A Lebanese bank employee counts money at a bank in Beirut on July 21, 2009. JOSEPH BARRAK/AFP/Getty Images[/caption]
Bankers are not exactly popular these days. Rightly or wrongly blamed for myriad economic woes, from the recent financial crisis to the more general pains inherent in the capitalist system, it is certainly not part of today’s standard discourse for banks and bankers to be bastions of stability and public stewardship. But banking and finance is also shrouded in mystery that many cannot penetrate; lost in the public clamor about “evil” bankers is the debate over what a bank might be other than a gargantuan profit-making machine, and thus a liability.
It is common wisdom among those who know about banking that history creates banking systems and regulatory objectives. It is a sad irony, then, that the history of violence and political uncertainty in what was once the Middle East’s banking capital, Lebanon, has contributed to the creation of one of the world’s most stable banking sectors—and probably not by chance. As Lina Makarem, an assistant general manager at the Lebanese commercial bank BBAC, explained to The Majalla, “Lebanon's political instability, high-risk political environment and geographical location in a troubled area forced banks to create a system resilient and immune to any event.”
Speaking to The Majalla, a London-based Lebanese financial services professional who has worked in banking and finance in both Lebanon and Britain emphasized that the major difference between his country and the West over the past half century has been the decades of war and instability. In his view, the West has felt free to experiment with new, often poorly understood financial products and looser regulations in the hope of gaining higher profits during a period of (for it) historically unprecedented political and social calm. Lebanon, in contrast, has had to rebuild a fractured economy and regain the confidence of investors at home and abroad—a wholly different goal that has resulted in this decision to promote resiliency through conservative regulation and cautious expansion.
A model regulation
When the Basel Committee met in 2010, it focused on reeling in banks’ ability to take extreme risks, curtailing both the possibility of making the kind of wild profits we saw in the heyday of the early 2000s and the chance that a bank would take an unbearable loss, as some did in 2008. The committee’s new best practice guidelines for banking regulation in the signatory states—the G20 and certain other countries with large banking sectors—aimed to increase liquidity and decrease leverage in an attempt to strengthen capital adequacy, the amount of liquid assets a bank has to hold in relation to its loans/obligations. In general, the more a bank has to hold in liquid assets, the less it is able to invest in riskier ventures.
In contrast, Lebanon has been implementing this kind of regulation for years. When Riad Salamé became the governor of its central bank, the Banque du Liban, in 1993, he ignored prevailing trends in his industry and imposed unusually conservative regulations on Lebanon’s banking sector. (They were so strict that at least thirty banks were forced to close because they were unable to meet such high standards.) He began by reforming the transparency laws that had made Lebanon an attractive destination for depositors in the 1950s and 1960s, and which had turned it into a money-laundering hub. After that, he imposed capital adequacy standards that foreshadowed Basel III, preventing banks from riding the wave of high profits and unknown risks that characterized the boom of the early 2000s.
Lebanese banks adhere to some of the most stringent standards in the world on capital reserves and liquidity, and have met or exceeded some of the main standards in Basel III for some time already. For example, regulation in the country requires strong liquidity, currently set at or around 30 percent (the figure changes periodically based on economic and political circumstances)—the highest capital reserve standard in the world. Lebanese banks’ capital adequacy ratios, or the measure of a bank’s capital against its risks, surpassed the requirement set out in Basel III in 2011, four years before it will be required of signatory countries.
This cautious approach to banking has paid off both recently and throughout Lebanon’s history. “It is well known that when the world was facing the worst financial crisis [in 2008], Lebanon then was booming,” said Makarem, highlighting that when the crisis hit, the bank for which she works was already avoiding the high leverages and complex structures and products now thought to have caused the 2008 collapse.
In fact, all Lebanese banks were avoiding the products that have since been implicated in the crisis: In 2004, Salamé famously barred banks in his country from purchasing mortgage-backed securities, one of the products that would be at issue in the 2008 financial crisis. As the Lebanese financial services professional in London told The Majalla, while Salamé’s order appears prescient to Western observers considering it in hindsight, the move is probably better explained by Lebanon’s generally conservative banking culture. There had been rumors for some time that such complicated and poorly understood financial products would pose a risk, so, in its typical conservative fashion, the Banque du Liban decided to limit Lebanon’s exposure to them.
The creation of the customer
Regulation, however, is only the foundation on which a system is built. Even a perfectly regulated banking sector will fail if there is no market, and to understand the market for Lebanese banks’ services, we must look again to history, and again to the wars and crises endemic in modern Lebanon.
After its independence in the 1950s, Lebanese economic policy had favored the development of a service economy, with a special emphasis placed on developing the banking sector, then the largest in the Middle East. Lebanon also had a slightly atypical financial services industry for that time—especially for a country that had focused its development so relentlessly on banking—with very little diversification into related financial services such as insurance or investments. This meant that Lebanon’s banks were largely in the business of holding deposits in the lead up to the outbreak of civil war in 1975, a feature that is apparent even today.
Crucially, Lebanon’s main depositors have been members of its wealthy diaspora and even wealthier benefactors from the Gulf countries. (Many wealthy foreign governments are benefactors of Lebanon, and are quick to pour money into the coffers of its central bank to help the government meet its obligations during times of instability, as Saudi Arabia and Kuwait did during the 2006 war with Israel.) These are two relatively secure sources of deposits, as customers with personal or political ties to the country are more likely to remain depositors even in the face of a crisis.
Lebanon’s diaspora has been building in waves for more than a century, to the point that today it is often said that there are four or five Lebanese outside the country for every citizen actually living there. During the civil war, more Lebanese were forced to move abroad to escape the violence, and they often left with the hope of one day returning to their homeland. These Lebanese expats earn higher, Western salaries, and they look to the country they left as a place to invest their earnings.
A spate of legislation enacted during the first decade of war ensures that money can be moved in to and out of the country without restriction and with minimal taxation, so many in the diaspora send their money to Lebanon to be held in tax-free accounts. This form of foreign investment, known as expatriate remittances, has accounted for up to a third of deposits in Lebanon’s banks over the last ten years and has been a reliable source of funds for the banks through even the most severe crises.
The civil war also had an unexpected effect on the type of assets held by Lebanon’s banks. Increasing reliance on deposits held in US dollars during the civil war forced the banks into holding more Lebanese treasury bills (t-bills) and notes, or government debt. In addition, most post-war reconstruction was financed through government borrowing from domestic banks. Lebanese t-bills are a relatively safe investment for two reasons. First, the Lebanese government offers a high rate of return to encourage investors to buy them. Second, and perhaps more importantly from a systemic viewpoint, the government is unlikely to default on its debt regardless of political instability or economic difficulties. Generally, a minimum level of stability is all but guaranteed when banks hold their own government’s debt, since the government is unlikely to default and risk plunging its banks (and likely the whole economy along with them) into chaos. This is especially true in a country like Lebanon, where so many of its banks’ assets are held in t-bills.
History repeats itself
It wasn’t always like this. Lebanon learned lessons from a financial crisis the way the West might now learn some of those lessons. Independent since only the Second World War, in the middle of the last century Lebanon was enjoying the fruits of its heavy focus on developing its service industries, and the banking sector in particular. Lebanon’s banks were at their peak in the 1950s and 1960s; they were the most successful in the Middle East and were even able to take the mostly unprecedented step of expanding into Europe and the US. Petrodollars from newly discovered and developed oil reserves further east were flowing in, and the essentially unregulated free market in the sector meant there was plenty of opportunity for the ambitious to make unprecedented sums of money through banking.
But that period of seemingly unbridled economic and cultural success was short lived. When Intra Bank, then one of Lebanon’s largest and most successful private banks, collapsed in 1966, it collapsed hard, bringing at least twelve other banks along with it. (Some even point to this financial crisis as one of the causes of the civil war that would break out less than ten years later.) The crash and, more importantly, the subsequent civil war sounded the death knell for Lebanon’s unbridled banking culture; in its place a regulatory framework known for its conservatism and simplicity would be built.
By the end of hostilities in 1990, the Lebanese economy had been devastated. Most physical and financial infrastructure had to be rebuilt, and the conflict meant that most of the labor force had either been killed or had left the country. In addition, tourism, which traditionally bolstered import-dependent Lebanon’s balance of payments, had almost completely ended. Banks themselves had suffered a severed decline, largely due to hyperinflation and a depreciating exchange rate against the US dollar; as a result, customers began moving their deposits to banks outside Lebanon. Reassuring customers of the banks’ safety in order to attract investment was the first step Lebanon had to take to reassume its place as the banking center of the Middle East.
Of course, there are critics of the highly conservative system that has emerged after the civil war. They point out that Lebanese banks have not been especially profitable when compared to other banks in the region; profit is, of course, traditionally one of the key measures of a business’s success. Lebanese banks also do not give many loans, whether to businesses or for residential mortgages, as a result of both local traditions and business practices that preference alternate forms of financing and the attractive returns offered on Lebanese treasury bills and notes. This circumvents the traditional function of a bank, to collect deposits and then channel them into productive investments, which exacerbates economic stagnation. In addition, Lebanon continues to have an underdeveloped financial market by Western standards: there is only one under-used stock exchange and no bond or money markets. In short, the business Lebanese banks actually do is markedly different from the business of banks in the West and elsewhere, and it is not always as efficient or profitable as it might be.
Instead, its seems that Lebanon’s bankers have chosen to define the role of a bank—and the meaning of “success”— in their own way. They have created a system that has weathered numerous shocks in recent years, from the global 2008 crisis that mostly passed them by to the Syrian crisis that has had a somewhat greater effect. (The World Bank has estimated that Lebanese banks had an exposure of USD 2 billion to Syria, or 0.27 percent of total assets held—but the banks had adequate reserve coverage, and thus profits are likely to be affected only slightly, and only in the short term.)
Lebanon has also created a banking system that some have credited with promoting political stability: the president of the Association of Lebanese Banks, Joseph Torbey, recently stated that Lebanon’s “banking sector consistently provided the government with the necessary funds to ensure the continuity of the public authority” during the fifteen years of conflict. In his view, the banks’ resilience took some of the pressure off a fractious government.
Lina Makarem summarized the Lebanese view of the role of banks in their economy by saying: “The Lebanese banks believe that the strict capital and liquidity requirements, especially in foreign currencies, despite its high cost, has helped in protecting Lebanon against crisis. [They] have been proven sound many times,” adding, “It might be considered restrictive, but not from our point of view.”
