The Federal Reserve is widely expected to lower rates by 25 basis points on Wednesday Image Credit: Supplied

Dubai: The Federal Reserve is widely expected to lower rates by 25 basis points (a quarter percentage point) on Wednesday to support the flagging US and global economic growth outlook with further possible rate cuts anticipated in October.

Most GCC countries with their currencies pegged to the dollar follow the Fed lead in the monetary policy and cut rates in tandem to avoid currency speculation.

While the lower interest rates are positive for reducing debt-servicing costs of companies and individuals, banks are expected to face pressure on their interest margins as a result of lower interest rates.

In a rising interest rate environment, banks have the option to reprice their loans to higher rates while deposit rates rise at a lower rate with a lag, resulting in improved interest margins for banks. As the rates drop, the difference between deposit rates and lending rates shrink faster applying pressure on loan yields bank, impacting their profitability.

“We expect to see some pressure on margins as more rates cuts are expected this year,” said Abdul Aziz Al Ghurair, Chairman of UAE Banks Federation (UBF) and CEO of Mashreq last week.

Despite the expected margin compression in the second half of 2019, UAE banks are expected to maintain their profitability, thanks to gradual pick up in credit growth and lower impairments.

“All key sectors of the economy, particularly, the banking sector has been fully prepared for some slowdown in the economy. We do not expect to see any spike in non-performing loans this year,” said Al Ghurair.

Data for the second quarter of 2019 showed net interest margins (NIMs) improved marginally by 3 bps to 2.48 per cent over the first quarter of 2019. The improvement was largely driven by increase in loans and advances, and a stabilised yield on credit.

“The top ten UAE banks reported steady performance in top line during Q2 ’19 but well below the 2018 average of 5.6 per cent, against a backdrop of reduced economic growth. For the remainder of 2019, we expect margins to remain under pressure due to the rate cut in July 2019, and further rate cuts are possible,” said Asad Ahmad, Head of Financial Services, Alvarez & Marsal (A&M) in their second quarter Banking Pulse report.

While lower rates are expected to reduce borrowing costs of companies and individuals analysts said it is unlikely to increase credit growth to private sector.

“Lower interest rates are positive for reducing debt-servicing costs, though we are cautious on the potential additional support to credit demand with the economic headwinds,” said Monica Malik, Chief Economist of ADCB.

Latest central bank data shows, gross credit expanded by 0.7 per cent month on month in July for the second consecutive month, its strongest pace seen so far this year. Annual gross credit growth accelerated to 5.1 per cent year on year in July on the back of the monthly expansion, up from 4.3 per cent year on year in the previous month. However data showed private businesses’ credit growth steadily decelerated to 4.3 per cent from a recent high of 7.5 per cent year on year in October 2018.

What lower rates mean for UAE banks, customers

- Lower debt burden for borrowers

- Lower debt servicing costs for individuals and companies

- Lower interest margins for banks (the difference between the interest income of banks and interest paid out to depositors

- Banks’ profitability to shrink

- Private credit demand unlikely to go up because of economic headwinds