Lebanon’s banks enjoyed a profitable 2010, with a growing economy backed by rising confidence and large capital inflows. The economy expanded by 7.5 per cent in 2010, which helped the banking sector maintain a robust performance.

Bank deposits grew by 10 per cent and exceeded $110bn at the end of 2010. Credit to the private sector reached an unprecedented $36bn and the average capital adequacy ratio of Lebanon’s banks increased by more than 12 per cent. Total assets reached $128.9bn at the end of 2010.

Even with an environment affected by a global financial crisis, tight interest rate spreads and political tensions, the country’s three largest banks - Blom Bank, Bank Audi and Byblos Bank - managed to earn $861.3m in profits combined in 2010, an increase of 18.4 per cent on the previous year. Bank Audi’s profits rose the most, climbing 21.9 per cent to $352.2m.

Sovereign ceilings

In April 2010, US ratings agency Moody’s Investors Service upgraded the constrained long-term foreign currency deposit ratings of Blom Bank, Byblos Bank, Bank Audi and Bank of Beirut to B1 from B2. The outlook on these ratings remains stable.

The decision was prompted by an upgrade of Lebanon’s sovereign ceilings. The sovereign upgrade reflected the sustained improvement in the country’s external liquidity position.

While the results of 2010 were overall positive for the banks, the sector is showing signs of slowing down amid political uncertainty in the country and the unrest that has swept across the Middle East.

The ongoing delays in the formation of a new government poses a risk to the growth of Lebanon’s economy, which already suffers from high public debt and a rising yearly budget deficit.

“The delays in the formation could place a hold on many business activities, affect the flow of foreign direct investments (FDI) and slow the flow of remittances,” says Mohamed Ali Beyhum, executive general manager at Bank Med.

Out of 53 commercial banks operating in Lebanon, 44 are Lebanese, making for a very competitive market. With the blessing of Banque du Liban, the central bank, these Lebanese banks have over time expanded outside the country.

Unlike other countries in the Middle East, domestic banks’ exposure to the sovereign in Lebanon is very high, reaching 56 per cent of the consolidated balance sheet as of March 2010. Avoiding exposure to this risk has also pushed many operators abroad.

Lebanese banks enjoy a presence in 31 countries through subsidiaries, direct and indirect branches, and representative offices. This foreign presence is heavily focused on the Middle East, particularly Syria and Egypt, and first-quarter results indicate a negative impact of the current political turmoil.

“Political events have … increased uncertainty, but the extent of the short-term impact has yet to crystallise”

Stathis Kyriakides, Moody’s

“What was previously considered an opportunity - regional diversification - has become a key challenge. The banks must manage their exposures, normalise relationships with their clients abroad and ensure that any financial loss is minimised so that their group balance sheets are not harmed,” says Stathis Kyriakides, an analyst at Moody’s.

The operating environment is becoming increasingly tense. The Washington-based International Monetary Fund (IMF) has revised down its gross domestic product growth forecast for Lebanon to 2.5 per cent for 2011 from 4.5 per cent. The IMF also downgraded its 2011 growth forecast for the Middle East and North Africa region as a whole to 4.1 per cent in light of decreased inflows, FDI and tourists.

Fostering liquidity

“Political events have clearly increased uncertainty, but the extent of the short-term impact has yet to crystallise as the situation continues to remain fluid,” says Kyriakides.

“If political conditions in Lebanon permit, the sector could … reap benefits from what is going on in the region”

Mohamed Ali Beyhum, Bank Med

These indicators have pushed the banks to adopt a wait-and-see attitude, focusing more on fostering liquidity, reducing loan exposures and controlling operating expenses. The potential decrease in the flow of remittances as a result of the return of migrant workers to Lebanon could become a further challenge. Remittances is one of the biggest forms of income for Lebanon and is key in bolstering the strength of the Lebanese banks. In 2010, remittances stood at $8.2bn, about 7.7 per cent of total deposits.

“So far, we have not experienced an exodus of Lebanese migrant workers from countries witnessing unrest, but it could pose an additional challenge. We anticipate remittances in 2011 to drop slightly when compared with 2010,” says Beyhum. Since the highest share of remittances comes from the 25 per cent of Lebanon’s working population that live in the GCC, the impact should not be too severe.

Lebanon’s banking sector grew by 2.8 per cent in the first quarter of 2011, slower than the same period in 2010. Total assets reached $132.5bn in the first quarter of 2011, compared with $119.9bn in the first quarter of 2010.

Contingency plans

The main source of funding for Lebanese banks is customer deposits, which accounted for 82 per cent of total assets at the end of March 2011, or $941m, a modest rise of 0.9 per cent since the fourth quarter of 2010.

Loans to the private sector stood at $31bn in March 2011, or an increase of 20 per cent when compared with the same period in 2010. While these results are relatively modest, it is commendable in light of the continuing uncertainty in the region.

“The luxury that Lebanese banks have is experience in uncertainty,” says Freddie Baz, chief financial officer and director of strategy for Bank Audi. “We have had wars, political insecurity and upheavals in Lebanon, so have learnt from these experiences and have developed sophisticated contingency plans.”

It was contingency plans that ensured minimal impact and it is the level of sophistication and experience in the sector that has seen several Lebanese banks venture into Iraq to establish a presence.

“If the political conditions in Lebanon permit, the sector could potentially reap great benefits from what is going on in the region, by attracting large inflows of capital that is escaping from the troubled countries. This has not happened yet, but it may still do, given the banking sector’s reputation and strength at the regional level,” says Beyhum.

The global economic crisis that shook the GCC particularly badly led to high inflows of deposits for Lebanon. According to one analyst, Lebanese banks were struggling to find where to invest these deposits.

“Over the short term, Lebanese banks are likely to become more conservative until political uncertainty subsides,” says Kyriakides. “In the longer term, and depending on how things evolve, regional markets may once more present interesting opportunities for Lebanese banks. Domestic consolidation may also provide opportunities to establish larger Lebanese banking groups better placed to compete regionally.”

The regulatory bodies have made it clear they want consolidation in the sector, but only for the smaller banks. When this consolidation will take place is unclear. The Central Bank, in particular, has been pushing for it over the past 10 years, but there has been little commitment due to the unstable environment.

Speaking at a conference in Beirut in early May, central bank governor Riad Salameh announced that the sector might increase its solvency ratio to 10 per cent within the next four years to meet Basel III standards. The move will help boost liquidity in global markets. The solvency ratio currently stands at 7 per cent, borne from years of conservative banking policies, which helped the sector to weather the global financial crisis and the country’s ongoing political problems.

Salameh also said loan provisions would rise to 2 per cent, and that the Central Bank would begin to urge banks to cut dividend distribution by no more than 25 per cent of their profits and capitalisation.

In February, the sector was also rocked with allegations of corruption when Lebanese Canadian Bank (LBC), the country’s eighth-largest bank, was accused of money laundering and connections to terrorist group Hezbollah. The bank has more than $5bn in assets.

According to a statement issued by the US Treasury department, LBC became a primary concern due to “the bank’s role in facilitating the money-laundering activities of an international narcotics trafficking and money laundering network.”

“This network moves illegal drugs from South America to Europe and the Middle East via West Africa and launders hundreds of millions of dollars monthly through accounts held at LCB, as well as through trade-based money laundering involving consumer goods throughout the world, including through used car dealerships in the United States,” the statement read. The US authorities estimated $200m was being laundered a month.

More disclosures

LBC’s chairman, Georges Zard Abou Jaoude, denied the accusations, but in March the bank was put up for sale in a bid to shield the sector’s reputation. The same month, the Lebanese subsidiary of France’s Societe Generale agreed to a merger. The incident was written off as an isolated event, but has increased worries that other banks could fall under the wrath of US authorities.

More regulatory disclosures are expected over the next couple of years from the Central Bank and the Banking Control Commission to maintain the sector’s strength.

Financial results for 2011 are expected to show a deterioration due to lower growth, higher provisioning requirements and possibly margin contraction. But even if the regional unrest creates additional non-performing loans, compared with the overall balance sheet of the groups and earnings capabilities, this will largely be manageable for banks in Lebanon.