have spiralled. The logistics of transferring cash between branches are difficult and expensive, particularly in areas where regime control is minimal. There have been at least 10 significant bank raids in the past two years. Lenders now also have to spend more on ensuring employee security. “It’s a lot harder to operate now as banks need extra security in moving cash from branch to branch, and there are higher insurance costs too,” says Badra.

Bad loans

By far the biggest drag on the bottom line is the significant rise in NPLs. According to BSFF, NPLs have continued to increase as a proportion of total loan books, with the average ratio at the end of 2012 more than 23 per cent (compared with 6.6 per cent a year earlier). Syria recorded provisions of more than £Syr16bn in 2012, up from £Syr6.6bn in 2011. It is unclear what proportion of these NPLs banks will be able to recover, given the uncertainty surrounding the state of the collateral backing many of these loans.

“NPLs range between 20-40 per cent for private banks, and there was a big increase in reported NPLs at the end of 2012,” says Andrew Cunningham, founder of Darien Analytics, a UK financial consultancy. “Bankers were playing wait and see in 2011, but by 2012, it was clear they would have to hike provisions.”

The average NPL ratio for the 14 non-state lenders was 23 per cent at the end of 2012, but some are showing rates as high as 40 per cent – getting perilously close to having the majority of their loan book damaged. The level of provisioning by Syrian banks is likely to have underestimated the true amount of bad loans, as bank chiefs engage in financial engineering that prevents loans from being considered as NPLs – thereby enabling them to overstate recorded interest income. One technique being deployed by banks involves transforming three-year loans into six-year loans, while waiving some of the fees to clients. 

The longer-term concern is that the capital levels of Syrian lenders will simply be insufficient to deal with the full extent of the bad loans when they are revealed.

Capital levels

For the moment, though, capital levels seem to be sufficient. Qatar National Bank Syria (QNBS) has the highest capital of all Syrian lenders, at £Syr15bn at the end of 2012, comfortably ahead of the next highest, SIIB at £Syr8.5bn. But smaller banks, or those that entered the market later, such as Al-Baraka Bank Syria, Bank of Jordan-Syria, Fransabank Syria, QNBS, Syria Gulf Bank or Bank al-Sharq – deemed ‘beta banks’ – are not necessarily in a weaker position than the more established ‘alpha banks’. The beta banks recorded a 21 per cent increase in assets in 2012, compared with just 3 per cent for the alpha banks.

“Smaller banks may have smaller capital buffers, but they also have smaller exposure to bad loans,” says Badra.

Private lenders will not face the same solvency challenges as state-owned banks in Syria, says Cunningham: “It’s not as though they need a lot of capital to do business these days.”

Public lenders, such as the sanctions-targeted Commercial Bank of Syria, have no recent financial results to assess, but are estimated to account for more than two-thirds of the country’s total banking assets. The state banks are also likely to be suffering significant damage to their loan books, but their immediate future is not in doubt.

“With a sympathetic central bank and sympathetic accountants, banks can survive for a very long time even though they are clearly insolvent,” says Cunningham. “Syrian lenders – especially the state-owned ones – do have a sympathetic central bank.”

Another reason why bankers have not yet hit panic mode is that the sector is still small and the collateral damage is concomitantly limited. A Darien Analytics report released in July says that with assets of about $47.7bn at the end of 2010, Syria’s banking sector represented just 2.1 per cent of the assets of all commercial banks in the Middle East. Banking failures are not going to tarnish institutions across the region.

There are other reasons for the Syrian banking sector’s confidence. Liquidity in general is fine at the moment, says Badra: “At BSFF, 30-35 per cent of our assets are liquid.”

Looking ahead, the main priority for banks is to control losses, serve existing customers, maintain liquidity and preserve shareholder capital. This is easier said than done.

“There is still economic activity in Syria, but there’s no durable investment – there’s no capital expenditure, and companies aren’t expanding, so there’s no project or corporate finance,” says Badra. “But there’s still 20 million people that need to eat, drink and consume, so there are some sectors, such as fast-moving consumer goods and healthcare, that are still working.”

Some lines of business persist, such as short-term lending and trade finance. Banks are also continuing to service their pre-crisis loan books. The financial community is also drawing solace from the remarkable performance of the Damascus Securities Exchange (DSE), which has emerged as one of the region’s best-performing bourses this year. 

By 10 July, the DSE main index was up 57 per cent on the start of the year, at 1,210 basis points. Although this effect is partly a reflection of a low base relative to pre-crisis levels, it is substantially higher in 2013 than in 2012.

Thriving bourse

There has been renewed interest in the market this year and more so in March and April, again primarily driven by the accelerating depreciation of the Syrian pound. “The pound was trading at $100 in March and went up to $300-plus at one point, although it has dropped since,” says Badra. “Investors are looking at stocks as a hedge for their Syrian pound assets, since the real estate market is inactive and bank deposits are paying 8-10 per cent.”

The market has returned 45 per cent over the past three months, so it has offered at least partial protection against the devaluation of the Syrian pound and in dollar terms, stock prices today offer substantial upside should they recover to anywhere near their pre-crisis dollar-equivalent levels.

According to Badra, there is substantial interest from large institutional players (particularly insurance firms) that are very liquid in Syrian pounds and have no options to deploy the currency other than in bank deposits – they are not allowed to buy foreign exchange, metals and others – so they are also investing heavily.

Syria’s financial community will continue to batten down the hatches. A reckoning is inevitable at some point and many institutions are unlikely to escape the consequences. But, for the moment, bankers will seek to make the best of a bad situation.

Key fact

The depreciation of the Syrian pound has led banks to record more than £Syr14bn in unrealised foreign currency gains

Source: MEED

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