Dubai: The low interest-rate environment that resulted in margin compression in the UAE’s banking sector is seen easing on the back of interest rate contraction which is bottoming out, according to Peter Baltussen, CEO of Commercial Bank of Dubai.
The increased risk premium that was charged in the years following the financial crisis has been reduced in the last 18 months, especially for large corporate clients. But the fall in cost of funds for banks, to some extent mitigated the impact on the net interest margins.
“I see we are witnessing the bottom of margin compression. I believe the low interest rates are bottoming out and there are clear signs from the US Fed that the rates are likely to be raised this year,” he said.
While the overall margin compression has been severe from 2013-2014, Baltussen expects it to moderate in 2015 and 2016. With a mid-year hike in interest rates by the Federal Reserve in the US, lending rates in the UAE are also expected move up.
The flip side of an interest rate hike for banks will be a surge in cost of funds. But CBD, which has a significantly large corporate client base, has access to a large pool of liquidity that is a fairly sticky source of cheap funding.
“We have a lot of individual and corporate clients with significant turnover that comes to our bank, which means we are sitting on a lot of free cash flow. Today nearly 60 per cent of our total liabilities come from such sources. As interest rates rise this source of funds generates more margins as these are almost free funding,” Baltussen said.
He expects that on the liability side there could be pressures on wholesale deposits this year from large corporations and government-related entities. However, he said the bank has less dependency on such deposits.
CBD went to the market last year and raised $500 million (Dh1.83 billion) through medium term notes programme.
“We have the option to go further to the market and raise funds, but I would rather work with our customer funds which is more cost effective and prudent. However, with Basel III deadline approaching, it is good to have some longer term funding to mitigate potential asset liability mismatches,” he said.
The bank is very comfortable on the capital adequacy front. CBD’s capital adequacy and Tier-1 capital ratios were at 18.1 per cent and 16.8 per cent respectively, and were significantly above the regulatory thresholds of 12 per cent and 8 per cent mandated by the UAE Central Bank.
On the liquidity front, the bank may not require to tap to the market this year. CBD’s liquidity continued to be comfortable with an advance-to-stable resources ratio of 82.6 per cent at year end 2014. The liquidity coverage ratio calculated as per Basel III guidelines was at 109.1 per cent, compared to the minimum stipulated ratio of 50 per cent.
