Dubai: Banks in the UAE and Saudi Arabia are expected to benefit from the rising interest rates after the recent interest rate hike by the Federal Reserve, according to rating agency Moody’s and independent analysts.
Central banks of both countries track US interest rates, as their currencies are pegged to the dollar. It is important to maintain interest rates at par or in close range with US rates to prevent capital flight in the event of higher rates offered on dollar deposits.
Analysts say banks in the UAE and Saudi Arabia continue to hold significantly large low cost deposits in current and savings accounts (Casa), the pricing of which is not hugely impacted by the Fed rate hike because of the comfortable liquidity situation and relatively modest credit growth. On the lending side, banks have more flexibility on the pricing, leading to better yield and net interest margins
On September 26, the Central Bank of the UAE and Saudi Arabian Monetary (Sama) Authority increased their lending rates by 25 basis point eat in response to the Fed rate hikes.
“The rate hikes are credit positive for UAE banks because they will support their profitability by increasing net interest income. This is a key profitability driver, accounting for around 69 per cent of rated UAE banks’ total net revenue during 2017,” said Mik Kabeya, an analyst at Moody’s.
According to Moody’s, loans to the corporate and government sectors, which typically carry floating rates that reset at predetermined intervals, account for the bulk of UAE banks’ loan books with 74 per cent as of June 2018.
“We expect increased government spending in the country to support economic growth and lending opportunities. This will make it easier for banks to re-price their lending in the competitive local environment following constrained pricing increases in 2017 amid muted credit growth and lenders’ focus on high-quality, price sensitive large borrowers,” said Kabeya.
Surge in funding costs
UAE’s Credit growth picked up to 2.7 per cent in the first six months of this year, compared to the 0.4 per cent growth during full-year 2017. Moody’s expect that rising interest rates will increase system-wide net interest margins, as banks’ higher gross yields outweigh the increase in funding costs.
With every rise in interest rates, banks are expected to face a surge in their funding costs. However, analysts say banks stand to gain from better loan yields. “The move will increase borrowing costs, and likely improve banks’ profitability, marking further improvement for the sector this year after the robust performance of 2017. The hope remains that the broader industry will absorb the higher costs buoyed by the oil price recovery and given the strong performance of loans and deposits growth in August,” said Emilio Pera, partner and lead of Audit at KPMG Lower Gulf.
In the case of Saudi banks too, Moody’s said the rate hike will have a positive impact on their profitability through higher net interest margins. Despite subdued credit growth, Saudi banks’ net interest margins have been widening since 2016. Overall, the rating agency expects the gap between Saudi banks’ lending rates and low cost of funding to continue to widen, because rate hikes are likely to continue.
“The widening [of net interest margins] reflects banks’ ability to re-price corporate loans (64 per cent of total bank loans as of June 2018), which are typically extended on a floating-rate basis, and a favourable funding structure, supported by a large base of non-interest bearing demand deposits (63 per cent of total bank deposits as of June 2018),” said Jonathan Parrod, an associate analyst at Moody’s.
