Bankers in the United Arab Emirates have good reason to be happy. Despite softer economic growth in the domestic economy in recent years, the performance of the country’s lenders has remained relatively buoyant. By most key indicators, including capitalisation, liquidity and profitability, Emirati banks are in rude health. This matters, because opportunities for growth in the UAE are likely to be less abundant than they once were, at least in the short term. Most estimates expect gross domestic product to hit between 2.5% and 3% in 2019, figures which fall well below recent historical norms.
Nevertheless, Emirati banks are opening 2019 from a position of considerable strength. The sector’s Tier 1 capital ratio stood at 16.6% by the end of the third quarter of 2018, while its capital adequacy and liquid assets ratio were 17.9% and 15.3%, respectively, according to data from the Central Bank of the UAE. Meanwhile, the total assets of Emirati banks grew by 7.4% year on year in the third quarter, though gross credit growth came in at 3.7% over the same period. Total deposits also grew by 9.7%.
Though UAE banks have, in general, deployed effective growth strategies in recent years, their development trajectories remain hitched to the fortunes of the oil-weighted economy in which they operate. “In general the UAE’s banks are highly liquid, well capitalised and profitable,” says Redmond Ramsdale, senior director, financial institutions, at Fitch Ratings. “Higher oil prices over the past two years have translated into stronger economic growth which, in turn, has been contributing to stronger credit fundamentals for the UAE’s banks.”
Forewarned is forearmed
Over the coming year, UAE banks are expected to receive a boost from a number of stimulus measures introduced in both Dubai and Abu Dhabi. These include spending on hydrocarbon projects in the latter, while the Dubai government is also ramping up spending in preparation for hosting the World Expo 2020.
However, it is not all good news for the banks, with asset quality pressures on the rise.
“Deteriorating asset quality in some sectors is the main pressure facing the banks,” says Mr Ramsdale. “The real estate and construction segment is at the forefront of this, while retail and wholesale trade and the hospitality sectors are also enduring some difficulties. The expectation for the year is a mild increase in impaired loans. The UAE’s banks are, however, well positioned to deal with this.”
Indeed, the UAE’s real estate market is under growing pressure. According to data from the central bank, residential property prices in Dubai decreased by 7.4% in the third quarter of 2017 on an annualised basis, while for Abu Dhabi this figure was 6.1%. Rent values also fell over the same period, with prices dropping by 9.6% in Dubai and 11.3% in Abu Dhabi.
“This is an area where we see pressure continuing with the level of new supply, ongoing slower growth to absorb that supply and the fact that the UAE is experiencing a number of external headwinds,” says Monica Malik, chief economist at Abu Dhabi Commercial Bank.
Softer economic growth across the UAE has led to a decrease in the number of white-collar jobs being created at a time when high levels of new mid- to upper-tier residential developments are coming online. These trends, in conjunction with the headwinds hitting the economy, have negatively affected the country’s property market. According to research from ratings agency Moody’s, UAE banks’ direct lending to the real estate and construction sector accounted for about 21% of the sector-wide loan book by mid 2018.
Good news and bad
Over the next 12 months most analysts expect the Dubai and Abu Dhabi real estate market to remain quiet. Yet there is widespread recognition that changes to regulation and underwriting practices in recent years mean that Emirati banks are less exposed to the dangers of any material downturn in property prices than in previous years.
“In 2013 and 2014 a number of macroprudential measures were announced to reduce exposure and leverage to the real estate sector,” says Ms Malik.
Meanwhile, rising interest rates are delivering a mix of challenges and opportunities for the wider banking sector. In September 2018 the central bank raised interest rates on its certificates of deposit, as well as the repo rate, by 25 basis points. This was largely in response to the Federal Reserve’s 25-basis point increase to its federal funds rate. This is good news for most UAE lenders, given the boost it will provide to net interest income. However, the associated increase in the cost of borrowing could hit small and medium-sized enterprises (SMEs).
“If interest rates keep going up that could lead to a mild margin improvement [for UAE banks] but it will also hit the SME portfolios of smaller banks,” says Chiradeep Ghosh, research manager for the Securities and Investment Company (SICO).
Meanwhile, in the wake of the merger of First Gulf Bank and the National Bank of Abu Dhabi to create First Abu Dhabi Bank, additional consolidation is expected in the UAE banking market over the medium term. This reflects a wider trend across the Gulf Co-operation Council (GCC), according to Ashraf Madani, vice-president and senior analyst at ratings agency Moody’s. “Slow growth and subdued credit demand in the region is one of the biggest drivers of consolidation,” he says. “This has intensified competition for depositors and borrowers, dampening profits at GCC banks.”
In late 2018 it was announced that three UAE lenders – Abu Dhabi Commercial Bank, Union National Bank and Islamic lender Al Hilal Bank – were in talks to create a new entity with estimated combined assets of about $113bn. The tie-up, which is still subject to approval by the banks’ boards of directors, shareholders and regulators, has been widely welcomed by analysts who have long viewed the country, with 60 lenders serving a population of just 9 million, as being overbanked.
“Clearly the UAE is an overbanked market and that’s why discussions have increased over potential consolidation,” says Fitch Ratings’ Mr Ramsdale. “Consolidation is about creating shareholder value and new market leaders. These new entities should be in a better position to compete for deposits and find growth opportunities in a region that is expanding, economically, more slowly than it once was.”
Small banks struggle
Further merger and acquisition activity in the UAE is expected in the coming years. With the two largest banks – First Abu Dhabi Bank and Emirates NBD – accounting for close to 45% of the total banking sector’s market share by assets and the creation of another mega-bank on the horizon, smaller lenders are finding the environment increasingly difficult.
“With larger banks having massive balance sheets it is getting harder for smaller banks to compete. Further consolidation is a logical expectation but nobody can know for sure,” says SICO’s Mr Ghosh.
Indeed, this process of consolidation could be helped along, in some cases, by the banks’ ownership structures, according to Mr Ramsdale. “The truth is there are a lot of common shareholders between the banks,” he says. “Where you have common shareholders it makes it easier to ensure that these deals happen.”
Beyond the domestic market, UAE banks have maintained their push into higher growth markets in the region. In 2018, Emirates NBD agreed to the acquisition of Russian lender Sberbank’s Turkish unit, Denizbank, for $3.2bn. This follows similar buy-ins to the Turkish markets from lenders from Qatar, Bahrain and Kuwait, among others. Nevertheless, acquisitions of this nature are now being executed in a more volatile political and economic environment. Since the deal was agreed the value of the Turkish lira has slumped and the currency was, at the time of writing, the worst-performing emerging market currency of 2019.
Despite these difficulties, appetite for overseas acquisitions is expected to remain if the right valuation can be sought. “I wouldn’t be surprised if the larger UAE banks increased their exposure to other markets,” says Mr Ghosh. “It makes sense if they can find the right value and the right opportunities. Challenges [in these markets] will come and challenges will go. But it makes sense for the banks to diversify their liability base.”
Fighting crime
At home, UAE banks are investing heavily to counter new threats that are emerging in cyberspace. In common with other Gulf markets, which boast relatively high average personal loan sizes and deposits, the UAE banking sector offers an attractive prospect for cybercriminals.
According to comments made by the chief executive of Dubai’s Electricity and Water Authority, Saeed Mohammed Al Tayer, at a cybersecurity conference, the UAE was subject to 561 cyber attacks on public and private sector websites in the first half of 2017. These efforts were reportedly thwarted by the Telecommunications Regulatory Authority.
In the face of an ever-growing threat, Emirati lenders, under the auspices of the UAE Banks Federation (UBF) and in partnership with US technology firm Anomali, have banded together to create an information-sharing and analysis centre. Participating institutions are able to correlate and analyse information around the cyber threats they face, and alert other lenders to new and emerging dangers in the cyber realm.
Speaking at the Himaya Cyber Threat Intelligence Collaboration Forum hosted by the UBF in December 2018, the organisation’s general manager, Nasser Sarris, said: “Cybercriminals are posing an increasing threat to all businesses alike around the globe. It should come as no surprise that the financial industry is a top target for attackers; with the entry of new players and technologies such as fintech and blockchain, the financial services sector has become a magnet for hackers and fraudsters.”
Indeed, some Emirati lenders are turning to technology to address risks linked to fraud and cyber attacks. Emirates NBD, for example, has launched a ‘cheque chain’ technology which uses a blockchain platform to prevent cheque-based fraud. The system works by printing a unique QR code on each cheque which is then added to the bank’s records on a blockchain platform.
In many cases, technological investments of this sort fall under a wider cybersecurity development agendas. Abu Dhabi Islamic Bank has launched a three-year information security transformation programme that covers 35 different initiatives to enhance cybersecurity in line with internal and external regulatory priorities. One feature of this programme is a Group Information Security Department, which acts as a centralised and independent security entity within the bank. Another is a cybersecurity awareness campaign launched through its social media channels.
Future signs
Looking ahead, the UAE banking sector is clearly on a steady growth path. With economic growth expected to pick up, albeit moderately, over the next couple of years, and with interest rates on the rise, most of the country’s mid-sized to large banks should find ample opportunity for growth. Moody’s expects net income to hit about 1.6% to 1.8% of tangible banking assets in the near term. This generally healthy performance is likely to be accompanied by notable changes to the shape of the banking landscape, however.
Over the next couple of years this could include the completion of the Abu Dhabi Commercial Bank, Union Bank and Al Hilal Bank merger, which would add to the list of the region’s mega-banks. Further deals are also expected to occur as smaller lenders feel the pinch from their larger rivals. The result of all this is likely to be a leaner and more profitable banking sector and one that is better positioned to weather the uncertainties of a rapidly shifting global economic landscape.
Amid heightened regional political uncertainties and growing tensions between the world’s great powers, the UAE, as an outward-looking and trade-focused economy, is likely to face a number of unforeseen challenges in the coming years. But unlike the last time the country endured the shockwaves of a global crisis, today its banking sector is both robust and well regulated, and only getting stronger.
