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Risk and funding costs weigh on UAE banks

Loan-to-deposit ratios suffer despite net interest margins improving on higher loan yields

Gulf News

Dubai: UAE banks continue to perform well, albeit at lower levels of profitability caused by costs growing at a faster pace than operating income, according to the latest UAE Banking Pulse report from Alvarez & Marsal (A&M), a global professional services firm.

Data for the last quarter of 2017 showed a rise in costs and lower loan growth, moderating profitability of top 10 UAE banks by assets.

“Although profitability in the final quarter of the year saw a modest reduction compared with the previous quarter, this was mainly due to a more conservative approach adopted by the banks, as demonstrated by an increased cost of risk. The increase in operating costs, which is quite usual for the final quarter, also had an impact,” said Dr Saeeda Jaffar, a managing director at A&M.

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 indicates improved liquidity across the banking sector. But rising interest rates, combined with lower lending opportunities, are likely to challenge loan growth.

“Lending activity was overtaken by deposits from customers as a result of higher interest rates, leading to an increased level of liquidity. Our overall analysis suggests that while both banks and customers are exercising some caution, the sector is in good health, and is well placed to achieve further growth during the year,” said Dr Jaffar.

The overall net interest margins (NIMs) of leading UAE banks marginally improved in the fourth quarter despite a decline in loan-to-deposit ratios.

“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.

Operating income growth showed a sharp increase, driven mainly by higher levels of non-interest income such as fees and commissions, and seven out of 10 banks reported growth in their operating incomes.

Banks’ cost-to-income ratios rose from 32.7 per cent to 34.2 per cent, bucking the downward trend of the previous three quarters, as banks increased their operating expenditure in the final quarter.

Overall cost of risk for lenders increased as they adopted a more conservative approach and made higher levels of provisioning, with three banks also having to increase allowances for impairment.

Nine out of the top 10 banks saw reduced returns on equity (ROE), driven by higher operating expenses and a higher cost of risk.

Average RoE decreased to 14.3 per cent in the fourth quarter from 15.1 per cent in the previous quarter.

Looking ahead, the profitability of banks will largely be driven by loan growth supported by new customer acquisitions and retention in the context of rising cost of risk and cost of funds.

Analysts say a clearer picture will emerge in the results of the first quarter of 2018.