Margin pressures to moderate UAE bank profitability

Dubai: Profitability of the UAE banks are expected to moderate in 2020 on the back of low interest rate environment and further weakening of asset quality, according to banking sector analysts.

Data up to the close of the third quarter of 2019 showed despite an increase in asset growth, margins and loan yields are under pressure. According to an analysis of the third quarter financial results of top 10 UAE banks by Alvarez & Marsal (A & M), although the top 10 UAE banks by assets reported a combine 25.5 per cent year-on-year increase in the top line during the third quarter of 2019, margins are starting to come under pressure largely due to interest rate cuts. Analysts expect the impact to continue in the fourth quarter and linger into 2020.

Credit growth across the banking system is expected to be modest amid slow economic growth environment. Various international agencies such as the Institute of International Finance, the IMF and the credit rating agencies forecast the UAE’s real GDP growth in the range of 1.7 per cent to 2.1 per cent in 2020.

Amid slower economic growth, rating agency Moody’s expects credit growth of 4 per cent in 2019 and 2020, compared to 4.3 per cent in 2018. Despite the slower credit growth and weakening asset quality likely to apply pressure on profitability, analysts expect banks to benefit from strong capitalisation level, stable funding and healthy liquidity.

“The outlook for the UAE’s banking system remains stable as banks’ credit profiles are resilient. Banks’ strong capital, stable funding and healthy liquidity balance weakening asset quality and softening profitability amid steady but subdued economic growth,” said Mik Kabeya, an analyst at Moody’s.

An analysis of published financial data of banks up to the third quarter of 2019 by A & M showed the reduction of base rates has led to a mixed trend in net interest margin (NIM) for top ten banks. The marginal improvement in net interest margins (NIM) was supported by stable loans and advances and increase in yield on credit. Analysts have noted the nearly 40 bps increase in Q3 in banks’ exposure to real estate and construction. Given the challenging market conditions in those sectors, this has inevitably led to the cost of risk going up in Q3 2019, as well as contributing to a 32 per cent increase in provisioning.

“The UAE banking sector maintained a modest growth, even though profitability was impacted by lower gross yields and higher net impairment charges during the (third) quarter, a knock-on effect from the real estate and construction sectors. Looking ahead, we anticipate this pressure will continue as two successive rate cuts by the Fed in September and October 2019, are likely to put further pressure on banks’ margins. We expect that Q4 will not be dissimilar,” said Asad Ahmed, a managing director of A & M.

Loan growth

Bankers and analysts expect credit growth in 2020 to be largely driven by government, government related entities (GREs) and corporate sector. Credit data of the UAE banking sector up to November showed on an annual basis, loan growth decelerated to 3.8 per cent at the end of October from 4.8 per cent at end-2018.

Most components of credit saw a monthly decline in October, with the exception of the government loans which witnessed a 0.4 per cent growth. On a year to date basis, the government loans grew 15.1 per cent while the loans by GREs grew 5.2 per cent. While government and GREs continue to drive loan offtake in the country, private sector loan growth has been sluggish with a meagre 1 per cent growth at the end of October, likely reflecting the challenges facing economic activity. Retail loans are down 1.2 per cent year to date and 1.7 per cent year on year. Credit to corporates also contracted by 1 per cent October.

The third quarter Credit Sentiment Survey of the Central Bank of UAE (CBUAE) showed a marginal pick up in credit demand largely driven by an increase in demand for business loans. The survey results showed a modest increase in demand for business loans in the third quarter. By emirates, Dubai and Abu Dhabi witnessed an increase in demand appetite for business loans supported by Expo 2020 related projects while Northern Emirates witnessed a decline.