The UAE’s banking sector has recently been crowned the largest market in the GCC by total assets, valued at $336 billion. The IMF believes the “financial system remains sound,” even though external borrowing by financial institutions and big corporations has tripled from 2004 through the end of 2006, reaching $80 billion. The IMF holds back from sounding any alarms, as the UAE’s large net creditor position suggests there is no reason to worry.
The bursting economy of the UAE is mainly due to population influx, considerable infrastructure projects, and increased oil prices. Mihir Marfatia, author of a Global Investment House (GIH) report published in March 2008 believes, “High oil price revenues are a major benefactor to [the banking sector which is] benefiting from a booming economy.” The increased demand for sharia-compliant banking services is also positively influencing the banking sector.
The US subprime mortgage calamity is a hot topic throughout the global financial sector — yet the majority of banks in the UAE have been unaffected, as according to Fitch Ratings, the “UAE banking system seems to be less exposed to the turmoil than the Bahraini sector, where a number of banks have reported significant losses.” Fortunately, the UAE economy has vanquished most external negativity, allowing its economy to rocket further. Marfatia added that: “These boom times are creating strong investment-led growth, a rapidly expanding population and a recovery in fee income.”
In May 2008 Fitch Ratings released a report United Arab Emirates Banks: Annual Review and Outlook, analyzing the overall performance of the UAE banking sector. Fitch Ratings states that as the banking sector is “benefiting from a benign operating environment and a strong demand for credit, operating profits for most banks grew in double digits.”
Further, GIH brings to light the factors aiding efflorescence of the banking sector: “The considerable project pipeline in the UAE is also providing ample finance opportunities for the Emirates’ leading institutions. In addition, a favorable demographic profile is accelerating urbanization and infrastructure investment, providing impetus for corporate and consumer lending portfolio growth.”
While the banking sector flourishes, there are some factors to be wary of. Fitch Ratings rightfully highlighted that UAE macro-economic indicators suggest “the banking system is highly exposed to risks associated with rapid credit growth, excessive property price increases (and to a lesser extent stock market exposure), and high inflation.” Overall the banking sector is exceptionally robust, but the IMF notes that it faces challenges ahead.
Total UAE bank assets ($ billions)
Key performance measures
Bank performance
At present, Fitch Ratings states that the UAE banking sector “continues to benefit from the buoyant economic environment it mainly operates within.” The banking sector’s net income greatly increased by a healthy 26% year-on-year growth, reaching record highs of $6.53 billion in 2007. Overall, the performance of banks in the UAE “have been very encouraging, with all banks (with the exception of ADCB) experiencing double-digit annual growth in operating income during the year.” The Index of Economic Freedom 2008 reckons that six major banks in UAE account for 70% of total assets. According to Fitch, the net interest of banks operating in the UAE swelled by an average of 26%, and “[for] almost all banks, it remained the main source of income.”
The UAE tops its fellow GCC members, possessing the highest penetration level in the banking sector in terms of assets, loans, and deposits. Abu Dhabi-based investment bank The National Investor (TNI) trusts that such soaring levels of banking penetration “is reflective of the relatively developed nature of banking infrastructure in the UAE.” Between 2003 and 2007, assets to GDP of banks witnessed a sturdy increase from 118% to 180.2% respectively. Banks’ deposits to GDP also saw a substantial increase, from 76.4% in 2004 to a whopping 105.6% in 2007, “and credit penetration, i.e. loans to GDP ratio increased from 75.2% in 2004 to 105.3% in 2007,” reports TNI. Currently, UAE deposit penetration ranks highest among all other GCC nations.
Fitch firmly believes that “banks with domestic retail franchises continue to benefit from increasing demand for consumer credit, where wider margins can be charged.” For example, the National Bank of Ras Al-Khaimah (RAK) bears considerably higher net interest margins than other banks in the UAE.
The banking sector is dominated by the recent birth of Emirates NBD (ENBD), a merged entity of the UAE’s two leading banks — Emirates Bank International (EBI) and the National Bank of Dubai (NBD) — in 2007. In terms of asset size, the merger recently surpassed Saudi-based National Commercial Bank, becoming the largest banking entity in MENA region. (It is imperative to note that the merger is still in its final phases, as EBI is still independently operating in some aspects. Regarding total assets, with $39.5 billion EBI ranks second in the UAE. The last phase of the merger includes de-listing EBI and NBD from the Dubai Financial Market.)
As a necessary trend to follow, bank mergers assist the government’s diversification plan involving colossal infrastructure projects. TNI firmly states that, “size is the key with respect to project execution and scalability.” TNI views the merger as highly beneficial “by way of cost and revenue synergies as well as help the merged entity to fund such large ticket projects at competitive pricing.” Due to an increase in demand growth and corporate and retail loans, Q1 profits in 2008 weighed in at $324.5 million, up 37% from the same period last year. ENBD rules in the UAE with total assets measured at $69.2 billion, and according to TNI are “expected to grow at a CAGR of 21.8% during [2007-2011].” The enormous ENBD amalgam makes competition slightly difficult for other UAE banks.
Coming in third place, the National Bank of Abu Dhabi (NBAD)’s total assets for 2007 rang in at $37.9 billion. Better known as the ‘bank of the Abu Dhabi Government’, TNI notes that NBAD capitalizes from both government and public sector companies. First quarter profits for 2008 rose 45% from the Q1 of 2007, reaching $238.3 million. TNI reports that NBAD should expect a CAGR growth of 20.5% in fee income for 2007-2011. “The thrust towards consumer lending has benefited the bank during the last three years… the consumer loan has increased by 19% to AED14.3 billion [$3.9 billion] in 2007” asserts TNI. At present, NBAD is making efforts to diversify its non-interest income by increasing fee related business. TNI ensures that the bank “is well positioned to benefit from the current economic boom in Abu Dhabi.”
National vs. foreign banks (asset size)
National domination
With a population of 4.5 million and 49 banks, the UAE is rather ‘overbanked’. Currently, of these banks, 22 alone are national banks while the remaining 27 are foreign banks. And let’s not forget the 65 representative offices of other foreign banks throughout the UAE, as well as two specialized banks. Emirates Bank Group highlights that the UAE has “one of the highest ratios of bank branches / presence population.” Although there are more foreign banks than local ones, the latter largely surpasses the former in overall performance. The market share of domestic banks increased from 78.7% in 2003, and by September 2007 had reached 82%.
While national banks are outperforming foreign banks, especially in terms of credit growth, “one might feel that the [domestic banks] must be having a tough time in sustaining the current position in the UAE market,” according to the March 2008 Global Investment House report. More bad news for foreign banks is they are restricted from operating more than eight branches, whilst national banks are not subject to any such regulations.
Though outnumbered, domestic banks have an unbeatable edge over foreign banks. Seeing as there is no homogeneous taxation policy for banks throughout the UAE, national banks are exempt from any tax operations within the UAE. Foreign banks are not as lucky and are subject to a 20% tax on all profits. The IMF suggests extending liberalization policies to non-GCC foreign banks, thus permitting them to benefit from the thriving economy, as currently GCC banks have the advantage, especially regarding credit growth.
An April 2008 report Exciting Times Ahead by TNI states that internal banks are able to dominate the sector “as they have access to the UAE government surplus funds”.
Although the UAE has been under pressure from the WTO to liberate the banking sector to allow foreign competition, TNI doubts any such action will occur in the near future. But, TNI observes, “local banks are scaling up their operations and are expanding their footprint locally and regionally to combat the increased competition.”
Even more good news for national banks: TNI identified that UAE national banks account for approximately 75% of the banking sector’s total assets. With the perks of government on their side, domestic banks will continue to reign over the banking kingdom.
United Arab Emirates bank ratings at May 2008
Current United Arab Emirates bank government ownership
Inflation on the rise
The banking sector’s most noted challenge to growth is undoubtedly the continuous rise of inflation. The UAE economy was smacked with a 19-year peak of 9.3% inflation rate in 2006, and soared further in 2007 to 10.9%. According to Zawya Dow Jones, inflation velocity is expected to surge to possibly reach a dangerous height of 12% in 2008. Investment bank Merrill Lynch cautioned that such a staggering increase is unavoidable “unless the dirham is re-valued or de-pegged from the US dollar.” The UAE government is bravely attempting a target of 5% inflation for 2008, but in reality this goal is acutely unattainable.
The UAE’s endeavors to fight inflation involve tightening monetary policies and cutting interest rates. Given that all GCC currencies have been pegged to the US dollar since 2003, shielding options are rather restricted as central banks of the region are required to emulate the US Federal Reserve’s policy.
In line with Federal Reserve reductions, Central Bank of the UAE (CBUAE) cut its discount rate in 2007 and “is expected to continue to move in step with US dollar rates, given that the UAE dirham/dollar currency peg still holds,” according to Fitch Ratings. What’s worse is that “high inflation has put the peg under pressure, and Fitch expects that any potential revaluation of the currency would be coordinated with other GCC states, as preparation for a GCC currency is still ongoing,” albeit, Fitch subtly notes, “the official target date of 2010 looks unlikely.”
At a time when, according to OBG, the “US economy’s fundamentals are precisely the opposite of the Gulf’s,” the dwindling muscle of the dollar has jeopardized the ambition of a GCC monetary union by 2010. OBG notes that “the varying effects of the weak dollar and the high price of oil have strained solidarity among the [GCC] members.”
Mohsen Khan, IMF Director of the Middle East and Central Asia believes, “At the moment, since inflation is not driven by dollar depreciation, focusing on de-pegging or revaluation is not the solution.” Contrarily, other financial experts consider that by making imports more expensive, the dollar peg plays a key role in driving inflation rates in the UAE as well as throughout the GCC as a whole. The paramount downside to revaluation, explained Khan, is that Gulf states risk suffering approximately a $400 billion loss in their holdings value, “if they were to revalue by [only] 20%.” Without a doubt, CBUAE needs to create an anti-inflation strategy in order to tackle the banking sector’s primary dilemma.
Transparency concerning the veridical level of inflation in the Emirates is rather limited. In February of this year, the government of the UAE revealed it intended to kneel to long-term pressure imposed by the IMF and agreeing hereafter to publish a monthly consumer price index (CPI) rating. “However,” the Oxford Business Group (OBG) notes, “there is some debate as to whether the CPI basket currently used will give an accurate reflection of the true picture for UAE residents. Economists say up to 50% of local inflation is directly attributable to increases in rents, whereas the basket allocates only 36%.”
Country forecast
Basel II
As of January 2008, banks operating throughout the UAE were required to implement Basel II, a standardized regulatory accord to credit risk. The CBUAE has worked alongside UAE and other GCC banks in order to efficiently utilize the principles “giving due consideration to points of national discretion under Basel II.” Fitch Ratings believes that the 2008 implementation of Basel II “has had a moderately negative impact on most banks’ capital ratios given the charge for operational and market risk.” Under the auspices of Basel II, the large UAE banks “are aiming to maintain capital ratios… at 12%-15%,” considered sufficient by Fitch. In the big picture, Basel II should aid transparency regulations as well as management of credit risk.
Forecast
Mainly thanks to mammoth infrastructure projects, real estate investments, expanded bank investments, high oil prices, monetary liquidity, and consumer spending, the UAE banking sector has seen vigorous growth. TNI trusts that the “contribution of UAE’s banking assets to the aggregate GCC banking assets as at end 2007 stood at 40.5%.” Fitch reports that UAE banks will continue to enlarge their branch networks in order to “remain competitive and attract retail customers.” With Emiratization efforts being made, talented UAE nationals are being urged to join the banking sector. Many banks are providing programs aimed at informing new graduates of the new developments, issues, and services of the banking sector. With such opportunities, the banking sector is only sure to flourish from here on out.
TNI expects collective assets of UAE banks (specifically ENBD, NBAD, Abu Dhabi Commercial Bank, Mashreq Bank, RAK, First Gulf Bank, and Union National Bank) to increase at a compound annual growth rate of 20.1% in the coming four years. Profitability is predicted to persist “in 2008 at broadly the same levels as in 2007,” given the UAE’s propitious operating environment.
Although tackling inflation is a challenge for UAE banks, their performance is rather stellar. Sallie Krawcheck, CEO and Chairman for Citi Global Wealth Management believes that the “best is yet to come in the Middle East… and the UAE is making quite a significant impact on the global economy.” The future of the UAE banking sector looks exceptionally positive, and trends of profitability are expected to remain sound.
