Banking with a stacked deck

As the bubble forms, Lebanon's economic policy makers look the other way (Photo: Sam Tarling)

By Sami Halabi

The economic implications of going all-in on Lebanon’s banks

If the global financial crisis taught the world anything, it was that the banking world and the real economy are two arms of the same body. But while countries around the world use both those arms to haul themselves out of recession, Lebanon has for years relied almost solely on its banking sector to drag the country’s economy forward.

“The most powerful section with regards to contribution to [gross domestic product] is the banking sector,” says Simon Neaime, professor and chairperson of the economics department at the American University of Beirut. “If the banking sector is not doing well, Lebanon does not do well.”

Luckily for Lebanon, the sector has been performing marvelously as the alpha banks held $122.17 billion in assets at the end of March 2010, according to the Bankdata financial services. That figure represents a 24.7 percent rise in the past year.

This is also significant for the job market, as the banks are currently the largest private sector employer in the country, according to Nassib Ghobril, head of economic research and analysis at Byblos Bank. Indeed, at the end of 2009 the banking sector accounted for nearly 20,000 jobs, a year-on-year increase of 6.2 percent according to preliminary 2009 results from ABL.

This claim may be somewhat undermined by government figures from 2007 which show that the sector only made up some 2 percent of total private sector employment and 1.6 percent of total employment. Current official statistics on Lebanon’s job market are unavailable due to the government’s apparent inability or disinterest in updating figures.

The ability of employees in the banking sector to contribute to GDP through consumption is dependent on their pay, which totaled $667 million in 2008 (ABL’s latest available figure), accounting for 2.4 percent of total real GDP that year. That works out as an average monthly salary of just under $3,000 per employee for that year.

Employee pay is agreed on a yearly basis between ABL and the Union of Syndicates of Bank Employees (USBE), which is under the General Labor Union. The difference between the highest and lowest paid salaries is currently unavailable as the banks keep them confidential, according to George Hajj, president of the USBE.

Profit over productivity

By nature, the primary means by which a banking sector supports the economy is through lending to allow for consumption and/or investment. This creates jobs that contribute to GDP through further consumption and investment.

The most recent consolidated figures from the Banque du Liban (BDL), Lebanon’s central bank, show total lending to the private sector at the end of February reached $33.2 billion from financial institutions, $25 billion of which came from commercial banks.

As per the latest estimates from the Ministry of Finance, GDP in 2009 hit $34.5 billion, roughly comparable to the $31.6 billion of active loans in the economy at the time.

According to Ghobril, when banks decide how much they will lend to each sector of the economy, they look at how much each sector contributes to GDP and allocate their loan portfolio correspondingly. Yet this approach may not be the most conducive to boosting overall output, as banks limit the amount of loans to more productive sectors such as agriculture and industry.

“When banks give out loans they are after profit, and directing those loans to productive sectors in the economy is not a lucrative business,” says Neaime, explaining that these returns take longer to mature, given that it takes time for the borrower to translate the loans into business growth to make repayments; turnaround on consumer loans, among others, is much shorter.

“When you buy a car you contribute to GDP when you make the purchase but afterwards, that’s it,” he adds. “It’s money lost.”

The most recent figures at the end of February showed lending to agriculture at just 0.8 percent of total lending. But there are some extenuating circumstances at play in Lebanon’s agricultural sector.

“You don’t have companies to lend to, you have small farmers,” says Ghobril. As such, lending to a large part of the agricultural sector is included under the classification “individual lending,” which makes up 22.1 percent of total lending.

Agriculture could be seen as a missed opportunity for the banks, given that despite infrastructure constraints, the sector has been growing. According to Bank Audi, during the first quarter of this year agricultural exports hit $48 million, a 38.7 percent jump in value over the same quarter in 2009, with a corresponding 21.8 percent increase in volume, indicating that the higher value traded was attributable to more than just inflation.

Industry takes a larger share of lending, comprising 11.5 percent of total loans at the end of February 2010, down 1.9 percent since the beginning of 2008. Figures provided by Bank Audi would suggest that this sector has also been showing growth potential, with exports up 11.3 percent in the first quarter of 2010 year-on-year.

Industry has its own problems, however, according to Ghobril, who says the sector is not broken down into sufficiently accurate subcategories, or ‘codes,’ to allow the banks to manage their risk portfolio and allocate more loans to encourage growth.

The Ministry of Finance generally lacks a methodical breakdown of each sector’s contribution to the economy in its GDP calculations, though Ghobril says the Central Administration for Statistics (CAS), Lebanon’s official body for statistics, is currently working on a program to unify subsector codes in the economy.

“As banks we don’t know the subsectors of each industry and their exact size or number. There are overlaps between numbers and codes,” he says.

Nader Keyrouz, head of economic statistics at the CAS, says that the unified codes have actually been completed and are in use at the finance ministry, and have been disseminated to the private sector but are yet to be implemented.

More real estate eggs in banks’ baskets

From what is known about Lebanon’s economic sectors, the lion’s share of loans go to real estate. At the end of last February, loans to the sector totaled $12.2 billion when combining loans for construction, housing and rent.

Using the finance ministry’s latest GDP estimate at the end of 2009, loans to the sector amounted to around 33 percent of the economy at the time. Bank loans to real estate have increased 59 percent from the beginning of 2008 to February 2010.

In light of this recent rapid growth in Lebanese bank exposure to the property market, especially given the catalytic role real estate around the world played in the global financial collapse, one might think it prudent for the banks to show restraint in approaching future growth lest this bubble burst, but alas, there is little to be found:

“I am not at all concerned about any real estate bubble in Lebanon… whatever the banks’ exposure,” says Freddie Baz, chief financial officer at Bank Audi.

There is some rationale behind this thinking, as developers can only leverage their projects by 60 percent and the local market is less speculative than, say, Dubai in 2007. But no matter what precautions are being taken, prudence does not seem to be the trend in the market today. During the first four months of this year construction permits hit 5.1 million square meters, 59 percent more than the total issuance of 2009.

Should something trigger price deflation, or if a slowing economy impacts debtor’s repayment facilities, the consequences could spiral.

“I see it backfiring soon,” says Neaime. “I see a bubble forming because the banks are all venturing into that business and inflating prices, and when you do that there is risk of a crash.”

According to Ramco, a local real estate advisory group, in the five years to February 2010, property prices increased some 120 percent on average at the lower end and 150 percent at the higher end.

Debt impediment

It is understandable that banks focus their lending portfolio on the more profitable, transparent, and — at least in the short-term — less risky segments of the economy. After all, it is not the banks’ role to protect the public economic interest. Yet, when it comes to Lebanon, government policy since the end of the Lebanese Civil War has produced a situation where the government and the banks are “co-dependent,” according to Moody’s investor service, and thus there are many in Lebanese society who hold the banks partly responsible for the current debt situation.

Moreover, because liquidity levels are at an all-time peak and interest rates on deposits in local currency are relatively high, continuing to bankroll the government by buying up treasury bills has become a profitable option — even if it means increasing the volume of their exposure to government paper.

“Let’s not fool ourselves, for the time being, with that much in-flow of money and growth in deposits, the Lebanese economy does not have the means to absorb or to use this money,” says George Abou Jaoude, chairman and general manger of Lebanese Canadian Bank. “And the banks do not have a choice but to go into sovereign securities. Of course, we are trying to go into some sovereign tools abroad, but the return is much lower than the Lebanese ones.”

Last year the government paid out $4.27 billion in debt servicing, while total expenditures amounted to $11.6 billion, finance ministry figures show. This means that more than $1 out of every $3 the Lebanese government spent last year went to pay the interest on money the government owes, largely to Lebanese banks.

At the end of March, the latest available figure, local commercial banks held $29.5 billion in claims on the Lebanese sovereign, according to the BDL, while the gross public debt stood at $51.5 billion.

The future amortization schedule of the debt shows that this year the government will need to roll over $11.1 billion in loans; next year it will be more than $12.8 billion.

A crowd is gathering

As any couple knows, honeymoons don’t last forever. And the situation of late has been something of a honeymoon — one where deposits have grown, spurred by the safety and high interest rates that Lebanon’s banking sector offered during the global financial crisis, and its corresponding ability to lend to the growing public and private sectors.

There are signs that the good times may be coming to a close, however, with the International Monetary Fund predicting growth slowing to 6 percent this year and 4.5 percent in 2011. Mild troughs are not a problem in diversified economies — Lebanon’s, however, is not.

Since banks lend to the private sector according to how large it is and slowing economic growth means the same for private sector growth, banks will be lending Lebanese businesses less. The attractiveness of the Lebanese banking sector — and the trend of high deposit growth — may be susceptible to a slowing economy, not to mention the distraction of new investment opportunities abroad being created by the abatement of the financial crisis.

The BDL has also recently eased restrictions on lending to non-residents, making it more attractive for the banks to lend outside of the economy. While Lebanese interest rates are still high compared to global standards, the trend of falling rates could eventually sour the attractiveness of placing deposits in Lebanon.

Last July, interest rates on Lebanese lira deposits stood at a weighted average of 7.02 percent; in March they had fallen to 6.11 percent. Similarly, the weighted average of dollar deposit interest rates fell from 3.19 percent to 2.86 percent. It is apparent that market sentiment still deems these rates attractive, however, as capital inflows rose 65.4 percent in the first quarter of 2010 relative to 2009, totaling some $4.3 billion.

In the 2010 budget proposal the government projects hiking the deficit by 35.5 percent to $4 billion, which, to a large extent, will have to be borrowed from domestic banks.

Furthermore, government contribution to GDP — basically government spending minus debt servicing — is set to increase by 20 percent to $9.12 billion, or 24 percent of the finance ministry’s total estimated nominal GDP for 2010. Ghobril argues that funding GDP increases through public debt is “absolutely not” sustainable and keeps the banks cautious which, in turn, stems economic stimulation through private sector lending.

Neaime says that: “When government spending goes up, interest rates rise and consumption and investment go down because there is a crowding out effect on private consumption and investment.”

“We are already in a problematic situation but we are benefiting from some short-term factors which are contributing positively to the economy,” he adds. “But these are effects that will soon vanish.”

So while things are good now, it would seem prudent for both the banks and the government to address their, and the economy’s, wider structural issues before they find themselves looking back and saying “what if?”

First published in Executive Magazine’s June 2010 Issue

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