Home to nearly one-third of the GCC’s banking assets, the UAE’s banking industry is the biggest in the region. Dubai is one of the nation’s two financial centres, and through its vibrant onshore and offshore markets, the emirate has established itself as an integral component of the global financial services sphere. Despite the adverse effects of low oil prices in recent years, the domestic banking sector has remained both well capitalised and liquid, while its financial performance has been characterised by rising net profits and lower cost-to-income ratios. “One of the main advantages of Dubai as a place to do business is that it is easy to attract capital here as well as human capital,” Wissam Khoury, senior vice-president and general manager of Finastra, told OBG. Challenges to future growth, however, remain, with continued oil price volatility and a subdued real estate sector representing downside risks in the near term. Finding avenues to asset growth is therefore a key priority for banking sector strategists in 2020.
At the outset of 2019 a total of 22 licensed UAE banks competed for business in the country. Dubai’s institutions play a prominent role within this crowded market. Dubai-based Emirates NBD is the second-largest bank in the country after First Abu Dhabi Bank, the largest in the emirate, and the third-largest in the GCC, claiming approximately 20% of the national loan portfolio. The institution is government-owned via a 55% stake held by the emirate’s investment arm, the Investment Corporation of Dubai, and is in effect Dubai’s flagship financial institution. As well as possessing the largest branch network in the country, Emirates NBD has an international footprint which includes presences in Asia, Europe and MENA. The second-biggest bank in the emirate, Dubai Islamic Bank (DIB), is the largest sharia-compliant institution in the UAE, as well as the world’s second-largest Islamic bank. The Investment Corporation of Dubai holds a 28.4% stake in DIB, which operates around 70 branches in the UAE and is present in seven markets worldwide. Mashreq Bank, the third-largest bank in Dubai, claims to be the oldest regional bank based in the UAE, having been established in 1967. Majority-owned by the Al Ghurair family, the bank’s UAE operations are supplemented by branches or representative offices in London, New York, MENA, and South and East Asia. Rounding out Dubai’s big four national banks is the Commercial Bank of Dubai, another veteran of the domestic industry, having been established in 1969. The Investment Corporation of Dubai maintains a 20% stake in the institution, with the remaining shares held by UAE nationals. Over the past decade the Commercial Bank of Dubai has moved from its original corporate base to make inroads into the retail, small and medium-sized enterprise (SME) financing and sharia-compliant segments.
Nearly 90% of the UAE’s bank assets are held by locally owned institutions. Much of the remainder is managed by the 38 foreign institutions licensed to operate. These include regional players such as Al Ahli Bank of Kuwait, National Bank of Bahrain, National Bank of Oman and Bank Melli Iran, as well as global giants such as HSBC and Barclays. A larger number of foreign institutions operate from the Dubai International Financial Centre (DIFC) – the offshore financial services free zone that is one of the key pillars underpinning the emirate’s reputation as a regional financial centre. Around 100 foreign banks have established a presence in the DIFC. They are not permitted to take onshore deposits and generally use their Dubai foothold to provide advanced specialist services to regional markets. Prominent brands within the DIFC jurisdiction include Bank of China, Citibank, Bank of India, the Bank of New York Mellon, Crédit Agricole, Société Générale, Merrill Lynch, JPM organ Chase, Sumitomo Mitsui, EFG, Lloyds, Deutsche Bank, Barclays and Standard Chartered. Foreign interest in the domestic banking sector is increasing as a result of a strategic shift on the part of Dubai’s biggest banking institution. In September 2019 Emirates NBD raised its foreign ownership limit (FOL) from 5% to 20%, having secured the necessary approvals from the regulator and its shareholders. The bank also announced its intention to raise its FOL even more, to 40% over the longer term, in line with the emirate’s overall strategy of attracting more foreign investment to the market.
Islamic banks accounted for about 23% of total sector assets at the outset of 2019, offering sharia-compliant alternatives to conventional finance that do not violate the religion’s prohibition on charging interest or investing in proscribed economic activities. The UAE’s regulatory framework allows conventional banking institutions to offer sharia-compliant products and services through Islamic windows, and therefore the amount of sharia-compliant assets in the system is likely higher than officially stated, as standard banks do not separate Islamic and conventional assets in their reporting. Dubai’s Islamic institutions are subject to the same regulatory oversight and regulations as their conventional peers, but the establishment of a Higher Sharia Authority in 2017 is increasing the level of segment-specific oversight.
Around 20 finance companies licensed by the Central Bank of the UAE (CBU) account for approximately 1.4% of UAE banking system assets, signalling their limited risk to the overall financial system. Five of these institutions are bank-owned, and together they claim nearly 30% of the assets controlled by the finance company segment. Over half – or 57.5% – of the segment’s assets were made up of loans in 2018, according to the CBU. Finance companies are not permitted to accept retail deposits and their business activities are restricted to retail finance (including personal loans, credit cards and car loans), mortgage finance, wholesale finance (from corporate borrowers to microfinance) and the distribution of third-party products.
The UAE and the wider region has seen a marked increase in merger activity since 2017, a trend that has been driven by low oil prices starting in late 2014. In January 2019 the domestic banking sector learned of plans for Abu Dhabi Commercial Bank (ADCB) and Union National Bank (UNB) to merge, and to together acquire Al Hilal Bank. The newly formed banking group will carry the ADCB identity, with a combined asset base of $114bn that will reinforce its position as the third-largest financial institution in the UAE, as well as promote the institution to become the fifth-largest in the GCC. Al Hilal Bank, meanwhile, will be retained as a separate Islamic banking entity within the wider group.
According to Bloomberg, more than 20 GCC financial institutions with combined assets of more than $1trn were in merger talks as of early 2019, including Dubai Islamic Bank and smaller rival Noor Bank. The two institutions have a common investor in the Investment Corporation of Dubai, which owns 28.4% of DIB and more than 22.7% of Noor Bank. An acquisition would create a sharia-compliant lender with Dh278bn ($75.7bn) in assets. While the long-awaited trend of mergers and acquisitions is a welcome one in the UAE’s fragmented banking sector, the particular form it has taken is an unexpected one – driven as it is by the market leaders rather than banks with smaller balance sheets. This is largely a consequence of the government’s ability to lead the consolidation movement through its control of the more significant banking institutions. Whether the merger and acquisition momentum will carry through to the rest of the market, however, remains to be seen.
Dubai’s banks have faced significant challenges in recent years, including a struggling global economy and a decline in oil prices which has undermined the UAE’s fiscal position and slowed economic growth. However, a gradual recovery of oil prices resulted in improved business sentiment in 2018, with private sector credit growth expanding by 4% over the year, compared to the previous year’s more modest 3%, according to Emirates NBD. The recovery was primarily driven by lending to business and industry, the total for which increased by 5.8% in 2018. The aggregate net profit of the UAE’s banking system grew by 9.8% in 2018, fuelled largely by an improvement in interest income resulting from more robust credit growth and a higher interest rate environment. After three years of heightened provisioning and deleveraging from risky sectors and asset classes, most UAE banks entered 2019 well positioned to boost margins.
The aggregate net profits of the 18 national banks listed on the UAE’s financial markets climbed to Dh24.5bn ($6.7bn) in the first half of 2019, compared to Dh21bn ($5.7bn) during the same period of 2018, an increase of 16.6%. Dubai’s big four lenders all succeeded in growing their total assets in the first half of the year. Commercial Bank of Dubai showed the largest rise in percentage terms, at 14%. In fact, the combined net profit of these four significant players increased from approximately Dh9.2bn ($2.5bn) in the first half of 2018 to nearly Dh12.3bn ($3.3bn) during the same period of 2019 – a gain of around 34%.
Dubai’s banking system remains focused on traditional loan-based commercial banking activities, principally funded by deposits. Lending trends are therefore key to overall financial performance, and the wider UAE market the last two years has produced mixed results. Wholesale corporate lending represents 65% of the Dh1.7trn ($462.7bn) aggregate balance sheet of the UAE banking system, and remains the principle route to lending expansion for Dubai’s banks. The majority of lending to the wholesale segment is directed to private corporate loans, and in 2018 results showed this to have been the liveliest segment during the year. Lending to other corporate segments, such as government-related entities and SMEs, showed slight declines. Retail lending during 2018, meanwhile, remained stagnant, easing by 0.1%. Car loans – down 13.4% – suffered the largest contraction in this category, while credit card lending and personal loans showed more modest decreases of 0.6% and 1%, respectively. For the emirate’s big four banks, however, the first half of 2019 was an encouraging one: the banks’ combined lending and Islamic financing portfolios expanded by 8% year-on-year, from approximately Dh570.1bn ($155.2bn) to Dh613.5bn ($167bn).
Throughout the recent period of economic headwinds Dubai-based lenders showed their capacity to maintain positive financial stability indicators. Because of the relatively small involvement of Dubai’s banks in investment banking, structured products and the capital markets, when it comes to calculating the banks’ risk exposure, it is their lending activities that carry the most weight. Indeed, risk-weighted assets (RWA) represent nearly 80% of the UAE banking sector’s total assets, and credit risk makes up nearly 90% of that amount.
At the close of 2018 the banking sector’s aggregate non-performing loan (NPL) ratio stood at a manageable 5.6%, up from 5.3% the previous year. Troubled loans were largely concentrated in the wholesale corporate sector, with the SME segment showing the weakest asset quality. These facilities were well covered: the total provision coverage of NPLs, which includes specific and general provisions, stood at 106.1% during the year.
With deposits in 2018 growing more quickly than lending, the banking sector’s overall liquidity improved: the banks’ loan-to-deposit ratio fell from 97.1% to 94.3% during the period, according to figures provided by the CBU. While the Emirates Three-Month Interbank Rate increased to a recent high of 3% at the start of 2019, by the second half of the year it had fallen to 2.4%, indicating that banks faced little to no liquidity challenges.
The UAE’s banking system is also well capitalised, with capital adequacy ratios (CARs) comfortably above minimum regulatory requirements. At the close of 2018 the sector’s aggregate CAR stood at 17.5% of RWA, compared to the minimum requirement of 13%. Within this total, the Tier-1 capital ratio stood at 16.2%, against the mandated 9.5%. These figures were achieved despite the introduction of Basel III capital requirements in late 2017 and the implementation of the International Financial Reporting Standard (IFRS) 9 early the next year, both of which placed notable pressure on the capital position of banks. However, this challenge was overcome in large part through improved earnings and a number of capital issuances.
Looking to downside risks, banks’ exposure to real estate assets continues to present a challenge. Increasing supply, rising interest rates and negligible growth in household incomes in 2018 and 2019 have not alleviated concerns regarding further declines in residential real estate prices in Dubai.
The CBU regulates all financial service providers in the country, and handles the licensing and regulation of the domestic banking system, including both national and foreign lenders. The institutions based in the DIFC’s offshore banking sector are subject to a distinct legal environment, overseen by the Dubai Financial Services Authority. The free zone operates in accordance with its own laws, largely based on English common law. It also maintains its own courts and an independent arbitration system which, together with its legislative platform, are key factors in its attractiveness to foreign investment and institutions.
As the banking sector in Dubai has developed, so too has the regulatory structure that supports it. The CBU has kept the sector in line with the global regulatory framework outlined by Basel III, in 2017 introducing new capital adequacy regulations that set common equity Tier-1 capital at 7% of RWA and total Tier-1 capital at a least 10.5% of RWA. Further regulations to support the Basel capital regulation were formulated in 2018 and 2019, covering areas such as the leverage ratio, counter-party credit risk and credit value adjustment.
The regulator has also significantly overhauled the domestic law that governs the banking sector, introducing a new piece of primary legislation in 2018 from which further regulations are being spun out on an ongoing basis. The primary effect of Federal Law No. 14 of 2018 is to strengthen the central bank’s role with regard to monetary credit and banking policy within the UAE. It grants the regulator a number of new powers over licensed financial institutions operating in the onshore environment, as well as the ability to exercise its authority over institutions outside the UAE or in financial free zones in consultation with the relevant regulatory bodies. While all current CBU regulations, decisions and circulars remained in force after the initial application of the new law, the regulator is in the process of replacing them with revised versions – a process which it expects to complete by 2021. Unlike the old law, the new legislation does not specify minimum capital requirements for financial institutions, instead granting the regulator the ability to establish minimum requirements which it can subsequently increase or decrease, as well as the power to determine risk-based capital requirements. The law also has a strong consumer protection focus, imposing a duty on financial institutions to safeguard the confidentiality of customer information and giving the regulator the power to take over the management of an institution via an interim committee in order to protect depositors.
Perhaps the most significant regulatory change of recent years, however, has come in the form of a change to banks’ accounting practices. IFRS 9, introduced in the UAE at the beginning of 2018, significantly alters the way banks classify and manage their financial assets, compelling them to evaluate how changes to both credit conditions and the economic backdrop will alter their business models, portfolios, capital allocation and provisioning levels. From the perspective of Dubai’s banking institutions, IFRS 9 brings a number of challenges. Banks’ provisioning practices are significantly affected, with lenders being asked to adopt forward-looking provisions from the point of the loan’s origination. The effects of this requirement were immediately visible: according to professional services network KPMG, the aggregate provisioning level of UAE banks increased by 18.7% upon the implementation of the new standard. The long-term effects of higher levels of provisioning on operating margins and profitability is a key concern for banks’ shareholders, and will be more readily apparent upon the publication of the sector’s fullyear results in early 2020. In the meantime, banks are coping with other challenges related to IFRS 9, including the need for suitably qualified human resources and significantly enhanced data-capturing system. Despite these potential difficulties, however, the arrival of the standards promises a number of benefits for Dubai’s banks over the longer term. The new framework directly tackles the late recognition of credit losses that proved so costly during the 20017-08 global financial crisis, while the higher volumes of data required by IFRS 9 usefully increase the amount of information available to banks when it comes to establishing an effective and efficient risk-management policy. More broadly, the same information will enable a bank’s management to make better strategic decisions, while the country’s economy will benefit from a stable, sounder and more efficient banking sector.
As well as managing regulatory change, banks are faced with the challenge of seeking out growth in a potentially sluggish economic environment. For most banks, the question of asset expansion after Dubai’s hosting of Expo 2020 is a primary concern. In the years leading up to 2020, banks have found lending opportunities in the pipeline of infrastructure and construction projects associated with the global event, which will see more than 130 countries participate in a months-long world fair. During the expo itself, a Dh22.7bn ($6.2bn) contribution to the UAE’s GDP is predicted, with the main beneficiaries being the entertainment, hospitality, transport, and food and beverage sectors. The number of full-time jobs supported by the event, meanwhile, is expected to peak at around 94,000 in 2020. With the event’s conclusion and the removal of one of the most significant economic spurs of recent years, competition for lending opportunities will increase. Which sectors will interest margin-seeking lenders after 2020 is a matter of debate. Dubai’s corporate-focused banking sector has traditionally lent primarily to the real estate, services, trade and construction sectors. However, the dependence on real estate and construction sectors on the performance of the real estate demand means that this lending pattern may change in the near term as banks look for more secure opportunities. “The infrastructure, travel, tourism and logistics sectors remain the most low-risk opportunities for lending within the UAE,” Timothy Fox, chief economist for Emirates NBD, told OBG. The nation’s SME segment also represents an opportunity for banks that can overcome the associated risk-related challenges. SMEs account for around 60% of the UAE’s GDP, according to the Abu Dhabi-based Khalifa Fund for Enterprise Development, yet only around 4% of outstanding bank credit is attributable to them.
One way for the emirate’s banks to drive efficiency and pursue increased margins is to deploy the increasing array of technological solutions available. The digital wave that is sweeping global banking sectors is already having a significant effect on local banking practices. For example, in March 2019 Mashreq Bank announced that it would close half of its branches during the year and shift its business away from the traditional bricks-andmortar model to a more online one. In addition, banks are starting to introduce specific tools in order to establish more comprehensive and durable connections with their customers. For example, Emirates Islamic introduced its WhatsApp banking channel in April 2019, claiming to be the world’s first sharia-compliant bank to do so. Its customers are able to use the application to undertake simple processes such as balance checking and temporarily blocking or unblocking of an existing card. “The introduction of Chat Banking services via WhatsApp is part of our long-term strategy to shift the majority of our transactions towards mobile and online channels,” Suhail Bin Tarraf, COO at Emirates Islamic, stated when the new mobile service was launched.
Financial technology (fintech) solutions utilised by banks in the Middle East have been concentrated in the areas of electronic “know-your-customer” (KYC), lending processes, client acquisition and wealth management. However, there are signs that the base of banking fintech is becoming wider. Deposit Book from Dubai-based NewBridge Fintech Solutions aims to match banks in need of short- to medium-term funding with investors looking for yields in the current low interest rate environment. The platform, at an advanced stage of development in 2019, will allow banks to offer off-market rates to customers ranging from offshore Chinese funds to Scandinavian pension funds, with loan ticket sizes starting from $10m and a shortest tenor of a month.
The UAE Banking Federation (UBF), through its digital banking and information security committees, is playing a leading role in the expansion of fintech solutions into the banking sector. Key initiatives from the industry’s representative body include the introduction of blockchain technology to enhance KYC processes, boosting cybersecurity, the use of artificial intelligence in areas such as customer service, data analysis and decision-making, and Emirates Digital Wallet – a company owned by 16 shareholding banks and fully sponsored by the UBF, which aims to facilitate a society-wide transformation from physical money to digital transactions.
Even with the success of Dubai’s longterm programme of economic diversification, the wider UAE economy remains a hydrocarbons-based one. Global oil prices therefore are a significant factor in the short- to medium-term growth prospects of Dubai’s banking sector. Price predictions for 2020 varied widely in the second half of 2019, with some influential bodies, such as the International Energy Agency, predicting oil surpluses rather than the expected tightening of the market.
Nevertheless, Expo 2020’s effects on the emirate’s non-oil sector GDP is expected to mitigate oil market sluggishness in the short term, and some observers have forecast that the UAE will be the fastest-growing economy in the region in 2020 as the impact of low oil prices is countered in the run-up to Expo 2020. Dubai’s banks, with their sound capitalisation and stable liquidity buffers, are well positioned to take advantage of the lending opportunities that will inevitably arise from an uptick in economic activity.
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