The largest merger in Lebanon's banking history could trigger consolidation among the country's big players eyeing the entire Middle East, where they are dwarfed by rivals, analysts say.
Banque Audi and Banque Saradar signed on Monday a $159 million merger deal - the first between two top-10 Lebanese banks - to create the country's biggest banking group.
The deal puts pressure on other big banks in what was once the financial hub of the Middle East to grow or get left behind.
"Even the largest bank in Lebanon is nothing in comparison to the size of other Arab banks. They are five to 10 times bigger," said Tony Hchaime, investment banker at Middle East Capital Group.
"Banks need to be big if they want a regional share. That is the rationale for this merger and it applies to all of them."
Some local banks are trying to get a foothold in private banking for rich Gulf clients, a sector that relies more on expertise than size.
Others, like Audi which is opening a network of branches in Jordan, are expanding retail activity beyond the borders of tiny Lebanon, where sluggish growth and high exposure to a government debt above $31 billion limit commercial lending opportunities.
With the banking sector's assets far exceeding the country's entire GDP, mega-mergers, regional growth and new rules allowing local banks to lend abroad are some of the few ways Lebanon's big players can expand market share.
"The biggest banks are more aware of the challenges, the trends outside Lebanon, more conscious about the importance of risk management and the absolute size of an institution," said Standard & Poor's credit analyst Emmanuel Volland.
SOVEREIGN BIGGEST RISK: At Monday's signing, Audi and Saradar said they hoped their merger would be a catalyst for the sector.
They urged monetary authorities and fellow banks not to let Lebanese banks fall behind as finance becomes increasingly border-less.
Lebanon's central bank has for years encouraged Lebanon's more than 50 banking groups to consolidate, especially through take-overs of smaller banks, or raise capital adequacy ratios.
But consolidation has been slower than many expected.
The last big merger talks, between Audi and Banque Libano-Francaise, an affiliate of France's Credit Agricole, were discontinued in 2002. Differences over valuations helped end a Libano-Francaise attempt to take over Saradar the same year.
Consolidation in a sector with too many banks for the size of the economy and population has partly been hindered by a reluctance among family-run institutions to relinquish control.
"It is not easy to merge banks in Lebanon because you have to take into account the objective of the owner," said Moody's banking analyst Adel Satel. "Who runs the resultant bank?"
Blom, Lebanon's largest bank by assets before Monday's merger but still the leader by profits, would appear to be most affected by the newly formed Audi-Saradar Group.
But analysts say that bank, which has shown little appetite for acquisitions, would remain one of the country's strongest even if it continued to pursue organic growth.
While consolidation would improve efficiency and create solid banks better able to compete in the region, analysts say the biggest risk local banks face remains exposure to government debt, worth 185 percent of GDP, much of which they hold.
"The improvement in this situation will not come from the banking sector, it has to come from the government through an improvement in the sovereign situation," said Volland.
"The banks are 100 percent tied to the fortunes of the sovereign."
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