Despite undergoing a profitability squeeze in 2016, Abu Dhabi’s banking sector nonetheless demonstrated its ability to expand its asset base during a period of difficult economic conditions.
A recovery in deposit growth means that liquidity concerns have abated, while the stabilisation of oil prices and continued expansion of the non-oil economy brought cheer at the outset of 2017. The sector also appears to be on the brink of a long-anticipated phase of consolidation, in which a number of its biggest names are contemplating joining forces and reshaping the local market.
New Era
The announcement in 2016 that two of the largest banks headquartered in Abu Dhabi were to join forces in April 2017 was an important moment in the sector’s history. The combined balance sheets of National Bank of Abu Dhabi (NBAD) and First Gulf Bank (FGB) leaves the new institution – First Abu Dhabi Bank – with a total of Dh670bn ($182.4bn) in assets, and establishes it as not only a national champion capable of supporting the UAE’s economic expansion, but also a regional giant bigger than the largest banks in Saudi Arabia, Qatar, Kuwait and Oman. Reports suggest that this may not be the only structural alteration to take place in the short term, with a number of the emirate’s biggest conventional and sharia-compliant institutions seen as potential merger candidates over the coming year or two (see analysis).
The possibility of a new era of consolidation is exciting for what is still a relatively young market. The UAE relied on the currency of its Bahraini and Qatari neighbours for cash transactions until 1973, when the UAE dirham was established. The Currency Board established at that time also oversaw the nascent banking sector, working with the IMF to produce the annual reports and bi-annual bulletins that tracked the sector’s early progress. This first era of the UAE’s modern banking industry was one of rapid growth, driven by a booming hydrocarbons sector, which soon necessitated a comprehensive regulatory framework. The government’s response came towards the end of the 1970s, with the transformation of the Currency Board into the Central Bank of the UAE (CBUAE). The law that created the new body gave it a wide array of powers, including the formulation of monetary, credit and banking policies, roles which it retains to this day.
Regulator
The CBUAE has overseen a rapid rise in economic activity, with cash in circulation expanding from Dh2.4bn ($653.4m) in 1980 to Dh472.5bn ($128.6bn) in September 2016. It has implemented a prudent regulatory policy, which was instrumental in protecting the industry from the effects of the global economic crisis that began in 2008, and has left it well defended against recent challenges arising from a protracted period of subdued oil prices.
Today’s Market
For many, the merger of NBAD and FGB represents the start of a much-needed process of consolidation. The banking sector in the UAE has become the biggest in the region, with Dh2.6trn ($707.9bn) of assets held by banks as of December 31, 2016. However, it is also a highly fragmented market. The federal nature of the UAE means that Abu Dhabi competes directly with the nation’s other banking centre, Dubai, in what is a very vibrant arena.
As of the fourth quarter of 2016, 23 locally incorporated banks were licensed to operate in the UAE, between them maintaining 846 branches and 33 electronic service units, where customers can access smart ATMs which allow online account consultations and various predefined transactions. A further six GCC banks operated a main branch in the country, as well as four additional branches.
Also licensed by the CBUAE were 20 commercial foreign banks, which between them have established 81 conventional branches and 31 electronic service units. In addition the UAE has 11 wholesale banks, which are permitted to carry out all commercial activities, such as offering lending facilities and letters of credit to companies, but are disbarred from all retail operations. A further 114 financial institutions have established representative offices in the UAE, and more competition comes in the form of 27 finance companies and 25 financial investment companies.
Structural changes to the market have in recent years been largely confined to the foreign segment. Royal Bank of Scotland, Lloyds, Barclays and Standard Chartered have all either ceased or reduced their retail operations in the UAE, usually as part of a global retrenchment, in a trend that has strengthened the position of highly liquid state-owned institutions.
In some cases foreign banks have recalibrated their operations in the UAE towards niche segments and wholesale banking. For example, Lloyds Banking Group took the decision to sell its onshore retail, commercial and corporate business to HSBC Bank Middle East, while retaining its international wealth business in the UAE. Until the NBAD and FGB merger the local players had sought to grow organically in the domestic market, investing in large-scale branch networks and competing on price and service levels.
The 2017 merger of two of the emirate’s biggest banks, and the prospect of more consolidation to come, means that the structure of the “big five” institutions could well change. The top banks are a diverse mix of conventional and Islamic, retail-focused and corporate-aligned operations which, from the point of view of future mergers, offer useful synergies.
In early 2017 Fitch Ratings affirmed the long-term issuer default ratings, support ratings and support rating floors of some of Abu Dhabi’s largest banks. The ratings indicate how much strategic importance the banks hold, and the likelihood of their being given state support in times of need. NBAD, Abu Dhabi Commercial Bank (ADCB), FGB and Union National Bank (UNB) were all given a support rating of “1”, indicating the extremely high probability of state support, while NBAD’s “AA-” support rating floor reflects its flagship status in both Abu Dhabi and the UAE as a whole. ADCB, FGB and UNB are classified as domestic systemically important banks – one rung below NBAD – and were given a support rating floor of “A+”, indicative of their high systematic importance.
First
The largest of Abu Dhabi’s banks, with total assets of approximately Dh420.7bn ($114.5bn) at the end of 2016, is NBAD – Abu Dhabi’s flagship financial institution and the second-largest bank in the UAE after Dubai’s Emirates NBD. Established in 1968 and majority-owned (70%) by the government of Abu Dhabi through the Abu Dhabi Investment Council (ADIC), NBAD’s status as a quasi-government institution has placed it at the centre of Abu Dhabi’s economic development for nearly half a century.
As a universal bank it has adopted a diversified business model, covering domestic and corporate banking, real estate, global financial markets, wealth management and an international division which now includes networks in nine Arab countries and branches or representative offices in the UK, France, the US, Hong Kong, China, Malaysia and Brazil, giving it the largest international presence among the UAE’s banks. NBAD’s loan book, which is worth a total of Dh200.5bn ($54.6bn), is weighted towards the corporate end of the market, and therefore its 2017 merger with FGB, which has a strong retail base, represents a useful pairing of specialities (see analysis).
Second
Given the consolidation of NBAD and FGB balance sheets in 2017, ADCB will be able to retain its position as the second-largest banking institution in the emirate – a position that it briefly lost in 2015 to FGB. ADCB had total assets of Dh258bn ($70.2bn) at the end of FY 2016. As with NBAD, the bank is linked to the state through a 62.5% stake held by ADIC.
Established in 1985, ADCB’s early development was built upon its wholesale business, but more recently it has sought to broaden its revenue stream by moving into the domestic market’s retail arena, where it has emerged as a significant player, with more than 50 branches and cash offices and 300 ATMs. ADCB has also invested heavily in alternative channels, such as online banking, and deployed retail-centric corporate imaging. In January 2017 it opened its first “uBank”, or digital banking centre, in the capital’s Yas Mall, and announced plans to open two more digital units later in the year. The bank’s expansion strategy has been largely focused on organic growth within the UAE, which has included the establishment of a sharia-compliant component, Meethaq, but it has also moved beyond the nation’s borders to establish two branches in India and one in Jersey, along with a representative office in London.
Third
With assets of approximately Dh233.2bn ($63.5bn), FGB entered 2017 as the third-largest bank to be headquartered in Abu Dhabi. Incorporated in 1979, the bank has developed a universal set of services, encompassing the core revenue drivers of consumer and wholesale banking, as well as establishing several regional banking, asset management and real estate interests, such as First Gulf Libyan Bank, First Gulf Properties, Aseel Finance, Dubai First, Mismak Properties, First Merchant International and Radman Properties. The bank also maintains representative offices in the UK, South Korea, India and Singapore.
The rationalisation of these domestic and foreign assets as the bank integrates its operations with those of NBAD promises to be one of the most complex aspects of the 2017 merger.
Fourth
Abu Dhabi Islamic Bank (ADIB) is the fourth-largest bank in Abu Dhabi, with total assets of Dh122.6bn ($33.4bn). In 2016 its share price spiked on the back of news of a possible merger with Abu Dhabi’s second Islamic bank, Al Hilal, and while neither institution has revealed merger plans, the two banks remain potential candidates for consolidation.
Established by the government of Abu Dhabi in 1997, ADIB is the largest sharia-compliant bank headquartered in the emirate, and the second largest in the UAE. Its major shareholders include ADIC, with a 7.6% stake, and Emirates International Investment Company, which has a 40.4% strategic holding.
Since the arrival of a new management team in 2008 it has followed a three-pillar strategy aimed at establishing itself as the market leader in the UAE, creating an integrated financial services group and pursuing growth opportunities abroad. Acquisitions, rather than organic growth, have driven much of ADIB’s expansion over recent years, such as the 2014 purchase of a 51% stake in Arab Link Money Exchange, the establishment of Abu Dhabi Islamic Merchant Acquiring Company, and the acquisition of the retail banking business of Barclays Bank in the UAE.
In the domestic market, the bank currently operates 88 branches, including a 24-hour branch located at Abu Dhabi International Airport, and a total of 780 ATMs. The bank has also extended its brand overseas and has established a presence in the UK, Saudi Arabia, Qatar, Iraq, Sudan and Egypt.
Fifth
Rounding out the top-five banks at the outset of 2017 was UNB, with assets of about Dh105bn ($28.6bn). The bank is unique in the domestic market in that since its establishment in 1982 it has been jointly owned by the governments of Abu Dhabi and Dubai. The bank provides a full range of wholesale and retail banking services through its network of more than 70 branches distributed across the nation, 22 of which are located in Abu Dhabi.
The UNB Group also includes one of the oldest brokerage companies in the UAE as a wholly owned subsidiary, while its Al Wifaq Finance Company offers sharia-compliant financial, commercial and investing services to both organisations and individuals. Its retail Islamic operations are carried out through its Islamic window, accessible to customers in the UAE through its conventional network. UNB has established operations in China, Egypt, Kuwait and Qatar.
Challenging Environment
The oil price decline which began in the second half of 2014 created a challenging economic environment for banks across the region. Reduced hydrocarbons revenues have resulted in a prioritisation of governmnet expenditure and investments. Construction and real estate are well supplied from an economic perspective, which is why spending has been reduced.
However, investment in real estate and infrastructure is still relatively high with new projects introduced in Yas, Saadiyat and Al Ain. While Abu Dhabi and the wider UAE is well-positioned to ride out the turbulence, its regionally active banks may be slightly impacted by regional austerity programmes.
The small and medium-sized enterprise (SME) segment has been particularly affected by the change in economic circumstances. In July 2016 a number of Abu Dhabi-based banks reported that they were restricting the amount of new credit they were extending due to an increase in defaults across their business lines. The UAE Banks Federation (UBF) played an important role in combating this challenge, working throughout the year to help SMEs tackle their debt obligations. “When we saw the problem emerge we began to help SMEs with their loan restructuring,” Nasser Sarris, general manager at the UBF, told OBG. “We launched an initiative in March, and by August we had restructured 1700 accounts, both SMEs and corporates.” In early 2017 the CBUAE drafted regulations to encourage banks to increase lending to SMEs. The proposed rules, circulated by the UBF to all the banks, would require them to establish a dedicated unit for lending specifically to SMEs, backed by an SME lending strategy and policy.
Under the rules, banks would be forbidden from having too-high collateral requirements and be required to provide an explanation for refusing to lend to a prospective borrower.
In the longer term, the introduction of a new bankruptcy law in the UAE is expected to reduce the number of business owners leaving the country as a result of debt problems. Due to be implemented in 2017, the framework decriminalises bankruptcy and establishes a number of remedial pathways for troubled companies, ranging from a mutually agreeable debt settlement to insolvency with restructuring or liquidation (see analysis). By the fourth quarter of 2016, for example, bankers were reporting that the problems in the SME segment were contained. Nevertheless, the adverse effects of the new economic scenario were evident in the cost-cutting measures which many banks found necessary during 2016, most notably the payroll reductions which were made by numerous UAE banks in the early part of the year.
Robust Performance
In this context, Abu Dhabi’s top-five banks performed relatively well in 2016. All of them succeeded in growing their assets over the first nine months of the year, with the largest gain (18%) posted by ADCB. Aggregate customer deposits rose by 6%, while loans and advances extended by the five institutions expanded by 2%.
The liquidity question receded somewhat as an industry concern in 2016, although funding costs were elevated for the smaller banks which do not share the brand recognition or ratings of their larger peers.The effects of the regional slowdown were visible, however, in the income statements of Abu Dhabi’s biggest banks. While all of the top-five posted a profit for the first nine months of 2016, net profits were either static or down on the previous year in all cases but one. FGB’s 5% growth in net profit, from Dh4.3bn ($1.17bn) for the first nine months of 2015 to Dh4.5bn ($1.23bn) for the same period in 2016, was the exception to the trend, which saw aggregate net profit decline by 6%. Additionally, in line with the US Federal Reserve, the CBUAE raised interest rates applied to its certificates of deposits by 25 basis points in December 2016, and again in March 2017, with further increases expected in 2017 on the back of a stronger US economy. Such changes are likely to result in an increase in the cost of borrowing.
Regulation
With forecasters including the World Bank and Goldman Sachs predicting only a modest recovery in oil prices over the medium term, the question of sector stability has become increasingly salient. According to the CBUAE, the UAE’s banking sector is well positioned to traverse this challenging period. At the end of 2016 the aggregate capital adequacy ratio stood at 19% and Tier-1 capital at 17.3%. The strong growth of deposits in 2016 reduced the loan-to-deposit ratio to 100.7% by the close of the year, compared to 100.9% at the end of 2015.
The CBUAE also notes that in the fourth quarter of 2016 funding became more stable due to the increased use of deposits and a reduction in market finance, reflecting the more conservative lending policies adopted by a number of banks. Additionally, non-performing loans (NPLs) have remained flat, following successive decline since the financial crisis. The end of October 2016 witnessed an NPL ratio of around 6.4%, down from a total of 7% in December 2014. The stability of the UAE’s banking sector is testament to the prudential regulatory approach that the CBUAE has implemented since its inception. In the years following the global economic crisis of 2008 it has worked hard to reduce systemic risk. Asset quality was addressed through the Provisioning Circular of 2010, while the framework surrounding retail lending was tightened the following year, which saw the introduction of lending caps and fee limits.
More recently, the CBUAE has turned its attention to the risk of banks’ exposure to government-related entities. In April 2013 the central bank set a limit of 100% of the capital base for all lending by a bank to governments of the federation and their non-commercial entities, and 25% to individual borrowers, establishing a five-year grace period for compliance which ends in 2018. Out of the total domestic credit, The CBUAE reports that exposure to government-related entities has remained steady, with a share of the total averaging 24.9% over the last two years, versus 73.9% for the private sector.
Basel
At the end of 2015 it was announced that the CBUAE would begin engaging with banks to implement Basel III regulations. The process involves gradual changes to capital structure, business models, risk management systems and corporate governance structures. In January 2016 approved banks started the transition to Basel III’s liquidity coverage ratio, designed to ensure that banks have sufficient high-quality liquid assets to match the anticipated net cash outflows during a 30-day stress scenario.
The next major Basel component due to be introduced to the market is the net stable funding ratio (NSFR), which concerns the longer-term stability of banks’ liquidity positions.
In the meantime, the CBUAE is in the process of developing an upgraded regulatory framework for the UAE banking system, part of which saw minimum capital requirements amended in March 2017. According to analysts, most UAE banks are adequately capitalised to meet the Basel III regulations, especially given their robust levels of Tier-1 capital. “Migrating banks operating in the UAE to the Basel III requirements for capital and liquidity is an integral part of this process,” Khalifa Mohammed Al Kindi, chairman of the CBUAE, told OBG. “Maintaining sufficient quality capital and liquidity in the UAE banking system is a key focus for this work. The new regulatory framework that is currently in progress also places a strong emphasis on good corporate governance and new regulations in line with international standards.”
Outlook
The regulatory changes introduced by the CBUAE, which are intended to keep the UAE in line with international best practice, may add fresh impetus to what appears to be a movement towards consolidation in the market.
Smaller banks, in particular, may find that new capital and liquidity requirements are most easily accommodated through a merging of balance sheets. In light of the consolidation of NBAD and FGB, the question of further mergers arises, but the industry signals throughout 2016 suggested that, for now at least, it is the larger banks rather than the smaller institutions that will drive the consolidation trend forward (see analysis). In 2017 banks will be preparing for the 2018 introduction of Basel’s NSFR.
The CBUAE’s reworking of the Union Law No. 10 of 1980, which applies to the central bank’s workings, the monetary system and the organisation of the banking sector, will be of great interest to industry participants should details emerge in 2017.
OBG understands from its discussions with the UAE Banks Federation and the CBUAE that new legislation regarding digital operations is expected in the short to medium term, and will address issues such as the blockchain’s role in the financial sector and the use of digital signatures.“The objective of the regulation is to facilitate widespread adoption of safe and secure digital payments in the UAE, and foster relationships between the relevant stakeholders in the market to enable prudent innovation to continue,” Al Kindi told OBG.The industry entered 2017 on a note of optimism despite the challenging economic environment. The IMF’s GDP growth forecast for the UAE is 2.5% for the year, against 2.3% in 2016.
Over the medium term, oil prices are widely forecast to recover moderately, while investment is expected to rise in the run-up to Expo 2020 Dubai.
UAE business leaders reported growth in orders towards the close of 2016 as the non-oil economy showed signs of regaining momentum, while the Emirates NBD Purchasing Managers’ Index rose to 55 in December, from 54.2 the previous month. A recovery in aggregate net profit growth is a very real prospect in 2017, although for many observers the most significant story of the year will be the merging of some of the emirate’s biggest financial brands and the effect of that on the wider market. “The overall outlook bodes well for healthy and efficient intermediation by banks in support of credit growth and continued growth of the non-energy sector in attaining our goals of further diversification,” Al Kindi told OBG.
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