Syria’s financial sector is entering a period of rapid transformation. In the greatest leap forward for financial services in decades, investors will soon be able to trade in equities and bonds. Plans for a Damascus Stock Exchange (DSE) are also at an advanced stage, with the government’s economic reform guru, deputy prime minister Abdullah Dardari, promising the bourse will open its doors before the end of this year (see box). Treasury bills are also being introduced, widening the range of lending instruments available to local financial institutions.

“Syria is opening up every which way,” says Bassel Hamwi, general manager of Banque Audi Syria. “Companies can access finance locally when they have been dependent on outside sources for more than 40 years.”

Key reforms

Banking liberalisation has proceeded steadily since the landmark reforms of 2004. The proportion of assets held by state banks is on a downward trend. At the end of 2007, state banks held 82 per cent of banking assets, but this still represents an easing of the 87 per cent held at the end of 2006, according to independent estimates.

Foreign banks are piling into an untapped market, spreading branch networks across the country in the pursuit of unbanked clients. There are now nine private banks functioning in Syria - not many for a country of 20 million people, but nine more than there were five years ago.

These banks are already feeling the impact on the bottom line. “In most jurisdictions, it takes a few years to start making money,” says Hamwi. “In Syria, the private banks have been doing it from day one.”

Gulf finance houses are moving into the territory with plans to set up Islamic banks, another first for the country’s financial market. Over the past six months, the country’s first two Islamic banks have opened their doors to business: Cham Bank, in which Kuwait’s Investment Dar has a stake; and Syria International Islamic Bank, part owned by Qatar International Islamic Bank. Another six have received licences to operate.

A sustained government push on the regulatory side is reinforcing the appeal of the Syrian financial services sector. Over the past five years, the government has fleshed out legislative frameworks for banking and insurance. Private insurance companies have been able to operate in Syria since 2005 and enjoy more favourable ownership regulations than banks, with 100 per cent foreign ownership allowed, compared with banks’ 49 per cent foreign ownership ceiling.

The liberalisation effort has made it easier to do business. The Central Bank of Syria’s Credit & Monetary Council issued a decree in January 2008 authorising Syrian banks to lend in foreign currency to licensed investment projects. The establishment this year of a hard-currency clearing room that allows automatic conversion of dollars and euros from local currency will also dispense with the time-consuming process of having to conduct business through correspondent banks.

More recently, the central bank has amended its rules on deposit rates, enabling banks to be more flexible in setting rates for deposits. Under the new rules, banks can set rates of 5-11 per cent, depending on the term. Previously, the rate for deposits with a maturity of one year or more was fixed at an interest rate of 9 per cent, with deposits of up to a year drawing rates of 7.5-8.5 per cent.

Helping banks

Like the introduction of treasury bills, this measure is crafted to facilitate long-term deposits and thereby improve the capacity to extend long-term lending. More will need to be done to support this effort, such as relaxing the rules requiring banks to deposit a fixed amount of their capital at the central bank at an interest rate of 0 per cent.

Bankers remain upbeat about the progress of reform, pointing to the impact of the many foreign banks - most of them Lebanese - on the market. “Syria has been opening up its banking and insurance sector at an accelerated pace, propelled by the existence of non-Syrian banks,” says Joe Sarrouh, adviser to the chairman of Lebanon’s Fransabank, which is in the process of rolling out a large branch network across Syria. Two new branches will open in October, to be followed by another seven.

The big three Lebanese banks - Blom Bank, Banque Audi and Byblos Bank - have all expanded their footprints with extensive networks. The largest private bank in Syria is Banque Bemo Saudi Fransi (BBSF), a part-Lebanese-owned institution that has assets of $1.7bn and a 15-branch network. The second largest is Banque Audi, with 14 branches. The total number of private bank branches reached 66 at the end of 2007.

Growth opportunity

There is still substantial room for growth, with a penetration rate of just one branch for every 300,000 people. Banque Libano-Francaise and Bank of Beirut are also intent on establishing branch networks across the country. “Expansion is contagious in Syria,” says Sarrouh.

Adib Mayaleh, governor of the central bank, has won plaudits for his handling of the financial services reforms. “He is flexible and open-minded and knows exactly what to do and over what timeframe,” says Sarrouh. “The central bank feels that it should accelerate the process of reform, but is not pressured to the extent that it is making premature steps.”

But there is still much to do to drag Syria’s financial services sector into the 21st century. Private banks have yet to develop robust loan portfolios, with recent figures from the central bank suggesting that private bank loans equate to just 27.5 per cent of their total customer deposits, compared with state banks, which lend out 74 per cent of their customer deposits. The loan books of private banks amounted to just $1.5bn at the end of 2007.

The lack of opportunities available to foreign banks could change, say local experts. “There is plenty of capital, but it is a question of how to bring it to the market,” says Nabil Sukkar, head of the Damascus-based Syrian Consulting Bureau. “There is still a lot of hoarded money around.”

Private banks handle half the foreign-exchange deposits coming into the banking system, but the limited opportunities on offer have led to a build-up of central bank deposits. There are still too few profitable avenues to put these to good use. According to the central bank’s most recent quarterly bulletin, published in March 2008, private banks hold £Syr130bn ($2.5bn) in deposits.

The completion in late July of Syria’s first major project financing, a $380m facility for France’s Lafarge to finance a cement plant, sets a benchmark for future deals. Banque Audi arranged the structure, which comprises an 18-month bridging loan that will be replaced on maturity by a longer-term loan.

Trade finance is one of the biggest activities for private banks, with retail franchises likely to follow. “Retail will provide a lot of opportunities as there is a real need to finance house and car purchases,” says Hamwi.

A catalyst for the economy

If the authorities meet their aim of establishing the Damascus Stock Exchange (DSE) by the end of the year, investment banks are likely to follow the commercial banks that have beaten a path to Damascus’s door.

The government is preparing the way, awarding a contract to OMX, part of the recently formed Nasdaq-OMX group, to provide technology for the bourse.

Plans for the DSE were first announced in July 2006, but a series of delays - some of which were blamed on a lack of available technology because of US sanctions - stymied the bourse’s trading start-up.

The regulator, the Syrian Commission for Financial Markets & Securities, has published licensing regulations and a code of practice for financial intermediaries. So far, 47 companies have taken the necessary legal steps to list.

“They will probably start with 20-25 companies,” says Nabil Sukkar, head of the Damascus-based Syrian Consulting Bureau. “With T-bills [treasury bills] being introduced, at least they will have something to trade.”

The bourse is likely to attract foreign investors, with Syrian equities likely to be considered under-priced compared with other emerging markets.

But it is local investors who will be the most enthusiastic. Initial public offerings are expected to draw a significant portion of privately stashed Syrian capital into the formal financial sector.

State-owned companies will need to rethink their operations along more commercial lines to make them appealing to potential investors. Private companies will have to publish full balance sheets, thereby making them liable for taxation - a potential disincentive for many. Tax incentives are nonetheless promised to encourage family-owned companies to go public.

The DSE will have a catalytic effect on the wider economy, predicts Bassel Hamwi, general manager of Banque Audi Syria. “It is a signal that there is no going back,” he says. “And people here like to invest in equities.”

The reform effort is still a work in progress. With a fragile political climate and an economy whose main source of income, oil, is steadily diminishing, deputy prime minister Abdullah Dardari needs to fill in the remaining gaps to give the private sector a chance of becoming the engine of growth.

“There is a lot in the pipeline,” says Sukkar. “But we are still a long way from establishing the institutions of a market economy.”