Dubai: The recent central bank decision to increase local capital requirements of UAE banks related to the Basel III regulations are expected to add to the regulatory burden and costs according to bankers and analysts.

Analysts say most UAE banks are adequately capitalised to meet the new regulations, but some say the opportunity cost of additional capital buffers will by significant for banks, especially at a time cost of funds are rising and yields are low on assets due to competitive pressures and low growth economic environment.

“UAE banks are mostly well placed to meet new local capital requirements related to the global Basel III regulatory framework, given their strong levels of Tier 1 capital in particular. The minimum total capital ratio, including a capital conservation buffer, has risen to 13 per cent of risk-weighted assets (RWAs) from 12 per cent under the previous regime, and most major banks are comfortably above this,” said Redmond Ramsdale, Senior Director of Fitch Ratings.

The Central Bank of the UAE issued new regulations last week, effective from February 1, to ensure that banks’ capital adequacy is at least in line with Basel III requirements. In addition, they must hold further common equity Tier 1 (CET 1) of 2.5 per cent of risk weighted assets (RWAs) as a capital conservation buffer, and manage their capital and dividends to maintain this buffer.

Analysts expect UAE banks to continue to calculate RWAs using the standardised approach, at least in 2017, as the central bank seems unlikely to allow the use of internal models to reduce capital requirements.

Strong loan growth

Most banks in the UAE and across the Gulf Cooperation Council (GCC) region are capitalised well above the new minimum regulatory requirements and will also comfortably meet the 3 per cent leverage ratio required under Basel III, given their high Tier 1 capital levels. Although a few banks are near the new minimum capital requirements, reflecting strong loan growth or pressure from their institutional shareholders for higher returns on equity, they have the ability to raise capital if needed, through internal capital generation or rights issues.

The new capital regulations announced by the UAE Central Bank require banks to maintain a minimum CET 1 of 7 per cent by 2017 with the countercyclical capital buffer (CCB) increasing each year until full implementation in 2019. Including these buffers, common equity tier 1 capital ratio threshold increases to 8.25 per cent in 2017, 8.88 per cent in 2018 and 9.5 per cent in 2019.

“Even though the central bank has not stipulated the countercyclical buffer, but a range, we use the top end on prudent terms and calculate the CET 1 minimum requirement at 9.5 per cent in 2017, 10.76 per cent in 2018 and 12 per cent in 2019. Accordingly, the minimum CAR requirement stands at 11.75 per cent in 2017, 12.38 per cent in 2018 and 13 per cent in 2019,” said Jaap Meijer, head of Research at Arqaam Capital.

Including countercyclical capital buffer the capital adequacy ratio (CAR) could go up to 13 per cent 14.26 per cent, 15.50 per cent in 2017, 2018 and 2019, respectively. Under Basel II, Tier I minimum threshold was 8 per cent and CAR 12 per cent.

Minimum CET1 requirement

UAE banks typically have high capital ratios by international standards. However, analysts consider them only adequate, given the concentrated exposure in UAE banks’ loan books to individual sectors and borrowers, which makes them more sensitive to event risk.

“Some banks with a higher proportion of additional Tier 1 capital, which is not included in CET1, could struggle to meet the minimum CET1 requirement with the additional 2.5 per cent capital conservation buffer. But, again, we believe they have the ability to raise capital if needed,” said Ramsdale.

The UAE tends to follow US interest rates as its currency is pegged to the US dollar and potential rises in interest rates could reduce capital ratios through lower mark-to-market values of banks’ bond portfolios. However, most capital ratios are well above regulatory minimums and most banks have strong internal capital generation through earnings to bolster capital if needed to support loan growth.