The banking sector is a pillar of Dubai’s economy, having provided the basis for the development in the past decade. The banks serve as conduits that link Dubai to the regional and global economies, and their publicly traded shares are one of two main drivers of the local stock market along with real estate stocks. For now, the banking sector in Dubai appears to be in the midst of change, with lenders adjusting to changing demand patterns triggered by lower oil prices and continuing to evolve their offerings and operations. While it is expected that top-line growth will be muted in 2016, banks as a group appear ready to meet the challenge of staying profitable.
The emirate’s lenders exist in the wider national system of the UAE, which means they are licensed at the federal level and authorised to operate anywhere within the seven emirates, regardless of where they are based. Many of the larger banks have expanded beyond their initial core areas to become national presences. Others, often ones based in smaller emirates, typically remain focused on serving the emirate they are based in, with national-level activities sometimes included.
Given this market structure, Dubai’s banks exist in a larger system where aggregate numbers and sector averages may not tell the whole story or fully reflect the different experiences banks have within it. One current Dubai-based example is oil – the drop in prices has contrasting effects on different banks. Dubai’s lenders may suffer fewer direct impacts from lower oil prices than some of their peers in the UAE banking sector as a whole because the emirate itself is not a major producer, and its government has not seen a drop in revenue (and therefore cash available to deposit in banks) as a result. The current price situation is an issue, but many of the major players expect it to improve in 2016. Julian Wynter, CEO for Standard Chartered Bank, UAE, told OBG that “One of the critical determinants of the banking sector’s growth this year is undeniably the oil prices, which may pick up and stabilise at around $50 per barrel by the end of 2016. While the banking sector continues to see sluggish growth overall, the end of 2016 should be more promising.” However, the global drop in crude prices has brought with it some indirect repercussions.
Some of Dubai’s banks are still working to fully reconcile legacy loans from the previous decade, with the debtors often being government-related entities (GREs) unable to repay on account of the impact of the global financial crisis of 2007-08. Financial crisis legacy loans are another example of a major market condition unevenly felt across the sector as Dubai’s GREs typically sought financing mostly from the emirate’s largest banks. Thus far, the strategy of the GREs has been to extend payment periods where possible, increasing the length of time these loans will linger on balance sheets. However, despite the time this is taking, the impact on the system has been manageable, said Khalid Howladar, a banking analyst and global head of Islamic finance for credit ratings agency Moody’s. “Almost all affected banks continued to make profits, and over time build up strong liquidity and capital buffers,” Howladar told OBG. As of October 2015 the sector was still considered liquid – capital remained available for lending, and banks had the ability to quickly sell assets to raise extra cash if necessary. However, some key indicators were beginning to respond to the global environment – the loan-to-deposit ratio had ticked up to 102.3% by August 2015, up from 94.8% a year earlier, for example.
For 2015 and possibly 2016 the analysis starts with crude prices. The drop in export revenue felt across the Gulf is filtering through to Dubai’s banks in the form of slower growth in deposits and tighter lending conditions. Another impact is on tourism – with oil prices down, the geographical origin of visitors to Dubai has changed. The drop in tourists from Russia, a major oil exporter, has been noticeable, but counteracted by an increase in those from China, a major importer, according to the “Annual Report 2014” from the Central Bank of the UAE (CBU). Overall, however, a fall in hotel and retail activity was seen in both Dubai and Abu Dhabi as a result. A secondary external factor for the banking sector is the UAE dirham’s peg to the US dollar. The rising dollar is raising the value of the dirham, making Dubai more expensive for tourists and its exports more costly for those paying in other currencies. Losses in exports are somewhat offset by the lower costs of imports. According to March 2016 government figures, imports accounted for the majority of Dubai’s direct foreign trade at Dh796bn ($216.7bn).
For banks, lower oil income may mean more demand for financing, at a time when there is less excess cash in the region in search of profitable deployment. Public sector bodies, in particular Dubai’s GREs, play pivotal roles in executing the emirate’s economic strategies and have typically opted for bank loans.
For the CBU, the hope is that the system is more stable and resilient now than it was when the global financial crisis hit. For instance, before the drop in crude oil prices reset the narrative, the CBU was monitoring Dubai’s real estate market, where fast-rising prices were creating concern of a property asset bubble reminiscent of the one that troubled so many investors in the emirate after the global financial crisis. In 2013 the CBU introduced regulations that prevented first-time buyers from financing more than 75% of the value of a property, lowered access to credit for those investing in properties bought in advance of construction, and mandated that mortgages cannot be sold to retail customers if the monthly repayment exceeds 50% of that person’s income. Partly thanks to these moves aimed at keeping banks from taking on too much real estate risk, and in part thanks to global economic trends, the market in Dubai cooled off.
These measures, as well as others to cap lending to some public sector bodies, have initiated a shift in the banking sector toward a more diversified approach, rather than one that focuses on GREs and real estate. As a result, one question for banks in Dubai now is whether they can retain sufficient stocks of cash and maintain balance sheet flexibility to respond to the shifting patterns in lending these regulations have caused, as well as the increased needs for financing from major entities that have not typically needed to rely on outsiders for capitalisation. For GREs different banks are now playing major roles. The government of Dubai has also moved to facilitate public-private partnerships through a law established in late 2015, which should provide a catalyst for change.
Established in 2010, the Al Etihad Credit Bureau is responsible for collecting information and maintaining a database on credit in the UAE. After initially focusing on retail, the bureau was able to offer commercial credit reports four months after they were launched. As a result, the UAE has a much more developed credit data segment than other GCC countries.
In line with the government’s aim of better regulating the lending market, Al Etihad Credit Bureau is working on improving analytical processing. The more data that is available to credit bureaus, the easier it is to assist in changing how banks monitor their performance and review their strategies. Sectors such as telecoms and utilities are also rising areas for analytics and data providers, because companies in these industries need to communicate as customers’ credit scores have a direct effect on operations.
Looking To Alternatives
The issue of whether the banking sector is able to meet all this demand on its own has sparked talk of an increased role for sukuk (Islamic bonds) to reduce reliance on bank loans. It is also impacting how foreign lenders approach Dubai. While some have exited the Dubai market in the last few years, often citing difficulty in competing with domestic banks in the retail market, others are re-establishing themselves and changing the profile of foreign investment in the sector as they go. Many major foreign banks reduced their presence in Dubai after the global financial crisis, with a focus this time on infrastructure finance across the region. One prominent example, Société Générale of France, has increased its Dubai-based staff in the hope of providing financing to governments and their entities for large-scale projects across the GCC.
For the long term, lenders in Dubai and the UAE look forward to some new economic drivers with great potential to reset banking. Dubai’s hosting of Expo 2020, for example, means opportunities to finance infrastructure and hospitality projects. Additionally, now that the economic sanctions that isolated Iran have been lifted, Dubai could benefit from providing financial services to Iranians and to outsiders wishing to do business there. Iran’s re-entering the global economy should filter through Dubai and its banks.
The remittances segment has also seen new developments and has been branching out into new services as the emirate grows. Osama Al Rahma, CEO of Al Fardan Exchange, told OBG, “The industry has evolved and become a financial services one-stop shop that includes not just sending remittance overseas, but also paying utilities and topping up mobiles. Our role has shifted towards the ability to promote multiple services through the use of technology.”
The overall banking system in the UAE has emerged as the largest in the MENA region, with a total of Dh2.47trn ($672.3bn) in assets at the end of 2015, according to the CBU.
Dubai’s leading and largest banks are also national flagships with majority government ownership, such as Emirates National Bank of Dubai (Emirates NBD) and Dubai Islamic Bank. The largest privately owned lender is Mashreq Bank, which reported its first quarter 2016 net profits as Dh531.8m ($144.8m), down from its first quarter 2015 figure of Dh651.1m ($177.2m). Overall there are 23 locally incorporated banks in the UAE, and 26 branches of foreign ones, including six from elsewhere in the GCC.
The question of whether there are too many banks is a common one, in particular because the UAE’s banks are small in comparison to the global giants. “The federal structure of the country has, to some extent, encouraged the fragmented nature of the banking sector, with the individual emirates wishing to retain their own national banks,” according to a market overview contained in a July 2015 rights-issue prospectus submitted to potential investors by Abu Dhabi Islamic Bank (ADIB).
Mergers & Acquisitions
However, in June 2016 the National Bank of Abu Dhabi and First Gulf Bank confirmed that they were in negotiations over a possible merger, which would lead to the creation of one of the largest banks in the MENA region. The merger would create a bank with assets worth around Dh627bn ($170.7bn), according to first quarter 2016 figures. The move is likely to encourage a wave of mergers, and was followed two weeks later by the announcement that Abu Dhabi-based holding company IPIC and the Mubadala Development Company were also considering a merger.
Peter Baltussen, CEO of Commercial Bank of Dubai, told OBG, that these developments bode well for the sector, and the bank is optimistic as it continues to grow its retail presence, which represents more than 20% of its revenues. He said, “As consolidation in the overcrowded UAE banking sector has been discussed for quite some time, it is encouraging to note that the merger of two local banks is presently being evaluated, which will support the ambitious growth plans of the UAE. It is likely that this merger will trigger more mergers and acquisitions in the region.”
Banks are defined under the UAE’s Union Law, and are required to be public shareholding companies with at least Dh40m ($10.9m) in capital. Foreign banks must put up the same amount for their UAE operations to be licensed. The licensee roster of the CBU also includes eight wholesale banks, 122 representative offices, 26 finance companies, 25 investment firms, 140 exchange bureaux, and 12 currency and money market intermediaries. Regulatory oversight is provided by the CBU, headquartered in Abu Dhabi.
Islamic banks have in recent years grown at a faster pace than their conventional counterparts, and are, to some extent, poaching customers from them. In the first half of 2015, the eight Islamic banks’ share of total banking assets rose to 18.4%, according to Mubarak Rashed Khamis Al Mansoori, governor of the Central Bank. By the end of 2015 this figure reached 19%, according to the “Annual Report 2015”. The report stated that financing of the Islamic lenders of the UAE increased by 15.4% over 2015, higher than the average growth rate for domestic credit across the sector.
The regulator currently supervises Islamic banks by applying the same rules as it does to all banks, with little in the way of formal distinctions or regulatory differences. However, this is one area to watch for new legal and regulatory developments, and one in which some market leaders have called for action. “There is a need for specific regulations related to Islamic banks,” argued Jamal bin Ghalaita, CEO of Emirates Islamic Bank, in the “State of the Global Islamic Economy” report 2014/15 produced by Thomson Reuters. Current regulations do not factor in elements including Islamic banks’ higher exposure to real estate, he wrote, or the differences in some sharia-compliant Islamic products to their conventional counterparts.
Dubai’s banking sector is also characterised by offshore offerings in the Dubai International Financial Centre (DIFC), where a large number of boutique service providers have helped the emirate establish itself as a regional hub for financial services. The DIFC is a free zone in which companies of all kinds are licensed and supervised according to a bespoke legal system that is based on English common law. They are not subject to federal regulations but are instead overseen by the Dubai Financial Services Authority (DFSA).
Banks in the domestic market play a role in the global marketplace as well. In the past, UAE banks followed a model common across the Gulf, which features a strong focus on lending, rather than expanding into newer areas. But in recent years, UAE banks have increased activity on a global scale, including in foreign acquisitions, and lending and borrowing internationally. The sector overall has managed to increase its global presence without triggering concern at the CBU about exposure to downsides.
In addition to its universal banks and the offshore offerings of the DIFC, Dubai contains a small but growing number of non-bank financial companies, which are often focused on lending in a particular segment of the domestic market. The CBU defines shadow banking as “credit intermediations involving entities and activities outside the regular banking system”, and pegged these companies’ total share of financial system assets at 3% of the whole in 2014, down from 3.5% in 2012. In addition to the 26 finance companies in the UAE, there is also a growing market for alternative vehicles such as peer-to-peer lending platforms and crowdfunding. These options are relatively new and operations are small for now but are seen as a competitive alternative, in particular for small and medium-sized enterprises (SMEs), which commonly struggle in many developing and developed markets to secure sufficient credit.
The aggregate net profit of the banking sector reached Dh37bn ($10.1bn) in 2015, continuing a trend that has delivered a compound annual growth rate of 16% since 2009, according to the most current figures available from the CBU. The change in total credit to GDP ratio was 5.3% in 2014, according to IMF figures, up from 0.4% in 2013. Financial soundness indicators showed that the sector remained well capitalised, with a total capital adequacy ratio (CAR) of 18.3% at the end of 2015, and Tier-1 capital at 16.6%.
The Basel Committee on Banking Supervision’s new standards, created in response to the global financial crisis, defines Tier-1 capital as assets that can be converted to cash at short notice, which is important in case of emergencies. Other assets do not have to be as easily converted. The capital adequacy ratio peaked at 21% in 2011, and Tier-1 capital at 17.2% in 2013. “The banking sector is resilient and has enough capital and liquidity buffers to withstand an adverse shock,” according to the IMF’s 2015 Article IV consultation, the fund’s annual economic check-up on member countries. Though UAE banks are among the best-capitalised globally, they are still working to be seen as on par with those of two important metropolitan economies Dubai benchmarks itself against, Singapore and Hong Kong. The “Global Competitiveness Report 2015-16”, published by the World Economic Forum, ranks the UAE 21st out of 140 countries in its “soundness of banks” category, compared to Singapore at fifth and Hong Kong at seventh.
Return on assets rose to 1.7% in 2014, from 1.5% in 2013, although both figures are below the high-water mark of 2% in the current decade, reached in 2012. While Dubai’s banks have helped in the overall recovery of the sector, the emirate’s well-documented difficulties during the global financial crisis have not been forgotten. Some debts have been successfully collected, but loan restructurings that extend maturities mean that legacy loans are still on the books. Non-performing loans stood at 6.3% in the final three quarters of 2015, down from 7% in 2014 and 8.2% the previous year, as per CBU and IMF figures.
Profits & Losses
Indicators in the third and early fourth quarters of 2015 showed that oil prices were beginning to make an impact. The system-wide loan-to-deposits ratio, frequently used as a measure of how much cash banks have to deploy, had risen to 100.9% by the end of 2015, posting 4% growth over the year-end 2014 figure of 97%, as highlighted in the CBU’s “Annual Report 2015”.
Leading banks’ third-quarter earnings in 2015 also showed deterioration in the overall operating environment, but healthy profits were still reported. Emirates NBD, for example, reported a net interest margin – the spread between its cost of funds and the average rate at which it lent – of 2.75% in the quarter, a contraction from 2.95% in the same period a year earlier, according to a research report from NAEEM Securities. However, the bank also showed a net profit of Dh1.68bn ($457.3m) for the third quarter of the year, up 7% from the third quarter of 2014.
During a conference call to discuss the results with financial analysts it credited overall growth in interest income, including retail assets, and a jump in fee-based income, primarily from foreign exchange services, asset management charges paid by clients and derivatives. One explanation for profitability in the face of challenging market conditions may be improvements in operational efficiencies. The CBU also reported a system-wide drop in the ratio of non-interest expenses to gross income, from just under 38% in 2012 and 2013 to slightly over 36% in 2014. The bank includes staffing, premises and technology costs among non-interest expenses, and considered the drop in the ratio evidence of “a satisfactory balance between cost control and revenue growth” in its “Financial Stability Report 2014”.
As expected, overall deposit levels across the system declined from quarters one to three of 2015 as lower oil prices left some customers with fewer liquid assets. However, deposits returned to positive growth in quarter four, according to the CBU. In total, deposits rose 3.5% in 2015, compared to 11.1% growth the year prior. The flux seen across the year is certainly a departure from the post-financial crisis trend, in which deposit growth was constant. Most of the growth in deposits after the crisis came from demand and savings deposits, which climbed from Dh301bn ($81.9bn) in 2008 to Dh709bn ($193bn) in 2014, according to CBU data. Time deposits increased from Dh622bn ($169.3bn) to Dh730bn ($198.7bn) over the same period. With the pool of cash from current and savings accounts growing, the central bank noted “little incentive for banks to compete for deposits through offering higher interest rates”. This has helped keep costs low and net interest margins from contracting despite considerable competition in the market.
Other options for Dubai’s banks to raise funds include sukuk or bond sales, as well as adding global exposure by tapping international lending markets. Syndicated loans for the Middle East as a whole almost doubled from October 2014 to October 2015, rising to $7.8bn in total value from $4.1bn, according to Thomson Reuters. Another indication of the growing appetite is increased demand for a credit rating from a globally recognised agency. “We’re seeing a lot of new banks get rated,” said Moody’s Howladar. “It makes sense that they need it more in a low-oil-price environment where cheap credit is not available, and they may have to borrow from the markets.”
Moving to an increased reliance on international lending markets means adding exposure in an area where there has been very little since the financial crisis, according to the CBU. National banks at the end of 2014 were net lenders in the foreign interbank market. The trend of borrowing internationally restarted in 2013, according to the central bank, in part thanks to low interest rates making the proposition an attractive one. Overall funding from capital markets was a small part of the funding mix, at about 10%, according to its 2014 report (see analysis).
In securitised debt markets, banks are expected to continue fundraising in the short and medium terms to comply with the Basel III solvency regulations. According to research from Dubai’s Arqaam Capital, banks in the GCC could issue up to $17bn in Tier-1 debt securities and $26bn in Tier-2 versions for this purpose by 2019. A preferred instrument in the past for this purpose has been perpetual sukuk, which are sharia-compliant fixed-income securities that do not have a maturity date and continue to pay a profit rate to holders until they choose to cash them in. The first to market was a UAE bank, ADIB, in 2012. Perpetual sukuk qualify as Tier-1 capital under Basel III if investors hold them for at least six years before cashing them in, and if the debt is subordinated.
Selling bonds and sukuk could become easier on account of the UAE’s plan to become a regular issuer itself. The CBU and the Federal Ministry of Finance are working together on a regular issuance programme with a variety of structures and maturities. Since commercial debt is typically priced at a premium compared to government debt with the same maturity, as they are perceived as more risky, a critical mass of outstanding government bonds creates points of comparison, which, when plotted on a graph, are called a yield curve. Having a yield curve would make pricing easier for commercial sector lenders, including banks, and encourage more debt sales.
Legal & Regulatory
The sector envisions several legal and regulatory changes on the horizon. One of the most long-awaited changes was announced on September 4, 2016, when the UAE cabinet approved the final draft of the Federal Law on Bankruptcy. The new legislation provides a legal framework to help ailing companies and enumerates four ways insolvent firms can avoid bankruptcy. Another evolution under way is a move to allow the CBU to share more of its oversight responsibility with the Emirates Securities and Commodities Authority (SCA), as well as a wider shared effort to promote and protect financial stability among regulators. According to the ADIB rights-issue prospectus, under this system the CBU would continue to control monetary policy, macroeconomic stability, capital adequacy requirements, risk management, compliance with global norms and local laws on illicit financial flows, and licensing. Areas of oversight that could be shifted to the SCA include commercial and consumer-facing areas, such as consumer protection and corporate governance.
The CBU itself is also growing in its capacity to fulfil its roles. Late 2014 saw a change in the governor’s seat for the first time since 1991, when the current governor, Al Mansoori, former CEO of the federal Emirates Investment Authority, was appointed. “The central bank is becoming stronger and stronger under the new governor,” said Mohamed Abdul Rehman Amiri, CEO of Ajman Bank, adding, “It is good for the economy and for customers.” The CBU uses a dual-leadership structure, whereby the governor shares the role with the chairman. Since November 2012 Khalifa Mohammed Al Kindi has filled that role.
In 2014 the CBU disclosed a plan to overhaul liquidity regulations, which will require lenders to enhance risk management frameworks. In 2014 the central bank also introduced a “dashboard” concept for risk evaluation, which involves 12 evaluation criteria to assess institutional strengths and weaknesses, the quality of governance and risk management capacity.
Currently, there is no formal deposit insurance system in the UAE, and the CBU has not in the past been seen as a “lender of last resort” – a source for emergency capital. That is because of the UAE’s federal system, in which banks are more likely to rely on governments at the emirate level, according to where they are headquartered, for help, according to ADIB’s prospectus. An example in Dubai is Dubai Bank, which in May 2011 was taken over by the government of Dubai to prevent instability.
The UAE has contemplated moving to a system in which banks or some of the assets in the system are backed at the national level. A historical precedent for this came in October 2008, when the federal government said it would guarantee the deposits of banks. In May 2009 a draft law for the provision of a formal deposit insurance system was written but has yet to be enacted. Draft laws in the UAE must sometimes await approval for years in this manner. For those that are eventually approved, this approach avoids shocking the market with new rules and allows a period for participants to adjust to the change.
The UAE has also been encouraged by the IMF to adopt several formal and procedural concepts in its approach, including making financial stability a clear part of the CBU’s mandate, the creation of a financial stability committee and increasing inter-agency coordination with the Ministry of Finance and other relevant agencies. The IMF made the recommendations in its most recent Article IV publication. It praised the UAE for steps taken to minimise exposure to real estate, including caps on how much of a real estate property can be purchased using a mortgage.
The low-oil price environment presents a test for Dubai’s banking sector, which has enjoyed the benefits of high or rising crude prices for more than a decade. Though the impact on the fundamentals is already showing, high capitalisation levels and institutional buffers are creating expectations that the sector can weather the storm. “If it continues for a more prolonged period, ultimately there could be some asset-quality problems,” said Howladar. “Luckily, the banks have not had time to forget the previous crisis, and they have been more cautious as a result.”