Entering consolidation phase

Banks seek to lock in the benefits accrued in the first half of the year.

The great wave didn't crash, but it did subside quickly. The UAE's banks found that their profitability streak was indeed unsustainable, in the main, during the first half of 2006, with the notable exception of the Islamic sub-sector.

The reasons were not hard to detect. Much of the preceding buoyancy had owed particularly to a booming stock market, which banks had tapped directly for their own portfolios and indirectly by lending to others for the same purpose.

Exceptional gains were made through exposure to a succession of large IPOs, whose discounted price at issue had prompted a flood of eager investors taking advantage of a pretty sure thing.

Brokerage activity too was leveraging off the soaring interest in equities, and developing wealth and sophistication were creating opportunities in asset management.

All this on top of a generalised liquidity surge, owing to the region's windfall from oil and gas receipts, with prices well-established at high levels in excess of $50 a barrel and equivalent. Mainstream corporate and consumer lending was always liable to respond, and the UAE's ambition as a financial centre on the world stage continued to take advantage of this historic chance.

The challenge has become to lock in the benefits of past performance, utilising capital injections to grow in a diversified way in tandem with the economy as a whole.

Diversifying growth

High oil prices will mean credit portfolios are still in expansionary mode, as massive projects come forth in a steady stream in tourism, real estate, infrastructure and energy.

In addition, Islamic finance is making a tremendous impact, now representing around 15 per cent of the market. With annual business growth rates currently far outstripping conventional forms of finance and investment, not only local institutions but international players are increasingly focused on this area.

It is a trend that presents great opportunity which the UAE intends to seize. Economy minister Sheikha Lubna Al Qasimi has called for Islamic finance's demystification, so that greater strides can be taken in tapping the region's burgeoning wealth. DIFC's plan for a liquidity management centre, and DIFX's move to attract 50 per cent of the world's sukuk issuance underline the point.

Otherwise, the general outlook for banks remains positive, subject to the bumpy ride that might result from fluctuations in stock markets or real estate.

Maturing debt markets have enabled innovative funding options, which the big names have embraced, such as National Bank of Abu Dhabi's recent announcement of a listed convertible note, and National Bank of Dubai's ECP programme. These offerings reduce dependence on deposits, and also illustrate investor development.

It is argued by some, in fact, that the banks are overcapitalised, well above the Central Bank's minimum 10 per cent capital adequacy ratio. Consequently, sector liberalization in such countries as Egypt and Pakistan presents chances to grow.

The GCC states are allowing national banks to set up across borders to facilitate the flow of capital ahead of proposed monetary union in 2010. Thus, for instance, NBAD has ventured into Kuwait, and the UAE Central Bank has granted licences for Saudi American Bank and Doha Bank.

Recovery signs

Other cautionary notes would be (a) non-performing loans arising because of investors overextended in the stock market, and (b) the preparation still required, with potentially significant associated costs, for basic compliance with the Basel II accord by next year.

At time of writing, the UAE markets are showing signs of recovery, having passed through the summer doldrums. The situation will evolve further, with discussion of a share sale in Dubai Financial Market, and support for the idea of a common UAE exchange. Nothing much stands still for long in the UAE these days, and banking and finance reflects that as well as anything.