Balanced payments: Strong fundamentals help raise returns in the sector

The market for financial services in Ras Al Khaimah is growing in size and sophistication along with the emirate’s broader economy. As a supplier of a range of basic building materials, RAK’s industry-fuelled economy is aligned with the fortunes of the wider region, and this should result in opportunities for financial services companies to fund or insure new projects, as well as capitalise on the growth in demand as economic expansion helps to create more wealth and generate new business.

Regional Drive 

Financial services providers in RAK generally rely on the opportunities created by public sector ventures. The GCC states are expected to initiate a steady stream of construction projects for the remainder of the decade and beyond. These include infrastructure works designed to keep pace with growing populations and commercial needs, as well as major event-driven projects. For now, Qatar’s hosting of the football World Cup in 2022 is the main opportunity; however, another large-scale opportunity would come if Dubai’s bid to host the 2020 World Expo is successful. According to Middle East Economic Digest (MEED), the value of construction and infrastructure contracts awarded in the GCC in 2012 was $51.9bn. The total value of construction projects planned or under way in the UAE alone was some $549bn as of February 2013, second only to Saudi Arabia with $732bn and ahead of Qatar with $222bn, as per MEED figures.

Steady Demand

For RAK this should translate into sustained ongoing demand for construction materials. The emirate’s economy is tightly aligned with its natural resources, drawing on the limestone, clay and silica that it has in abundance. It is a major regional supplier of cement, aggregate, ceramics, glass and other materials for construction, and the large-scale building projects being carried out across the Gulf region will likely rely on output from RAK’s producers, boosting economic growth in the emirate as well as the demand for financial services.

Size & Scope

As a member of the UAE, financial companies in RAK are licensed and regulated at the federal level by the Central Bank of the UAE, and its insurers by the Insurance Authority. The central bank is also responsible for monetary policy. The dirham is pegged to the US dollar at a rate of Dh3.67:$1, and because of this benchmark interest rates in the UAE are generally set according to the policy decisions of the US Federal Reserve.

There are a handful of institutions with roots in the emirate: the National Bank of RAK (RAK Bank) and Commercial Bank International are the lenders, while the RAK National Insurance Co. (RAK Insurance) and United Insurance Co. are the insurers (see analysis). These firms benefit from access to the wider UAE financial sector, which is one of the largest in the region, with total banking assets (net of provisions) of Dh1.88trn ($511.74bn) as of March 2013.

In terms of capital markets, RAK uses the Abu Dhabi Securities Exchange (ADX) and the Dubai International Financial Exchange (DIFX). Many of the largest public firms have been partially privatised through share sales on the ADX. Sales of sukuks (Islamic bonds) and other debt securities are available through licensed investment banks, and banks from other emirates also maintain local branches.

Like the other emirates, RAK benefits from the reputation of the UAE as a safe and stable country with a healthy fiscal environment. According to the constitution of the UAE, education, health, security, welfare and most other forms of social spending are administered at the federal level, while infrastructure, natural resources and economic strategy are managed at the emirate level.

RAK has worked to ensure that its balance sheet is not reliant on any one sector and is instead based on diverse revenue streams from publicly owned or controlled enterprises, fees and licensing income.

The federal system supports RAK’s appeal as a destination for foreign investment, particularly in industry and manufacturing, by enabling it to leverage the UAE’s financial strength while also adding its own incentives. For example, RAK can offer a lowor no-tax environment in its free zones or in its regular economy for export-oriented manufacturing.

The federal system also helps RAK with the financing of its activities. Considered a quasi-sovereign entity, the emirate is not required to disclose the details of its balance sheet but enjoys an investment-grade credit rating – “A/A-1” from Standard & Poor’s (S&P). In reiterating its rating in December 2012, S&P analysts cited “limited fiscal risks in Ras Al Khaimah due to the government’s minimal expenditure responsibilities, prudent fiscal policy, and ongoing indirect financial support from the UAE”.

S&P also highlighted the emirate’s “comparatively wealthy and increasingly diversified economy”, adding that “while data on Ras Al Khaimah’s balance of payments and external position is not available, we view the UAE’s extremely strong net external asset position as a support, with the UAE likely to provide assistance to Ras Al Khaimah in the event of financial distress.” RAK’s credit rating is most relevant for its sukuks. These Islamic alternatives to bonds are regularly deployed financial instruments, both at a government level and by executive agencies, such as the RAK Investment Authority (RAKIA) and the RAK Investment and Development Office.

Banking

RAK is home to two banks: RAK Bank and Commercial Bank International. The latter institution was founded in the emirate but now maintains its headquarters in Dubai. Other banks licensed in the UAE typically maintain a presence in the emirate through local branches.

RAK Bank was established by the ruling family, and like other similar ventures it has gone on to become an important part of the emirate’s economy, although it has since diversified its ownership and its shares trade on the ADX. The bank is known for a prudent and traditional approach to banking, deploying its capital by lending to low-risk sectors and relying on a diversified roster of clients, and as a result it avoided system-wide problems such as excessive lending to the real estate and construction sectors.

RAK Bank, for example, stopped lending to the construction sector in the UAE in 2006 – well ahead of the financial crisis of 2008-09 that saw projects in the sector halted and real estate values fall substantially. In the first quarter of 2013 the bank reported a net profit of Dh367.9m ($100.1m), which was 13.1% higher than the Dh325.3m ($88.5m) it earned in the first quarter of 2012. Profits continued to rise into the second quarter of the year, with the bank reporting net profits of Dh392.1m ($106.73m), up 14.1% over the same period the previous year.

Within its target zone of low-risk clients, RAK Bank is focused on lending to personal customers and to small and medium-sized enterprises (SMEs) across the country. Working in this segment of the market typically means engaging with customers whose records and accounting practices are often informal, which mandates a high level of face-to-face interaction: visiting offices and shop floors, working with customers to better track their finances and staying in touch on a regular basis.

Service is a key part of RAK Bank’s offering (the lender recently introduced a mobile-banking application, for example), providing access to management if customer problems cannot be solved at a lower level. Human capital requirements for this business model can be higher, potentially squeezing return on equity; however, the benefit is a more stable revenue stream.

Key Components

RAK Bank categorises its activities into three operating segments: retail, corporate and treasury. The operations of its Islamic window, which was established in January 2013, are divided into the same three categories. Retail banking includes the standard personal-banking products, such as current and savings accounts, loans, mortgages and credit cards, which can also be used by SMEs. Corporate banking ranges from SMEs to larger commercial clients and the government, and also includes trade finance. The treasury segment includes money market, interbank and foreign-exchange transactions. Of the three categories, retail banking accounts for the vast majority of operating income: Dh657.8m ($179m) out of a total of Dh692.5m ($188.5m) in the first quarter, or a 95% share.

Islamic services are offered through the newly created Amal sharia-compliant window, domiciled in Performance of listed financial firms, 2011-12 RAK Bank’s corporate structure under its wholly owned RAK Islamic Finance Co. subsidiary. Products on offer since January 2013 include a mudaraba- based savings account (mudaraba is a type of profit-sharing agreement in which one party provides capital and the other labour), debit and credit cards, and financing. Car loans, through Amal Auto Finance, are on the basis of murabaha, a method in which a financial intermediary buys something and sells it on at a higher price, but in exchange for a deferred payment arrangement.

As of the end of the first quarter of 2013 RAK Bank reported Dh204.5m ($55.7m) in sharia-compliant loans outstanding. Of that total, Dh175m ($47.6m) were personal loans, Dh28.2m ($7.7m) were related to auto finance, and Dh1.3m ($353,860) were credit cards. Deposits totalled Dh273.9m ($74.6m).

At the end of the first quarter of 2013, the total loan book comprised Dh19.9bn ($5.4bn), down from Dh20.3bn ($5.52bn) at the end of the previous year. Cash, investments, property and other assets brought the bank’s total asset value to Dh28.3bn ($7.7bn), an increase of 3.9% for the quarter. With liabilities at Dh22.9bn ($6.23bn), the bank’s total equity was Dh5.46bn ($1.49bn). RAK Bank’s capital-adequacy ratio based on Tier 1 capital (core funds including equity and disclosed reserves) was 28.11% at the end of the first quarter of 2013.

In early September 2013, RAK Bank appointed a new CEO, Peter England, formerly the head of retail financial services at Malaysian lender CIMB Group, to replace outgoing CEO Graham Honeybill.

Maintaining Local Ties

Commercial Bank International retains a strong RAK-based influence: three of its nine board members are from the emirate, according to its 2012 annual report. The bank’s main shareholder, however, is Qatar National Bank, which has a 40% stake. Plans for the coming years include an increase in capital and efforts to balance its presence – it aims to have branches and services in each of the UAE’s seven emirates.

The bank’s net profit in the first quarter of 2013 was Dh70.1m ($19m), up 6% from Dh66.1m ($18m) in the same period in 2012. Total assets grew by 12.8% from Dh12.7bn ($3.46bn) at the end of December 2012 to Dh14.4bn ($3.92bn) at the end of the first quarter. Customer deposits increased 11.1% from Dh8.9bn ($2.42bn) to Dh9.9bn ($2.69bn) over the same period, while loans and advances went up by 10.4% to reach Dh9.6bn ($2.61bn). The capital adequacy ratio remained strong at 14.5%.

National Forecast

On a national level, the outlook for the financial sector was positive in mid-2013, thanks to several factors, including an uptick in real estate demand in Dubai and a forecast for general economic growth throughout the region. Though RAK Bank, in particular, avoided losses and deterioration in asset quality following the onset of the global financial crisis of 2008-09, most of the UAE’s banks did suffer, largely due to exposure to the real estate sector. Lenders are still working to clear nonperforming loans from their books, or are hoping for a market resurgence that could help borrowers return to profitability and catch up on loan repayments.

Regional political instability has played a role in the recovery of the local property market as well, with capital in search of a safe haven shifting to the UAE to purchase of real estate. Local banks may also be emerging as a safe place for foreigners’ cash – deposits from non-residents spiked 14.3% in 2012, according to market research from Bank Audi, Lebanon’s largest bank.

Regulatory Developments

Several regulatory changes being considered may be implemented by the end of 2013. The reforms have the potential to impact banks operating in RAK, as many are an attempt by the regulator to prevent excess lending and improve solvency in the case of a future crisis. For example, the central bank is considering reducing the proportion of a property’s value that can be financed with debt instead of equity. The maximum amount of a real estate loan to an Emirati would be capped at 80% of the value of the property if the EIBOR rates, 2012-04/13* buyer owns no other real estate, and 65% if they do. For expatriates, the thresholds are 75% and 60%, respectively. The move could serve to moderate real estate price rises by potentially removing from the market those speculators most reliant on debt.

Solvency

Overall, the central bank’s moves aim to boost solvency – loan-to-deposit ratios fell to 94.9% as of October 2012, as loan growth lagged that of the aggregate deposit base. Banks’ liquid assets stood at 35.4% of total deposits as of August 2012, as opposed to an industry-wide average of below 30% when the global financial crisis hit, according to research from Bank Audi.

The central bank has already implemented some measures to achieve this aim, including a 2011 regulation stipulating that a loan cannot exceed 20 times a borrower’s salary, and that credit cannot be extended for terms longer than four years. Another regulation that has been announced but not yet implemented is the large-exposures rule, which is essentially a cap on lending to local governments. The central bank’s goal is to reduce concentration risk and therefore strengthen banks, as well as encourage lending to the private sector.

Over the long term, the regulator aims to ensure solvency by requiring banks to comply with the Basel Committee on Banking Supervision’s Basel III banking regulations as they are implemented internationally. The central bank has also introduced four new liquidity ratios that have yet to be implemented, but are under consideration as a way of limiting overall risk exposure in the sector.

Another financial service being introduced is RAK Offshore, an offshore financial instrument marketed to foreign investors as a place to domicile assets to secure favourable tax treatment. RAK Offshore, a unit of RAKIA, was founded in 2006 by decree, and now has roughly 7000 international business companies (IBCs), making it the only territory in the Middle East to offer that type of legal entity.

Setup fees are Dh4000 ($1088), with renewals costing Dh2500 ($680). About 300 UAE-based agents have been registered so far, most of them either in RAK or Dubai, RAK Offshore officials told OBG. Offerings at the moment are limited to IBCs, but expansion plans include a maritime registry, trusts and foundations. Another possibility is a real estate project called RAK Financial City, which would be a mixeduse waterfront development of office towers, hotels, residences and retail.

Outlook

The emirate’s economic vision is still being implemented, which means additional infrastructure, investment in new ventures, and steady increases in consumer demand driven by broadbased economic growth are expected in the future, with demand for financial services likely to rise in turn. For RAK’s financial services providers this should translate into a number of significant opportunities.