UAE banking sector recovery will be gradual in 2021: S&P

Dubai: The UAE’s banking sector recovery from the impact of pandemic will be a gradual in 2021, rating agency Standard & Poor’s said.

Banks’ asset quality will likely deteriorate and the cost-of-risk to increase further as they start recognizing the impact of 2020's shockwaves. Plus, the Central Bank of UAE (CBUAE) will lift its forbearance measures gradually in the second-half of 2021.

Given continued low interest rates, banks’ profitability will remain low in 2021 with a few banks potentially showing losses. “We expect GDP growth to recover in the UAE this year from the sharp recession of 2020 triggered by the COVID-19 pandemic and low oil prices," said Mohamed Damak, Senior Director and Global Head of Islamic Finance at S&P. "However, we think the 2020 shock will continue to reverberate through the economy and banking sector.” 

Despite the expected boost to growth from the Expo and a recovering hydrocarbon sector, S&P forecasts GDP to return to the 2019 level only by 2023.

Loan growth

S&P expects gross lending growth to accelerate slightly on 2020, when banks recycled the Central Bank's Dh50 billion liquidity support to help clients navigate rough waters. The Expo and borrowing by the government and related entities will support lending growth.

Corporate borrowing will likely improve only slightly because some of the deferred capital expenditures in 2020 may be executed this year along with refinancing existing debt.

We expect GDP growth to recover in the UAE from the sharp recession of 2020 triggered by the pandemic and low oil prices. We think the 2020 shock will continue to reverberate through the economy and banking sector

- Mohamed Damak, Senior Director and Global Head of Islamic Finance at S&P.

Asset quality

S&P analysts expect asset quality indicators to weaken further. “We expect problem loans to increase once the CBUAE forbearance measures are lifted and banks start to account for the impact of the economic shock," said Puneet Tuli, an analyst at S&P. "We expect this process to be gradual to minimize the impact on the banking system,”

Real estate, construction, hospitality, consumer-related sectors, and SMEs will be the chief contributors to the asset quality issues. UAE banks increased their provisions in 2020 to cover for the impact of a fraud case at one of the largest corporate houses and the default of some construction and other companies. S&P expects additional defaults to occur in 2021 and believe that cost-of-risk will increase further. Coverage ratio will remain below historical levels.

Lower profitability

After dropping in 2020, UAE banks’ interest margins are expected to stabilize at lower levels, mirroring exceptionally low interest rates. As cost-of-risk continues to increase, S&P analysts believe UAE banks’ profitability will keep declining, with limited prospect of returning to historical performance over the medium-term.

Cost-reduction initiatives will therefore be on top of banks’ management agenda. Reducing real estate footprints, relocating staff to lower cost areas, and leveraging the opportunities offered by digitalization will be among their action plans.

Lower profitability, or even losses for some players with high-risk exposures, could provide the impetus for further consolidation of the banking system. “Given continued low interest rates, banks’ profitability will, therefore, remain low in 2021 with a few banks potentially showing losses,” said Benjamin Young an analyst at S&P.

Capitalisation

Despite the likelihood of lower profitability in 2020-21, S&P expects banks to maintain strong capital buffers, with reduced dividend payout ratios. Some banks may raise additional capital in the form of Tier 1 or Tier 2 instruments to benefit from supportive market conditions. Quality of capital is still good, with a modest - but increasing -contribution of hybrid instruments.

Funding & liquidity

UAE banks’ funding structure benefits from a strong core customer deposit base and limited reliance on external funding. Overall deposit growth dropped in 2020, as some corporates had to use their deposits to cover operating costs while their revenues contracted.

At the same time, government and cash-rich public sector entities deposited their extra cash in the banking system. S&P analysts expect some of these deposits to be withdrawn in 2021.

Retail deposits continued to increase despite significant job losses, as individuals prioritized saving over spending. UAE banks benefited from a Dh50 billion free liquidity injected by the CBUAE and a relaxation of regulatory liquidity ratios in 2020. As of September 2020, almost one-quarter of UAE banks’ assets were in liquid form.