Sometimes there are advantages to living in a region with a history of instability. Beirut’s banks, whose combined assets are three times larger than the country’s gross domestic product (GDP), have long been forced to maintain high levels of liquidity as a response to the country’s volatile operating environment.

This has afforded them an added buffer to withstand the problems of the global credit crisis better than other banks in the region. The banking system is highly liquid, supported by the sustained confidence of the Lebanese diaspora, which has maintained a strong inflow of remittances throughout the past two years. Deposits account for 80 per cent of Lebanese banks’ capital bases.

Strong profits for Lebanese banks

That the banks are both liquid, well-capitalised and able to attract significant customer deposits from abroad, has helped them to avoid relying on the interbank market, which lay at the epicentre of the global crisis. Even the more recent Eurozone crisis has had little impact in Beirut.

Lebanese banks do not have significant exposure to the sovereign or corporate securities of the affected economies, while deposits in euros account for only 10 per cent of aggregate foreign currency deposits at commercial banks in the country.

The latest figures reveal a banking system in a good state of health. By the end of February, customer deposits had increased by around 20 per cent year-on-year, while total assets reached $118.3bn, a 24.4 per cent rise on the year-earlier period. Bank assets have continued to grow in 2010, reaching $120bn at the end of March, representing an increase of 4 per cent from the end of 2009.

Lebanese banks have also recorded strong profits. Financial results issued by the five banks listed on the Beirut Stock Exchange reveal combined profits reached $812.6m in 2009, an increase of 18.5 per cent on 2008. The largest banks – Blom Bank, Byblos Bank and Banque Audi – reported a near 20 per cent increase in profits in 2009. Audi showed the strongest improvement, with profits rising by 21.4 per cent to $288.9m.

“The overall profits of the banking sector have increased 20 per cent to $1.2bn last year,” says Nassib Ghobril, head of research at Byblos Bank. “That’s not bad and the profitability ratios are acceptable – 15.5 per cent return on average equity and 1.2 per cent on return on average assets. In the first quarter, we’ve seen an increase in profits of listed banks and a 30 per cent increase of the top 11 banks.”

Other key indicators are also positive. Blom Bank posted the lowest loans-to-deposits ratio at 22.6 per cent in 2009, followed by Banque Audi with a ratio of 28.8 per cent, compared with 34.8 per cent at end-2008.

Blom Bank also boasts the strongest loan quality with a non-performing loan (NPL) ratio that is lower than the sector average. Banque Audi’s NPL ratio and provisioning charges increased in 2009, but the quality of its credit portfolio is sound and provision coverage is at a comfortable level. 

Much of the strong profit showing is due to higher investment income, but net interest margins have been under pressure more recently. The reason, says US ratings firm Moody’s Investors Service in a June 2010 special comment on Arab banks, is that a more stable operating environment has encouraged customers to take advantage of the interest rate differential between the dollar-pegged Lebanese pound and the dollar.

Consequently, the dollarisation of deposits has been declining with a shift towards higher interest-bearing local currency deposits, while loan dollarisation has remained relatively stable. The average interest rate on new or renewed Lebanese pound-denominated deposits at commercial banks was 6.11 per cent in March 2010, whereas the average interest rate on new or renewed dollar-denominated deposits was 2.86 per cent.

“The high interest rate differential between rates given on deposits in Lebanon and global interests rates is the main reason for the high deposit inflows,” says Ghobril. “It’s not altruism by the diaspora, it’s a rush to pick up the differential.”

Lebanese banks show slower growth

Despite a post-Lehman dip in deposit inflows, Lebanese banks managed to attract an impressive $1.5bn a month in funds last year. Deposits denominated in Lebanese pounds reached $36bn by March 2010, up 38.6 per cent year-on-year, while deposits in foreign currencies reached $62.1bn, up 13.9 per cent from end-March 2009.

However, there are some risks clouding the sector’s outlook. Margins are coming under pressure because of the increased level of liquidity. “Increased Lebanese pound liquidity is forcing interest rates to come down and this is squeezing margins, making it possible that the rate of profit growth will slow in 2010,” says Morris Helal, senior bank analyst at the Cyprus-based rating agency Capital Intelligence. “At least, based on the first quarter results we’ve seen, there has been some downward pressure on margins and hence profit growth will not be as strong as before.”

Profitability will also be undermined by the fact that a large proportion of banks’ balance sheets remain invested in lower-yielding liquid assets. In the months ahead, high exposure to government securities will continue to constrain the banks’ capacity to diversify revenue sources, says Moody’s.

Commercial banks accounted for about 59 per cent of the total public debt at the end of March. Lebanon’s gross public debt reached $51.5bn that month, a 7.4 per cent increase from the end of March 2009.

“The asset base of Lebanese banks as a group remains characterised by a high concentration of assets to the Lebanese sovereign in the form of government securities (including dollar-denominated euro bonds), treasury bills and central bank CDs [certificates of deposit]” says Helal. “Thus, as the largest holders of Lebanon’s government debt, local lenders play a key role in financing the country’s budget deficit.”

So far, banks have not encountered problems rolling over the debt. Although Lebanon’s debt-to-GDP ratio has declined in recent years, it remains among the highest in the world, at 148 per cent in 2009, far exceeding Greece’s 115 per cent debt-to-GDP ratio. Furthermore, the government unveiled some ambitious spending programmes in its 2010 budget, which could drive up the fiscal deficit.

Banks are concerned that the government is spending too much, placing more of a burden on them to underwrite state profligacy. The cabinet is under pressure to disburse funds to development schemes favoured by influential political factions. The Finance Ministry’s preliminary projections for the 2011 budget estimates overall spending at 34.2 per cent of GDP.

“The main risk remains exposure to the sovereign and we are surprised at the expansionary 2010 budget, which requires the government to continue borrowing large amounts and therefore continuing the cycle of government borrowing and dependence on the banking sector,” says Ghobril. “Banks are reluctant and concerned about this trend.”

This exposure remains a cause for concern given the size of the state’s debt and the lack of real progress on economic reform.

Banks have few options at their disposal to deal with this. They can continue receiving diaspora deposits and finance the public debt, but the room for growth in a small domestic market is limited.

Overseas expansion

One key strategy is to deploy their balance-sheet to help grow in neighbouring countries – the key trend of the past five years. Lebanese banks have expanded into markets, including Syria, Jordan, Egypt, and Turkey, and locations increasingly further afield.

The top-tier banks have made the strongest impression in overseas markets. Byblos Bank’s strategy has been to diversify sources of income by expanding in selective markets with strong economic growth and low levels of banking penetration, with the aim of having at least 40 per cent of its revenues and assets overseas. This will help mitigate its high exposure to Lebanese sovereign debt.

Its ambitious overseas expansion saw the bank open a branch in the Democratic Republic of Congo this year, the first Lebanese bank to enter the market. Byblos acquired local bank Solidaritie Banque International.

It was also the first Lebanese bank to have a presence in the Iraqi capital Baghdad, opening a branch in the capital of the Kurdistan region, Erbil in 2007. The expansion in Iraq falls within the group’s strategy of asset diversification and moving into emerging markets and developing economies. Byblos also has a presence in Syria, Sudan, the UAE, Nigeria and Armenia,

“The objective of banks expanding abroad is to have around 40-50 per cent of revenues and profits generated from foreign markets in the next three to five years. We started off in Egypt, the Gulf, Jordan and Syria, but now we are looking at Africa, opening in Senegal and Gambia, but the push is not limited to Africa,” says Ghobril.

Overseas expansion, together with the funding of government paper, has put limits on bank lending to the local private sector. Private sector lending has increased, but from a low base and still represents a small proportion of total assets at around 20 per cent. Despite a 13.3 per cent increase in loans to the private sector in 2009, amounting to $28.4bn, this is still low by regional standards.

“Lending has picked up this year on the non-resident level and we see that reflected in the numbers and it continues to pick up here, especially at the retail level,” says Ghobril.

Consolidation

Another key challenge is consolidation, a continuing question in a country that has more than 50 banks servicing a population of little more than 4 million. The central bank, Banque du Liban, is putting pressure on smaller banks to consider mergers with larger rivals, but the turbulent global events of the past two years leave little impetus for major mergers among leading banks. Central Bank Governor Riad Salameh has stated he will oppose any merger between the top 11 banks in the country, due to concerns about creating institutions deemed “too big to fail”. 

But despite some pressure on margins and slower deposit inflows, Lebanese banks have good reason to be optimistic about their prospects in 2010. Funding the large public debt provides a steady income stream, and their growing overseas presence provides for a diversification of revenues when lending opportunities in the domestic economy are limited.