The National Bank of Abu Dhabi (NBAD) is the second largest bank in the UAE with assets reaching $45 billion. Executive Magazine recently conducted an exclusive interview with the bank’s CEO of 10 years, Michael H. Tomalin, a senior international wholesale and private banker with more than 30 years experience with Rothschild and Barclays in the UK, Japan, the Middle East, Australia, the Caribbean and the Far East.

E What strategies will UAE banks be using in 2009? How will they differ from previous strategies?
Obviously global markets are more tricky and I think that the strategies in 2009 are going to be more focused on good housekeeping and also more at home than abroad. There’s going to be a lot more concentration on getting it right inside the UAE. It will be less expansionist and mostly internalized.

E Will banks be more prudent with lending and provisions? Seeing as many banks grew very quickly in the UAE, it seems that increasing loans may not be a good idea.
I’d be careful about how you express that because the UAE was growing very fast and the banks were supporting the growth of the UAE. So, I don’t think banks were imprudent in terms of developing the UAE. The job of the banks in the country is to support the economy and to mobilize deposits on the one hand and apply them to projects on the other. They also financed people and businesses so the economy could grow. The economy was growing and what was happening was that the banks were following and supporting the growth in the economy.
Now clearly, the economy is growing at a slower pace. Because the economy is growing at a slower pace banking and business will grow at a slower pace. The growth of the whole banking system of the UAE is going to slowdown from the very high numbers that we saw — which were again, a reflection of the very high growth rates that we saw in the UAE — to a more modest number, somewhere probably around 10 percent rather than 30 or 40 percent.

E Undoubtedly, the real estate bubble has burst in the UAE. How has the downturn in the property market affected your operations?
I would say we are less exposed than most. We think that there has been a correction in property prices, but there is some good value emerging. The basic story of the UAE is a very strong story. The UAE economy is in a very strong position. We’ve seen property corrections like this elsewhere in the world and my expectation is that we will bounce of out it in due course — it may take a bit of time, but we will bounce out of it. As far as this bank is concerned, we’re very comfortable and relaxed about our property exposure as a whole.

E Will you be tightening your lending conditions for property developers this year?
We will continue to lend to projects that we think make sense. We’ve always been a prudent bank. The country will still continue to grow. Buildings will have to be built. Projects will have to be completed, there’s a big infrastructural spread planned for this part of the world — in Abu Dhabi in particular — and we’ll have to play our part in that. The issue for the banks is not so much the credit quality issue, but the actual liquidity issue. The problem for the banks is that there is not enough liquidity in the overall banking market for the banks to grow very fast. The reason why the liquidity is tighter than it was is that there has been a very substantial withdrawal of liquidity by foreigners. So foreign managers, foreign banks, foreign hedge fund managers and others came in anticipation of a possible re-valuation of the dirham and the continuation of markets moving in a very positive direction. The global downturn has meant that a lot of that foreign money that came in has actually gone out and of course, the UAE is a free and open market. That money going out has left a hole that needs to be filled.
The central bank, Ministry of Finance and others have begun filling the hole but the hole is still large. So the difficulty is that with international lenders basically strapped for cash in terms of lending themselves, and international investors having taken money out of the economy, the problem for the UAE banking system is actually a shortage of liquidity.

E Recently, the government of Abu Dhabi announced it would inject $1 billion into your bank and provide similar amounts to four other banks in Abu Dhabi. This injection was not like the prior injections in Dubai banks.
The first $13.6 billion injection was made by the government of the UAE, not the government of Dubai. The UAE government injected $13.6 billion in two tranches into the whole banking system, and we benefited from that along with Ras Al Khaimah banks, Sharjah banks and Dubai banks. They all benefited from that more or less in relation to their size.
So it was the federal government of the UAE that injected this money into the banking system. This money was a deposit, as you rightly say, I think it was a five and a seven year deposit. The borrowers have the option of turning it into Tier 2 capital by accepting convertibility in favor of subordination. In other words, if the banks are willing to offer a conversion option into equity, the lender — the federal government — is prepared to subordinate its claim and that would make it Tier 2 capital.
Most banks, as far as I know, have not gone and accepted that option because the terms of the conversion are quite tough. The conversion terms are the lower of book or market, so most people have chosen not to take that conversion. We have not accepted it, for instance, and I doubt that any or many banks will.
Now quite separate from that, the government of Abu Dhabi chose to invest $4.3 billion in Tier 1 capital into its own banks. Indirectly, it is actually the owner because 70 percent of the stock [of several Abu Dhabi banks] is owned by the Abu Dhabi Investment Council, which is a trustee on behalf of the government of Abu Dhabi and similarly for the other banks. So this is actually the owner investing in its own bank, effectively. This investment was made via Tier 1 capital by way of a perpetual instrument, so it’s a deeply subordinated perpetual instrument, which is in fact Tier 1 capital for the Abu Dhabi banks. Tier 1 capital is obviously very different from Tier 2 capital and it is obviously very different from a deposit.
So what we got from the federal government was a deposit, which will be repaid at the end of its life and it will rank alongside any other deposit. Tier 2 capital is subordinated but termed, in other words it becomes repayable at some point in the future. Tier 1 capital, like equity, is permanent capital — it’s there forever. So the Tier 1 capital that the government of Abu Dhabi put into the Abu Dhabi banks is treated for capital adequacy purposes just like equity, it’s permanent capital. The primary purpose of it was to boost capital adequacy ratios because it actually increased the capital adequacy ratios of the Abu Dhabi banks by two, three, or four percent depending on the original size of the capital. So the Abu Dhabi banks had a substantial boost in their capital ratios. As a secondary effect, it also improves liquidity because obviously the $1 billion that is placed with us is extra cash that we have.

E On February 9, Standard Chartered announced that the UAE needs to inject an additional $27.2 billion into the banking sector in order to bring the advances to deposit ratio below 100 percent and to boost liquidity conditions. What’s your take on this? Is this a necessary step?
It comes back to the earlier point I made — one must distinguish between capital and liquidity. As far as capital is concerned, the Abu Dhabi banks are in a very strong position. As far as liquidity is concerned, because of the withdrawal of foreign money earlier, there is a shortage. Around $54 billion that came into the economy was withdrawn from the economy. That’s more or less 20 percent of the deposit base of the banking system. Now of that 20 percent, the federal government have replaced about $13 billion.
So yes, arguably, another $27 billion of liquidity is required to rebalance the market as a whole. But that’s not the same as capital. The system doesn’t need an extra $27 billion of capital, the system as a whole needs extra liquidity. The issue is liquidity, not capital. The capitalization of banks in the UAE, generally, is very strong. Banks in the UAE are very strong banks, they have very strong capital positions, there is nothing wrong with their capital positions. The difficulty for the UAE, is because — nothing to do with the UAE by the way — we are part of the global marketplace, foreign moneys that came into this market were withdrawn. This is not because people disliked the UAE at all, but because the world situation became very bad and people were forced to bring back money to meet claims that they themselves had on their own banks or funds. Now what the Standard Chartered economist is saying — and he’s right — is that there is a shortage of liquidity in the UAE banking system, it’s obvious. That’s clearly the case and that shortage of liquidity ultimately needs to be covered.

E What new regulations should be put in place to help the UAE banking sector weather the effects of the financial slowdown? What lessons can be learned from what has happened?
I don’t think we need any new regulations. Perhaps, first of all, we need to accept that what has happened is a function of global market forces. In terms of going forward, we need to find ways of closing the liquidity gap so that banks can go about their jobs and support the ongoing growth of the UAE. I would say the lessons to be learned are that we need to grow our balance sheets inline with our growth in deposits. In other words, the business of the bank cannot grow faster than the business of the deposit base behind it. We can’t have one growing at a different pace than the other. So we’ve had this enormous withdrawal of money. The banks either have to slow their lending down enormously to rebalance it or there has to be new liquidity coming in. The problem with slowing the lending down so much is that it could actually have negative effects on the economy as a whole and that’s what the authorities are trying to resolve. You’ve got to try to find that balance. The alternative for the banks is simply to bring their loan book down to meet their deposit position, but the effect of slowing a car down from 130 to 50 kilometers per hour in the space of 300 meters is you often have an accident. So, it’s better to do it in a very gradual way. On the one hand we have to find more liquidity, on the other hand banks should be more careful about expanding their loan books going forward.

E In the fourth quarter of 2008, your profits decreased by 34 percent year-on-year due to high provisioning. What can you tell us about this?
The provisioning we made in the fourth quarter was largely voluntary, these were collective provisions that we made. There are two spins you can put on our numbers. Spin number one is: operating profits are up 48 percent, the results are brilliant. This is a very, very strong bank with a very, very strong set of results. So the headline that we had for our press release is ‘NBAD record results buck the global trend.’ [We had been seeing] banks around the world with their profits going down catastrophically like UBS, Royal Bank of Scotland, Citibank, Merrill Lynch, Goldman Sachs, Deutsche Bank, you name it. Very strong banks that we see as our peers going from big profits to losses, if in the context of that we increase our net profits by 21 percent, it’s fantastic. But it’s actually even better than 21 percent because our operating profit was up 48 percent.
Because our operating profit was up so much we chose — we weren’t forced — to make an extra collective provision against things that might go wrong in 2009. They may not necessarily go wrong in 2009, [but] they might. We’re being precautionary and prepared. Much of that collective provision was taken in the fourth quarter, so actually our fourth quarter profits were up 16 percent, they were not down 34 percent. But the analysts say they’re down 34 percent — the reason why they’re down 34 percent is because we took this huge lump of collective provision, which was made in the fourth quarter.
So, it depends from which end of the telescope you look at it. You could say — which is the way I like to look at it — the bank did so well, it could afford to make a massive collective provision against the future and still increase its earnings year-on-year by 21 percent. We may bring all this back to account next year. We are as cushioned as we can be for a tough 2009. I think the spin the press has put on our results isn’t right. How many banks in the world actually had their profits up 16 percent? I think virtually no one. Because our profits were up 16 percent, we were able to take an extra load of general provisions.

E In your opinion, what is the key element that will provide a competitive advantage to banks in order to brave the economic slowdown and make them stand out from crowd?
I think very strong risk policies, both credit risk, market risk and operational risk. Risk policies in the sense that prudent extension of credit, market policies, very careful management of balance sheets, operational policies, making sure that everything you do operationally is perfect. That’s why I use the phrase ‘good housekeeping,’ I think that’s what banks should be concentrating on in 2009. The banks that do those things well are the banks that will be in a stronger position in 2010.