The United Arab Emirates is exposed to the ebbs and flows of the global economy like few other regional markets. As one of the great centres of east-west and south-south trade, the country was hit hard by the financial crisis. But its recovery, off the back of a fragile global economic revival and improving domestic output, has been equally swift.
The UAE’s banking sector is now setting the regional standard in terms of profitability and asset growth, while maintaining prudent capital levels and liquidity ratios. With gross domestic product (GDP) growth expected to hover between 4% and 5% in 2014 and 2015, the banking sector’s medium-term prospects are promising.
Nevertheless, a number of local lenders are still contending with high legacy non-performing loan (NPL) positions. This will remain a challenge for the foreseeable future, albeit a manageable one. In tandem, near-term difficulties also remain. Pressure on most of the local lenders’ margins has the potential to increase as price competition in the retail sector escalates. Meanwhile, corporate lending has been dented as larger entities look to the attractive pricing offered by the local debt markets.
Beyond these difficulties, the introduction of a long-awaited UAE credit bureau is expected to have a sizeable impact on the sector’s stability. Traditionally starved of detailed credit information, Emirati lenders struggled throughout the financial crisis to accurately determine loan applicants’ credit histories. This looks set to change, though uncertainties still remain regarding the issues of liability and responsibility for information provided by the bureau.
Growth projections
For now, extensive government infrastructure plans and the diversified nature of the UAE’s economy are likely to support the continued growth of the banking sector. “From an economic point of view, the UAE’s medium-term outlook is promising. Demand seems to be quite consistent across the board, from trade to tourism to services, while the country’s banking system is in excellent health,” says Mohsin Nathani, chief executive of Standard Chartered in the UAE.
In tandem, the country’s banks have also benefited from growth in the retail and small and medium-sized enterprise (SME) space. A low-interest-rate environment, coupled with slower corporate loan growth in key sectors, has forced many to prioritise these business areas. Moreover, asset management and brokerage services have been strong profit drivers for some lenders, in light of the country’s buoyant equity markets.
As such, recent oil price volatility has done little to dampen the optimism that now permeates the country’s largest banks. Third-quarter results from 2014 were overwhelmingly positive, with most lenders posting record year-on-year profit growth, improvements to asset quality and increases in loan growth. The country’s largest bank by Tier 1 capital and total assets, Emirates NBD, recorded a 51% increase in net profits in the third quarter of 2014 year on year, while total income for the first nine months of 2014 grew by 25% compared with 2013.
“The strong operating performance was helped by all parts of the business delivering year-on-year revenue growth supported by strong economic growth in Dubai as SMEs and trade finance drove recovery,” says Shayne Nelson, chief executive of Emirates NBD. “Net interest income grew 19% in the first nine months of 2014, attributable to an improved asset mix due to retail and Islamic growth, a lower cost of funds helped by both current and savings accounts growth, and the full repayment of relatively expensive ministry of finance Tier 2 deposits, as well as a contribution from our Egyptian business.”
Building on success
The National Bank of Abu Dhabi (NBAD), the UAE's second largest lender by total assets and Tier 1 capital, reported similar gains, with net profits rising 32% year on year, while revenues grew by 8.4% for the first nine months of the year compared with 2013. “We have continued to see our businesses build momentum during the first nine months of 2014. We generated growth across our businesses, and this is an indication that our five-year strategy is beginning to take effect. We look forward to building on this success and continuing this momentum going forward,” says Alex Thursby, chief executive of NBAD.
Figures from the central bank underscore this positive trajectory. In the first nine months of 2014, the growth rate for gross loans hit 8% while total asset growth reached 10%. These encouraging trends stem, in part, from the resurgence of the UAE’s non-hydrocarbon private sector. The country’s two dominant business hubs, Dubai and Abu Dhabi, have fostered strong activity in trade, transportation and tourism, according to a research note published by ratings agency Moody’s. Other sources of growth include large-scale spending on various megaprojects, including massive residential and infrastructure developments, particularly in the build-up to Dubai’s Expo 2020.
Nevertheless, 40% of the country’s GDP is comprised of hydrocarbon contributions, meaning that any sustained price drop will have implications for future government spending. Moreover, many of the UAE’s largest lenders are still grappling with substantial legacy NPL positions. While the introduction of regulations that discourage speculation have stabilised the real estate market, and affected lenders have implemented NPL reduction strategies, these positions will remain a longer term challenge. This is particularly true for those banks that were exposed to government related issuers, including Dubai World.
“Over the next couple of years, we aim to manage the NPL ratio towards 12%, including Dubai World exposure, or 8% excluding Dubai World," says Mr Nelson. "NPL improvement has arisen and will arise through a combination of existing NPLs being made good and recoveries/work-outs in existing NPLs. In 2014, [our dedicated] financial restructuring and remedial unit successfully recovered more than Dh2.8bn [$762m] of problem loans. We expect the coverage ratio to grow to 80%, including Dubai World exposure, or 100% excluding Dubai World,”
Competition heats up
While the bigger picture is undoubtedly an encouraging one, niche pressures are beginning to emerge. Notably, lending to larger corporate entities has suffered in recent months as these groups have turned to the attractive pricing offered by local debt markets. This has diminished the opportunities available to the country’s banks, increasing competition and placing pressure on margins.
“Increased liquidity in the system has allowed corporates to refinance at lower rates and repay old loans, which is stimulating increased competition in the market. The market is moving towards bonds and sukuk and the development of debt capital markets rather than bilateral lending,” says Mr Nelson.
As a consequence, the UAE’s lenders have placed greater emphasis on their higher margin retail operations. Competition is now fierce in the battle for the country’s diverse consumer market. “Margin pressure continues to be a factor, and we believe that is has just about bottomed out for our wholesale banking business but not necessarily for the market as a whole. We are focused on investing in higher return-on-equity businesses in retail and commercial, and across all of our businesses – existing and new lines of business – and this will help to offset margin compression,” says Mr Thursby.
Stellar year
This competition for consumers is fostering product and service innovation, as well as a drive to access new consumer segments. In this respect, Abu Dhabi Islamic Bank (ADIB) has emerged as one of the most ambitious lenders in the market. In 2014, ADIB acquired the retail operations of Barclays in the UAE, in a $177m deal which saw the sharia-compliant lender obtain an additional 110,000 customers. Not only was this one of the most significant deals of the year, it also crystallised the bank’s plans to tap into the country’s lucrative expat retail sector.
“In the UAE we aim to be the biggest retail bank. We believe that we are already the biggest retail bank among UAE nationals but we want to be the number one across all customer segments in the UAE. The acquisition of Barclays accelerates our growth plans in the UAE. By absorbing Barclays’ retail staff we now have the experience and knowledge required to engage with the expat market,” says Tirad Al Mahmoud, chief executive of ADIB.
The deal also capped another stellar year for the country’s booming Islamic banking sector. According to data from Moody’s, Islamic banks account for about 16% of system assets in the country. This figure rises to 28% when including the Islamic windows of conventional lenders. Yet, the priority for a number of these lenders is now to push beyond the traditional constituencies invested in Islamic finance. This drive emphasises the ethical nature of sharia-compliant finance, and is finding success in attracting interest from groups new to this area of banking.
“Our business model is not a religious business model; it is a universally ethical business model. Ethics will become a fundamental issue in the way that banks develop their policies. We have a head start because it is something we already possess,” says Mr Al Mahmoud.
Welcome development
For sharia-compliant and conventional lenders alike, the next milestone in the industry’s growth is the development of the country’s first credit bureau. For lenders more accustomed to dealing with higher level lending risk and thin-file credit histories, this is a welcome development. After significant delays, the Al Etihad Credit Bureau (AECB) became operational in September 2014 before formally launching a month later.
“When the credit bureau comes in we’ll see a slight slowdown in the applications for borrowing but over the medium term it is the best thing that can happen for the country,” says Mr Nathani at Standard Chartered.
For now, the new bureau will only cover UAE residents and citizens. Under the second phase of the AECB’s roll out, expected sometime in 2015, its services will extend to corporates. Nevertheless, question marks over the credit bureau’s operations remain. At the time of writing, a number of UAE lenders were refusing to engage with data sourced from the bureau. Confusion over who would be liable for the data provided has dogged its launch. Speaking at a local press conference in November 2014, Abdul Aziz al-Ghurair, chairman of the UAE Banks Federation, stated that lenders would not engage with the bureau until the liability and responsibility for information was made clear.
Moreover, other challenges related to data privacy, data sharing and the development of an effective technological platform remain. “In the short term, there are four key issues that need to be ironed out: developing a well-defined regulatory framework that addresses issues such as data privacy, data protection and effective data sharing; overcoming data issues such as unique identifiers and consistent and accurate data feed from member banks; strengthening the technology platform on which the bureau runs; and, not least, ensuring that the bureau is able to attract staff with requisite skills and experience,” says Mr Thursby.
New space
Once these challenges can be overcome, expectations for the credit bureau are high. This is particularly true for the SME segment, which stands to benefit from the roll out of corporate-related risk assessment mechanism in 2015. At present, smaller sized businesses in the UAE are starved of credit, and lending to these entities remains well below the regional average despite the banks’ recent efforts to target this segment.
According to the UAE Banks Federation, bank lending to SMEs accounts for about 4% of loans, against a regional average closer to 8%. These figures are all the more startling given that SMEs represent 95% of all firms and contribute 40% to GDP generated in the UAE economy, according to figures from Emirates NBD.
Moreover, the SME sector has become more appealing as foreign lenders have retreated from the space due to a more stringent global regulatory environment, coupled with higher costs of delivery. “Over time, it will become increasingly clear that local banks add more value in certain segments. We are currently in the process of exiting our SME business and increasingly this segment is becoming more attractive for local banks. Their cost of delivery for that business is lower than it is for foreign banks,” says Mr Nathani.
Building on opportunities such as these, the UAE’s lenders will continue to benefit from the wider macroeconomic revival of the country. The next 12 months are likely to see a continuation of the impressive results posted in the first nine months of 2014, buttressed by the ongoing expansion of the strongest banks as they tap into larger, higher growth markets across the region and beyond.
