Interview: Varouj Nerguizian; Sami Rashed Farhat; Ahmed Saad
How will strategic investments, total customer deposits and financing of new infrastructure projects affect the UAE banking sector?
AL NUAIMI: Total customer deposits have a significant impact on the banking sector. These deposits enable the industry to weather stress scenarios and financial imbalances that may result from any crisis situation. Well-diversified customer deposits will also enable banks to mitigate concentration risk and protect the banking sector’s net interest margin. Deposit mobilisation will further allow banks to comply with international standards prescribed by Basel III regulations. In terms of new infrastructure projects, the real estate and construction sectors contribute around 30% to the UAE’s GDP; participation in infrastructure funding is therefore a vital component of the banking sector’s business objectives. Strategic investments, particularly in terms of mergers and acquisitions, will also enable the banking sector to grow organically.
FARHAT: The UAE experienced stronger economic growth in the beginning months of 2018, and this is expected to continue for the rest of the year through further economic diversification and non-oil growth, as well as the continued recovery and stabilisation of global oil prices. In 2017 the UAE experienced its strongest third-quarter non-oil sector growth in three years.
Dubai’s Expo 2020 convention will contribute to growth in the local banking sector through investments in real estate, construction, public infrastructure and transportation, while the vision and economic strategy of the UAE as a whole will continue to support economic growth in all emirates. Government spending, the launch of additional infrastructure projects and timely payments will encourage further trade and service growth in the UAE economy, and strengthen the banking sector through increased cash circulation. Customer deposits are expected to remain stable, particularly due to the surge in interest rates in December 2017.
NERGUIZIAN: There is a general misconception that the UAE market is overbanked, but growth in profitability shows that the banking sector is benefitting from broader economic expansion. Many key banking indicators, including liquidity and total deposits, have strengthened across the UAE. Liquidity in the global banking sector is closely tied to oil prices, and governments tend to inject more money into the banking system during periods of higher, or more stable, prices. We are currently in this period, but liquidity is an issue that all banks must address. The Central Bank of the UAE (CBUAE) has implemented a liquidity management requirement that ensures no bank will fail because of a lack of liquidity.
SAAD: The UAE economy is one of the most diverse in the region, and this creates opportunities for banks to expand their business and target markets by entering new sectors. The outlook is very positive, with growth in profitability expected in the short to medium term. A number of factors are helping strengthen the local banking sector. We now see opportunities in supporting both government infrastructure projects and the expected growth in corporate and retail banking. The improvement and stabilisation of global oil prices within an acceptable price range, and the strong project pipeline in terms of local infrastructure – particularly for Expo 2020 – will encourage further public investment that will improve other sectors of the economy.
In what ways could digital innovations in the banking sector support business growth?
FARHAT: Emerging and financial technology ( fintech) will have a major impact on the payment business model of banks, particularly money transfers and foreign currency exchanges. Many UAE banks, for example, are now strengthening their internet banking services and entering the mobile wallets market. The retail lending segment will also need to adapt accordingly, as the UAE has already seen an increase in the number of registered peer-to-peer lending firms. Digital innovations will not disrupt corporate banking strategies, however, as corporate lending remains predominantly relationship based.
Although the landscape for these new fintech products and services is certainly dynamic, it will take some time for the full scope of these changes to be implemented and adopted by banks. Due to the high level of innovation in these product offerings, the market will need time to mature in order to ensure full legal clarity and implement a comprehensive regulatory framework to address the shift.
SAAD: The growth focus for banks is supporting new government-led infrastructure projects, but this is closely followed by the introduction of new technologies and digital innovations into product and service offerings. This innovation is no longer a choice, but rather a necessity for businesses that must respond to a fast-moving and demanding environment. Banks are adapting in order to maintain their existing customer base – whose expectations are increasingly digital – and to stay ahead of the competition they need to use technologies like business process management, robotic process automation and artificial intelligence.
For example, we have invested in improving our delivery channels by integrating our services to streamline offerings and improve turnaround times. We have made changes to our internet banking platform and invested in mobile banking, call centres, robotic process management and business process management solutions. These digital platforms will help banks achieve operational efficiencies, as smart technology solutions will reduce costs, streamline communication channels with customers and allow for better analysis of customer demographics to address their evolving needs. It will help banks assess risk more effectively and efficiently.
AL NUAIMI: Retail banking is being transformed by three key global trends: disruptive technologies, increasing customer expectations and new business models. Financial organisations will need to adopt more challenging notions of what traditional banking is supposed to be, as banks’ target markets are now defined by the technology used and related regulatory boundaries. Customer segments, particularly students, that were once largely ignored by banks can now be serviced through a simple mobile banking app thanks to high mobile penetration rates and improved digital solutions. Growing acceptance of proximity payments has created a conducive environment for growth in mobile wallets as well.
By adopting big data measures, personal financial management can now be extended to other business segments through tools such as predictive analytics, user tracking and machine learning. Although these are just a few examples of the current paradigm shift in target segments, we expect digital innovations to become more effective, especially around user interactions, production configuration and transaction processing. This will lead to further growth opportunities for the sector.
NERGUIZIAN: Although there are real economic units in any economy – for example, the industrial and trading sectors – virtual units are the new business frontier of the banking sector. To address this, banks must incorporate and develop new human resources who are more knowledgeable about the demands of the target markets.
The entire operational model for banks is being transformed by digital innovations; in the future, we can envision customers visiting a kiosk rather than a traditional physical branch to open an account. Services are now accessed digitally, through computers and smartphones, for example, rather than by visiting a branch. This is particularly important for younger customers who no longer utilise the traditional branch network of their bank and instead expect these digital services. These changes will oblige the banking sector to evolve and address new markets with innovative and more specialised services. This evolution will see banks move away from being a centre for payment operations to focus instead on playing an advisory role, such as through investment consulting services. In this way, private banking and corporate debt issuance will become major revenue sources for the local banking sector.
What measures are banks implementing to improve their product offerings for start-ups and small and medium-sized enterprises (SMEs)?
SAAD: Banks must fully understand the challenges and opportunities involved in this segment, as these start-ups and SMEs cannot be compared to larger corporates, as their level of capital, structure and expertise are different. Despite the risks involved, the SME arena offers banks the potential to diversify their revenues due to higher returns and the number of opportunities available. SMEs are the backbone of any economy and represent approximately 90% of the total number of companies in the UAE. A healthy SME sector is important for any economy to enjoy stable growth, diversify, and promote business entrepreneurship and job creation. Financing and supporting new businesses offers advantages for banks, but cooperation between the government and financial institutions is crucial to support this sector, particularly in early-stage funding. We are working with the government’s Ruwad Establishment, an entity designed to support local Emirati start-ups by helping to provide funding.
NERGUIZIAN: It is important for banks to differentiate between SMEs and start-ups, as each have different financial and service requirements. Start-ups are seen as the future, and every government is looking to promote their success to strengthen local job creation and encourage young graduates to come up with solutions for themselves.
Servicing this part of the market, however, must involve measures by the government and the CBUAE. For example, the CBUAE could offer banks relaxed enforcement of regulations for a certain period in order to afford banks the flexibility needed to offer services to new start-up and SME customers.
FARHAT: Banks must ensure that the retail products and services they offer are varied and meet the changing demands of corporate clients. SMEs are a main driver of the local economy and banks must focus on meeting their needs and financing requirements in partnership with government programmes. Although digital financial solutions are important for smaller businesses, many continue to prefer a more traditional customer experience through face-to-face interactions and personalised service. It is necessary for banks to offer ethical service that combines the traditional product range with the technological sophistication and innovation required by modern customers.
AL NUAIMI: SMEs have transformed into a segment that can generate considerable returns for banks. To strengthen and empower these smaller businesses, banks can take additional measures such as improving the digital services they offer, increasing transparency, trust and disclosure in business lending, and encouraging investment in infrastructure and business services. Banks can also engage in microfinance by expanding their product offering to SMEs, and ensure that customers have the means to escalate and resolve their disputes.
Balancing asset quality, growth and liquidity are critical in retail banking services. To improve this segment more generally, banks will need to implement CBUAE measures, including caps on mortgages, new lending restrictions that comply with government regulations, lower management costs, higher interest rates and improved asset quality.
To what extent do you expect the regulatory environment to change for banks?
NERGUIZIAN: Most banks in the UAE are prepared for any new regulations from the CBUAE, including the implementation of the Basel III framework and International Financial Reporting Standard (IFRS) 9. IFRS 9 is a game changer, so banks must be more careful concerning their financial instruments and business operations, and this may lead to the sector becoming more risk averse in the future. The IFRS 9 regulations will be challenging for banks, but it will serve as a reminder to continuously calculate the possibility of losses. At the same time, most of the UAE banking system is highly capitalised, so the requirements under Basel III will be easily met, although they may constrain future growth.
These measures will be a major contributor to the profitability and bottom lines of local banks once fully adopted. Although the CBUAE will ensure the effective implementation of these new regulations, it is aware of the challenges and recognises that the implementation of IFRS 9 may take time. The adoption will require constant communication between the CBUAE and the financial services sector in the UAE, and this will ensure that the implementation is gradually fine-tuned over time.
AL NUAIMI: Expectations continue for enhanced regulatory standards and tightened supervision. Banks are expected to maintain higher capitalisation and liquidity levels in order to comply with the new Basel III regulatory framework. Banks in the UAE, however, have already demonstrated their ability to plan regulatory responses and adjust their business models accordingly. There is much to be optimistic about regarding the medium-term prospects for the UAE banking sector in general, and Sharjah more specifically. For example, in 2017 Moody’s maintained its view of a stable outlook for the country’s banking system, reflecting economic resilience and strong capitalisation, with profitability expected to remain strong through to 2019.
SAAD: Since 2008 the CBUAE has revised the regulatory environment by introducing new regulations and making changes to the previous framework. Implementation of the Basel III regulations will allow banks to better assess the position of the financial sector as a whole, while monitoring the capability and adequacy of their capital, and their risk exposure. These new regulations – including the implementation of IFRS 9 on the classification and measurement of financial instruments – will strengthen the outlook of the UAE banking sector.
Given the opportunities available for UAE banks in new segments of the market, the CBUAE and other regulators will need to ensure adequate support for the banking sector, and be proactive in developing the required regulations and policies.
FARHAT: Although most banks in the UAE remain well capitalised, local banks face a number of challenges. The trend towards increasing interest rates due to rate hikes by the US Federal Reserve and the introduction of the GCC-wide value-added tax may affect the liquidity of financial institutions.
The implementation of new regulations, particularly Basel III over the course of 2018 and IFRS 9, will have a major impact on banks, and smaller financial institutions will need both time and greater investment in order to comply with these changing requirements. This may also affect the profitability of the sector. The CBUAE has been proactive in recent years and has responded to the more challenging business conditions for banks. Stress tests and inspections of UAE banks have resulted in the sector becoming more dynamic and responsive.
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