LEBANON BANKING INDUSTRY

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1 TABLE OF CONTENTS Executive Summary 1 Activity Growth 2 Activity Concentration 3 Geographic Diversification 4 Sovereign Exposure 5 Liquidity Risk 5 Exchange Rate Risk 6 Interest Rate Risk 7 Equity Market Risk 7 Credit Risk 8 Capital Adequacy 9 Cost Efficiency 9 Profitability and Return 10 Fundamental Market Value 11 Concluding Remarks 12 CONTACTS Research Marwan S. Barakat marwan.barakat@banqueaudi.com Jamil H. Naayem jamil.naayem@banqueaudi.com Fadi A. Kanso fadi.kanso@banqueaudi.com Lea R. Korkmaz lea.korkmaz@banqueaudi.com INDUSTRY THE BLESSINGS OF A RIGOROUS RISK PROFILE Dynamics converging to moderate growth performances Lebanon s banking activity is displaying favorable performances on the whole, underlined by moderate deposit growth along with increasingly significant lending growth on the background of large financial flexibility. A consolidated activity growth of 11.7% was recorded in 2010, although it is lower than the 21.7% registered in 2009 when Lebanon had benefited from the global crisis effects with its financial sector perceived as insulated from the spillovers of the global turmoil. Growing foreign dimension though still representing low share in consolidated activity The growing diversification of Lebanese bank activities by markets of presence has started to show preliminary results on their balance sheet building and revenue and income generation. But despite the recent cross border expansion efforts, the domestic component of Lebanese banks activity is still highly dominant. The mild increase in foreign entities shares (to circa 15%) over the past few years is partly related to the considerable growth in the domestic market itself that outpaced growth in regional markets. Steadily declining State exposure in relative terms Although the domestic exposure to sovereign debt still weighs on the Lebanese banks activity profile, it has been on a declining trend in relative terms in recent years. The aggregate portfolio of sovereign bonds in foreign currency held by banks as a percentage of their deposits in foreign currency reported its record low for more than a decade, reaching 16.6% in The ratio of sovereign bonds to shareholder equity reached 102.0% in 2010, bearing witness to a gradually improving trend since the early 2000s. A burdening negative interest carry on a highly liquid position Banks operating in Lebanon remain considerably liquid, as witnessed by their comfortably high liquidity levels (FC primary liquidity at 51.5% of FC deposits). Maintaining high primary liquidity recently had its relative cost in terms of negative carry on liquid placements as a result of the drastic drop in reference rates. While banks have tried to corolarily decrease their cost of FC deposits through cuts in deposit rates, this was obviously not enough to compensate for the drastic drop in their yield on FC liquid uses. Asset quality sustaining its year-on-year improvement trend Lebanese banks asset quality metrics are quite satisfactory and continue to post steady improvement. The ratio of doubtful loans to total loans reached a historical low of 7.0% at end Provisioning levels are adequate, with the ratio of loan loss provisions to doubtful loans at 92.5%. When considering net of provision figures, the ratio of net doubtful loans to gross loans reported a mere 0.5% in 2010, a record low in the recent history of the Lebanese banking sector. Satisfactory capital adequacy in the absence of excessive leverage In parallel, Lebanese banks have a good capitalization level. Reflecting an adequate coverage of credit, market and operational risks, the banks consolidated Basel II capital adequacy ratio reported 13.0% at end-2010, well exceeding regulatory requirements of 8%. At the mirror image of capital adequacy is leverage, whereby comparative analysis suggests Lebanese banks have somehow acceptable leverage (11.2x) when compared to international benchmarks. Sound earnings growth despite tough operating conditions Amid rather difficult operating conditions, a healthy 27.4% rise in consolidated net profits of Lebanese banks was registered over the past year, outpacing asset and equity growth. As such, the return on average assets rose by 11 basis points to 1.24% in 2010, while the return on average equity rose by 96 basis points to 13.90%. Beyond the temporary effect of the current regional turmoil on newly established Lebanese bank subsidiaries, financial intermediation prospects in the region remain sound in the middle run, apt to have positive spillovers on Lebanese banks revenue generation in years to come. The following banking sector research is based on consolidated Lebanese banking figures as at end-2010 as provided by Bankdata Financial Services. It aims at an in-depth analysis of Lebanon s banking industry, with a thorough investigation of banks performance drivers, their current financial standing and their overall risk profile. Bank Audi sal - Audi Saradar Group - Group Research Department - Bank Audi Plaza - Bab Idriss - PO Box Lebanon - Tel: research@banqueaudi.com 1

2 ACTIVITY GROWTH Dynamics converging to moderate growth performances Amid prevailing domestic and regional economic conditions, Lebanon s banking activity displayed favorable performance underlined by moderate deposit growth and strong bank lending. Total sector activity, measured by the aggregate domestic assets of banks, grew by US$ 16.3 billion in 2010, compared to a growth of US$ 24.6 billion in 2009 and an average yearly growth of US$ 10.2 billion in the previous five years. An activity growth of 11.7% was recorded in 2010, against 21.7% in 2009 within the context of contracting financial inflows from a record high base year in 2009 when Lebanon had benefited from the global crisis effects which saw depositors increasingly seek safe banking environments and with Lebanon perceived as insulated from the spillover effects of the global turmoil. The analysis by group of banks shows that sound growth was accounted for by the different bank groups though at different paces. Bilanbanques divides the banking sector by size into four groups, the first being the Alpha Group (Banks with customer deposits above US$ 2 billion), the second the Beta Group (Banks with customer deposits between US$ 500 million and US$ 2 billion), then the Gamma Group (Banks with customer deposits between US$ 200 million and US$ 500 million) and finally the Delta Group (Banks with customer deposits below US$ 200 million). The fastest activity growth rate was accounted for by the group of medium sized banks, with the Beta group displaying a growth rate of 18.0%, versus 11.1% for the Alpha Group, 9.4% for the Gamma Group and 12.8% for the Delta Group. Customer deposits continued to be the major driver of banking sector activity growth last year. Lebanese banks are considered deposit-rich banks as the deposit base constitutes 83% of their total funding at large, against 68% for the MENA region, 66% for emerging markets and 68% for the global average at large. It is important to bear in mind that the deposit-rich profile of banks pays in tough times such as the one the World has recently gone through, as customer deposits represent a much more stable funding base than all other sources of market debt funding. Customer deposits grew by 12.4% in 2010 to reach US$ billion at end-december While the US$ 14.2 billion deposit growth registered last year is by itself quite healthy compared to historical trends, it turned out to be 34% lower than that of 2009, which had witnessed unusually high inflows of deposits into the Lebanese banking sector. The growth in customer deposits in 2010, mostly accounted for in the domestic market, is still believed to be more than sufficient to cover all the economy s domestic financing needs in its private and public sector components, while continuing to nurture the healthy liquidity position of Lebanese banks at large. 2

3 The growth in the Lebanese banking sector was not at the detriment of its risk profile which continues to display sound risk exposures and coverage within the context of rigorous risk management. An indepth analysis of the various types of risk, from concentrations risks to exchange and interest rate risks, to liquidity and capitalization risks, to credit and sovereign exposure risks, to profitability and efficiency risks thus follows. ACTIVITY CONCENTRATION Extensive concentration in large banks though slightly less last year While the year 2010 reported a slight retreat in the deposit share of the Group of Alpha banks to the benefit of the Group of Beta banks, banking activity continues to be significantly concentrated. The former Group s share slightly declined from 87.6% in 2009 to 87.4% in 2010 and the latter group s share slightly rose from 9.5% to 9.8%, while the shares of Gamma and Delta groups remained constant at 2.1% and 0.7% respectively. Similarly, the Herfindahl index, also known as the H index, which measures the concentration of banks within the industry, has slightly declined from 9.19% in 2009 to 8.86% in 2010, suggesting a relatively lower concentration level though still high by comparative standards. The strong activity concentration in Lebanon gives large banks a greater control over their operating conditions. In an environment of declining rates, the analysis of cost of funds by group of banks suggests that Alpha banks reduced their cost of deposits at a higher pace than other bank groups, with the Alpha Group cost of funds dropping by 44 basis points, while the Beta Group cost of funds contracted by 22 basis points. The Gamma Group cost of funds dropped by 37 basis points, while the Delta Group cost of funds contracted by 28 basis points. Source: Bankdata Financial Services wll 3

4 GEOGRAPHIC DIVERSIFICATION Growing foreign dimension though still representing low share in consolidated activity The growing diversification of Lebanese bank activities by geographic location and markets of presence has started to show preliminary results on their balance sheet building and revenue and income generation. The geographic diversification mainly targets countries in a MENA region characterized by large pent-up growth potential despite temporary setbacks. Such a diversification provides a significant support to Lebanon s banking sector risk diversification and reinforces further the sector s resilience against adverse individual market developments. As a result of successful expansion and diversification plans, Lebanese banks are increasingly acquiring dynamic regional roles, offering their steadily growing regional clientele a wide range of universal banking services covering commercial and corporate banking, retail banking, private banking and Treasury and capital market activities. They are increasingly benefiting from a significant cross-selling potential, providing a large spectrum of products and services to their integrated regional customer base, taking advantage of a fast growing intra-regional trade and increasingly servicing Arab citizens and Diasporas of the MENA region at large. Despite the important cross border expansion efforts realized over the past few years, the domestic component of Lebanese banks activity is still extensively dominant. The share of foreign entities in the consolidated activity remains narrow, accounting, at the end of 2010, for 14.6% of assets, 12.7% of deposits, 20.2% for loans, 22.4% for branches and 25.4% for staff. It is important to note that the mild increase in such shares over the past few years is somehow related to the considerable growth in the domestic market itself that outpaced the pace of growth in regional markets at large. Source: Bankdata Financial Services wll 4

5 SOVEREIGN EXPOSURE Steadily declining State exposure in relative terms Although the domestic exposure to sovereign debt still weighs on the Lebanese banks activity profile, it has been on a declining trend in relative terms in recent years. The analysis of sovereign exposure risk requires differentiation between the two balance sheets that Lebanese banks manage, i.e. the Lebanese Pound balance sheet and the foreign currency balance sheet. As default risk is quasi inexistent in Lebanese pounds, with the monetary authorities being the lender of last resort in domestic currency, the relevant sovereign exposure is that in foreign currency represented by the sovereign eurobond portfolio held by Lebanese banks relative to their foreign currency funding or their capital bases. As a matter of fact, the exposure to the state in foreign currency has been on a gradual decline. The aggregate portfolio of sovereign bonds in foreign currency held by banks as a percentage of their deposits in foreign currency reported its record low in more than a decade, reaching 16.6% in 2010, against 18.3% in When adding the Central Bank exposure, the ratio goes up to 42.0%, still its lowest level in almost ten years. The ratio of sovereign bonds to equity reached as low as 102.0% in 2010 (against 115.1% in 2009), bearing witness to a gradually improving trend since the early 2000s. LIQUIDITY RISK A burdening negative interest carry on a highly liquid position Banks operating in Lebanon also remain highly liquid, as witnessed by their comfortably high liquidity levels, though slightly declining in relative terms over the past year. The most relevant liquidity measure remains that of FC primary liquidity and which stood at 51.5% of FC deposits at end-december 2010, slightly less than year-end 2009 (54.4%). FC primary liquidity is broken down almost evenly into FC placements at Central Banks and FC liquidity in foreign banks (25.4% and 26.1% respectively). The Lebanese banks large liquidity buffers actually come in recognition of the uncertainties inherent to operating within Lebanon s often volatile environment. Maintaining high primary liquidity in foreign currency recently had its relative cost in terms of negative carry on liquid placements as a result of the drastic drop in international reference rates. The US Libor rate had dropped from an average of 293 basis points in 2008 to 68 basis points in 2009 and to 34 basis points in 2010, thus settling at historically low levels. At such levels, the differential between the cost of deposits in FC and the US Libor rate stands at more than 250 basis points, representing close to US$ 800 million of income foregone on this primary liquidity part of the FC uses as a voluntary insurance cost in difficult times. While banks have tried to decrease in parallel their FC deposit rates, the drop in their cost of FC deposits from 3.25% in 2009 to 2.96% in 2010 evidently was not enough to compensate for the drastic drop in their yield on FC liquid uses. 5

6 EXCHANGE RATE RISK Activity dollarization at a decade low When addressing exchange rate risk in Lebanese banks, it is important to note that their exposure to such risks is restricted by law, with the maximum allowed foreign exchange position being capped at 1% of shareholders equity. This means that foreign currency liabilities are mostly placed in foreign currency uses and LP liabilities are mostly placed in Lebanese Pounds uses. It also means that a de-dollarization in bank liabilities is always coupled with a de-dollarization in banks assets and vice versa. In 2010, the rise in bank deposits is attributed to both those denominated in Lebanese pounds and foreign currencies, yet with a slight advantage to the latter. LP deposits indeed grew by US$ 5.5 billion over the year within the context of stable monetary conditions at large, accounting for 39.1% of total deposit growth. Consequently, the deposit dollarization ratio tended towards a decade low level, reporting 66.8% at end-december 2010, against 67.5% at end-december On the asset side, the share of FC assets to total assets slightly dropped from 67.3% at end-december 2009 to 66.5% at end-december The more noticeable drop in dollarization on the asset side is tied to that of loans which declined from 87.7% at end-december 2009 to 84.5% at end-december The analysis of Lebanese banks groups by dollarization ratios suggests that the group of small banks is the most dollarized in terms of deposits and the least dollarized in terms of loans. Deposit dollarization stands at 73.9% for the Delta Group, followed by 67.9% for the Beta Group, 66.7% for the Alpha Group and 62.7% for the Gamma group. The most important drop in deposit dollarization was that reported by Beta banks with a decline of 1.9%, followed by Delta banks with a decline of 1.7%, then Gamma banks with a decline of 1.3%. The large banks seem to have witnessed a lower pace of conversion in relative terms, with the Alpha Group reporting a contraction in deposit dollarization of merely 0.5%. Loan dollarization stands at 85.4% for the Alpha Group, followed by 84.2% for the Beta Group, 79.1% for the Gamma Group and 48.3% for the Delta group. Having said that, the fact that Lebanese banks do not hold foreign currency risk does not mean that they are not subject to any indirect exchange rate risk. While the Lebanese banks are subject to rigorous asset-liability currency matching regulations, their debtor customers are not. If there were any shift in the LP/US$ exchange rate (though the probability of such an occurrence is limited), this could put strains on borrowers debt servicing capacity, which could result in higher delinquencies. 6

7 INTEREST RATE RISK Continuing maturity mismatching driving interest rate risk An enduring risk factor facing Lebanese banks is their interest rate risk, although the latter remains partly mitigated. This arises from maturity mismatches, as short term deposits (average maturity of less than 60 days) fund around 80% of total assets. Interest rate risk represents a threat to earnings generation through its impact on spreads and interest margins. A reflection of this is the drop in banks FC interest margin from 2.13% in 2009 to 2.07% in 2010 (a corollary drop in FC spread from 2.02% to 1.98%). It is yet worth mentioning that the drop in FC margins was compensated by a rise in LP margins. The latter rose from 1.87% in 2009 to 2.21% in 2010 as result of the significant efforts undertaken by banks to decrease the LP deposit rates during the year. In fact, the cost of funds in LP contracted by 95 basis points as a result of such efforts, generating a drop in the cost of LP earning assets (by 87 basis points) more important than the drop in the yield on LP earning assets (by 54 basis points). In the long term, the significance of the exposure to interest rate risk is tied to re-pricing gaps between the short dated customer deposit base and the long term government securities portfolio in the event of a surge in reference interest rates. It is worth noting that both LP and FC rates are now believed to have attained or are close to their record low levels. This maturity related interest rate risk could be yet compensated by remedial measures by the Central Bank such as swapping low-yielding securities for higher-yielding ones. In addition, Lebanese banks would benefit from the rise in their yield on their primary liquidity, placed both at Central Banks and at foreign banks and short term in nature, allowing banks to renew their liquidity positions at higher short term rates with a higher marginal pace than that of the rise in domestic FC deposit rates, at least in the short term. A 1% increase in Libor is apt to generate an additional US$ 388 million return on the current FC primary liquidity position, thus compensating for the interest rate risk incurred by long term bank placements. EQUITY MARKET RISK No significant exposure to equity market fluctuations Lebanese banks are not exposed to any significant stock market risk, with their total holding of marketable securities & financial instruments with variable income representing a mere US$ 1.2 billion, less than 0.8% of their total asset base. In addition, the Lebanese stock market does not witness significant volatility, with the stock market volatility indicator measured by the standard deviation of daily price indices to the average daily price index standing at a mere 5% in 2010, a low level relative to regional and emerging markets at large. Even when considering third party risks, it is worth mentioning that bank exposures remain limited by law. In fact, banks are not allowed to lend for the acquisition of shares by more than 50% of the investment value and they are not allowed to lend to real estate development projects for more than 60% of the project cost. 7

8 CREDIT RISK Asset quality sustaining its year-on-year improvement trend Supported by favorable domestic growth environment, bank lending activity regained a lot of vigor last year, posting a 25.1% growth in 2010, moving from US$ 34.0 billion at end-december 2009 to a high of US$ 42.5 billion at end-december This mainly mirrors the buoyant economic activity in Lebanon throughout most of last year and the Lebanese banks ability to match growing domestic and regional demand for credit, with the US$ 8.5 billion growth in bank loans extended to the private sector in 2010, almost twice that of It is worth noting that while it is true that lending to the private sector represents close to the size of the domestic economy in Lebanon, such a lending is constrained to a small portion of the large bank resources, with deposits to GDP standing at 327% in Lebanon, against 62.0% for the region, 74.3% for emerging markets and 93.4% for the global average. As such, loans to deposits stand at a mere 33% in Lebanon, one of the lowest ratios around the Globe. Such a low ratio also provides banks with important flexibility at a time when a number of banking sectors in the region and in the World have loans to deposits ratios approaching 100% limiting their loan extension capability. A closer look at banks lending activity from a currency angle shows that while foreign currency denominated loans continued to account for the bulk of loan growth in 2010, LP loans witnessed strong unprecedented activity, supported by BDL s reserve exemption measures, to bring their contribution to total lending growth to a record high 28.1% in While the latter share is close to that of 2009, it remains much higher than that of the corresponding period of the previous few years which did not exceed 10%-15%, thus allowing lending dollarization ratios to pursue their gradual downward trajectory. As for loan diversification risk, it is important to mention that the loan portfolio of Lebanese banks is well diversified by both loan type and sectors of activity. On one hand, no economic sector has more than 25% of the consolidated loan portfolio. On the other hand, corporate loans account for 44.7% of the total loan portfolio, followed by SME lending with 15.6%, retail loans with 14.8% and housing loans with 9.5% of the sector. More importantly, Lebanese banks asset quality metrics are quite satisfactory and continue to post steady improvement. The ratio of doubtful loans to total loans reached a low of 7.0% at end-2010, against 9.5% at end-2009, 10.7% at end-2008, 13.9% at end-2007 and double-digit levels above 15% in the previous few years. The improvement emanated from faster loan book growth regular NPL write-offs encouraged by central bank initiatives as well as better recoveries. Provisioning levels remain adequate as well, with the ratio of loan loss provisions to doubtful loans at 92.5% at end-december 2010 (88.8% at end-december 2009), compared to relatively lower levels in the previous few years. As such, when considering net of provision figures, the ratio of net doubtful loans to gross loans reported a mere 0.5% in 2010, a historical low in the recent history of Lebanese banking sector. 8

9 CAPITAL ADEQUACY A satisfactory capitalization in the absence of excessive leverage In parallel, Lebanese banks have a good capital adequacy level, i.e an acceptable leverage level in a period where the recent global crisis has underlined the threat of excessive indebtedness on behalf of banks. Reflecting an adequate coverage of the aggregation of credit, market and operational risks, the banks consolidated Basle II capital adequacy ratio reported 13.0% at end-2010 (against 12.8% at end and 12.2% at end-2008), well exceeding regulatory requirements of 8%. At the mirror image of capital adequacy is leverage, whereby comparative analysis suggest that Lebanese banks somehow have acceptable leverage relative to international benchmarks. When looking at individual bank groups, it looks like small banks are better capitalized than large banks relative to the size of their activity. While Alpha and Beta Groups reported Basle II ratios of 12.7% and 11.9% respectively, the Gamma and Delta Groups reported levels of 16.1% and 36.7% respectively in Likewise, while Alpha and Beta Groups reported equity to asset ratios of 8.9% and 7.4% respectively, the Gamma and Delta Groups reported levels of 12.1% and 20.5% in It should be noted however that some Lebanese banks rely to a significant extent on preferred equity. The use of such instruments allows additional flexibility for banks to manage their capital positions. However, they are relatively costlier, inhibiting their internal capital generation capacity. Moody s Investors Services, the international rating agency, argues that while the sector s capital position is good, they would assess it as further improved if there were an increase in the weight of common equity in its overall composition. COST EFFICIENCY Further efficiency gains on the basis of strict cost control measures Efficiency indicators of Lebanese banks show satisfactory norms in The cost to income ratios of Lebanese banks range within broadly acceptable levels, reflecting banks policies and success in managing costs and growth. Cost-to-income actually contracted from 51.9% in 2009 to 48.7% in 2010, which although it appears to be under the MENA region s average compares well by international standards. The most efficient group is obviously that of large banks, with an average cost to income ratio of 47.1%, followed by Beta banks with 57.9% and then Gamma banks with 59.3%, while the group of small banks is the least efficient with 59.6%. In other words, cost efficiencies are positively correlated with the size of banks due to economies of scale. 9

10 Given their relatively large asset base, Lebanese banks efficiency ratios measured against assets fare better. The banks cost to average assets ratio, which is historically low in Lebanon, has reported a gradual decline in recent years, moving from 1.64% in 2008 to 1.54% in 2009 and to 1.51% in These levels compare favorably well to regional and international benchmarks. PROFITABILITY AND RETURN Strong earnings growth despite tough operating conditions At the profitability level, a healthy 27.4% rise in consolidated net profits of Lebanese banks was reported last year, despite rather difficult operating conditions. The positive profit growth of Lebanese banks was actually sustained for the 8th consecutive year. Since 2002, the compounded average growth rate of net earnings of Lebanese banks reported a double-digit growth of circa 25% per annum, comparing significantly well to the earnings growth trends reported in most of the banking sectors around the region and the world at large. With the large earnings growth rate outpacing asset and equity growth in 2010, a net improvement in return ratios was actually reported over the year. The return on average assets rose by 11 basis points, moving from 1.13% in 2009 to 1.24% in The return on average equity rose by 96 basis points, moving from 12.93% in 2009 to 13.90% in At such levels, return ratios are now getting increasingly close to with regional and international benchmarks. The detailed analysis and breakdown of return ratios (Dupont analysis) suggests that the yield on earning assets has contracted less than the cost of earning assets in 2010 (33 basis points and 40 basis points respectively), leading to a slight rise in interest margin by 7 basis points, moving from 2.05% to 2.12%. With the ratio of average interest earnings to average assets of circa 95%, the rise in interest margin was coupled with a similar rise in spread by 7 basis points, moving from 1.95% to 2.02%. This was actually coupled with a rise in the ratio of non-interest income to average assets from 1.02% to 1.09%, leading to a 14 basis points expansion in asset utilization that reached 3.11% at end The rise in asset utilization coupled with a growth in net operating income as a result of cost efficiencies has generated the observed rise in ROAA. Consequently, the registered rise in ROAE resulted from the rise in ROAA along with a drop in leverage (from 11.45x in 2009 to 11.22x in 2010). 10

11 FUNDAMENTAL MARKET VALUE Relative value on a cross-regional scale Notwithstanding steadily growing fundamentals, Lebanese banks today appear undervalued relative to regional and international peers across a range of market pricing ratios. As of mid-july 2011, listed Lebanese banks were trading on average at a P/E of 8.9x, against a regional bank average of 14.1x and a global market average of 12.4x. Similarly, they were trading at a P/BV of 1.20x and a P/Assets ratio of 8.1%, against respective regional averages of 1.63x and 21.3% and global averages of 1.71x and 16.9%, thus reflecting relatively low stock liquidity in the Lebanese stock exchange. As a result of lower P/E multiples and solid average EPS growth over the past few years, Lebanese banks PEG ratios (measuring current P/Es over the average EPS growth per annum of the past five years) also look attractive relative to benchmarks. The average domestic PEG ratio stood at 0.65x at mid-july, trading at a 40% discount relative to regional banking PEG averages and at a 65% discount relative to global market PEG averages. As a result, with relatively low price multiples resisting to rising fundamental value, the Lebanese banking sector continues to offer relative value on a cross-regional scale. Lebanese banks also appear to offer value from a longer term perspective. Their expansion policies across captive markets in the Middle East and North Africa region, which have proven successful in recent years despite the current temporary setbacks, are actually apt to reflect positively on their relative value. Domestic banks respective subsidiaries across a number of regional markets with pent-up growth potential are more and more contributing to consolidated performances since the launching of activities a few years ago. Notwithstanding the current regional turmoil, financial intermediation prospects in those countries remain sound overall, and this would continue to have positive spillovers on Lebanese banks activity growth and revenue generation in years to come. Sources: Zawya Investor, Citigroup, IMF, Beirut Stock Exchange 11

12 CONCLUDING REMARKS Financial sector resilience revisited Maybe the most significant feature of the Lebanese banking sector is its resilience to domestic or external turmoil. Beyond the banks conservative banking practices outlined throughout this report, this resilience characteristic is also tied to the banks strict regulatory and supervisory framework. Lebanese banks are indeed very well regulated by international standards and fully adhere to international accounting standards as acknowledged by all international reports on the Lebanese banking industry. The financial industry is well supervised by the Central Bank of Lebanon and the Banking Control Commission, which impose significant regulatory measures for risk management and control. The non-existence of exposure to derivatives and structured products has allowed banks to avoid the accumulation of portfolios of toxic assets on the Lebanese banks balance sheets at large. It is important to note that the early months of 2011 reported a new episode of banking sector resilience to turmoil. Amid an unprecedented regional turmoil on the basis of widespread protests triggered by political and socioeconomic demands, as well as the background of deteriorated domestic political conditions in Lebanon since the beginning of the year, Lebanon s financial sector proved to be quite resilient once again. Though political developments caught the Lebanese financial markets by surprise, the markets were able to contain them without recording noticeable pressures. As a matter of fact, a wait-and-see attitude and a cautious mood dominated Lebanese financial markets in early 2011, yet did not lead to any kind of market jitters. The foreign exchange market was able to smoothly absorb the local political stalemate, thanks to the solid confidence in the Central Bank s strong ability to defend the currency peg, given its long track record of successful monetary management and the currently historical high level of reserves. Likewise, no considerable interest rate increases were reported on the market for Treasury bills, while CDS spreads did not encounter major fluctuations. More importantly, no considerable capital outflows from the Lebanese banking sector were reported in the midst of Lebanon s political stalemate. While Lebanon s financial system has a long track record of successfully coping with the political and security shocks, it is important to note that the recent adverse political developments happened in a period where economic conditions and market buffers were at their best level in Lebanon s recent contemporary economic history, due to recent economic achievements: A four-year track record of high 8% average growth, a gradual reduction of fiscal imbalances with debt to GDP dropping from 180% to 135% over four years, a record high foreign asset position covering 80% of Lebanese Pound money supply, good levels of inflows of no less than 40% of GDP and a healthy banking sector financial standing with primary liquidity representing more than half the banks customer deposits. As such, the emerging domestic and regional uncertainties have been translating into economic slowdown since the beginning of 2011, with its adverse impact on the real sector much more than worrisome financial and monetary pressures. It is important to always keep in mind that the observed Lebanese resilience is not equivalent to financial immunity. Thanks to its rigorous regulatory framework and its conservative bank risk management philosophies and practices, Lebanon s financial sector provides an interesting resilience phenomenon that has been practically tested in atypical times. Still, for the Lebanese resilience to turn into long term immunity, it needs to be reinforced by an appropriate gradual reduction of persisting macro risks and exposures. It is then that the Lebanese model could provide an important example of immunity, serving as viable lessons to a number of countries in the region and across the globe. 12

13 DISCLAIMER The content of this report is provided as general information only and should not be taken as an advice to invest or engage in any form of financial or commercial activity. Any action that you may take as a result of or in connection with information in this report remains your sole responsibility. None of the materials herein constitute offers or solicitations to purchase or sell securities. The report should not be regarded by recipients as a substitute for the exercise of their own judgment. Bank Audi Sal - Audi Saradar Group shall, upon its sole discretion update, renew, continue or cease to continue to provide this report or similar reports or publications. Any opinions expressed in this report are subject to change without notice and may differ or be contrary to opinions expressed by other business areas as a result of using different assumptions and criteria. Bank Audi Sal - Audi Saradar Group is under no obligation to update or keep current the information contained herein. The analysis contained herein is based on numerous assumptions. Although Bank Audi Sal - Audi Saradar Group considers the content of this report to be reliable, it shall have no liability for its content and makes no warranty, representation or guarantee as to its accuracy or completeness. Bank Audi sal - Audi Saradar Group - Group Research Department - Bank Audi Plaza - Bab Idriss - PO Box Lebanon - Tel: research@banqueaudi.com 13