UAE’s credit demand seen picking up in the third quarter
The impact of war between Russia and Ukraine is likely to have only limited and or indirect impact on the UAE banks. Image Credit: Supplied

Dubai: The impact of war between Russia and Ukraine is likely to have only limited and or indirect impact on the UAE banks, according to rating agency Standard & Poor’s.

“Direct impact is likely to be limited given banks’ limited exposures to Russian and Ukrainian counterparties,” said Puneet Tuli, an analyst at S&P.

Indirect impact on UAE banks, largely positive, could materialize through higher oil prices improving overall economic confidence in the country leading to higher lending and interest income.

Economic rebound

Rating agencies expect the improving economic conditions combined with higher interest margins and decline in provisions will improve overall profitability of UAE banks.

The four largest banks, First Abu Dhabi, Emirates NBD, Abu Dhabi Commercial Bank and Dubai Islamic Bank, which account for 78 per cent of UAE banking assets, reported a combined net profit of $8 billion, up 31 per cent from $6 billion in 2020, according to Moody’s.

“The four largest banks’ bottom-line profitability rebounded to near pre-pandemic levels in 2021, largely reflecting robust non-interest income and softening loan loss provisions. The recovery was a result of improving consumer confidence as macroeconomic conditions in the UAE recovered,” said Nitish Bhojnagarwala, a VP-Senior Credit Officer at Moody’s.

“We expect a full return to pre-pandemic levels of profitability in the next 12-18 months.”

Loan growth

According S&P, UAE bank are expected to record an increase in lending this year as the Arab world’s second-largest economy charts a strong recovery from the Covid-19 pandemic.

“Higher oil prices, supportive government policies and improving economic sentiment could lead to a faster return to pre-pandemic levels,” said Mohamed Damak, Senior Director within the Financial Services at S&P Global Ratings.

Analysts expect UAE banks’ profitability will get a lift from improving lending and higher interest margins resulting from higher interest rates. “We expect the lending growth to accelerate thanks to UAE’s economic growth, albeit tempered by the expected increase in rates,” said Tuli.

Funding and cost of funds

Cost-reduction initiatives have been at the top of banks’ management agendas during the past few years. Banks in the UAE have been reducing costly branch operations, relocating staff to lower-cost areas and managing staff costs through digitalization.

“We expect the banks’ net profitability to be driven more by growth in net interest income, underpinned by rising interest rates and strong business momentum supporting non-interest income, while provisioning requirements ease,” said Bhojnagarwala.

UAE banks’ funding structures benefit from strong core-customer deposit bases and limited reliance on external funding. The higher interest rate environment means a higher return on deposits, which could further accelerate deposit growth. However, it would inevitably rise in cost of funding as some deposits migrate to interest-bearing products from no-or low-interest-bearing products.

Strong capital buffers continue to support the UAE’s banking sector. With the anticipated increase in profitability, S&P analysts expect banks to further strengthen their capital buffers. Some banks have raised additional capital in the form of Tier 1 instruments over the past couple of years to benefit from existing rates.