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General background. Before the civil war erupted in 1974. Lebanon was the Middle East’s banking center. The strict secrecy law and the free exchange system attracted money from all Arab countries. During the civil war period. The picture became totally different.
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Before the civil war erupted in 1974 • Lebanon was the Middle East’s banking center. • The strict secrecy law and the free exchange system attracted money • from all Arab countries
During the civil war period • The picture became totally different. • “In the 1980s banks grew more reliant on lending to government, either directly or via three month treasury bills” • (EIU Country Profile 1997-1998, p. 25).
Following the civil war • Lebanon has been a dollarized economy (Khoury, 1999, p. 26). • 65.6 per cent of deposits and 89.2 per cent of credits are dominated in US dollars (Banque Audi, 1st Quarter Economic Report, 1999, p. 5).
The days of banks’ healthy profits and easy money are coming to an end • The Lebanese government succeeded in saving interest payments by switching from domestic to international borrowing. • A decline in the Treasury bill yields and a decrease in the banks’ profits manifested this success. • Pressure is mounting on the smaller banks and acquisitions are picking up.
To minimize the risk facing the banking industry in Lebanon, the Central Bank has been working hard to promote merging between banks by offering: • low cost loans • two-years tax holiday • Exemptions from employment legislation to acquirers for five years. • “In 1997 the Central Bank also imposed new capital requirements to encourage undercapitalized banks to merge” • (EIU 1998-1999 Country Profile, p. 21).
Table Ishows that 19 banks have been taken over by larger ones in the period 1993-1999.
Need for the study • During the post-war period 1992-98 Lebanese commercial banks enjoyed making huge profits by offering short-term deposits and reinvesting the proceeds in high-yielding government Treasury bills. • Charles Olivier (1999) reports that a significant chunk of Lebanese commercial banks’ profits between 55 and 70 per cent has been made by taking 45 days deposits (offering 12 per cent) and reinvesting the proceeds in government treasury bills (where two-year paper yields 16 per cent).
There is, however, a darker side to this rosy picture • The short maturity of the deposits has prevented commercial banks from lending to firms on medium or long term basis.
In addition to this, the emphasis of the Lebanese government on borrowing from abroad has caused the Lebanese interest rates to go down • (Euromoney, June 1999, p. 280). • , “In late 1995, however, the steam began to run out of the construction boom” • (EIU Country Profile 1998-99, p. 13).
Internet waves have arrived on Lebanese shores and the transactions moved up from ATM to Pay-by-the-Phone to E-banking. • Customers at few-alpha group banks (banks whose deposits are over US $500 million) such as Saradar, HSBC Bank Middle East, Credit Libanais and Banque National de Paris, Intercontinentale (BNPI) can sit at home and enjoy browsing few banking services .
Convenience, customer satisfaction and low cost are the name of the game in this information age. The big banks are able to play the game. They are customer driven and working hard on satisfying customers’ needs and retaining customers. • Knowing all of these, it becomes imperative to ask what will happen to the smaller banks? • “The general sentiment among analysts is that Lebanon’s bank merge process is on track” (EIU Country Report, 2nd Quarter 1999, p. 27).
If Lebanon plans on having big competitive banks it can expands regionally into countries having underdeveloped banking systems and tight control such as Iraq, Syria, Jordan and Palestine. Today, “Together with Bahrain, Lebanon is considered a regional leader in derivatives trading” • (EIU Country Profile 1997-98, p. 29).
Purpose of the study • There are 59 commercial banks in Lebanon which make their financial statement available to the public. These financial statements are published in an industry publication, Bank Data: 328 Financial Statements Analyzed . • 52 financial ratios are calculated for each of the banks, and the banks are ranked based on their performance for each ratio.
For decision makers trying to compare banks, analyzing 52 financial ratios may be too rough • It would seem more appropriate to look at a smaller number of ratios that explain nearly as much as the 52 ratios do.
Analysis • Factor analysis is used to find seven financial ratios that adequately explain the differences in bank performance. • Cluster analysis is then used to separate banks into four different performance clusters. • Multidiscriminant analysis is then used to quantitatively examine the differences in performance between these clusters.
This research is organized as follows: • A review of the literature is provided in the next section • The data are described in the following section. • The application of factor analysis as data reduction technique is shown in the section after this.
The application of multidiscriminant analysis to examine the differences between clusters is shown in the following section. • The predictive ability of the model is shown in the penultimate section while the concluding remarks for merger between banks are presented in the final section
Review of literature • Bridging the gap between advanced multivariate statistical analysis and financial ratio analysis for studying industry characteristics has been growing steadily in the financial literature, e.g. Charbaji and Ali (1995), Altman (1968), Collins and Green (1982), Deakin (1972), bond ratings, e.g. Beaver (1966) and mergers and take-over, e.g. Stevens (1973), Pinches et al. (1973).
The data • The data used in this study are 52 different financial ratios that have been calculated for 59 commercial banks in Lebanon for the fiscal year 1999. • All of these data were taken from the publication, Bank Data: 328 Financial Statements Analyzed, by Fredi Baz (1996).
In view of the sensitivity of the results to the assumption of normality in the observed sample, it was decided to use the common log transformation of the financial ratios. • Because of having missing observations, nine banks were deleted from analysis by the use of SPSS.
Table II shows the skewness of the seven financial ratios that were selected by factor analysis Skewness of two financial ratios (X15 and X44) are shown before and after log transformation in Table II.
Application of factor analysis Factor analysis was used to find seven financial ratios that adequately explain three dimensions of bank performance. The three dimensions of bank performance were: • The profitabilityfactor • The investment factor • The liquidity factor • The oblique solution from the factor analysis is shown in Table III.
Definition of the significant financial ratios Profitability ratios X5 Interest margin = (Interest income from loans and securities – interest expense on deposits and other debt issues)/Total assets. The net interest margin measures how large a spread between interest revenues and interest costs management has been able to achieve by close control over the bank’s earning assets and the pursuit of the cheapest sources of funding
X8 Total spread = (Interest income/Earning assets) – (Interest expense/Interest bearing liabilities). • Spread measures the effectiveness of the bank’s intermediation function in borrowing and lending money and also the intensity of competition in bank’s market area. • Greater competition tends to squeeze the difference between average asset yields and average liability costs.
If other factors are held constant, the bank’s spread declines as competition increases, forcing management to try other ways to make up for an eroding earning spread. • X15 Interest paid/Interest received. Shows how much of the interest received goes to interest to be paid. It measures operating conditions and cost efficiency .
Investment ratios • X34 ROE = Net income after tax/Total equity. It is a measure of the rate of return flowing to the bank’s shareholders. • It approximates the net benefit that the shareholders have received from investing their capital in the bank.
X39 Net return on average equity to hurdle rate. The hurdle rate is the required rate of return in a discounted cash flow analysis. • This rate must be equal to the increment cost of capital. If expected rate of return on an investment is below hurdle rate, the project is not undertaken.
Liquidity risk ratios • X24 Total net liquid assets/Total deposits. Banks issue liabilities that are redeemable at par. Saving accounts are deposits that pay interest. Checking accounts are deposits that have no maturity. • Current accounts are similar to saving accounts but subject to income tax. • Fixed deposits are deposits blocked for a period of time and pay higher interest rates.
Banks and correspondents are placement accounts that a bank opens with its correspondent bank. • They are of two types: call accounts with a two days notice before withdrawal and blocked accounts with longer maturities. • The liquid assets consist of cash with banks, plus securities, which are the short term Treasury Bills by the Lebanese government. • X44 T Bills/Tot Deposits
Classification of banks into homogeneous groups • Cluster analysis was used to identify four relatively homogeneous groups with the 50 commercial banks that had complete information on the financial ratios that were determined by factor analysis. • The banks are classified into four cohesive clusters, depending on their profitability, investment and liquidity risk factors.
Group I consists of Bank of Beirut and Arab Countries sal., Bank of Kuwait and the Arab World sal., Bank of Lebanon and Kuwait, Banque Lebanaise Pour le Commerce sal. (This bank is under consideration to be taken over very soon by UBL: United Bank of Lebanon), Byblos Bank sal., Banque Audi sal., Banque Libano- Francaise sal.
Banque Misr Liban sal., Banque de la Bakaa, Banque de la Mediterrennee sal., Banque du Liban et d’ Outer Mer sal., Credit Bancaiare sal., Credit Lebanese sal., Fransabank sal., Lebanese Canadian Bank sal., Lebanese Swiss Bank sal., Lebanon and Gulf Bank sal., Saudi Lebanese Bank sal., Societe Generale.
Libano-Europeenne de Banquesal Group I is characterized by having very high T bills/Total deposits, the highest interest paid to interest received, average total spread, close to average interest margin, above average ROE and above average total net equity to total deposits. Group II consists of Al Mawarid Bank sal., Allied Business Bank sal., BEMO- BanqueEuropeenne Pour le Moyen- Orient, BanqueLatisal, BanquePharoan et Chihasal.
Banque de l’Industrie et du Travail sal., First National Bank sal., Jammal Trust Bank sal., Metropolitan Bank sal., Middle East & African Bank sal., National Bank of Kuwait (Lebanon) sal., Near East Commercial Bank sal. SocieteBancaire du Libansal, Group II is characterized by having the minimum ROE, minimum total spread, minimum interest margin and they are middle on interest paid to interest received and are low to middle on T bills/Total deposits and are below average on total net equity to total deposits.
This segment of banks is known for having specialized types of banking transactions. Group III consists of: HSBC Bank Middle East, Bancadi Roma, Bank Saderat Iran, Intercontinental Bank of Lebanon sal., Saudi National Commercial Bank, Habib Bank Limited and characterized as being the highest on:
ROE, total net equity to total deposit, interest margin, total spread and the lowest on two financial ratios: T bills/Total deposits and interest paid to interest received. This segment of banks is known for its short-term and small amount of profitable loans. Group IV consists of the following banks: ABN Amro Bank N.V., Arab Bank plc., Bank Al-Madinasal, Bank of Beirut sal., Bank Nationale de Paris (Intercontinental).
BanqueSaradarsal, Banque de Credit National sal., Citibank, ING Banks and the Syrian Lebanese Commercial Bank sal., Group IV is characterized by having high ROE, minimum total net equity to total deposits, below average total spread, middle interest paid to interest received and high T bills/Total deposits. This segment is known for its huge transactions outside Lebanon.
Assessing the relative importance of the discriminant financial ratios The question of interest is whether the banks that are broken into four segments can be differentiated in terms of these financial ratios. Since there are four groups, three equations are extracted. Table IV shows that the eigen value associated with the first equation is 3.817, and this function accounts for 68.7 per cent of variance in the data. The second function has a smaller eigenvalue while the third has the smallest (the first is superior).
To test the null hypothesis of equal group centroids, the three equations are considered simultaneously. The value of Wilks’ Lambda λ transformed to a χ2 that is significant beyond 1 per cent indicates that no functions have been removed. The three functions together separate between the four groups.
An examination of Table V indicates a large coefficient for interest paid to interest received and low coefficient on T bills/Total deposits on function I. Function II has relatively very high coefficient for total spread and low coefficient for total net equity to total deposits. Function III has very high coefficient for total spread and very low coefficient for ROE.
