Dubai: The latest round of stress tests conducted on systemically important banks and the UAE banking system as a whole has shown that the UAE’s banking system is geared to withstand potential risks from macroeconomic and geopolitical dynamics impacting the economy.

Under the latest stress testing, participating banks were required to cover risks such as credit risk, including sovereign and bank exposures; market risk in the trading book and available for sale debt securities and their designated hedges; counterparty credit risk — largest derivative counterparty default and debt security haircuts; net interest income from rising interest rate environment; and liquidity risk of the five largest banks through extended, more severe liquidity coverage ratio.

Capital adequacy

The stress test results showed the participating UAE banks reported weighted average common equity tier 1 (CET-1) capital ratio at 13.9 per cent as of December 2017. After the implementation of Basel III in the UAE, the prudential requirement of CET-1 ratio became the focus point in the stress testing exercise. Under the baseline scenario, the banks reported an aggregate increase of CET-1 capital ratio of 190 bps leading to a 15.8 per cent CET-1 capital ratio at the end of 2020. Under the adverse scenario, banks reported an aggregate decrease of CET-1 capital ratio of 320 bps resulting a 10.7 per cent CET-1 capital ratio at the end of 2020.

The test results showed the UAE banking system remained adequately capitalised with capital ratios well above minimum regulatory requirements. At the end of 2018, the overall CET-1 capital ratio was 14.3 per cent, the Tier-1 capital ratio represented 16.2 per cent, and the total Capital Adequacy Ratio was 17.5 per cent, compared to the minimum capital requirements of 9.5 per cent, 11 per cent, and 13 per cent, respectively.

Credit dynamics

Credit cycles tend to go through periods in which funds are relatively easy to borrow followed by a contraction in the availability of credit or a tightening credit standards by banks. Credit Sentiment Surveys of the Central Bank of the UAE (CBUAE) showed that factors such as quality of bank asset portfolio, economic outlook, and change in tolerance for risk were important in determining the changes in credit standards.

The total private credit in the UAE represents funds borrowed by non-bank UAE entities and comprises of three components: UAE bank loans, issuance of bonds by UAE entities, and borrowing of UAE entities from abroad. UAE bank loans represent around 70 per cent of the private credit in the UAE and the rest is equally split between the other two categories.

The average private credit growth in the UAE over the past 10 years was 5.2 per cent. However, in the past three years, private credit grew at a slower rate than the average. In 2018, private credit growth was 3.5 per cent, a slight acceleration from 2.5 per cent during the previous year.

The credit-to-GDP gap is one of the main indicators considered for analysing credit cycles and to guide the build-up of the countercyclical capital buffer in response to excessive credit growth. At the end of 2018, the private-credit-to-non-oil GDP gap was -21 per cent. Negative values imply that the credit growth is lagging behind the long-term trend, which signals absence of excessive credit growth.

“This negative value has marginally diminished though mainly because of the pickup in private credit growth, which was slightly stronger than the growth of nominal non-oil GDP. Looking ahead, the gap could narrow due to expected stronger credit growth according to the credit sentiment survey, improved GDP outlook, in addition to the flattening of the long-term trend,” the report said.