A teller at a bank in Dubai
A teller at a bank in Dubai. A week away from reporting the third quarter results, bankers and anlysts have indicated that the profits for the sector is under pressure. Image Credit: Gulf News Archives

Dubai: A week away from reporting the third quarter results, bankers and anlysts have indicated that the profits for the sector is under pressure from rising non-performing loans linked to COVID-related job losses, shrinking interest margins and some corporate restructurings.

UAE lenders witnessed a considerable contraction in net interest margins (NIM) in the second quarter due to factors such as the shift to the marginal cost of funds-based lending rate and all-time low interest rates.

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An analysis of top 10 UAE banks performance for the second quarter of 2020 by Alvarez & Marsal showed a 21.2 per cent improvement in profits on quarter on quarter basis. However, in the third quarter, the profitability is expected to weaken both on quarter on quarter and year on year basis.

NIMs Q2
Profits for the UAE banking sector has been under pressure from rising non-performing loans linked to COVID-related job losses, shrinking interest margins and some corporate restructurings.

“While there has been a peripheral increase in profitability [in the second quarter], the outlook for the domestic banking sector still remains subdued as a result of the weakened after-effects of COVID-19, in addition to low oil prices, and the postponement of Expo 2020. Moreover, the low interest environment, along with a possible increase in impairments, is expected to further weigh on profitability,” said Asad Ahmed, A&M Managing Director and Head of Middle East Financial Services.

Anemic growth in loans & deposits

Data from the latest Quarterly Review of the Central Bank of UAE (CBUAE) showed total assets of UAE banks increased in the second quarter by 2 per cent quarter on quarter while gross credit increased by 1.3 per cent, and domestic credit increased by 1.9 per cent. While the overall loan growth remained weak, the government borrowings drove most of the positive momentum in credit growth.

On the deposits side, the central bank data showed despite challenging market conditions, the banks witnessed marginal deposit growth in the second quarter (Q-on-Q). This has added liquidity in the banking system. Resident deposits (89% of total deposits) increased by 1.9 per cent quarter on quarter in the second quarter owing mainly to an increase in government deposits by Dh33.9 billion and a rise in private sector deposits by Dh15.6 billion, as households became thriftier in their day-to-day expenses, therefore saving more as a precaution against rising uncertainties.

Job losses and restructurings

COVID-19 related job losses, mainly in the private sector and the rising loan restructurings by both individuals and business are expected to increase provisions and apply further pressure on profits.

“With the COVID-related loan reliefs ending and or tapering, there has been an increase in defaults or requests for further relief in terms of deferrals, especially in the retail book. This will likely to have an impact on the overall NPL growth,” said a banker.

While big corporate defaults such as the ones from the NMC Healthcare, Finablr and their associate companies have been largely provided for, the potential spike in NPLs from the dissolution of construction major Arabtec is likely not to reflect in the accounts of Q3.

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Net interest margins (NIM) of top UAE banks fell by about 24 bps to 2.29 per cent in the second quarter of 2020, on account of the sharp decline in interest rates. With the interest rates remaining low, banks are expected report further squeeze on margins in the third and the fourth quarter.

Soundness indicators

Latest data from the CBUAE shows the advances to stable resources ratio (ASRR) of banks decreased from 82.3 per cent in the Q1of 2020 to 81.9 per cent in Q2. Meanwhile, the eligible liquid assets, as a ratio of total liabilities remained at 16.6 per cent, well above the 10 per cent regulatory minimum requirement, constituting an adequate buffer for banks which allows them to weather situations of liquidity squeeze.

The level of total liquid assets at banks at the end of Q2 2020 stood at Dh432.4 billion, Dh10.4 billion lower compared to the end of Q1 2020 (2.4% decrease).

Banks operating in the UAE remain well capitalised, with an average Capital Adequacy Ratio (CAR) of 17.6 per cent, Tier 1 Capital Ratio at 16.4 per cent, and Common Equity Tier 1 Ratio (CET 1) at 14.7 per cent.

With loan yields and margins under pressure, banks have been focusing on operating efficiency with a range of measures including aggressive digital adoption, reduction in branch operation and significant reduction in staff costs, which are likely support the bottom-line.