With higher interest rates, UAE banks are headed for pre-pandemic profitability

Dubai: High oil prices and economic activity coupled with rising interest rates will lift the UAE banking sector’s profitability to pre-pandemic levels.

While the risk perception on overall asset quality is improving - with significantly lower provisions reported in the first quarter of 2022 - margins are on the rise. All three leading credit rating agencies have assigned a stable outlook for UAE banks.

“We have changed our outlook for the UAE’s banking system to stable from negative - this reflects our view that operating conditions in the UAE are returning to normal,” said Moody’s.

According to Fitch, “Financial performance is recovering towards pre-pandemic levels, and the agency recently revised its outlook on the operating environment to stable, reflecting substantially lower risks to the banks.”

Oil boost

Although the UAE Central Bank has maintained a modest GDP growth forecast of 4.2 per cent, with the oil prices expected to maintain an average $100 per barrel, the UAE economy could grow in excess of 6 per cent.

Improving business conditions in both oil and non-oil sectors are supportive of loan growth and profitability for UAE banks. The central bank said in its latest credit sentiment survey that overall first quarter bank results are indicative of ongoing confidence in the UAE’s post-pandemic economic recovery, supported by strong domestic demand.

According to Nitish Bhojnagarwala, VP - Senior Credit Officer at Moody’s: “The ongoing expansion of the services sector will drive economic growth, particularly in Dubai where tourist arrivals and hotel occupancy rates have recently soared.”

Rates impact margins

Rising interest rates will be a key driver of UAE banks’ profitability this year. The central bank, in two tranches, raised 75 basis points (0.75 per cent) in key lending rates in tandem with US rake hikes.

With a minimum of three more rate hikes forecast for this year, analysts are factoring in a 150 bps rise in interbank lending rates by year-end that could translate into a substantial gains in terms of net interest margins (NIMs) for UAE banks.

“We anticipate domestic lending to grow on the back of revived economic activities,” said Asad Ahmed, Managing Director and Head of Middle East financial services at Alvarez & Marsal (A&M).

UAE banks are better positioned to benefit from higher rates than during the last round of monetary tightening cycle in 2014-18, when funding costs increased significantly due to tight liquidity amid low oil prices.

“This time, high oil prices should support liquidity, and the sector has a high proportion of corporate loans (78 per cent), which typically reprice in the short term, and a high proportion of low-cost current account savings account (CASA) deposits (63 per cent),” said Redmond Ramsdale, Senior Director, Head of Middle East Banks Ratings at Fitch.

Provisions on decline

Contrary to the earlier forecasts, many analysts are seeing overall loan quality to improve during the course of this year as strong economic conditions will help many deferred loans to become performing loans once the deferral scheme comes to an end by June.

With most large banks having taken advanced provisions on potential impairments and the adoption of IFRS 9 (International Reporting Standards 9), UAE banks are largely covered against future impairments. Over the last 24 months there has been a steady decline in bad loan provisions. Last year impairment charges ate away about 30 per cent of pre-impairment operating profit compared to about 55 per cent in 2020.

“We expect loan impairment charges to decline in 2022-23, supported by improving operating conditions and the front-loading of provisions in 2020,” said Fitch’s Ramsdale.