The new Hi Tech Emirates NBD Emirates Towers Branch
A Hi Tech Emirates NBD Emirates Towers Branch, at the Emirates Towers, Dubai. The bank on Tuesday laid off 800 employees across various sections. Image Credit: Antonin Kelian Kallouche/Gulf News archives

Dubai: A week away from reporting of the first half 2020 results, many UAE banks are headed towards implementing drastic cost-cutting measures to arrest decline in profits resulting from sharp decline in revenues and a potential spike in non-performing assets.

“Although some banks have been shedding jobs in small numbers quietly since the COVID-19 outbreak began; now it is obvious that more drastic measures are required to cut losses and make businesses viable,” said an industry source

Emirates NBD, the Dubai’s largest bank, on Tuesday laid off 800 employees across various sections. Banking sector sources have confirmed more banks are likely to lay-off workers in the next few weeks. The banking sector across the GCC is expected to witness similar trends.

Financial regulators across the GCC announced a number of policy measures during Q2-2020 to deal with the COVID-19 crisis that were marred by lockdowns. A significant element of these efforts involved the banking sector in the region that had to postpone installments, waive numerous charges and support the vital SME sector. Business activities have came to a halt due to the lockdowns that affected project activity and loan offtake and repayments by businesses.

To offset the impact, governments announced numerous monetary and cash-flow measures. Central banks in the region rolled out a number of policy measures starting with rate cuts to encourage borrowing, efforts that focused on continued lending by banks to support businesses and eased the burden of loan payments. In addition, liquidity support was offered through interest free funding and relaxation of requlatory capital requirements.

Slowing revenues and profits

UAE banks -operating income
UAE banks -operating income Image Credit: Alvarez & Marsal

Faced with the burden of slowing loan growth combined with the prospect of rising impairments from job losses and economic contraction, banks are facing sharp decline in their profits.

“The banking sector is expected to see severe impact in the near-term as businesses would require time to recover. Lockdown opening up plans are being drafted and implemented in a phased manner in the GCC but a full recovery and a complete end to the lockdowns cannot be predicted as the risk of a second wave could jeopardize the efforts over the last three months,” said Junaid Ansari, Vice President at Kamco.

Rising vulnerabilities

The GCC banking sector has significant exposure to some of the most vulnerable sectors like oil and gas, construction and real estate, which could affect the health of the banking sector in the near-term.

“We believe that the proportion of bad loans in the GCC loan book is expected to increase in case of a delayed opening of the economy. That said, adequate liquidity and strong balance sheet should cushion the sector from an economic slowdown in addition to active support from the regulators,” said Ansari.

The UAE’s banking sector is facing challenges on its asset quality and profitability from COVID-19 and low interest rate environment, according to an analysis of the first quarter 2020 financial results of top 10 banks by Alvarez & Marsal (A&M).

The report said that the top 10 UAE banks reported a combined 6.3 per cent quarter-on-quarter drop in interest income, largely due to the low interest rate environment.

The net profit declined by 22.4 per cent quarter on quarter on account of a 3.6 per cent drop in operating income and a 35 per cent increase in provisioning. Consequently, the average return on equity (RoE) for the universe was impacted by the reduced operating income due to a series of rate cuts and increased provisioning.

“The COVID-19 pandemic has negatively affected the real estate market in the UAE with banks’ exposure reduced by about 100 bps compared to the last quarter. The subsequent pressure on the real estate sector is imminent, underpinned by economic slowdown and persistent oversupply,” said Dr Saeeda Jaffar, co-author of the report and Managing Director and Head of Middle East A&M.

NIMs UAE banks
NIMs UAE banks Image Credit: Alvarez & Marsal

At the aggregate level, operating income of top 10 UAE banks declined after increasing for two consecutive quarters. The operating income sank by 3.6 per cent from Q4 2019 as major income streams reported reduced contributions. Net interest income (NII) dropped by 3.1 per cent as low interest rates fully offset a marginal increase in loans and advances and non-interest income dropped by 4.9 per cent, which impacted total operating income.

Net interest margin (NIM) witnessed sizeable contraction by about 15 bps to 2.54 per cent in the first quarter of 2020, on account of a sharp decline in interest rates. NIM decreased after rising for two consecutive quarters. Seven of the top 10 banks reported a decline in NIM.

Asset quality

Total loan loss provisions of top 10 banks saw a sharp increase by 35 per cent from Q4 2019, while non-performing loans (NPL) to net loans ratio increased substantially to 5.2 per cent. Tough market conditions due to COVID-19 headwinds was the primary factor that led to increased provisioning. Cost of Risk (CoR) increased to 1.8 per cent as banks took increased provisioning because the challenging operating environment weighed on asset quality.

Return on equity (RoE) continues to exacerbate in Q1 2020 with 9 per cent, compared to 15.4 per cent in Q1 2019.

Cost optimisation
Cost optimisation Image Credit: Alvarez & Marsal

“A low interest environment and increased provisioning impacted the net profit of the top 10 UAE banks. Profitability metrics (RoE and RoA) declined to multi-period low levels on the back of lower operating income and increased provisioning, which weighed on the net income,” said Asad Ahmed, a Managing Director, Head of ME Financial Services at A&M.

Why more job losses are inevitable
Shedding operating costs will remain the biggest focus area for regional banks in the next few quarters to arrest sharp decline in asset growth and profits and rising NPLs.
Responding to the slowing economies, most banks had initiated cost cutting measures even prior to COVID-19 becoming a global pandemic. During Q1 2020, cost to income C/I ratio of top 10 UAE banks improved by 110 bps, after rising for the previous quarters. The lower C/I ratio was reported due to decline staff costs associated with marketing expenses by 6.8. The decline in expenses was largely on the back of cost-cutting measures adopted by the banks, as eight of the ten banks reduced their expenses.
“The impact of COVID-19 on the profitability of banks is unprecedented. There is no other option but to downsize operations and reduce cost to make businesses viable in the short to medium term. It is painful, but there are few options,” said the retail banking head of a local bank.