It has been another tough year for Lebanese banks as they struggle to find lending opportunities amid slower economic growth.

Lebanon’s economy has continued to suffer from the fallout from the Syrian civil war, which led the country’s GDP growth to fall to 0.9 per cent in 2013. The conflict, now in its third year, has caused growth to remain at less than 2 per cent for the past three years, compared with about 8 per cent between 2007 and 2010.

The burden of more than a million Syrian refugees in Lebanon, combined with increasingly frequent instances of violence across the country, has caused its trade activities, tourism industry and real estate sector to contract.

Deficit widens

The value of property sales transactions dropped 7.2 per cent in Lebanon last year, while the number of construction permits issued declined 10.9 per cent. Exports fell 12 per cent in 2013, contributing to a 3 per cent rise in the country’s foreign trade deficit to $17.3bn. That is equivalent to 39.8 per cent of GDP.

As foreign investment dried up, lack of progress in these traditional sectors meant the Lebanese economy primarily relied on growth in consumer-related sectors. That came mainly as a result of a larger population rather than increased consumer confidence.

The economic slowdown has affected banks’ ability to find business. The country’s three largest lenders recorded mixed profits in 2013. Bank Audi and Byblos Bank saw profits drop 20.4 per cent and 6 per cent respectively, while Blom Bank’s profit grew 4.9 per cent.

The [Lebanese] banking sector’s deposits are about twice the level of government debt

Standard & Poor’s

Bank Audi’s profit was hit by the operational costs of setting up 20 branches and its subsidiary in Turkey, while Byblos Bank mainly attributed the drop to credit losses. Lenders are generally setting aside more funds for provisions as economic uncertainty could lead to a rise in non-performing loans, which represented 3.3 per cent of total loans in 2013.

Despite the regional turbulence, confidence in the local banking system remained intact, supported by remittances from the Lebanese diaspora and the interest rates banks pay on deposits, according to a report by the US’ Standard & Poor’s (S&P) published in November 2013. Steady inflows from the expatriate community have kept liquidity high and remittances have not dropped during the tougher times in recent years.

“The banking system’s funding profile features a high proportion of retail deposits,” says the S&P report. “We expect the depositor base to remain resilient, as it has done in previous instances of acute turmoil. Banking sector deposits are about twice the level of government debt.”

“Deposits have continued to grow at 8.5 per cent annually, which is more than Lebanon needs. We need deposits to grow 5 per cent per annum to finance the borrowing needs, so we are on the safe side,” says Marwan Barakat, head of research at Bank Audi.

Deposits account for 83 per cent of banks’ aggregated balance sheets, with about 40 per cent of deposits in 2013 from non-residents. An increase of $11.2bn in deposits in 2013 brought the total amount to $136.2bn. The additional liquidity kept loan-to-deposit ratios at just 35 per cent, allowing room for future loan growth.

The combined assets of lenders in Lebanon exceeded $164bn at the end of 2013, with the assets of Bank Audi rising 15.3 per cent, Byblos Bank 8.8 per cent and Blom Bank 4.6 per cent.

Loans grew 9 per cent in 2013 to $3.9bn, aided by government measures to inject more money into the banking system.

Stimulus strategy

Commercial lenders received aid from the central bank in the form of a $1.4bn stimulus package, which allowed them to borrow at an interest rate of 1 per cent provided the funds be used to charge lower rates on the financing of housing, education and renewable energy projects, innovative schemes, research and development ventures, entrepreneurship, and other productive sectors of the economy.

The measure was widely seen as a success. Without the availability of these low-cost loans, Lebanon’s economy would likely have contracted over the past year. That prompted the announcement of another stimulus package of $800m, which includes about 25 per cent in unused funds from the first round and will be made available throughout 2014.

Hopefully the second quarter will be better if the security situation continues to hold as it does today

Nassib Ghobril, Byblos Bank

Public and private sector lending ratios are almost equal, although lenders remain highly exposed to sovereign debt as the banking sector frequently purchases government securities. Government debt represents about a fifth of total banking system assets. In addition, Lebanese banks frequently buy certificates of deposit issued by the central bank, which in turn buys government debt. These certificates represent about a third of lenders’ assets.

Because of this, risk in the banking sector is mainly tied to the country’s public finances, which have become more problematic in recent years. Lebanon’s public debt is bigger than in other emerging markets in the world. At more than 140 per cent of GDP, the figure is very high, but is likely to be kept under control. The country has had a heavy debt burden for the past 25 years as it spent on rebuilding infrastructure following the end of its 15-year civil war in 1990. More pressing is the government’s need to bring down the rising fiscal deficit, which at $1.1bn in 2013 is about 9.5 per cent of GDP.

Fiscal crisis

“Revenue is depressed and expenditures have increased,” says the S&P report. “This is mostly due to an increase in public sector wages after a one-off cost-of-living adjustment in 2012 and increased pension costs due to the rising number of pensioners.

“Personnel cost accounts for more than one-third of expenditures and interest payments are about 40 per cent of revenues. The deterioration in the primary balance highlights the lack of fiscal space; [Lebanon] moved into deficit in 2012 for the first time since 2006.”

If the deficit continues to rise, the government may be forced to tap into international financial markets, where it would potentially have to pay high yields on its bonds. Currently, that is not yet the case – banks have high enough liquidity to absorb the growing debt.

If political progress is made in Lebanon, the tightening of fiscal policy could prevent the situation from further deteriorating. By the end of May, a new president needs to be elected, followed by parliamentary elections in November. That needs to be followed by the formation of another cabinet.

Once a new government is in place, it will need to tackle reforms to reduce public spending, improve the collection of taxes and structural reforms to reduce the public sector’s impact on the private sector. That could also provide a positive catalyst to the rest of the economy. Higher stability could prompt investors to once again deploy funds in the country and convince entrepreneurs to go ahead with their plans to open tourism-related businesses.

“We are still facing some uncertainties as major political deadlines are coming up, so that is causing the private sector to take a wait-and-see attitude,” says Nassib Ghobril, chief economist at Byblos Bank.

“We’ve seen growth of 0.7 per cent in the first quarter of 2014 on an annualised basis. Hopefully, the second quarter will be better if the security situation continues to hold as it does today and if political elections happen on time, we expect to see room for higher growth as the tourism season kicks off in summer.”

But it is likely these events will meet with delays resulting from disagreements among the main political parties. Political progress is stifled by disputes among the groups representing Lebanon’s 18 different religions and sects, with each major faction supporting a different side of the Syrian war. While 8 March’s Hezbollah has sent fighters to support the Al-Assad regime, 14 March is aligned with the Syrian opposition.

Parliament is divided on the election of Samir Geagea, leader of the Lebanese Forces and the only presidential candidate who has stepped forward so far, as well as over other potential candidates. The 10-month process leading up to the announcement of the 24-member cabinet in February, which is headed by Prime Minister Tammam Salam, was another attestation of how little cohesion there is among Lebanon’s political groups.

Until parties have the ability to introduce reforms, much of the responsibility in stabilising the banking sector remains with the central bank. Most of its initiatives revolve around encouraging the private sector to develop more independently. For instance, there are plans to develop the capital markets by privatising the Beirut Stock Exchange and creating financial districts for private equity firms that operate separately from the rest of the system.

Supporting innovation

To further encourage private sector activity, the central bank recently announced that lenders are allowed to participate in the equity capital of start-ups, incubators and accelerator firms, as well as venture capital companies, through interest-free facilities covering up to 75 per cent of their investment. The central bank has reserved $400m to support the creation of business that can help drive innovation.

Lebanon’s problems will need to be tackled one by one in order to bring about improvements in the economy and banking sector. If stability returns, that could attract regional investors and visitors to return to the country.

The Washington-based World Bank’s estimate of economic growth at 1.5 per cent this year shows there is confidence that current circumstances may improve. Unless the security situation drastically deteriorates, the banking sector will likely continue to hold up with the support of the government and the Lebanese diaspora across the globe.