Abu Dhabi: Almost everything that could have gone wrong for the UAE's banking sector did so in 2009.
The bursting of the bubble that has grown noticeably fatter in the last five years saw liquidity dry up almost overnight, non-performing loans multiply, and the real estate sector nearly collapse in parts of the country.
Analysts and bankers now say banks have the potential to rebound in 2010 considering record provisioning last year, government stimulus spending and regulation-tightening, and the perceived improvement in the global economy in recent months.
Tirad Mahmoud, chief executive officer of Abu Dhabi Islamic Bank (ADIB), the UAE's second largest Sharia-compliant lender, is optimistic things will get better, but only after they get worse.
In a meeting with Gulf News after the release of ADIB's earnings last week, Mahmoud touched on the position of his bank relative to the sector struggling to regain its balance. Although his outlook for 2010 on the whole is positive, but he remains concerned about the affects of the real estate sector "hitting the bottom," something he said is yet to happen.
The Central Bank may also have a role to play in helping banks recover, he says.
In an exclusive interview, Mahmoud elaborated his views on the latest situation. Excerpts:
Gulf News: Your board recently approved foreign ownership in the bank. How will it affect your business?
Tirad Mahmoud: Yes, we approved foreign ownership of up to 25 per cent…We're the last bank in Abu Dhabi to do this. We were criticised by many sources. When you're expanding outside the country, you're becoming an open bank doing business out of the UAE, but your shareholder structure is closed.
We felt this was the right time to do it. Our presence outside the UAE is becoming more visible. I believe as a matter of consistency, the time for us to do it is now. Delaying it much further has really not been beneficial to us or anyone else.
Your provisions came as a surprise to many especially since you reduced the amount from the second to third quarter. Why did you have the significant increase in provisioning in the fourth quarter?
Half of our provisions are collective, Dh517 million. We do our audit of our investments in the fourth quarter of the year. We have hired a large team of people to conduct a very thorough audit of everything we have in the bank. The results of this audit became very clear to us in October or November.
It's not a major surprise to us. From an accounting point of view, it had justification. We cannot just go take provisions like that. We have to justify it to our accountants that these provisions are required. You have to have behavioural and documentary evidence. We had to do this audit and it takes time, about four to five months.
We felt that it would be better to do it in "one go." I think we were a bit too conservative. Our auditors think we took too much. I tell them "OK, you can punish me for being conservative." Some people say the 1.25 per cent [collective provisions as a percentage of the total loan book] is not law; it's still a discussion paper.
We can be criticised for being very conservative. But that's not a criticism that I am very upset with. I can live with that.
The Central Bank has only asked for our opinion so far [regarding a 1.25 per cent of loan book collective provisioning requirement]. Why should I wait? What if they make the law in January, February, or March? Then I will be forced to take those provisions. If the law only comes out to 1 per cent, I will have an extra quarter and give it back to the shareholders.
It will be good news. But I don't want bad news in 2010…We're trying to enter this decade with a lighter load.
Does this mean you expect a rise in non-performing loans this year?
I expect some NPLs because of the nature of the market. I expect we will take general provisions of 1.25 per cent to the extent that we increase our loan portfolio.
I think 2010 will still be a challenging year for everyone in the Gulf. Because of that, I cannot rule out potential accidents relating to our customers. We're not an investment bank, we're an Islamic commercial bank. So it's our customers that get into accidents and we get hurt with them.
In Islamic banking, we refer to NPLs as non-performing assets (NPA). We already apply the 90-day rule [declaring a loan non-performing when payment is 90 days late]. The Central Bank is talking about 90 days but the real practice in the market is 180 days. We started applying the 90 day rule in January, 2009.
We are ahead of the market in two things: the 1.25 per cent rule and 90 day rule. To the extent that no further deterioration happens in the market place, I think what you see right now should be the peak.
I believe NPAs have peaked. But I cannot rule out additional accidents. If something happens tomorrow to one of our customers, we will have additional NPAs.
In 2008, I had a feeling based on the trends that 2009 would see many fall as victims. I still think 2010 will have more casualties. There are two reasons for this. The global economy has not recovered. Also the UAE is now an international economy, it's not a closed economy anymore…What happens in the global economy has a direct relationship to the UAE economy.
What challenges do you foresee for the banking sector specifically? And what do you see as the reason for slow loan growth in 2009? Is it tight liquidity or low demand?
The biggest advantage we have is from the UAE government and the Central Bank. They have done a wonderful job to give financial support to the bank. As a percentage of GDP, what the UAE government has done in terms of injecting liquidity in the system by far exceeds any country in the world.
I think that support will continue through 2010 and beyond. I think the challenges in 2010 will emanate from the real estate sector. I am speaking in general and not a specific city or emirate. I don't think the real estate sector has seen the bottom yet.
There are many projects [nearing completion]. When these buildings are complete and delivered, and I think that will happen in 2010, we will see more downward pressure on rentals and prices. When that happens, customers will suffer. If customers suffer, financial institutions will suffer.
The second source of pressure for the banks is the structural tightness in regulatory liquidity. The loan to deposit ratio in the industry is still very high. That causes pressure on interest rates on customer deposits to be higher.
This creates a higher cost of funding for the banks and it will continue through 2010.
Why have banks not taken advantage of credit facilities made available by the Central Bank?
It doesn't help. You have two kinds of liquidity: actual liquidity and regulatory liquidity. Regulatory liquidity is customer deposits. Actual liquidity is what you take form the Central Bank and other banks.
In all, customer deposits have to be greater than customer risk assets [loans]. This is the regulation. You have other deposits in the bank from the Central Bank and other banks. You cannot use this to improve your ratio.
A lot of the banks [count] the conventional bonds and sukuks [as deposits]. The only reason you can do that, from a proper accounting point of view, is if the bond is issued by the Central Bank or a Ministry of Finance, a real sovereign. But if the bond is issued by a semi government-owned entity, such as Nakheel, it should be treated as a loan. These are accounting games.
What [high loan to deposit ratios] do is it creates pressure on customer deposits. In normal markets, what you earn on a deposit is tied to the inter-bank rate. In Egypt, it's tied to the Corridor [system]. Here it should be tied to the Emirates inter-bank offered rate (Eibor) or the London inter-bank offered rate. In reality, what you pay to the customer is more than either rate. It could be double that. If Eibor is 2 per cent, banks sometimes pay 4 per cent on deposits.
[The loans to deposits ratio regulation] is increasing the cost of funding for banks and it has not been resolved fully. It has to be resolved. The only way you can resolve this is by increasing actual customer deposits or reducing loans. You cannot reduce loans in an economy like this, so [deposits] need to grow.
How can that be done without increasing the cost of funding?
I think the government has to do one of two things: remove the [loans to deposits ratio] regulation and say "for five years we're not going to ask you for compliance on this."
When you ease the regulation, the pressure on customer deposits drops. Why are we competing for customer deposits? It's not a custom or a tradition. It's the law. We're doing it to satisfy a certain regulation. So you can ease the pressure by introducing a regulatory grace period. You can apply some rules and regulations in order not to make matters worse.
Then banks will be less aggressive competing for customer deposits though pricing. They will compete through service instead.
The credit risk of the banks is guaranteed by the Central Bank. The Central Bank has guaranteed all deposits. So why do we pay 4 per cent [on deposits]; because we have to in order to meet the regulatory requirement.
So easing that requirement could solve the problem. That's one solution that does not cost money. The second solution is the government has to go and inject more deposits in the system in order to reduce the breach of this ratio.
How much needs to be injected?
One has to do the math. The public data is available on the Central Bank website. You can easily do the math.
Why did your earnings statement mention using the justice system to deal with defaulting customers?
There is a perception in the market place that Islamic banks are not as diligent in collecting their receivables as conventional banks. I think that is an unfair criticism and it's unfounded. Islamic banks worry about collecting their receivables like everyone else.
I wanted to make sure the analyst community understands the policy of the bank is consistent with best practices.
How do you assess your bank's performance in recent years? What are your expectations for 2010?
We have had tremendous growth in the last three years, including a 30 per cent compound annual growth rate.
When you talk about provisions, this is part of the legacy. This is the stuff that was built up over the years and we're doing a clean up of that. But looking forward, what we're saying is we will have double-digit growth in the key business areas. We have increased our customers from 200,000 to 340,000 in about two years and our target is to go to a half-million customers. We're going to 70 branches this year from 52 last year.
If you take all these things into consideration, including the rise in provisioning against NPLs, you see there's good and bad news. We think we have peaked in terms of NPLs and we have taken sufficient provisions. Then you can expect a dramatic increase in net income for 2010.
We are one of the most liquid banks in the country. Our surplus liquidity has resulted in Dh13.6 billion due to us from other banks. The biggest banks in the country do not have this.