This piece was prepared as part of the 2013–2014 Syrian Economic Reconstruction Project run by the Carnegie Middle East Center, which sought to help map the social, political, and institutional dynamics that will be generated when postconflict reconstruction begins in Syria.

Introduction

Syria has faced a difficult crisis since 2011, one that has led the country’s economy and capital stock to suffer substantial losses. Its gross domestic product (GDP) decreased by 3.4 percent in 2011, 21.8 percent in 2012, and 22.5 percent in 2013, and it is estimated to have dropped to about $35 billion in 2013.

Very few sectors were left unharmed, with manufacturing, mining, trade, transportation, logistics, and tourism suffering the largest damage. A recent needs assessment by the United Nations Economic and Social Commission for Western Asia put reconstruction costs at approximately $72 billion, although that figure is nothing but a running tally that will continue increasing until the conflict comes to a halt. Syria’s eleventh five-year plan had called for over $90 billion in spending across the economy during the 2011–2015 period. When added to the estimated reconstruction costs, that amount takes the country’s funding needs to over $160 billion for the five to ten years following the crisis, simply to reach the level Syria was supposed to reach in 2015.

This funding will likely come from numerous sources, including government borrowing (foreign debt to GDP was relatively low at 17 percent as of the first quarter in 2013), grants and other types of aid from international organizations, private investment from Syrians and foreigners, and last but not least, loans from local and foreign banks.

This piece takes a closer look at the impact of the current situation on the financial sector, how it will re-emerge following the crisis, and what role it will play in the future. Without getting into an analysis of the different political outcomes of the crisis, certain assumptions have been made that were necessary to attempt to build a numerical picture of what is to come. The core theme of these assumptions is that at some point the conflict will be resolved, and Syria will begin a reconstruction and recovery period in all fourteen governorates across the economy.

As in many developing countries, Syria’s financial sector was not channeling enough of the country’s transactions, savings, and investments, thus keeping its role relatively small and overall penetration of the bankable population quite low. The share of currency in circulation as a component of the money supply gradually decreased to reach 26.5 percent in 2010, although the current situation has probably caused this figure to go back up, because cash is the preferred transactional medium in times of war. Financial awareness among the general population remains very low, and not enough has been done by the various stakeholders to educate the population about the benefits of institutions like banks and insurers or the use of their products and services, which has been very limited, not coincidentally.

These challenges have grown even bigger as difficult economic conditions have led to an increase in the number of people living below the poverty line ($2 per day), from about 2 million in 2010 to almost 8 million in 2013. Education was affected across the country, preventing many children from going to school and young adults from attending university. While the primary consequences of higher poverty and undereducation are of greater concern, what financial sector participants will see is a smaller bankable population.

Though perhaps unquantifiable, one of the main damaging impacts of this crisis on the sector (and in fact the country at large) is the brain-drain effect, with many of the banks’ qualified management employees moving abroad to seek other opportunities. While some of this contingent will be back after the crisis, others will have relocated their families and embarked on new careers with perhaps brighter prospects; they will be unlikely to return, at least in the short to medium term.

Even though the sector is going through a difficult period that has yet to come to an end, it remains by and large in good enough shape from a continuing operations perspective and has learned to adapt to the challenging working conditions. Once the wait is over, however, the country’s banks, insurers, investment firms, and other financial actors are likely to return to playing the key role of the economy’s engine.

Banks

Following more than forty years of the monopoly of the public sector by six state-owned banks, the first private sector bank began activities in early 2004. By the advent of the crisis in 2011, there were fourteen operational private banks, including three Islamic banks. The sector as a whole was experiencing solid growth and was on its way to becoming a key contributor to Syria’s GDP. For the 2006–2010 period, assets at all Syrian banks grew at a compounded annual growth rate of 10.9 percent to reach 2.14 trillion Syrian pounds ($45.5 billion at the time),1 while customer deposits and loans grew at 16.3 percent and 25.9 percent to reach SYP1.07 trillion ($22.7 billion) and SYP638 billion ($13.7 billion), respectively. Private banks were naturally growing at a much faster pace than their more established public counterparts, and their share of total sector assets increased from 13.0 percent at the end of 2006 to 30.4 percent at the end of 2010. The Commercial Bank of Syria, a state-owned entity and the largest bank in the country, had close to 37 percent of the total assets in the banking sector and 52 percent of all assets at the six public banks.

Three years of conflict and a weakening economy have put a halt to the sector’s growth story and have had a large impact on banking operations throughout the country. Despite the Central Bank of Syria’s move to raise interest rates, banks faced small runs in the early days of the crisis for many reasons (for example, fear of the devaluation of the currency, desire to transfer funds abroad, fear and ignorance about the health of the banking sector, and need to dip into savings for those with limited or no income), which put high pressure on the banks’ liquidity levels.

Borrower defaults gradually rose as the conflict escalated and caused massive write-offs by the banks, severely impacting their bottom lines. Banks attempted to overcome delinquencies by working with borrowers to restructure loans, and in the more extreme cases, they were forced into an inefficient judicial process to recover their loans by going after the collateral, which in some cases was found to be damaged or overvalued. Many retail loans were unsecured or too small to pursue in court.

New lending opportunities with acceptable risk levels were becoming scarcer by the day, and as lending rates reached the mid-teens, the few remaining good prospects were reluctant to borrow, which increased the pressure on bank revenues. Weaker trade activity in turn impacted fee and commission revenues, while an inflationary environment and higher costs of doing business (cash movement, for example) caused an increase in operating expenditures.

Economic and financial sanctions on Syria and the threat of sanctions against the parent banks (for example, those based in Lebanon and Jordan) put massive operational and profitability pressure on Syrian private banks, and even more so on the Syria International Islamic Bank and public banks because they were directly sanctioned. Correspondent banks closed accounts, placement opportunities abroad became scarce, and U.S. dollar transactions were severely limited. The foreign strategic partners of the local banks have in several instances distanced themselves from their Syrian affiliates by limiting their interaffiliate cooperation, resigning from the boards of directors, and so on.

Staff and branch security have become a concern and a liability for the banks. Interbranch connectivity has been an issue when lines of communication are down, some employees have not always been able to get to work at all or at least on time, branches have faced numerous armed robberies, and banks have been forced to shut down branches in conflict areas. It is estimated that around 70 to 80 of the 243 officially registered private sector branches (as of December 2013) are no longer fully operational. It is safe to assume that the same proportion of branches (approximately 30 percent) is inactive among the 296 public sector bank locations.

Private Sector Banks

From a numerical standpoint, a comparison was made between precrisis and postcrisis financials for private sector banks using year-end 2010 balance sheet and figures from September 30, 2013, a period of two years and nine months. The Syrian pound’s devaluation from 47 to 174 per U.S. dollar inaccurately shows a 34.6 percent expansion in the aggregate balance sheets of private banks, from SYP650 billion to SYP875 billion during the aforementioned period.2

For a more reflective analysis, the figures were compared in dollar terms, in which case the expansion turns into a 63.6 percent drop in assets from $13.8 billion to $5.0 billion, and total customer deposits decreased by 73.0 percent to $3.0 billion. The average nonperforming loans ratio at the fourteen banks increased from 3 percent to 41 percent, leading to substantial write-offs and in turn an 82.5-percent drop in total net loans and advances to $976 million, taking the net loans-to-deposits ratio down from 51 percent to 33 percent.

Shareholders’ equity was partially protected given that on average, around half of total paid-up capital was contributed and maintained in U.S. dollars, thereby preserving its value. Aggregate shareholders’ equity decreased by 49.8 percent to $734 million, representing 14.6 percent of total assets, compared to 10.6 percent of total assets at year-end 2010.

Excluding provisions for nonperforming loans and unrealized gains on the revaluation of foreign currency assets, banks were still able to generate a pretax profit of SYP1.3 billion (about $10.2 million at the average rate for the period) in the first nine months of 2013.3

Public Sector Banks

Public sector banks do not disclose their financial results or their accounting policies, which means all published figures have to be taken at face value. Total assets at public sector banks at the end of 2010 (latest available as of this writing) were at $31.6 billion, with customer deposits of $11.7 billion and an $8.0 billion loan book. It was estimated that less than 10 percent of those deposits were in foreign currency, meaning even with zero net outflow, deposits are likely under $4.0 billion now simply due to the Syrian pound’s depreciation.4

The loan portfolios of these banks are likely to have been affected to a larger extent than those of the private sector, given that public sector lenders are less selective and have more socially driven lending. This means that their nonperforming loans ratio likely exceeds the 41 percent ratio of private sector banks. The paid-up capital of these banks does not include the foreign currency buffer available in private banks, meaning that depending on the amount of nonperforming loans, public banks may find themselves undercapitalized by international standards.

Contribution to the Reconstruction Effort

Syria’s banking sector is one of many financing sources for the country’s $150–$200 billion reconstruction phase. The sector’s contribution to funding will depend on numerous factors, the most important of which are the amount of customer deposits, banking regulations, and the lending environment.

The Syrian pound’s value and the unknown duration of the conflict mean a predicting the state of the private sector’s aggregate balance sheet is rather difficult without making certain simplistic, big-picture assumptions. For the purposes of this estimate, the assumptions are: the U.S.-dollar–to-Syrian-pound exchange rate will be similar to the rate in the third quarter of 2013; a further 25 percent of today’s net loans and advances portfolio will be written off; and the sector’s total deposit base will recover to 75 percent of precrisis levels relatively quickly. In addition, banks will continue to break even before nonperforming loan provisions are taken into account (they are still turning a small profit today). All other variables will remain constant.

The above would mean that private sector banks would have a $10.1 billion balance sheet, $8.3 billion in customer deposits, $732 million in outstanding net loans, and only $490 million in shareholders’ equity. To accurately estimate capitalization adequacy, the different asset categories (such as cash at the central bank, loans, and real estate) would need to be weighted by risk level. An equity-to-total-assets ratio of 4.9 percent shows that some banks are likely to be undercapitalized. Increasing this ratio to 6 percent would require an additional $116 million, while a more conservative 8 percent would require a total capital injection of $318 million.

The banking system’s reserve and liquidity requirements will dictate the power of the multiplier effect in expanding any new money injected into the system. Banks traditionally keep a small portion of the deposits they gather on hand and look to lend the remaining portion to their customers. These loans create additional deposits at other banks, which in turn relend the vast majority of those funds to their own clients, and so on. This continuous creation of additional deposits from the same initial deposit is called the multiplier effect.

Current regulations require banks to maintain 5 percent of their deposits at the central bank and a 30 percent liquidity ratio on total assets (20 percent on SYP assets), which means a conservative estimate of the reserve requirement (for multiplier purposes) would be 20 percent (0.2). However, the currency drain was estimated at 0.36 at the end of 2010 as Syria remained a cash-heavy economy.5 Under these assumptions, the multiplier turns out to be approximately 2.4.6 This means that every dollar (or pound) injected by the central bank into the banking system can lead to up to 2.4 dollars in additional money supply across the economy. As Syria resumes its move from a cash-heavy to a banking economy, the currency drain will drop and the multiplier effect will increase.

Foreign currency deposits represented roughly 30 percent of total deposits at private sector banks at year-end 2010 and this was at a time when the Syrian pound had been stable for years. There are two main views on the postcrisis split between foreign currency and pound deposits. One is that Syrians will not want to transfer their foreign currency savings back into the country or into pounds at all due to a fear that they will not be able to take the money out again or re-exchange it should the situation deteriorate, or that regulations will force them to exchange their money into Syrian pounds. In this case, the vast majority of deposits will be in Syrian pounds.  The second view is that the pound’s instability over the last three years (it is difficult to tell how it will behave after the crisis) has shifted depositors’ preferences to foreign currency deposits, which are seen to preserve the value of savings. In this scenario, the share of foreign currency deposits will be quite significant.

Limited Funding Potential

Irrespective of how this plays out, the fact is that under the existing regulations, banks are very limited in what they can do with their foreign currency deposits (especially when it comes to lending), leading them to simply place the vast majority of these funds abroad.  Doing so essentially means a significant portion of Syria’s savings is going out of the country instead of being channeled into the economy and reconstruction efforts.

For simplicity’s sake, and to attempt to forecast the best-case ceiling on private sector banks’ contributions to reconstruction funding, it will be assumed that banks will be able to freely lend in all currencies (that is, regulatory restrictions will be relaxed). With a potential deposit base of $8.3 billion and an aggressive loans-to-deposits level of 75 percent, banks would be able to extend a maximum loan book of $6.2 billion at the outset. Assuming an average loan tenor of three to five years, banks would be able to reinject an additional $1.2–$2.0 billion a year as the loans are repaid, even with no new deposits.7

How and when the required $150–$200 billion in investments will be needed remains in question, although the Economic and Social Commission for Western Asia study estimated annual needs at $17.5 billion in year one, $15.2 billion in year two, $14.1 billion in year three, and $13–$23 billion per year from then until year ten. This means that private sector banks will play only a secondary role in terms of funding.

One area likely to benefit from bank reconstruction funding is housing and real estate. The Economic and Social Commission for Western Asia estimated that approximately 300,000 houses have been completely destroyed, 500,000 have been seriously damaged, while 800,000 have been only slightly damaged. This is in addition to the about 90,000–100,000 houses that were needed on an annual basis prior to the crisis to renovate the housing stock and accommodate for population growth. The study puts the cost of a realistic ten-year program of 100,000–120,000 houses per year at roughly $23 billion for the entire period (without adjusting for inflation).

In practice, all of these figures and estimates may not be fully deployable for reconstruction funding due to various reasons. These reasons include: banks already have outstanding loans portfolios that will need to be deducted from the ceiling to reach available funds, banks may decide to maintain higher liquidity levels than what is legally required, the central bank may not relax foreign currency lending restrictions, banks may elect to place some funds abroad in spite of local deployment opportunities, there may only be a limited number of bankable projects with an acceptable risk, central bank regulations on risk-weighting may dictate high capital requirements, and the ability of banks to raise capital, if need be, may have an impact.

Regulatory Reform

Regardless of the above, Syria’s banking sector will have a significant role in the reconstruction and economic recovery period, whether as a means to channel foreign funds or facilitate trade, or as a source of funding.

That being said, the regulatory framework is one of the main determining factors for how big of a role the sector will play. Reforms are needed across the board: for example, a stronger and more efficient judicial system, stronger property rights, and better protection of creditor rights. The establishment of credit bureaus would also go a long way toward helping banks extend more loans and achieve lower nonperforming loans ratios.

In terms of specific banking reforms, in addition to liberating foreign currency lending, changes to the interest–rate-setting methodology and minimum capital requirements would benefit the sector a great deal. Interest rates on deposits are set by the central bank, limiting competition and operational flexibility among banks. Allowing banks to set the rates would lead to a more efficient banking environment, not to mention more competitive rates for depositors and borrowers alike. As for minimum capital requirements, the central bank had raised the minimum to SYP10 billion ($213 million at the time) for conventional banks and SYP15 billion ($319 million) for Islamic banks,8 figures that at the time were seen as excessive because they would put pressure on shareholders, both in terms of investment required and potential returns on investment. Best practices suggest leaving minimum capital requirements to capital adequacy ratios and the international Basel standards instead of setting absolute amounts.

Reconstruction and reform aside, the fact is that Syria was significantly underbanked before the crisis, and the sector had ample room for growth and profitability even then. The country’s 2010 loans-to-GDP and deposits-to-GDP ratios of 45 percent and 52 percent, respectively, paled in comparison to those of neighboring countries like Lebanon (101 percent and 310 percent) and Jordan (75 percent and 114 percent). A population-per-branch figure of 41,600 in 2010 was almost 8.8 times that of Lebanon and 4.2 times that of Jordan, showing the vast potential for expansion and penetration.

Insurance Companies

The establishment of the Syrian Insurance Supervisory Commission in 2005 was the initial step in the introduction of private sector insurance companies, the first of which began operations in mid-2006.

Up until that point, the state-owned Syrian Insurance Company had a monopoly on the sector, with the exception of a small pool of customers (high net worth individuals and large corporations) that were dealing with regional and international insurance players either directly or through brokers (mostly based in Lebanon). Twelve private insurers began operations in the three years that followed (up until 2008). Although other licenses were later granted by the supervisory commission, no insurance companies actually launched operations after that, keeping the total number of active players in the sector at thirteen (including the Syrian Insurance Company).

The sector did relatively well in the early years, with several companies achieving returns on equity in the mid- to high teens and paying strong dividends to shareholders. The vast majority of premiums came from compulsory and comprehensive car insurance (41.2 percent of 2012 premiums), medical insurance (34.6 percent), and fire insurance (12.4 percent), with minimal focus on and penetration in more profitable lines such as life insurance (1.3 percent). Other business lines include marine, engineering, general accident, and liability insurance.

As the crisis developed, new car sales slowed down dramatically while car exports began to increase, and many car owners moved to neighboring Jordan and Lebanon, either taking their cars or leaving them parked in Syria with no need for insurance. For the majority of those that stayed, income and inflationary pressures meant all spending beyond basic needs was halted. A slowing economy affected all trade- and manufacturing-related premiums, while limited construction and activity on new projects lowered engineering and liability premiums.

Insurance was still to some extent regarded as a luxury product in Syria prior to the crisis, and thus for many it was among the first cuts in nonessential spending. Perhaps one of the few exceptions was medical insurance, as the rising costs of healthcare and medicine, along with the government’s decision to cover all civil servants, led to an increase in medical insurance subscriptions, which is not one of the most financially rewarding business lines for insurers.

In SYP terms, total premiums collected in 2012 by the twelve private sector insurers decreased by 20.2 percent year over year while those collected by the Syrian Insurance Company dropped by only 7.2 percent. The private sector’s share of the market declined from 47.2 percent in 2011 to 43.4 percent in 2012, while takaful companies accounted for less than 4 percent of total premiums. The aggregate net profit realized by the twelve private companies increased by 1 percent year over year reaching SYP1.08 billion in 2012 ($16.4 million at the average rate)—despite eight of the twelve companies posting a decline—representing a 7.4 percent return on shareholders’ equity.9 Although the aforementioned revenue drops seem manageable and all companies remain profitable, looking at the drops after taking into account the Syrian pound’s devaluation against the dollar would present a different picture.

All insurers hedge their risks through reinsurers, and while some companies did not face many issues on this front due to solid foreign strategic partners, others had to look for more aggressive reinsurers that were willing to deal with Syria despite the sanctions and take on Syrian exposure and risk. Rising reinsurance costs were partially passed on to clients, and the higher premiums put further downward pressure on demand for insurance products.

Claims naturally increased as a result of the ensuing damages from the conflict, although many were turned down under the pretext that the underwritten insurance policies did not cover items like war and thefts directly arising from the conflict.

From a cash-in and cash-out perspective, Syrian insurance companies are still doing relatively well due in no small part to their high capital bases, which range from SYP850 million to SYP2 billion ($18–$42 million at the time).10 As is the case with all other companies, insurers are not allowed to buy foreign currency or gold with their cash so most turned to real estate as the first option to preserve their capital. The Syrian Insurance Supervisory Commission raised the cap on real estate ownership at the request of insurance companies, although the majority of the capital remained in cash (in pounds). The same goes for insurance float, over 90 percent of which was placed in term deposits at local banks, with very few companies investing in shares of local joint-stock companies.

Looking forward, three primary factors will determine whether insurance companies will need to raise their capital in the early stages of the recovery: the duration of the current situation, the volume of paid claims throughout the crisis, and the devaluation of the Syrian pound. In their current conditions, the existing companies, at least those that publicly disclose their financials, are unlikely to need to make a capital increase as their balance sheets still seem to be healthy.

On a more positive note, economic activity in Syria is expected to pick up again in the years following the resolution of the crisis, thereby driving up demand for insurance that will be further boosted by the large number of construction projects expected in the recovery period, such as those related to infrastructure, real estate, and manufacturing plants.

The insurance sector in Syria was still in the early stages of development in 2011. Although a state-owned insurance company was always present, insurance penetration in the country was very low and the product and service offerings very limited. The country’s premiums-to-GDP ratio, estimated at 0.62 percent in 2011,11 was less than half the Middle East and Central Asia average of 1.48 percent and one-tenth the international average of 6.60 percent, demonstrating the large potential of this sector in Syria. At only 3 percent of pre-crisis 2010 GDP, total premiums could reach $1.8 billion,12 compared to the 2011 total of $370 million.13

Syria is still behind in terms of standards and practices, and the regulatory framework does not provide the insurance sector with a boost outside of car and medical business lines. As an example, the relevant authorities could impose certain types of insurance policies as a prerequisite to securing a construction license. It is still uncommon for small or local developers to take on engineering insurance, let alone personal accident, worker compensation, and third-party liability insurance. Though imposing such a requirement would lead to an increase in project costs, it would not only benefit insurance companies but also push Syria closer to international best practices.

Insurance companies have a crucial role to play in the recovery period because they will be tasked with insuring the reconstruction work, an important factor in the puzzle given the possible uncertainty over the investment and security climate. The lack of coverage could discourage stakeholders from participating in the reconstruction efforts. From an investment perspective, and given that they are carrying a substantial amount of float on their balance sheets (albeit mostly in Syrian pounds), insurance companies can be prospective contributors to the financing of reconstruction projects.

In terms of opportunities, in the early stages of the conflict’s aftermath, insurance companies will concentrate on marketing the same core products they have always had, given the low penetration rate. In the long run, however, those companies that were already in the process of developing blended products with an investment component (with a focus on retirement or children’s education) will begin introducing more sophisticated products. Simple life insurance policy premiums were only at several million dollars per year for all of Syria, while in more developed countries there are insurance companies that exclusively focus on life insurance with dozens of products.

The combination of banks and insurance companies is another frontier that has yet to be tapped, despite the fact that several private banks own small stakes in private insurance companies. Cross-marketing opportunities and bancassurance are likely to become more of a target down the line, benefiting both banks and insurers with higher revenues.

Financial Services Companies and Investment Banks

 

Following the introduction of banking and insurance laws, the government announced the establishment of the Syrian Commission on Financial Markets and Securities in 2005, and the next year it introduced a capital markets law eventually allowing for the establishment of a securities exchange as well as financial services companies. Seventeen such companies were licensed between 2008 and 2011, with capital bases varying from SYP20 million ($425,000 at the time) to SYP300 million ($6.5 million) and focusing on activities such as brokerage, research, financial advising, and capital raising (without underwriting).14

The commission differentiated between financial services companies (those currently active) and investment banks, for which there is a separate governing law but no licensed companies. Investment banks were required to have a minimum capital base of SYP20 billion ($435 million) and could perform additional activities such as underwriting, securitization, and taking deposits. But the difference between investment banks and financial services companies simply does not justify the substantially higher capital requirements in a country with such nascent capital markets.

In addition to managing numerous initial public offerings and rights issues for private sector banks and insurance companies, active financial services companies executed transactions worth about $90.1 million on the Damascus Securities Exchange in 2010 (compared to $19.9 million in 2009).15 The market was developing at a healthy pace in terms of all quantitative metrics, including value traded, volume traded, number of executed deals, number of brokerage accounts, number of listed companies, and market capitalization. However, investment banking fees on capital-raising transactions were very low, primarily due to severe competition, and brokerage commissions were not sufficient for all thirteen brokerage firms, although they were rapidly growing. This led financial services companies to post operating losses in the early years of the market, and most were relying on revenues generated by their capital to stay in the black (through interest or proprietary trading).

Over the last three years, the market has faced a sharp downturn in terms of performance and activity, which, when coupled with the lack of capital-raising transactions, have put significant pressure on the profitability of financial services companies. At the time this piece was written, six of the thirteen firms with brokerage licenses have either shut down or had their licenses frozen, while all four advisory-only firms have discontinued operations. A couple of the remaining financial services firms have looked to neighboring markets with a view to generating financial advisory revenues, although the figures are small overall.

If, in 2009, it was difficult to predict how the Damascus Securities Exchange would develop following its launch, it is even more difficult now to predict how the market will bounce back following the resolution of the current crisis. During the conflict, it has been evident that a market this shallow and dominated by such a small number of players had the potential to react very quickly to even the slightest bit of positive news. Any such positive momentum is likely to reattract investors, but even getting back to pre-crisis trading levels of about $5 million per week would require a thirty- to forty-fold increase from current levels. Trading activity and stock prices could also be given a boost should the regulators choose to relax foreign investment laws in the exchange. It is worth noting that average daily trading on the Amman Stock Exchange (valued at about $16 million) was more than sixteen times that of the Damascus Securities Exchange at its peak, demonstrating the ample potential of Syrian capital markets.

On the other hand, many banks will look to conduct rights issues with a view to raising their capital base, and they will need to appoint financial advisors to manage these offerings. Other sources of capital-raising transactions could include partial privatizations of state-owned companies or initial public offerings for public- or private-sector-backed companies developing large reconstruction projects in sectors such as infrastructure. It is unlikely that there will be any existing companies (such as family businesses) that are in healthy-enough shape to go public in the near term, but should the market continue to develop, they will present long-term prospects. Advisory opportunities will also include debt structuring and equity private placements for the many reconstruction projects that will take place in the recovery period.

On the asset management side, only one firm had activated its license in 2011 and had begun to offer portfolio management services, but that coincided with the advent of the crisis so no significant achievements were made. Any asset management activities are likely to trail the start of the market’s recovery by at least six to twelve months given the difficulties involved in activating these operations. In the early stage, the service offering will probably be limited to portfolio management services until the market and regulations are ready for the introduction of investment funds. A law governing such funds was introduced in August 2011, but there are many hurdles that prevent this law from being put into practice in its current state.

In terms of private equity, two Syria-focused growth equity funds (Syria Rising and EFG Hermes) were announced before the crisis but did not materialize, while other regional funds were also beginning to consider opportunities in the country. It is possible, though unlikely in the short term, that private equity funds focused on buyouts, privatization, and infrastructure will look at Syria in the reconstruction period. Yet a Syria-focused fund seems far-fetched in the immediate aftermath considering likely future concerns over economic and political stability and previous concerns surrounding exit routes.

Lastly, it remains to be seen whether regional and international investment banks will choose to physically enter the Syrian market or whether they will remotely participate in select transactions from their regional offices. Either way, with an estimated $150–$200 billion in spending expected in the five to ten years following the conflict’s resolution, it is unlikely that they will sit out such an attractive opportunity, especially when considering the shortage of local investment banking capabilities and talent.

Other Players

The foreign exchange market was mostly composed of black market dealers until the sector’s regulation in 2006. While seventeen foreign exchange companies became officially licensed and 49 additional dealer-offices were registered, strict capital controls meant the black market was a permanent fixture. Foreign exchange dealers have had two primary roles over the last three years: fulfill the foreign currency needs of traders and industrialists, and assist the Central Bank of Syria in controlling the money supply and the value of the pound. How much of a role official and black market foreign exchange dealers will have is likely to be primarily dictated by the government’s capital control levels after the crisis, with the official share increasing only if regulations are relaxed.

Meanwhile, microfinance institutions are likely to have a well-defined and key role in the reconstruction period because the need for small unsecured loans will arguably be at its peak. There are two licensed, active microfinance institutions and several others working under so-called programs, generally financed through donations and sponsorships. The regional Aga Khan Agency for Microfinance has been active in Syria as a program since 2003, though it was officially licensed as the First MicroFinance Institution Syria in 2009, which allowed it to begin taking on deposits. The institution grew at a rapid pace, and by year-end 2010, it had approximately 20,000 loans outstanding valued at $21 million (making the average loan size $1,063) and deposits worth about $3.6 million. Ibdaa Microfinance (a nonprofit backed by the United Nations’ Arab Gulf Fund for Development or AGFUND) is the second licensed institution, and it had planned to extend nearly 400,000 loans in its first five years of operations. The United Nations Relief and Works Agency, one of those lenders operating under a program, extended 3,392 loans in 2013 with an average loan size of $270.

None of the active microfinance players have a profit-driven mandate and can afford to minimize interest rates to cost, but their growth story and the fact their portfolio-at-risk rate was in the 1–3 percent per year range shows that the model could work in Syria. Should this subset of the sector expand as expected, it will likely attract new profit-seeking entrants drawn by the prospect of high returns and the possibility of leverage through bank financing or deposits.

As far as financial companies that did not exist prior to the current crisis are concerned, the government introduced legislative decrees that paved the way for the establishment of leasing companies and mortgage providers, both of which could have a role in the reconstruction under the right investment and regulatory framework.

Leasing companies will allow industrialists to secure their machinery with limited capital compared to traditional financing, as they would only finance the depreciable life of the asset under the lease term. For those short on cash and looking to reconstruct their damaged factories, this method of financing could prove quite attractive. In addition to industrial equipment, leasing segments include agricultural machinery, cars, trucks, aircraft, ships, port equipment, and even consumer goods.

In a similar fashion, mortgage providers would allow long-term financing for prospective homeowners at a time when 1.6 million homes need to be reconstructed and many Syrians (particularly those who moved abroad) have sold their homes to finance their expenditures. While banks were offering housing loans prior to the crisis, the lack of a proper mortgage law, which would define the bank’s ability to take over a defaulting borrower’s property, among other things, has curbed the appetite of banks to provide mortgages, and their share of total loan portfolios has been insignificant. Interest rates on mortgages have been quite high and unsubsidized by the government, thereby making these loans rather expensive for the average middle-class borrower. Though costly, the government could look to subsidize (or guarantee) rates on housing loans, akin to the model adopted in countries like Lebanon, or at least guarantee these loans to provide comfort for lenders. Mortgage providers could also partner with the government on their affordable youth housing projects with a view to financing these developments.

While there have yet to be any applications for leasing companies or mortgage providers, it is likely that either local banks, their parent companies, or regional financial groups will seriously consider applying for a license as soon as there is some light at the end of the tunnel.

Conclusion

Syria’s financial sector has taken a big step back over the last three years even though it did not suffer the same physical and punitive damages as have other sectors, such as manufacturing, mining, and tourism. Banks have had to deal with shrinking balance sheets, nonperforming loans, and operational difficulties. Insurance firms have faced large drops in premiums and a devaluation of their cash base (both capital and float, in Syrian pounds). Financial services firms have lost practically all of their revenue sources, and the entire sector has lost valuable human capital, one of the main success drivers in any service-based industry.

That being said, if the future of this sector was bright before the crisis, it could be argued that it will increase even more should the regulatory, economic, and geopolitical climate accommodate. It is estimated that $150–$200 billion in investment will be needed over the next five to ten years, all of which will have to be channeled directly or indirectly through this sector.

While financial awareness and education have a long way to go before Syria’s financial sector can reach its true potential, the country was and remains underbanked and underinsured by all measures. The right framework could make this unharnessed potential very lucrative in the hopefully not-so-distant future.

Other Sources
Amman Stock Exchange, http://www.ase.com.jo.
Bemo Saudi Fransi Finance, Banking Sector Report 2010.
Bemo Saudi Fransi Finance, Banking Sector Report Q3-2013.
Central Bank of Syria, https://www.banquecentrale.gov.sy/.
Damascus Securities Exchange, http://www.dse.sy.
Insurance Regulatory Commission of Jordan, Annual Report 2011.
Syrian Commission on Financial Markets and Securities, http://www.scfms.sy.
Syrian Insurance Supervisory Commission, Annual Report 2012.
World Bank, “Syria Research,” http://www.worldbank.org/en/country/syria/research.

Notes

1 Dollar-to-pound rate of 47.

2 The dollar-to-pound rate used in audited bank financial statements.

3 Average dollar-to-pound rate for the nine-month period calculated as (174 + 77.5) / 2 = 125.75.

4 Conversion of Syrian pound deposits at a dollar-to-pound exchange rate of 47, compared to a rate of 174.

5 Ratio of currency in circulation to bank deposits.

6 Multiplier = (1+currency drain) / (reserve requirement+ currency drain) = (1+0.36)/ (0.2+0.36) = 2.43

7 A $6.2 billion loan repaid over three years would be $2.07 billion per year, and over five years would be $1.24 billion per year.

8 Dollar-to-pound rate of 47.

9 Average dollar-to-pound rate for the nine-month period calculated as (77.5 + 54) / 2 = 65.75.

10 Dollar-to-pound rate of 47.

11 2011 premiums at SYP18.5 billion to GDP at $60 billion, using a dollar-to-pound rate of 50.

12 GDP of $60 billion.

13 Average dollar-to-pound rate in 2011 of 50.

14 Dollar-to-pound rate of 47.

15 Dollar-to-pound rate for 2009 and 2010 set at 47.