After facing some tough challenges in recent years, Dubai’s banking sector now shows many signs of having turned the corner. Stronger regulation and more robust financials are providing a healthier environment for expansion, while significant progress has been made in tackling the legacy of the global financial crisis. A major part of the UAE’s financial universe, the Dubai banking sector remains a major regional and international player, with a key role as a centre for banking in the Middle East, Africa and beyond.

FEDERAL & LOCAL REGULATIONS: As one of the seven emirates that make up the UAE, Dubai’s banks are subject to federal and local regulations and laws, with the Abu Dhabi-based Central Bank of the UAE (CBUAE) the chief supervisor and regulator for the domestic banking sector. In addition, Dubai International Financial Centre (DIFC) offers a home to many international banks and financial institutions, onshore and offshore, with these regulated and supervised by the Dubai Financial Services Authority. This broadly follows UK law in financial services, with DIFC possessing its own courts to adjudicate among its members.

Banks registered in DIFC can be 100% foreign-owned, whereas outside of it they must be at least 51% owned by UAE nationals. DIFC banks are also not subject to UAE or Dubai laws, except for anti-money laundering regulations and the Federal Penal Code. Banks registered in DIFC with Category 1 licences are not allowed to collect deposits from UAE residents, nor manage funds in dirham, making DIFC largely a centre for regional and international banking activities, although they are not prohibited from local activities, provided these do not contravene their licences.

In terms of sector authorities, the government of Dubai has also often acted directly to assist the banking sector, as has the government of Abu Dhabi and the federal government, with the federal Ministry of Finance an important player in recent moves to bolster liquidity and capital. Since 2010 it has also been mandatory for both local and international banks based in Dubai to share information on clients within the UAE with private data collection agency Emcredit. A new federal credit bureau is also likely to be established in 2013, with this aimed at providing a countrywide credit checking facility (see analysis). The Emirates Banks Association holds representatives of most banks that operate in the UAE and acts as a lobby group for the industry.

THE NUMBERS: According to CBUAE data, at the end of 2011 the number of locally incorporated commercial banks in the UAE stood at 23, with some 768 branches between them. Of the 23, eight had their head offices in Dubai – Emirates NBD (ENBD – 83 branches in the emirate), Commercial Bank of Dubai (CBD – 17 branches), Dubai Islamic Bank (DIB – 32 branches), Emirates Islamic Bank (EIB – 17 branches), Mashreq Bank (33 branches), Commercial Bank International (CBI – five branches), Dubai Bank (DB – 13 branches) and Noor Islamic Bank (nine branches). EIB and DB are both now part of ENBD, which is the largest bank in the UAE by assets (see analysis). All the other UAE banks have branches in Dubai, with the best-represented being National Bank of Abu Dhabi, which has 18 branches in the emirate, followed by Union National Bank with 14 and National Bank of Ras Al Khaimah with 12.

There were also 28 foreign banks operating in the country at the end of 2011, six of them from other GCC states. There were representative offices of 110 foreign banks registered in the UAE, 67 of which were in Dubai. Of the 28 foreign banks with head offices in the UAE, 20 of them are headquartered in Dubai. These include international giants such as HSBC Bank Middle East, Credit Agricole Corporate and Investment Bank, Standard Chartered and Citi. HSBC has the most branches in Dubai of any foreign bank, with eight, followed by Habib Bank AG Zurich, with five.

In addition, there were a total of 24 finance companies registered in the UAE at the end of 2011, along with some 22 investment companies. On top of this, 119 licensed money-changers were also operating through some 628 branches, with 78 of them headquartered in Dubai, via 292 branches.

OLDER & WISER: Much of the current state of Dubai’s banking sector is the result of the events of 2008/09, when the global financial crisis hit the emirate. This had been preceded by a period of rampant asset growth in what had become a highly over-leveraged economy. Between 2006 and 2007, for example, banking assets in the UAE as a whole grew from Dh859bn ($234bn) to Dh1.22trn ($333bn), or 42%, according to CBUAE figures. GDP rose by 18% from Dh643bn ($175bn) to Dh758bn ($206bn). By the end of the following year, loans, advances and overdrafts, plus total personal loans, came to Dh1.22trn ($332bn), while deposits stood at Dh912bn ($248bn). The real estate bubble that then burst came at a time when there had also been widespread expectation of a de-pegging of the dirham to the dollar, and this had resulted in strong capital inflows. These then reversed when the US financial sector hit the wall, with credit lines cut and a major liquidity crisis resulting. Some Dh180bn ($49bn) of speculative capital left the UAE in the third quarter of 2008 alone, according to ENBD figures.

Faced with this crisis, the CBUAE and the UAE Ministry of Finance intervened, injecting some Dh50bn ($13.6bn) into local banks and allowing them to borrow against their holdings of central bank certificates of deposit (CDs). As the crisis continued, however, the CBUAE offered the option for banks to turn all this injection into Tier II capital, with the federal and Dubai authorities then injecting Tier I capital in the form of perpetual note-type structures (papers with no final maturity date and thus similar to an equity issue), with some Dh15bn ($4.1bn) injected by Abu Dhabi and Dh4bn ($1.1bn) by Dubai. In this way, liquidity and capital were shored up by effective government action. The initial impact of the real estate crash – UAE-wide real estate stock indices fell by around 60% in 2008 – was on the banks’ portfolios of securities, bonds and other financial instruments linked to the capital markets.

While Dubai’s banks were not significantly exposed directly to the exotic and toxic bundled debt products that caused so much damage in the US and Europe, many had significant amounts of investment in ordinary securities. As foreign funds – on which the local capital markets are highly dependent – quit Dubai and the UAE, market activity and prices collapsed, with major impairments appearing in banks’ investment securities portfolios.

RIPPLE EFFECT: The wave of crisis then moved on to hit the retail sector, with a significant spike in retail banking delinquency becoming apparent by 2009. Yet while for many ordinary Emiratis this indicated the beginning of the recession, for banks it had a relatively minor impact on balance sheets, as retail banking accounted for only 15-20% of most banks’ loan books.

Far more significant was the next sector to be hit – corporates. The most symbolic moment in this episode was the November 2009 announcement by the Dubai government that Dubai World (DW) and its two major property subsidiaries, Nakheel Properties and Limitless World, were to seek a stand-still on a total of some $26bn of loans, bonds and sukuks (Islamic bonds) due to mature a few weeks later. DW is a government-related enterprise (GRE), with GREs accounting for a major slice of the emirate’s economy, as well as the banking sector’s business.

Dubai has a series of such entities, with Dubai Holding (DH) and Investment Corporation of Dubai (ICD) the two other giants. These had all been involved in the emirate’s real estate boom – DH in Dubai Properties and Dubai Group, among others, and ICD with a major stake in Emaar Properties and other property outfits. Financing the huge expansion in the emirate’s built environment had involved borrowing heavily to help fund globally significant projects, such as the Palm, the Burj Khalifa and a host of other commercial, residential and mixed-use developments. A glut of such projects, however, coupled with the global downturn, then led to the bubble bursting.

The generally short maturity of much of these property companies’ borrowing, coupled with the much longer-term cash flow realisation of many of these developments, also left many property companies additionally exposed – with concomitant risks for the banks. This impacted both conventional and Islamic banks too, with the latter basing much of their business on real estate contracts (see Islamic Finance chapter). In June 2011 the CBUAE acted to help the Islamic banks though, creating a new liquidity tool for them – a repurchase facility for Islamic CDs.

The government and the CBUAE had long been aware of the risks. In July 2009 the Dubai government had unveiled a support package worth $20bn aimed at meeting the needs of the emirate’s GREs, managed by the newly created Dubai Financial Support Fund. Some companies also managed to restructure their debts without direct government support – Emaar being a case in point. Since 2009, though, this corporate debt challenge has been a major part of the banking sector’s business, with the formation of non-performing loans (NPLs) and interest-impaired renegotiated loans still an important feature of the sector. The worst of this is, however, widely thought to be over, although major challenges do remain.

In March 2011 DW reached an agreement with 80 different banks to delay payment on its $24.9bn debts, while Dubai International Capital (DIC), a DH subsidiary, reached a deal on $2.5bn of liabilities the following month. A year later, Drydocks World, a DW unit, was also close to pushing through a $2.2bn restructuring deal, involving redistributing the debt across company entities, while DW’s Limitless was reported to be close to a deal on its $1.2bn debts by mid-July 2012. Meanwhile, as of that month, DH’s Dubai Group had still to finalise a $10bn debt restructuring, with $6bn of this owed to banks and the rest to other investors.

In March 2012 the IMF estimated that the total GRE debt in the UAE stood at $184.8bn, with Dubai’s share of this standing at $84.3bn. With direct government debts added on, the most widely circulating figure is a total of around $110bn. In terms of GDP, the UAE total is some 51.3%, while the Dubai total is 60.4%. This legacy is likely to take some time to work through. Yet with good management and a will to reach a resolution, sector players are generally confident that the storm has now been weathered. According to a Standard Chartered research report published in the beginning of November 2012, Dubai faces almost $50bn of debt maturities between 2014 and 2016 but, unlike the crisis in 2009, is better equipped to handle redemptions due to an economic rebound.

However, news reports in December of 2012 seemed to indicate that there are concerns that banks in the region are not doing enough to address the issue of bad loans that have piled up following the crash. Bloomberg reported that Moody’s downgraded their ratings for several GCC banks in late 2012, with the credit rating agency saying in its report that banks set aside from 30-45% of the value of non-performing loans as a provision, whereas similarly rated lenders in the rest of the world set aside from 72-96%. Fitch also downgraded it ratings for 15 banks in the GCC region.

TAKING THE TEMPERATURE: CBUAE figures show that the total assets of the UAE’s banks, net of provisions and interest in suspense, stood at Dh1.66trn ($452bn) at the end of 2011. This was 3.5% up on 2010’s Dh1.61trn ($437bn) and gave the UAE the highest level of bank assets in the GCC. The assets-to-GDP ratio was 137%, while the foreign assets of banks operating in the UAE rose from Dh233.5bn ($63.6bn) to Dh248.9bn ($67.8bn) between December 2010 and December 2011. Total deposits, meanwhile, rose from Dh1.05trn ($286bn) to Dh1.07trn ($291bn), or 2%. Bank credit, which includes all loans, rose from Dh972bn ($265bn) to Dh992bn ($270bn), also around 2%.

Breaking down the bank credit figure, claims on the private sector amounted to Dh730.9bn ($199bn) at the end of 2011, up from Dh720.6bn ($196.1bn) the previous year, while claims on government rose from Dh99.98bn ($27.2bn) to Dh102.4bn ($27.9bn), while claims on official entities rose from Dh73.99bn ($20.1bn) to Dh92.9bn ($25.3bn). Adjusted figures in the 2011 CBUAE Annual Report also show real estate loans had risen from Dh237.6bn ($64.7bn) to Dh240.8bn ($65.5bn) between December 2010 and December 2011.

The capital and reserves of the UAE’s banks also rose from Dh256bn ($69.7bn) to Dh258.4bn ($70.3bn) over the same period, with the Tier 1 capital ratio rising from 16.1% to 16.3%, while the sector’s capital adequacy ratio (CAR) remained level at 20.8%. Banks in Dubai have followed this trend. “Dubai has seen a significant growth in capital adequacy ratios,” said Peter Baltussen, the CEO of Commercial Bank of Dubai. “Between 2008 and 2012 the CAR of banks in Dubai have risen to between 15% and 20%, indicating the regulators commitment to conservative minimum requirements.”

One of the striking phenomena highlighted by this report is how much the UAE’s banking sector has diverged in recent years between Abu Dhabi and Dubai. The former has long been largely characterised by public sector business, while the latter by the private sector and a more diversified range of clients. In Dubai though, government actors – both the government itself and via the GREs – are also a major part of business, with many private sector outfits dependent on these large holdings for work. A new wage protection system (WPS) in Dubai could help further diversify the sector’s base. “The UAE is one of the first markets to implement a WPS,” said Sultan Bin Kharsham, the managing director of Wall Street Exchange, an exchange services firm. “The public and private sector collaborated to develop this ‘salary pay-out service’, which helps companies reduce the risks of handling physical cash and offers a banking system to segments of the population that would otherwise not have access to any banking services. Approximately 60% of companies with 1000 or more employees utilise WPS and the end goal is to have 100% participation.”

CONCENTRATION RISK: At the same time, there is considerable familial overlap between government personnel and corporate and financial sector staff, while the government is often also a major shareholder in banks and corporates. This boosts the challenges posed by related-party lending while creating a considerable concentration risk. These challenges also exist in Abu Dhabi and elsewhere in the GCC, yet in Abu Dhabi, the government intervened directly to help floundering real estate companies when the crisis hit in 2008/09. Thus, the banks in Abu Dhabi were not as exposed to the bubble bursting as were the banks in Dubai.

This has led to a divergence in the NPL ratios between the two emirates. Figures from the IMF 2012 Article IV Consultation showed that in 2011, the NPL ratio in the UAE as a whole was 6.8%, while for Dubai it was 10.6%. This figure was also affected by a difference in credit growth between Dubai and the UAE average, with 2011 showing an average 6.5% increase in loans among Abu Dhabi’s top five banks, while ENBD, for example, saw around 4%. Much of this difference in growing loan books is also related to Abu Dhabi’s later opening up of economic growth, with Dubai a relatively mature market.

NPL levels have also required that banks undertake higher levels of provisioning than they have done historically. Indeed, with the NPL ratio expected to continue to climb in 2012, due to the ongoing corporate and GRE restructuring process, banks in the emirate are widely expecting higher provisioning levels to affect profitability and growth into 2013. Further separating Dubai’s banks from the UAE totals, figures obtained from the annual reports and financial statements of six of the eight banks headquartered in Dubai – with DB and Noor Islamic excluded, the former due to its takeover by ENBD and the latter due to the unavailability of data for the period – the total assets of Dubai’s banking sector were Dh525.9bn ($143.1bn) for 2011, down 3.3% on the 2010 total of Dh543.7bn ($148bn).

MAIN PLAYER: Of the 2011 total, 54% was held by ENBD. Adding in the assets of EIB and DB, both ENBD owned, would likely boost this figure to over 60%, given EIB assets of Dh21.5bn ($5.9bn) and DB’s assets of Dh11.99bn ($3.26bn). The latter were around 6-7% of ENBD’s assets at the time of the takeover in October 2011, while the last available Bloomberg data showed Dh17.4bn ($4.7bn) of assets for DB at the end of 2009, when the bank also posted a loss of Dh291m ($79.2m).

The impact of the DB takeover on ENBD was therefore slight. The bank was 70% owned by DH and 30% owned by Emaar, leaving it particularly exposed when these giants got into trouble after the real estate crash. A deal was then brokered by the Dubai government, with 100% of DB’s ownership being transferred to ENBD. The fair value of DB’s assets and liabilities was determined by an external evaluator, with the Dubai government also offering a guarantee for any losses at the date of acquisition, or future losses over the following seven years. This structure ensured there was no NPL or P&L impact on ENBD from the transfer.

Total liabilities of the six banks were Dh457bn ($124bn), with ENBD accounting for 55% of this. The 2010 total for the six was Dh311.6bn ($84.8bn), though most banks saw a decline in liabilities year-on-year ( yo-y), unlike ENBD, which saw its figure rise from Dh87bn ($23.7bn) to Dh250bn ($68.1bn).

Some banks reported that 2011 had also been influenced by the Arab Spring, which began in December 2010 and continued throughout 2011/12. This resulted in an influx of deposits into the UAE’s banks, as Middle Eastern and North African investors sought to hedge against the disturbances in their home countries. This wave of deposits had, however, largely moved on by 2012, reportedly going mainly into other assets, such as property.

Moving on to net profits, among the six banks, these totalled Dh5.71bn ($1.55bn) in 2011, up around 10% from Dh5.12bn ($1.39bn) in 2010. This demonstrates the continuing profitability of Dubai’s banks, despite an environment of rising impairments.

“Operating profit has been pretty robust, despite the challenges,” Ben Franz-Marwick, the head of investor relations and finance wholesale banking with ENBD, told OBG. “Even at very elevated levels of provisioning, we have been profitable throughout.” Operating profit has often been kept healthy by exercises in cost reduction, a strategy being adopted across the emirate’s banks. ENBD has thus undergone two major staff reduction exercises, in both 2010 and again in 2012, with the latter expected to result in annualised saving of around Dh80m ($21.77m).

Banks have also been growing fee income and becoming more competitive in growing their loan books. One way to do this is to boost the quality of customer service, winning new clients and broadening the commitments of old ones. This increase in competitiveness is likely to continue for some time, with banks aiming for leaner, more efficient operations.

AT THE GATE: The global downturn and the recent challenges facing domestic banking also resonated at the Gate, the centre of the DIFC. This had, pre-crisis, attracted some investment banks whose goals were often only short-term. These pulled out when the bubble burst, while some foreign-based banks, due to difficulty elsewhere, decide to either scale down their operations or closed their local offices.

Those who stayed suggest this has led to a healthier presence at DIFC, with a high level of quality evident among those now doing business. According to DIFC’s 2011 Annual Review, of the world’s top 30 banks, 21 had a presence in DIFC. That year, seven expanded their business, including JP Morgan Chase, Morgan Stanley, Merrill Lynch, Citi and Nomura International. Overall occupancy at DIFC for 2011 was reported at 95%.

DIFC’s health is not only a reflection of Dubai. The centre aims to be a financial hub for a much wider area. It is well positioned to do business in Africa and South-east Asia, as well as the rest of the MENA region. “Dubai, in its position as a regional hub, is becoming more attractive as a site for international banking,” Alexander MacDonald-Vitale, head of Investor Relations for HSBC in the Middle East, told OBG. “Recently we have seen more talent from developed markets move here, as opportunities open up and higher-level roles become available.” The future looks likely to attract more Asian banks too, with Chinese lenders in particular now taking a stronger interest, as the emirate becomes a clearing house for renminbi, while Chinese companies with significant African investments looking for a regional base with developed infrastructure.

OVERSEAS RISK: In 2012 Dubai’s banks are also operating within a constrained international environment, as the 2008-09 global downturn continues to resonate, joined by other ongoing risks such as the crisis in the Eurozone, the sluggish recovery in the US and the slowdown in growth in key markets in Asia, most especially China. Locally, the stiffening of UN sanctions against Iran in 2012 also had an impact on Dubai businesses trading across the Gulf, with a knock-on effect for local banks. The degree of exposure to the Eurozone among Dubai’s banks is, however, thought to be limited.

An IMF study in April 2012 found that lending by UAE banks to the peripheral EU states was small, while none of these more troubled European economies had ownership stakes in UAE banks – although the non-peripheral core of the EU owned around 20% of the UAE’s banking assets. Non-European ownership accounts for another 5%. Cross-border lending from Europe, as a percentage of GDP, is highest from the non-Eurozone UK, at 12-13% in the first quarter of 2011. The study also concluded that the UAE’s banks were well capitalised and capable of withstanding any likely global shocks.

Economic activity in Dubai, meanwhile, shows signs in mid-2012 of picking up, with the tourism and trade sectors both showing hikes. The first sector reported occupancy rates of 86.2% in January 2012, up from 75.4% in January 2011, while the most recent figures for the second showed non-oil trade up 23% in the third quarter of 2011 y-o-y, according to STR Global. There was some evidence, too, that real estate might be reviving, as the Dubai Land Department reported the number of property sales in the first quarter of 2012 up 54% y-o-y.

OUTLOOK: The above markers are encouraging for Dubai’s banks and for the international investor. Whatever jolts the emirate has had to withstand in recent years, the fact remains that Dubai is the world’s fifth-largest centre for re-exports, has perhaps the best transport, communications and financial infrastructure in the MENA, African and South Asian regions, and showed high political stability throughout the Arab Spring. These are all major factors behind the emirate’s continued status as an international banking centre.

In the year ahead banks are likely to remain conservative in their strategies, managing margins carefully in a tight environment. Provisioning – and negotiating through the remaining GRE restructurings – will continue to be key, although the rate of NPL formation is likely to ease off into 2013, once these deals are agreed. Regulatory improvements are also likely to help boost transparency and guard against unwarranted and unbudgeted risks, while keeping capital ratios high. The geopolitical environment remains uncertain too, with this likely to mean a not of caution in banking activity. However, the continuing profitability and strength of Dubai’s banking sector, along with all the emirate has to offer as an international financial centre, are likely to keep bankers busy for many years to come.