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Middle EastOctober 2 2017

UAE banks look to international expansion

Having survived a regional liquidity squeeze, the United Arab Emirates’ larger banks are eyeing opportunities further afield. Meanwhile, an overbanked market means consolidation is likely for the rest of the sector. James King reports.
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Dubai Islamic Bank

Lenders in the United Arab Emirates performed relatively well in The Banker’s Top 100 Arab Banks Ranking for 2017. Most aggregate growth indicators remained robust – though far from excellent – in relation to other regional markets. Asset growth was 6.93% over the 2016 review period, while lenders’ aggregate return on assets hit 1.63%. Despite pre-tax profits falling year on year by 2.9%, return on capital was respectable at 13%.

Within these figures some impressive growth stories emerged, with the likes of Emirates NBD, Abu Dhabi Islamic Bank and Dubai Islamic Bank, among others, outperforming the market average by most metrics. Equally, more challenging business trajectories have been exposed in this year’s ranking as many of the UAE's smaller banks appear to be enduring a tougher time.

Growing pressures

Nevertheless, the diverging fortunes of Emirati lenders have one thing in common: all banks are contending with a growing constellation of market pressures. Some difficulties are shared by peers in neighbouring markets, such as the impact of lower government spending and slower economic growth. Others are unique to the UAE. The country’s banking market includes 46 licensed lenders, 22 of them in The Banker’s Top 100 Arab Banks Ranking. This easily makes it the most competitive banking market in the region.

Cumulatively, these challenges have ensured that the UAE remains a difficult place to do banking. “Two of the biggest challenges that the UAE banking industry has faced over the past couple of years has been competition for liquidity from regional banks, and aggressive lending policies from an overbanked market,” says Shayne Nelson, chief executive of Emirates NBD.

According to Moody’s, by the fourth quarter of 2016 the cost of funds for the country’s five largest banks had risen from 0.9% at the end of 2015 to 1.2%. Even as liquidity pressures have eased in the second half of 2017, the rating agency expects these costs to remain elevated off the back of a rising interest rate environment. In March this year, the UAE central bank hiked the interest rate on certificates of deposit by 25 basis points, in response to a similar move by the US Federal Reserve.

Some lenders are more affected than others. As Emirates NBD’s Mr Nelson notes: “Emirates NBD is fortunate that a large part of our funding is sourced from current accounts and savings accounts. These resident deposits are more sticky and reliable than other forms of deposits or wholesale funding.”

Encouragingly, the UAE’s four largest banks, Emirates NBD, Abu Dhabi Commercial Bank (ADCB), Dubai Islamic Bank and First Abu Dhabi Bank (FAB) – which is not included in The Banker's ranking because the merger of its two predecessors occurred after the review period – have only seen a marginal decrease to their deposit base by the second quarter of this year.

“Combined deposits at the four banks marginally declined by 1% to Dh1000bn [$272bn] relative to the first quarter of 2017,” says Nitish Bhojnagarwala, a vice president at Moody’s. “The decrease was primarily driven by FAB, whose deposit base declined by 4% due to consolidation as a result of the merger. For Emirates NBD and ADCB, deposits were flat, while Dubai Islamic Bank’s deposit base grew by 3% relative to the previous quarter as the UAE’s oldest Islamic franchise continues to attract depositors.”

Growth limited

Beyond liquidity challenges, market competition is intensifying in the UAE. In a country of just 9 million people the opportunities for growth are limited, just as a changing global regulatory environment is making it increasingly expensive to operate. Some analysts see the current environment, and by extension the next few years, as the perfect moment for further consolidation in the UAE, even if complex ownership structures could make this difficult.

The merger of the National Bank of Abu Dhabi and First Gulf Bank to create FAB was partly helped by government backing for the move. The result has been the creation of a regional mega-bank, second only to Qatar National Bank in terms of asset size in the Middle East. But even a bank of this scale has not been immune from the challenges presented by the domestic market. Second-quarter 2017 net profits dipped by 4%, a result attributed to a slowdown in business and softer economic conditions.

In these conditions, some banks are pursuing aggressive lending policies to gain an edge. “In terms of competing with aggressive lending policies, it is important to maintain one’s discipline and preserve a responsible lending policy. If a loan does not make sense on a risk-weighted or return on capital basis, then writing that business may not be in the best long-term interests of the bank or the customer,” says Mr Nelson.

Islamic success story

Meanwhile, the UAE’s larger Islamic banks have maintained their market-beating performance, even if this growth story is moderating. Dubai Islamic Bank, for example, enjoyed a return on assets of 2.3% that was well above the regional average of 1.67%. Similarly, its return on capital surpassed regional norms by hitting 16.2%. Abu Dhabi Islamic Bank also saw positive gains to its assets and pre-tax profits over the 2016 review period, with return on capital of a respectable 13.5%.

But sharia-compliant lenders are facing their own set of difficulties, according to Khamis Buharoon, vice-chairman and acting chief executive of Abu Dhabi Islamic Bank. “[One] of the main challenges for Abu Dhabi Islamic Bank [is to] change perceptions about the industry and become truly mainstream,” he says. “Our research shows that Islamic banks strike a chord with people, not because of religion, but because of ethics. People are even more willing to use Islamic financial services when banks demonstrate their ideals of partnership, respect for the interests of the customer, and simple, transparent and honest business practices.”

In a market as diverse as the UAE, characterised by blue- and white-collar workers from all over the world, this is an important point. Mr Buharoon cites Abu Dhabi Islamic Bank’s successful acquisition of Barclays' retail unit as evidence that conventional operations and customers can be incorporated into an Islamic banking operation.  “This was proof that customers of conventional banks can easily be integrated into an Islamic bank if we offer attractive products and an excellent customer experience,” he says.

If Emirati banks performed relatively well in The Banker’s Top 100 Arab Banks ranking, what can be expected for next year’s prospects? For one, profitability is likely to remain decent among the very largest banks, according to Moody’s. “We expect core profitability to remain solid over the next 12 to 18 months. However, we anticipate that pressure on fee and commission income will continue for the next few quarters as economic growth remains sluggish,” says Mr Bhojnagarwala.

Extended opportunities

For Emirates NBD, the next few years look likely to entail a mixture of leveraging its market-leading positions in certain domestic business segments while keeping an eye on international growth opportunities. The Middle East, north Africa and Turkey region is of particular interest. Emirates NBD’s last international acquisition occurred in 2014 when it bought the in-country unit of France’s BNP Paribas. The lender is also expanding in the markets in which it already has a footprint.

“[In August] we opened our Mumbai branch and we are currently working on plans to add three additional branches to our existing presence in Saudi Arabia. In recent years, we have been vigilant in evaluating acquisition opportunities in the Middle East, north Africa and Turkey region,” says Mr Nelson.

Abu Dhabi Islamic Bank, meanwhile, is looking to opportunities arising from the UAE’s drive towards economic diversification. This, coupled with continued investments in digital automation across its branch networks and the rollout of new services for both retail and wholesale customers, will be pursued to meet the bank’s 2020 growth goals. Beyond this, Mr Buharoon also sees scope for growth in transaction banking.

“Transaction banking is another growth area for Abu Dhabi Islamic Bank, and we have a team of professional relationship managers who can advise customers and offer them cash management and working capital management solutions to unlock liquidity from their balance sheet,” he says.

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Read more about:  Middle East , United Arab Emirates