Rate hikes to increase cost of funds, likely to hurt loan growth

Dubai

The Central Bank of UAE raised its key interest rates on Wednesday following the widely anticipated rake hike by the US Federal Reserve.

The UAE raised its repo rate by 25 basis points (bps) to 2 per cent and increased its certificates of deposit rate by 25 basis points.

The most recent increase in lending rates is expected to increase cost of funds for both corporate and individual borrowers, potentially impacting loan demand and loan growth.

“We see a greater feed-through of rising rates in the US into the GCC in 2018 compared to 2017 with the erosion of the positive spread between regional interbank rates to Libor [London interbank offered rate]. As such, we see greater headwinds to economic activity in 2018 from rising borrowing costs,” said Monica Malik, chief economist of Abu Dhabi Commercial Bank.

Analysts expect the UAE Central Bank will look to uphold this 25 bps differential with credit demand remaining soft unless there is a widening in the Eibor [Emirates interbank offered rate] discount to Libor. So far, the sometimes-negative spread has been contained, thereby limiting the need for a wider differential in benchmark rates.

Although the policy rate hikes have been widely anticipated, it is likely to act as a damper for lending growth that has been anaemic in 2017 at around 2 per cent compared to 6 per cent in 2016.

According to a recent analysis of banking sector data of the top 10 UAE banks by Alvarez & Marsal (A&M), a global professional services firm, total loans and advances growth slipped from 1.26 per cent in the third quarter of 2017 to 0.22 per cent in the fourth quarter while deposits grew 2.47 per cent compared to 0.61 per cent in the third quarter.

A decline in the loan-to-deposit ratios in the last quarter of 2017 indicated improved liquidity across the banking sector. But rising interest rates, combined with lower lending opportunities, are likely to challenge loan growth.

In the past rising interest rates helped UAE banks to boost their loan yields and net interest margins (NIM) as repricing of deposits happened with a lag while higher rates were on loans were relatively faster.

Leading UAE banks continued to maintain strong NIMs last year but going forward loan growth is going to be defining factor in the profitability of banks.

“Stable NIMs came largely from higher loan yields, resulting from the automatic repricing of loans in the context of higher interest rates and a lag in the repricing of deposits. Going forward banks will need to work hard to keep up the NIMs growth,” said Asad Ahmad, a managing director at A&M.