As the dust from the global economic storm beings to settle in the UAE, banks are hesitantly wading into 2009. This year, the operating environment for banks is undoubtedly challenging. Experts say that since the estimated — but not official — $55 billion exit of foreign currency last year, a major liquidity hole has been created in the banking sector. When the global financial crisis shook the core of the UAE economy, what was once scarce liquidity had become almost non-existent. Thanks to the affluent sovereign that is the UAE federal government, the banking sector has been provided with liquidity assistance via cash injections totaling $13.6 billion. At present, the central bank claims Emirati banks have only absorbed two-thirds of this liquidity fix, with a third shot expected to take place sometime in the first quarter of this year.
While bankers, analysts and financial houses scream in unison for liquidity in the market, the governor of the central bank, Sultan Nasser Bin Al Suwaidi, claims that the liquidity situation in the UAE is “much better” and the emergency fund is “not being needed to a great extent.” It seems as though the federal government of the UAE is in dire need of a reality check.
In the first week of February, the Abu Dhabi government announced its plan to feed $4.4 billion of capital into five of its banks, with the National Bank of Abu Dhabi (NBAD), First Gulf Bank (FGB) and Abu Dhabi Commercial Bank (ADCB) each receiving some $1.1 billion, while Union National Bank (UNB) and Abu Dhabi Islamic Bank (ADIB) each took in $544.5 million. This cash boost from the government of Abu Dhabi differs from the UAE federal government’s injection to all banks in the Emirates, as it is a capital injection and not a liquidity injection; the former inherently increases the latter, with the added benefit of improving Tier 1 ratios. Now, with Abu Dhabi banks looking significantly more capitalized than their Dubai peers, sentiment on the ground is negative and tense — to say the least — and could leave Dubai banks searching for the panic button sooner rather than later. Fitch Ratings contends that this capital injection into Abu Dhabi’s top five banks “leaves other banks in the UAE looking potentially more vulnerable in the event of a significant domestic downturn.”
What’s love got to do with it?
Raj Madha, director of equity research at EFG-Hermes in Dubai, believes that with this recent capital injection by the Abu Dhabi government, the UAE is witnessing an expanding “gap between Abu Dhabi capital and Dubai capital.” What’s more, he exhorts, is that there could “be pressure for Dubai to find some way of increasing the capital of Dubai banks. If they can’t, then obviously the solvency advantages of the Abu Dhabi banks may be a significant advantage for them.” John Tofarides, an analyst in the financial institutions group at Moody’s Middle East in Dubai, considers the recent capital boost skewed as it “creates uneven competition as Abu Dhabi banks can borrow at a lower cost. After this move, deposits in Dubai and other Emirati banks pay as much at two percent higher on similar maturities.”
According to Robert Thursfield, a director in Fitch Ratings’ financial institutions team in Dubai, the nature of the new capital “looks like a financing plan to enable Abu Dhabi projects to continue as planned, although it could also be a cushion for potential future problems in loan books, in particular real estate related exposures.” Whatever the motive, evidently Abu Dhabi has made a clear statement that its number one priority is, well… itself.
Bankers and analysts alike are expecting similar action to be taken by the Dubai government in the near future, but as of yet no one is quite sure how the Dubai sovereign will play its cards. Thursfield asserts that banks preserving capital means they are trying to “effectively cushion future risks and defaults. If you’ve got a bigger cushion to absorb losses and problems, then you look stronger than if you’ve got a weaker, smaller cushion, which is effectively where we are now. The Abu Dhabi banks have got a much bigger cushion.”
Logically, to even out the disparity between the banking sectors of the two competing emirates, a comparable action would be necessary. Fitch notes that the “required injection for four [Dubai banks: Emirates NBD, Mashreqbank, Commercial Bank of Dubai and Dubai Islamic Bank] would likely be of similar magnitude given that the equity of the five Abu Dhabi banks at 30 September 2008 was about [$14.2 billion] compared to about [$14.4 billion] for the four Dubai banks.” Clearly, “Abu Dhabi is in a much better position than Dubai,” propounds Thursfield, “and any support it gives to Dubai and other emirates is going to come with greater strings attached.” Naturally, he says, Abu Dhabi “will stand by Dubai if they get into significant trouble”. While Thursfield is confident in Abu Dhabi’s potential backing of its neighbors, others are more skeptical as this recent move has sparked fears throughout the Emirates. Time will tell what the federal and/or individual sovereigns have in store for the fate of Dubai’s banking sector and entire economy.
The 2009 decline
The fourth quarter 2008 performance of most banks in the Emirates “remained satisfactory” notes Fitch, with a few exceptions. ADCB reported a net loss of $70.8 million, Emirates NBD reported a net profit loss of seven percent from 2007 and Union National Bank’s net profit came in at $18 million. The ratings agency claims, “the main banks that have reported headline figures to date all remain profitable for the full year, although [fourth quarter 2008] figures show a significant decline in net income compared to the previous three quarters in 2008.” With an extremely strenuous year ahead, “2008 levels of net income [are] unlikely to be repeated,” says Fitch, while liquidity and real estate exposure remain top concerns for UAE banks.
Popular consensus throughout the Emirates voices the need for solving the country’s liquidity problems. Without liquidity, the banking sector is not the only industry at risk — tourism, finance, labor and real estate sectors are all facing major losses and will continue to do so as long as liquidity is hard to come by.
With the inevitable burst of the property bubble, every bank in the UAE — to some extent — is vulnerable to the real estate sector. A chief concern for the UAE economy “is that there are direct as well as interlinked exposures to the property market that are not easy to accurately quantify, given current disclosures,” Tofarides indicates. Madha feels that in relation to property sector regulation, the Ministry of Finance “could do more to lower counterparty risk.”
Madha echoes that the UAE has not yet witnessed a harmonized liquidity situation. Pointing to the current deposit rates, which he says are a “reasonable guide to understanding where the banks are in terms of liquidity,” banks like ADCB and Emirates NBD possessing deposit rates of around seven and 5.5 percent respectively, are “de facto proof that the liquidity situation is not yet stabilized.”
It must be kept in mind that this liquidity crisis is also largely related to the implementation failures of Basel II. Apparently, authorities are now looking to apply Basel III in order to strengthen the financial system and hopefully help avoid any unforeseen crises in the future. Dr. Nasser H. Saidi, chief economist at the Dubai International Financial Centre Authority (DIFCA), told a panel at the Economic and Islamic Finance Outlook for the UAE that, “The scope for regulation… should be strengthened. We should develop early warning indicators. We need [the] Basel III framework in 2009 and key factors such as risk management, liquidity management, CAR [capital adequacy ratios] need to be incorporated in the new guidelines.” New regulations should be welcomed with open arms in an economy facing such major downturns.
Road to recovery
A recently published report by the Abu Dhabi Council for Economic Development articulated the need for an entire UAE stimulus package. Even with the liquidity boosts from the federal government, the council believes that “while such measures have succeeded in offsetting liquidity shortages and ensuring continuance of normal bank lending operations, more should be done by Abu Dhabi or the UAE as a whole in order to enable the banking sector to fully recover and resume its role in supporting the domestic economy,” the report states. “This can be done through the country’s massive financial reserves.”
Other preventative measures include managing liquidity and general risk management practices. Tofarides believes that banks should “design contingent strategies for liquidity stresses and asset quality stresses to see how sensitive they are and how they can respond to such events.” This year, Madha hopes that banks will be limiting their total size of exposure “and to make absolutely sure that where [they have] exposures, those are guaranteed in some shape or form by the state — better still, in contracts where the state has waived sovereign immunity.”
Highlighting the majority’s perspective, Tofarides points out that the primary concern is to manage liquidity. On February 9, Standard Chartered bank announced that the UAE needs to pump an additional $27.2 billion into the banking sector in order to bring down the advances to deposit ratio below 100 percent and to help boost liquidity issues in the market. Experts don’t seem to have any problem with this figure and at this point, the more liquidity, the merrier.
Another top concern, Tofarides says, is for banks to “maintain their profitability and build up a higher capital cushion, account for additional provisions, or be given direct support from the government if needed.” Madha would like to see “a continued drive to ensure there is an open, visible market in financial services and we need to have transparency in the quality of loans.” Banks should also be lowering their visible risk and increasing their transparency levels, adds Madha. Tofarides echoes the necessity for transparency and honesty. “As one of my senior managers used to say, the bottom line is ‘banking is people and people is trust’. Not safeguarding a trust relationship between banks and the corporate world would harm business development with longer-term implications,” he says. In a deteriorating situation like in the UAE, transparency and cash are king.
Madha claims that 2009 “is the year where every bank will argue why they are lower risk than they seem. As an outsider, we can’t definitively say whether the banks are correct or are even being honest in their assessment, but we will test all these hypotheses by the end of the year and find out which banks have been honest about their risk profile.”
Regarding banking strategy in 2009, Tofarides trusts that it is no longer a growth strategy. He believes that banks will take up “a consolidation and a liquidity directed managed strategy. Prudence dictates that banks’ loan growth should go in tandem with their availability to raise funds, manage their liquidity, manage their existing loan commitments, etc.”
As Thursfield puts it, “profitability will be low in 2009, delinquencies will rise, margins may decline, funding costs may continue to be high — it’ll be a much more challenging environment.” With the looming “lack of liquidity, lack of confidence and soaring negative sentiment that affects banks’ ability to lend,” says Tofarides, “people’s willingness to take up risks and invest” is sinking.
Tofarides foresees “very limited growth” for banks in 2009, “from about zero to five percent growth,” with some banks possibly reporting negative growth in the long run, “unless they are given more money like in the case of the Abu Dhabi banks.” This opinion seems unanimous throughout the banking sector, with experts like Madha hoping “to see recapitalization of Dubai banks to the same extent of the Abu Dhabi banks.”
This is definitely the year for conservative policies and prudent moves. The developments of the coming months may be the key to overcoming the long-term negative effects of the global financial crisis.