Loan growth, the main driver of bank profits, remains constrained by lack of demand from the private sector and the recent tightening of lending standards by the Central Bank that restrict the size and tenure of retail loans.
For the majority of banks, their exposure to bad debts in real estate continues to remain a problem. While valuations of these assets are still depressed, banks are forced to make provisions.
Total loan growth in the first quarter was 4.6 per cent compared to 4.4 per cent for the whole of 2010 and 1.6 per cent in the first quarter of last year. Leading bankers have said that although provisions are on the decline, reinforcing balance sheets will remain their top priority for the rest of the year.
"We have managed to strengthen our balance sheet significantly in the last quarter. There will be a pickup in lending during the rest of the year, and we expect about 4-5 per cent loan growth for the year," says Rick Pudner, CEO of Emirates NBD, the UAE's largest bank by assets.
Sustained provisions and a conservative approach to lending have strengthened the balance sheets of most banks. Emirates NBD, for example, booked an impairment charge of Dh1.37 billion in the first quarter compared with Dh555 million in the same period last year.
"Emirates NBD's loan loss reserves now stand at 45 per cent of impaired loans. All in all, operationally a little weak [for the] quarter, but the bank is now better provisioned versus year-end 2010," says Jaap Meijer, head of the bank team, AlembicHC.
Bankers and analysts say slow loan growth has not been all that bad. In most cases marginal growth in loans combined with stronger growth in deposits has meant that loan-to-deposit ratios are improving.
UAE banks have witnessed a steady improvement in deposits during the first quarter of this year, partly reflecting regional turmoil. International organisations such as the International Monetary Fund (IMF) and the Institute of International Finance (IIF) say that the UAE enjoys a safe-haven status in the region in the context of political uncertainty in some of the Middle East and North African (Mena) countries.
"From our interactions with bankers, there have been indications that non-resident deposits with UAE banks are increasing in recent months, which will eventually exert pressure on banks to lend more," says Garbis Iradian, IIF Deputy Director, Africa Middle East Department.
The UAE Central Bank recently disclosed that there has been an increase of more than Dh20 billion in foreign deposits during the past six months. Statistics show more than half of the increase was in time and savings deposits in local and foreign currencies. Analysts suggest that such inflows are likely to continue as many countries in the region are facing political unrest and prospects of slower growth.
"In our view, this increase in longer-term deposits reflects improved confidence in the UAE economy following Dubai World's successful debt restructuring and the subsequent bond issues by the government of Dubai and a number of government-related entities," says IIF's Iradian.
Clearly, the improved liquidity is being reflected in interbank borrowing rates. The UAE three-month interbank offered rate (Eibor) is currently hovering around 1.9 per cent, the rate that prevailed before the Dubai World debt issue in November 2009.
The Central Bank insists that liquidity is not an issue any more for the banking sector in the UAE. "Because of the surplus of liquidity that is available now, interbank rates are on the decline, and we would expect this reduction to continue in Eibor rates along the [yield] curve," says Saif Hadef Al Shamsi, Senior Executive Director at the Central Bank's treasury department.
Bankers admit the availability of funds has improved in the banking system, but say the cost of funds is far in excess of international and regional benchmarks.
"It is true that the Eibor is down from levels of around the 2.4 per cent peak in July last year to what it is today, but it is still far above Libor (0.27 per cent) and the Saudi benchmark (0.74 per cent)," a banker notes.
But it is the lingering fear of the unknown that is keeping banks conservative in lending, analysts claim, more than the cost and availability of funds.
The IMF in its latest regional economic outlook observed that UAE banks are recovering fast from the impact of the financial downturn, but are likely to resist balance-sheet expansion, owing to loan and portfolio impairments in the real estate sector.
"While the equity markets continue to underperform, the property sector recovery is a long shot. The debt overhang of state-owned entities combined with the possibility of more corporate restructuring is likely to keep banks cautious," says Masoud Ahmad, Director of the IMF's Middle East and Central Asia Department.
Bankers agree. "In the context of the ongoing discussions of a few more corporate restructurings, we expect our impaired loans ratio to be in the range of 13-14 per cent for the full year," says Surya Subramanian, Emirates NBD's Chief Financial Officer.
Analysts say the banking sector's recovery has a few more potentially challenging quarters, with the potential for further deterioration of asset quality, depending on the final settlement on the restructuring of Dubai Holding's debt.
Although the sector has seen improved liquidity as deposits increase, that is not likely to show on the assets side of the balance sheet for some months.
Meanwhile, whatever lending growth is happening, it is expected to be dominated by public sector projects, predominantly in Abu Dhabi.
The writer is Deputy Business Editor, Gulf News.
