BEIRUT, Lebanon - Flush with cash and looking to cut their dependence on government debt, Lebanon's biggest banks are expanding aggressively into neighbouring Arab states as they open up their under-developed markets.

Most of Lebanon's top banks are already up and running in Syria, which ended four decades of state control in the financial sector only last year. Others are awaiting licences to get a slice of what is practically a virgin market.

BLOM and Bank Audi, Lebanon's two largest banks, began operating in Jordan last year. And BLOM said last month it would bid for Egypt's Misr Romanian Bank in a deal that would be worth about $103 million.

On Monday, Cairo Far East Bank said Egypt had authorised Audi to conduct a due diligence study, a step that usually leads to an acquisition. Several other Lebanese banks are opening in Algeria and Sudan.

Bankers and analysts say all this is just the beginning.

Lebanese banks are expected to enhance their regional stature while diluting their exposure to $36 billion of government debt that overshadows local commercial lending.

"This is the most interesting and the most important news for us with respect to Lebanese banking," said Anouar Hassoune, credit analyst at Standard & Poor's. "For years, the Lebanese banking system was tied to the fortunes of the sovereign. More than half of the assets were invested in sovereign assets."

"This will help them diversify their income a bit more to be less reliant on local markets."

The total assets of Lebanon's banks grew by 12.8 percent to $67.8 billion last year, outpacing the country's economic growth.

With assets far exceeding the country's entire GDP, Lebanese banks are awash with liquidity and regional expansion is one of the few ways the biggest players can expand their market share.

Most have made use of changes to central bank rules allowing banks to devote 25 percent of their equity to business abroad.

"Today Audi's assets are almost 55 percent of Lebanon's GDP. When you reach such a size you are obliged to consider expanding over your national boundaries," said Freddie Baz, Chief Strategic Adviser to Audi. "We are all looking at captive markets where we can develop some franchises and bring some expertise."

"We have the standing, we have the financial muscle, we have the size, we have the knowledge so it is about time."

Captive Markets

Bankers and analysts say banking reforms under way in several Arab countries offer tantalising opportunities for big banks seeking captive markets outside the borders of tiny Lebanon.

They are seeking to develop retail and commercial activity in primitive markets such as Syria or Sudan, where they will be starting virtually from scratch.

More Lebanese banks are looking towards Egypt, a potentially large and promising market where the state is encouraging acquisitions in an effort to cut the number of banks operating.

In the Arab Gulf, already crowded by big banks that dwarf Lebanese players, some are carving out niches in private banking for rich clients.

Joe Sarrouh, adviser to the chairman of Fransabank, which has opened an Islamic bank in Sudan and will open in Algeria in early 2006, said Lebanon was also poised to draw in some of the cash washing around the region as Gulf economies ride an oil price boom.

"Banks have to diversify income channels, more so because the region is awash with liquidity and Lebanon is poised to attract some of it also to the financial sector," he said.

"Some markets are truly difficult but they are promising ... With the maturity Lebanese banks have gained over the past few years, they can do good business in these markets."

The killing of former Prime Minister Rafik al-Hariri in February briefly shook financial markets and prompted investors to switch to dollars, but banks have since recovered from the crisis, which had little impact on their bottom line.

Fitch Ratings last month affirmed the ratings of Audi, BLOM and Byblos at B-, citing resilience amid the political and economic turmoil of recent months.

Baz said big Lebanese banks should also seek mergers inside Lebanon, creating larger banks that could be more competitive region-wide, particularly if relations between Israel and neighbouring Arab states improve.

The central bank has for years encouraged Lebanon's more than 50 banking groups to consolidate, but the process has been slow and the country has seen few mergers among larger banks.

Lebanon's central bank plans to sell BLC bank this year and bankers say it has drawn healthy demand locally and regionally.

"We have seen lobsters eating shrimps but we haven't so far seen the lobsters getting together. It is about time," said Baz, whose Audi last year bought fellow Lebanese Banque Saradar for $159 million in the country's biggest banking merger. (Reuters)