UAE’s banking sector fundamentals remain sound to withstand economic challenges

Dubai: The UAE’s banking sector is well positioned to withstand the macroeconomic challenges arising from low oil prices and geopolitical issues, according to the International Monetary Fund (IMF) and the Institute of International Finance (IIF).

The banking sector is stable and has not been significantly affected by low oil prices and the standoff with Qatar, the IIF said in a recent report.

“Banks in the UAE are well regulated and supervised and remain well positioned to weather worsening in credit quality. Banks remain adequately capitalised with 17.1 per cent Tier 1 ratio in September 2017, non-performing loans (NPLs) to total loans remain modest around 5 per cent,” said Garbis Iradian, Mena Chief Economist of IIF.

The IMF, in its latest regional economic outlook said, financial sector in the UAE so far remained broadly resilient in the face of lower hydrocarbon prices and an increase in provision charges.

“With strong capitalisation levels and robust regulatory framework we expect the UAE banking sector is well equipped to face the current macroeconomic environment in the region resulting from lower oil prices and the ongoing fiscal adjustments,” said Jihad Azour, Director of the IMF’s Middle East and Central Asia Department.

The September monetary data from the Central Bank of UAE point to a further easing in banking sector liquidity as monthly deposit growth continued to outstrip credit growth. The gross system-wide loan-to-deposit ratio moderated further to 99 per cent in September, down from 99.8 per cent in August. With the monthly rise in GRE [government related entities] deposits and contraction in loan growth, the sector returned to be a net depositor in the banking system in September.

Profitability trend

Net interest margins of banks improved since the beginning of this year, as loans reset at higher rates and funding costs improved as liquidity conditions eased. Net profits of major banks were up by at least 5 per cent in the first half of 2017, broadly the third quarter data shows the profitability trend remains unaffected, year to date.

“We expect a rising interest rate environment to be eventually supportive of sector profitability. However, in the near term, banks are expected to face slower volume growth and pressure on their margins as deposits reprice faster than loans,” said Iradian.

Deposits in the banking system increased by 0.9 per cent month-on-month in September after having fallen 0.6 per cent in August. This was the sharpest monthly increase since March 2017, and is likely to have been supported by banks focusing on raising deposits at the end of the quarter. Anticipation of stronger demand for credit after the quieter summer period might also have contributed to the increase.

The private sector and GRE segment drove the monthly increase in resident deposits. Government deposits in the banking sector contracted 2.5 per cent month-on-month in September though remain up a strong 18.7 per cent year on year. Non-resident deposits also saw positive growth of 3.3 per cent. Non-resident deposits are still down 5.4 per cent year to date.

Deposit growth continued to outstrip loan growth. The deceleration in credit growth to 1 per cent in September, year on year, is partly due to the decline in personal loans, which reflect accounting adjustments made by banks to the amount of refinancing related to personal loans.

Liquidity eases

Like other GCC countries, monetary policy in the UAE is determined by the exchange rate peg to the dollar and an open capital market. Interest rates in the Emirates closely track US dollar rates. Liquidity management operations through the issuance of central bank certificates of deposits have aimed at smoothing changes in liquidity conditions.

Liquidity conditions have improved in recent months with the modest recovery in oil prices and as the authorities have diversified their funding requirements. Following the narrowing of the spread between EIBOR and LIBOR, the central bank reduced excess liquidity by a cumulative Dh24 billion, from June to September 2017 through the sale of certificates of deposits (CDs). Further increase in policy rates (EIBOR) is expected by end-2017, in line with future Fed move. Analysts expect two hikes in 2018 by the Fed, each 25 basis points or, pushing up funding costs of banks.