Dubai: The banking sector in the UAE is navigating through a tougher environment, after enjoying four consecutive years of favourable operating conditions. However, the downside risks to systemic strength are limited because lenders have substantially improved their funding, asset quality and capitalisation over the past few years.
Today, the banking sector in the country is the largest in terms of assets, exceeding Dh2.4 trillion at the close of the third quarter of the year, according to the latest data from Central Bank of UAE.
Amidst tightening liquidity and a reported gradual deterioration of asset quality faced by some banks, particularly relating to small-to-medium-sized enterprises (SME), the central bank and leading banks have said the potential asset impairments are small and do not pose any systemic risk to any bank or the banking sector as a whole.
Risk-monitoring
However, in the context of the global and regional economic slowdown and the sharp decline in oil prices, the Central Bank of UAE is monitoring potential risks to the UAE banking sector, Mubarak Rashed Al Mansouri, Governor of the Central Bank of UAE, said at the Middle East Banking Forum earlier this month.
“With the major stakeholders, the central bank is closely monitoring the financial soundness indicators for the banking sector to make sure potential vulnerabilities are identified and appropriate measures are taken on time to hedge against risks that could escalate to a full-blown crisis as our experience has taught us,” Al Mansouri said.
Global rating agencies such as Standard & Poor’s and Moody’s have said weakening macroeconomic conditions, due to a sharp decline in oil prices, are expected to weigh on outlook for the banking sector. The continued volatility on the country’s equity markets and somewhat of a correction in the residential real estate market after two years of sharp price appreciation are impacting both the asset and earnings growth of UAE banks.
Volatility seen continuing
“Today, we no longer view asset prices as a positive factor in recovery. Indeed, we expect continued volatility in the equities market, in line with movements in oil prices. For markets such as the UAE, we also expect to see a continued correction in real estate prices, potentially further contributing to credit losses,” said Standard & Poor’s credit analyst Suha Urgan.
According to the Central Bank of UAE data for the period up to the end of October, credit growth remained strong in 2015, expanding 7.5 per cent year-on-year in the first 10 months and 7.7 per cent in October. Notably, there has been a change in the factors driving credit growth.
Within the private sector, personal loan growth has been accelerating gradually this year — to 10 per cent year-on-year in October, up from 7 per cent seen in December 2014.
“Despite the recent tightening of liquidity, banks have managed to accommodate demand for credit, capitalising on [the] ample liquidity they had accumulated,” Al Mansouri said.
Weakening business credit
But despite the healthy overall credit growth, a closer look at the 2015 figures shows retail credit growth remained stronger than corporate credit growth. This likely reflects a more cautious approach by businesses, given the signs of softening economic activity. Meanwhile, government loan growth accelerated to the double-digit range — 11.5 per cent in October — something analysts say partly reflects the deterioration in the fiscal position.
The central bank expects the main challenges for the banking system to come from a global economic slowdown and lower oil prices, which could lead to further fiscal consolidation and tightening in bank liquidity, caused by a slowdown in customer deposit levels.
Customer deposits rose steadily to Dh1.4 trillion, improving the overall liquidity situation and strong capital base, with the average capital adequacy ratio — in excess of 18 per cent — exceeding UAE regulatory requirements.
“These strengths allowed our banking sector to expand credit despite a noticeable slowdown in deposit growth. This was made possible thanks to a satisfactory, albeit tightening, liquidity situation for banks,” Al Mansouri said.
Effect of oil slump
The central bank data up to the close of the third quarter of this year shows the overall ratio of non-performing loans (NPLs) falling from 8.6 per cent in the second half of 2014 to just 6.3 per cent as of September 2015. Continued improvement in the balance sheets of banks boosted the lending-to-stable resources ratio from 85.2 per cent at the end of last year to 88.1 per cent at the end of September.
The central bank governor said under the current economic environment, the banking sector is likely to be impacted by the slowdown in the non-oil activities in the UAE and may necessitate prudent measures.
The reduction in oil prices, which led to a fall in government revenues, could trigger further fiscal consolidation and lower loan demand. Further tightening in bank liquidity is expected due to slowdown in customer deposits. Additionally, banks are likely to face a higher cost of funding following a lift-off of interest rates in the US starting December.
“We believe that credit demand could well weaken in late 2015 and in 2016 on the back of the softening macroeconomic backdrop and expected rise in borrowing rates,” Monica Malek, chief economist at the Abu Dhabi Commercial Bank in a recent note. “In the retail segment, weaker population growth and slower wage increases will also likely contribute to a deceleration in credit growth. We forecast some moderation in total credit growth, to 7.5 per cent in the fourth quarter of 2015 and around 5.8 per cent in 2016.”
