banking in uae
UAE banks along with their GCC peers stand to benefit from the potential US interest rate hike that is expected to begin in March 2022. Image Credit: File photo

Dubai: UAE banks along with their GCC peers stand to benefit from the potential US interest rate hike that is expected to begin in March 2022.

A hike in US interest rates will be reflected in lending rates in the UAE and other GCC countries as their currencies are pegged to the dollar with the exception of Kuwait. Kuwaiti dinar is pegged to a basket of currencies with significant weightage to dollar in the currency basket. GCC central banks usually align interest rates with the US rates to avoid monetary policy divergence that could trigger currency volatility and speculation.

Analysts expect GCC banks to make significant interest rate margin gains as the interest rates go up.

“GCC banks are one of the biggest beneficiaries of rising rates within the emerging market banks space, given access to a sizable non-interest-bearing deposit base while loan books are predominantly floating rate in nature,” said Ehsan Khoman, Head of Emerging Markets Research (EMEA), MUFG.

Floating rate gains

While the UAE banks stand to benefit from the significant share of the loans in floating rate category, Saudi banks stand to gain big because of their higher proportion of non-interest bearing deposits (Islamic deposits) and current and savings account (CASA) deposits that carry marginal or no interest costs. These types of deposits comprise about 65 per cent of total Saudi bank deposits versus a GCC average of 45 per cent, and an emerging market average of about 35 per cent.

According to MUFG estimates, Saudi banks could see about 10 basis points (bps) NIM expansion on average on the back of a 50 bps SIBOR [Saudi Interbank offered rate] increase, which should boost earnings by 5 per cent on average. Fed officials have hinted at 3 to 4 rate hikes this year. According to rating agency Standard & Poor’s on an average, a 100-basis-point (bps) increase in rates would result in a 14 per cent increase in earnings and 1 per cent capital accretion.

Reversal of margin outlook

Lower interest rates had been squeezing overall margins and profitability of GCC banks. The UAE banks were severely impacted in the early stages of rate cuts as the lower rates were almost immediately reflected in the yields of floating rate loans while the re-pricing of corresponding deposits and other funding sources came with a lag. From the second quarter of last year, banks have been reporting a modest, yet steady improvement in margins. In the third quarter of 2021, net interest margin (NIM) increased by about10 bps quarter on quarter to 2.15 per cent with higher yields on loans (+24bps QoQ).

While anemic loan growth challenged UAE banks’ overall interest income, the pick-up in economic activity saw the aggregate interest income increasing by 6.1 per cent in the third quarter of 2021, primarily driven by an increase in loan yields to 5.3 per cent.

Analysts see margins improving across the board for GCC banks.

“Margins have stabilized for now and cost of risk has dropped compared with last year. We expect cost of risk to normalize over the next couple of years and margins to benefit from the expected increase in interest rates. Banks’ efficiency continues to support profitability, helped by low cost of labour and limited taxation,” said Mohamed Damak, Senior Director, Global Head of Islamic Finance at Standard & Poor’s.

Analysts say loan growth is an aspect that could have potential negative implications from higher interest rates. However, Damak and Khoman, see higher government spending driven by high oil prices to offset this.

“We do not expect a major slowdown in lending growth following a rate increase as this is more dependent on government spending and oil prices,” said Damak.

How interest margins impact bank profits
Net interest margin (NIM) is a measure comparing the net interest income, a bank/financial firm generates from credit products like loans and mortgages, with the outgoing interest it pays to holders of savings accounts and its other sources of funding.
In simple terms it is the difference between interest income and interest costs (or cost of funds). Expressed as a percentage, the NIM is a key profitability indicator for a bank. A positive net interest margin suggests that an entity operates profitably, while a negative figure implies poor investment efficiency.