Higher real estate exposure is yet to show up in full on banks' balance sheets. Banks in the UAE are allowed to increase their exposure beyond 20 per cent of their total loan book. File picture from a property exhibition held in Dubai recently. Image Credit: Gulf News Archive

Dubai: The UAE banking sector can maintain its resilient performance with stable credit profiles this year, according to S&P Global Ratings. Provided it doesn’t have to bear the burden of any unexpected increase in geopolitical risk sor a major fall in oil prices.

“We expect the UAE economy will expand at a slightly higher pace compared with 2019 - thanks to Abu Dhabi’s $13.6 billion stimulus package and the Dubai government’s planned investments for Expo 2020,” said Puneet Tuli, a credit analyst with S&P. “We also expect mid-single-digit net lending expansion in 2020, supported by some of these projects.”

Although lending growth slowed slightly to 4.5 per cent annualised in the first nine months of 2019, it icould accelerate to 5-6 per cent this year.

Margin pressures pile up

Banks are expected to experience pressures on margins and a slight deterioration in profitability, largely from the recent interest rates cuts and a gradual decline in asset quality.

“UAE banks, like their GCC peers, have long interest-rate positions,” said Tuli. “This is due to the sizeable share of non-interest bearing deposits in the funding structure. As a result, the shift in US Federal Reserve monetary policy toward a more accommodative stance - with three interest-rate cuts mirrored by the UAE central bank - will have negative consequences for banks’ margins.”

In the first nine months of 2019, UAE banks witnessed a slight decline in profitability and the trend the trend is likely to linger. The return on average assets for rated UAE banks, although high in an international context, declined to 1.5 per cent as at September 30, 2019, from 1.7 per cent at year-end 2018.

Asset quality

Although UAE banks’ real estate exposures are significant at 20 per cent of total loans, loan quality remained resilient in 2019. New real estate supply is expected to continue increasing. However, the overall effect is not yet apparent on bank balance-sheets or income statements.

This is largely because mortgage lending still makes a limited contribution to overall real estate transactions, while developers’ leverage appears to remain manageable. New supply is expected to continue increasing this year.

The impact of Financial Reporting Standards (IFRS) 9 transition to recognize problem loans is also expected to have some impact on overall cost of risk. “The stock of problematic assets (Stage 2 and 3) and loans should remain stable, but we foresee some migration between the two categories and a slightly higher cost of risk at about 120 basis points (bps) in 2020 (versus 110 bps in 2019),” said Mohammed Damak, Senior Director and Global Head of Islamic Finance at S&P Global.

With the rise in cost of risk, analysts expect banks to continue their proactive approach toward cost management. Most banks are trying to leverage technology and redeploy staff or close branches, while mergers are also expected to lead to cost savings.