Dubai: The UAE’s banking sector maintained steady asset growth, improved profitability and asset quality in 2018 and is expected to deliver similar performance in 2019, according to bankers, rating agencies and banking sector analysts.

“In spite of volatility across global markets and regional challenges, the sector delivered strong profitability during the current year and we expect next year to be a good year for banks in the UAE,” said Abdul Aziz Al Ghurair, Chairman of UAE Banks Federation.

Clean books

After going through a three-year cycle of provisioning, and deleveraging from risky sectors and asset classes, most banks have cleaned up the legacy non-performing assets from their balance sheets.

Nine-month bank results broadly confirm that banks have either fully provided for the problem loans linked to the small and medium enterprise (SME) sector and or deleveraged substantially from their exposure troubled segments of business.

Improved asset quality and stronger loan yields are expected to lift the margins of banks as they can quickly reprice loans in the context of the rising interest rate environment.

Slow credit growth

Banks are seeing a slow revival in credit demand from corporates, government and government related entities (GREs). With the UAE’s participation in Opec’s oil production cut starting January 1, 2019, banking sector do not expect any significant spending cuts that will impact loan growth and or quality.

“We expect a modest acceleration in growth in deposits and credit to 6.5 per cent and 4.2 per cent, respectively, by end-2018. Further increases in the policy rate are expected next year,” said Garbis Iradian, chief economist Mena, Institute of International Finance.

According to rating agency Moody’s, loan performance will stabilise over the next 12 to 18 months.

“Our forecasted stable problem loans/gross loans ratio reflects our expectation that the recovering economy and a resilient performance by large borrowers will offset problem loan formation among small and mid-sized businesses and individual borrowers,” said Mik Kabeya, assistant vice-president at Moody’s.

Moody’s expects problem loans to range between 5 to 5.5 per cent of gross loans by the end of 2019. Problem loans declined to 5.1 per cent in June, from 5.5 per cent at the end of 2017, as a result of a conservative approach adopted by large banks upon adoption of new IFRS 9 [International Financial Reporting Standards] in January 2018.

Year-to-date bank results broadly confirm that banks have either fully provided for the problem loans linked to the small and medium enterprise (SME) sector and or deleveraged substantially from their exposure to troubled segments of business.

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Better margins

Rating agencies and independent analysts confirm a steady revival in the financial performance of UAE banks, thanks to the rising interest rates and the improving macroeconomic conditions in the country.

Moody’s expect rising interest rates will increase banks’ gross yields as they gradually re-price their loan books. Loans to the corporate and government sectors, which typically carry floating rates that reset at predetermined intervals, account for the bulk (74 per cent as of June 2018) of UAE banks’ loan books.

While loan demand largely driven by corporate sector is gradually improving the interest income of banks, Moody’s expects that solid corporate loan performance will balance delinquencies among small businesses, with consumer loan performance at large corporate borrowers seen remaining resilient.

“Ongoing resolution of legacy impairments, including from Dubai-based public-sector bodies and large corporates, will limit problem-loan formation in this segment. Household loan performance will continue to weaken, however, as subdued employment and wage growth, combined with a higher cost of living, constrain borrowers’ repayment capacity,” said Kabeya.

Analysts expect slow, yet, steady improvement in UAE banks’ profitability, driven by higher loan yields and shrinking provisions. Moody’s expects profitability to improve slightly over the next 12 to 18 months, with net income at around 1.6-1.8 per cent of tangible banking assets.

“Rising interest rates will increase banks’ gross yields as they gradually re-price their loan books. Loans to the corporate and government sectors, which typically carry floating rates that reset at predetermined intervals, account for the bulk [74 per cent as of June 2018] of UAE banks’ loan books,” said Kabeya.

Although the currency’s peg to the dollar keeps the local currency interest rates going up with US rate hikes, Moody’s analysts believe that improved local liquidity resulting from higher oil prices will moderate competition for deposits and so ease funding cost pressure.