Key financials of banks such as First Abu Dhabi Bank (FAB), Emirates NBD (ENBD) and Dubai Islamic Bank (DIB) in 2021 showed these institutions maintained strong profitability, high credit quality and improving margins amid challenging economic conditions. Image Credit: Clint Egbert/Gulf News

Dubai: A combination of factors ranging from rapid recovery in economic growth supported by rising oil prices, pick up in loan growth, rise in interest margins and significant decline in costs and loan loss provisions are expected boost the fortunes of UAE banks.

Clearly the economic recovery is supporting appetite for both corporate and personal loans. The latest credit sentiment survey of the Central Bank of UAE showed rising credit demand supported by easing of credit conditions.

The increase in credit volumes along with higher margins resulting from higher interest rates and expected boost the profitability of UAE banks from the second half of 2022.

“We expect banks in the UAE to benefit from the planned increase in interest rates by the US Federal Reserve, which the Central Bank of the UAE will likely mirror because the UAE dirham is pegged to the US dollar,” said Mohamed Damak, Senior Director within the Financial Services at S&P Global Rating.

S&P Global economists expect the Fed to raise rates six times this year starting in March, and five more times in total in 2023 and 2024.

Analysts expect GCC banks to make significant interest rate margin gains as the interest rates go up.

“GCC banks are one of the biggest beneficiaries of rising rates within the emerging market banks space, given access to a sizable non-interest-bearing deposit base while loan books are predominantly floating rate in nature,” said Ehsan Khoman, Head of Emerging Markets Research (EMEA), MUFG.

On average, banks in the UAE are expected to benefit from the planned increase in interest rates. S&P estimates a 15 per cent increase in net income and 1.4 percentage-point rise in return on equity for every 100-basis-points (1 per cent) increase.

Operating conditions

The rapid recovery in operating conditions in the UAE supported by significant gains in oil prices and opening of the economy after the COVID crisis are expected to boost capital expenditure by both government related entities and the private sector resulting in higher loan demand.

The full year bank results for top five UAE banks showed significant year on year loan growth with bankers attributing it to strong underlying economy.

Key financials of banks such as First Abu Dhabi Bank (FAB), Emirates NBD (ENBD) and Dubai Islamic Bank (DIB) in 2021 showed these institutions maintained strong profitability, high credit quality and improving margins amid challenging economic conditions posed by the pandemic and low interest rate environment.

“The operating environment for the UAE banks is recovering from the effects of the pandemic. This is expected to support the banks’ financial fundamentals, particularly profitability, capital and liquidity,” rating agency Moody’s said in a recent note.

Rising credit yields, margins

Higher loan demand combined with rising interest rates are expected to boost the net interest margins and loan yields for UAE banks.

Lower interest rates had been squeezing overall margins and profitability of GCC banks. The UAE banks were severely impacted in the early stages of rate cuts as the lower rates were almost immediately reflected in the yields of floating rate loans while the re-pricing of corresponding deposits and other funding sources came with a lag. From the second quarter of last year, banks have been reporting a modest, yet steady improvement in margins. In the third quarter of 2021, net interest margin (NIM) increased by about10 bps quarter on quarter to 2.15 per cent with higher yields on loans (+24bps QoQ).

While anemic loan growth challenged UAE banks’ overall interest income, the pick-up in economic activity saw the aggregate interest income increasing by 6.1 per cent in the third quarter of 2021, primarily driven by an increase in loan yields to 5.3 per cent.

That UAE banks on an average are expected to benefit from the rising rate environment. Banks in the UAE continue to benefit from a large proportion of current account and saving deposits (CASA), which accounted for two-thirds of total deposits at system level as of September 30, 2021.

“Over the past three years, the contribution of these to the total deposit base of UAE banks continued to increase. Second, banks’ balance sheets have been positioned in a manner that makes them benefit from the increase in interest rates--with a higher amount of repricing assets than liabilities,” said Damak.

Cost efficiency, asset quality

Adverse economic conditions dictated by lower oil prices, higher loan defaults and the impact of pandemic made it imperative on UAE banks to seek cost efficiencies in operations through digitalization, rationalization of headcounts and branch operations. Significant cost savings achieved during the past few years are positively reflecting on profitability.

Legacy asset quality issues combined with those added to the balance sheets during the pandemic are now under control. While the CBUAE’s support measures helped the banks to soft land the residual asset quality risks are seen within manageable limits.