Cool in a crisis: Resilient during global crises, the emirate’s banks are now expanding

Among the banking sectors in the GCC, that of the UAE has grown to become the largest, and within this dynamic and competitive market the banks headquartered in the nation’s capital have expanded to become some of its most significant players. Over the past year they have demonstrated their resilience to unfavourable global economic conditions through continued profit growth and loan book expansion. They have also successfully adapted to a rapidly evolving regulatory environment, as the nation’s central bank moves to ensure the long-term financial soundness of the sector. Regulatory reform continues to pose a challenge moving into 2014, but the opportunities that are arising from the emirate’s economic expansion underwrite the continued growth of Abu Dhabi’s lenders.

Coin Of The Realm

 Banking in the modern sense began in Abu Dhabi with the creation of the national currency, the UAE dirham, which was introduced by a new Currency Board established in 1973. This historic development ended the UAE’s former reliance on the Bahraini dinar and the Qatar/Dubai riyal for cash transactions, and established the stage on which the banking industry was to rapidly develop. Having completed its first task, the Currency Board reverted to an oversight role, working with the International Monetary Fund (IMF) to produce annual reports and bi-annual bulletins that tracked the progress of the young banking sector.

By the end of the decade, the economy of Abu Dhabi was heating up on the back of an expanding hydrocarbons industry, and the emirate’s banking sector entered a new phase of development which called for greater regulatory oversight. The transformation of the UAE Currency Board into the Central Bank of the UAE (CBU) came in answer to this need, and the law which established the new body granted it a wide array of powers, including the formulation of monetary, credit and banking policies. In the little over three decades between January 1980 and January 2012, the activities of the central bank and the institutions it oversees have expanded exponentially: cash in circulation has grown from Dh2.1bn ($571m) to Dh42.6bn ($11.6bn), credit facilities extended to the nation’s private sector rose from Dh25.2bn ($6.9bn) to Dh816.5bn ($222.3bn), while monetary deposits increased from Dh5.2bn ($1.41bn) to Dh229.4bn ($62.4bn).

Relative Resiliency

The UAE’s banks, and Abu Dhabi’s in particular, demonstrated their robustness in the face of the 2008-09 global economic crisis, while the central bank moved swiftly to address the potential risks that the new economic environment exposed. Throughout these political and economic changes, the banking sector has continued to grow in both depth and complexity to become the largest in the region, accounting for 31% of the total volume of the GCC banking sector and about 20% of the gross volume of the Arab banking sector at the close of 2012, according to the 2012 annual report from the UAE Banks Federation (formerly the Emirates Banking Association).

Market Structure

The federal nature of the UAE makes for a lively and competitive banking sector at a national level. Banks headquartered in Abu Dhabi sit within a wider UAE market of financial institutions that operate across the seven emirates on a border-free basis, and they therefore compete for business in a market where domestic giants rub shoulders with foreign institutions that have established a presence in the country.

According to the CBU, a total of 23 national banks held licences to operate within the UAE in 2012, the same number as the previous year. The branch networks of the local banks, however, continued to rise, reaching 805 by the close of the year compared to 768 in 2011. The CBU also records that 32 foreign banks were operating within the UAE during 2012, with their branches reaching a total of 83. Additionally, more than 100 foreign banks have established representative offices in the UAE, 48 of which were located in Abu Dhabi as of June 2013.

Competitive Environment

No single bank dominates the diverse and competitive banking sector. According to CBU data, the largest bank in the country, Emirates NBD, accounts for around 20% of total loans in the UAE, while the following nine banks in terms of lending portfolios account for an additional 60.3% of total lending. The remaining 41 banks, meanwhile, account for 19.5% of total loans.

As one of the UAE’s two banking centres, Abu Dhabi is home to some of the sizeable domestic players that play a leading role in the development of the economy through their lending and investment activities (see analysis). National Bank of Abu Dhabi (NBAD) is the second-largest bank in the UAE, and runs the largest lending book of the Abu Dhabi-based institutions – valued at Dh173.5bn ($47.2bn) in June 2013. An Abu Dhabi government interest of 70% has helped it to maintain its position at the centre of the emirate’s economy. The government also retains an interest of 58.08% in Abu Dhabi’s third-largest lender, Abu Dhabi Commercial Bank (ADCB). The largest privately owned bank in the emirate is First Gulf Bank (FGB), although the sizeable stake the ruling family holds enhances its ties to the state. Union National Bank (UNB) is the fourth-largest bank and the only one in the UAE market jointly owned by the governments of Abu Dhabi and Dubai.

Abu Dhabi Islamic Bank (ADIB), meanwhile, is the fifth-largest bank in the emirate, as well as its largest sharia-compliant lender (or, in Islamic terms, financer). Abu Dhabi’s top-five domestic banks offer sharia-compliant financing either through subsidiaries or dedicated Islamic windows.

Lender Performance

As with banks across the world, Abu Dhabi’s lenders have been faced with a challenging environment in recent years, from the mortgage crisis that began in 2008 to the global credit crisis and the more recent debt crisis in the eurozone. However, the banks of the UAE have succeeded in maintaining comfortable liquidity levels and capital adequacy ratios (CAR), while also continuing to see profitability. In 2012, the aggregated net profit for the sector reached Dh26.5bn ($7.2bn), according to the UAE Banks Federation, while total assets grew by 8% to hit Dh1.8trn ($490bn).

Amidst the strong performance of the national sector, Abu Dhabi’s banks acquitted themselves well. Aggregate loans and advances for the emirate’s five largest banks grew to Dh540bn ($146.9bn) by the close of 2012 from Dh495bn ($134.7bn) at the end of 2011 – a rise of 9.1%, while customer deposits expanded by 14.3% over the same period to reach about Dh481.9bn ($131.2bn), according to their published financial data. Abu Dhabi’s lenders also continued a profitable trend that has been maintained since the onset of the global financial crisis, with their aggregated net profit for 2012 reaching Dh14.1bn ($3.8bn) – a rise of 7.65% over the previous year’s total of Dh13.1bn ($3.6bn).

The first half of 2013 saw this positive trend strengthen further: aggregate net profit for the period ending June 30, 2013 reached Dh8.3bn ($2.3bn), a 13.4% rise on the Dh7.2bn ($2bn) aggregate net profit for the first half of 2012. NBAD finished the period with the greatest gain, showing a profit of Dh2.6bn ($707m), which represented a year-on-year (y-o-y) rise of 25.6% (see analysis).

Asset Quality

In terms of asset quality, Abu Dhabi’s banks have, like those in the rest of the UAE, spent four years strengthening their balance sheets in the wake of the global economic crisis, which saw asset quality deteriorating markedly in 2009, to give an average non-performing loan (NPL) to gross loans ratio of 4.3%, compared to the 1.7% of 2008.

The overall NPL ratio of around 5% seen by Abu Dhabi’s banks since that time has increased their impairment charges and placed downward pressure on profitability, but in the eyes of many industry observers the worst of the NPL cycle is now behind the sector and, after some fluctuations in the NPL rate in 2012 and early 2013, a sustained easing of NPL pressure is forecast.

According to regional investment firm Global Investment House, almost all significant defaults in the UAE sector have been “either been restructured or are close to being restructured with some making it back to the performing loans category”, and most banks are not expecting any new defaults originating from large exposures. The successful restructuring of Dubai Holding Group, the insolvency of which represented the most challenging default faced by the nation’s banking sector, has played a significant part in the stabilisation of the NPL trend.

A tentative recovery in the local real estate market has also helped to bring about the sector’s more positive NPL outlook, although this trend has yet to make a significant impression on banks’ current NPL situation. “The pressure on collateral as a component in the provisioning calculations is starting to ease but has not yet eased completely,” Andrew Moir, the global head of strategy and finance at ADIB, told OBG. “We have seen some real estate prices tracking up … but we still think there is another year to go in terms of certainty across all sectors of the real estate before you can really start calling a clear easing on provisioning.”

Recent Regulation & Reform

One reason frequently cited for the strong performance of the UAE’s banks in the challenging years since the global credit crisis is the CBU’s reaction to that event. The central bank responded to the altered economic circumstances that followed the credit crunch in two discernible phases: initially, it moved to secure the sector by setting up a Dh50bn ($13.6bn) short-term liquidity support facility that was then followed by a similarly sized liquidity injection contributed by the Ministry of Finance. During this period the government of Abu Dhabi provided a further Dh16bn ($4.4bn) injection to five Abu Dhabi-based banks, significantly strengthening their capital base.

Having given the banks the opportunity to strengthen their balance sheets, the central bank has since implemented the second phase of its response, which aims to address the potential systemic risks that the economic crisis exposed. This effort continues to this day, and as a consequence of it Abu Dhabi’s banks are adjusting to a number of key regulatory changes. The first of these came in late 2010 with the Regulations for Classification of Loans and Determining Their Provisions, better known as the Provisioning Circular. The new regulation establishes a framework by which the banks are to evaluate their loans and advances portfolio to better reflect their asset quality, as well as to introduce consistent, prudent credit risk management policies. The new loan definitions range from “normal”, “watch-list”, “sub-standard”, “doubtful” and “loss”, and their adoption across the sector has brought a heightened degree of clarity to portfolio management.

An even more comprehensive regulatory change soon followed, in the form of the Regulations No. 29/2011 Regarding Bank Loans & Other Services Offered to Individual Customers, published in February 2011 and implemented in May 2011. The regulations are applicable to individual consumer retail banking practices, and have the dual purpose of controlling lending activity and the level of fees that might be charged for it. A new lending cap of 20 times salary has replaced a previous fixed limit on personal loans of Dh250,000 ($68,050), and has been welcomed for the heightened flexibility it has brought to the market. The regulations also set out a standard formula for the calculation of interest on a loan, and establish that the combined monthly installations for all loans, including overdrafts and credit cards, must not exceed 50% of an individual’s gross salary. The caps on fees and commissions that the regulations have levelled, although considered a prudent response to over-borrowing, represents a significant challenge to the industry, and its effects were immediately apparent in the reduced revenue from fees and commissions posted by all five of Abu Dhabi’s top banks in 2011.

As a result of the regulatory change, banks were compelled to revisit their retail banking strategies, perhaps the most notable result of which was the decision by ADCB to address the challenge by introducing free banking to its retail clients – a first for the UAE. In the difficult operating environment characterised by customer deleveraging, more stringent regulations, and intense price competition that shrank the UAE’s consumer banking revenue pool, ADCB’s Consumer Banking Group posted a healthy performance. This was largely the result of substantial investments in customer service, with higher performance and operational standards, simpler documentation and improvement in turnaround times, the launch of an electronic payment mechanism, the implementation of a new credit risk policy based on customer segments, the launch of mobile internet banking for iPhone, and improved loan and customer relationship management systems.

New Exposure Limits

A third significant regulatory change was introduced by the central bank in April 2012, when it issued a notice which amended a CBU circular from 1993 concerning the monitoring of large exposure limits. The revised regulation changes the nature of banks’ concentration of risk levels, removing a previous lending limit to any individual borrower of 7% of the capital base and replacing it with a new matrix that encompasses government-related entities (GREs) and local governments, although not credit extended at the federal level.

Just what the exposure limit to GREs should be was a matter of heated debate. In April 2013 the CBU set a limit of 100% of the capital base for all lending by a bank to governments of the federation and their non-commercial entities, and 25% to individual borrowers. However, as the September 30, 2013 deadline approached, the UAE Banks Federation announced it would request a delay in the regulation’s implementation, citing inter alia the inconsistent classification of exposures across banks’ balance sheets and government fiscal accounts as a potential risk to transparency.

As a result, the new rules were suspended while the CBU examined the implementation issues in greater detail. In November 2013 the chairman of the UAE Banks Federation disclosed that, although there would be no exemptions to the exposure limits as some lenders had requested, the nation’s banks will likely be granted a grace period of up to five years to comply with the new rules. The new exposure limit was announced in late 2013, and both its level and the timescale over which banks will be required to meet it will represent one of the most significant regulatory changes of the coming year.

Seeking Stability

The question of exposure to GREs is linked to the CBU’s wider ambition to ensure the future stability of the banking sector, and the past year has seen it take another important step in this regard. In 2009 the CBU established its Financial Stability Unit (FSU), tasked with monitoring and reporting on the UAE financial system’s macroprudential levels. For the subsequent two years the new body concentrated on building its team and establishing a methodology, and in September 2012 it published its inaugural Financial Stability Review – a wide-ranging document which covers areas such as domestic economic outlook (including matters like inflation and oil prices) and financial soundness indicators in the banking sector (such as profitability, CAR, asset quality and liquidity).

Reporting & Review

The development holds some significant implications for Abu Dhabi’s banks, most notably in the short term a requirement to provide the CBU with a greater amount of data in their regular reporting to the regulator. The 2013 Financial Stability Review, expected to be issued in late 2013, will likely now be released in 2014. The CBU has completely overhauled the reporting process by which banks submit data on a monthly and quarterly basis and introduced new methodology in June 2013. A parallel run of reporting systems continued until September, after which time banks were asked to make sole use of the new, more granular, framework. The more exhaustive process has placed an added burden on Abu Dhabi’s lenders in terms of both human resources and technological infrastructure, but the CBU has taken some steps to ease the implementation of the new system.

The FSU plans to widen the scope of its stability review to include areas such as real estate and GRE risk, but for now there is no direct linkage between the report’s findings and the formulation of policy. While the CBU holds a mandate to ensure financial stability in the country, responsibility for financial regulation and supervision is divided amongst the CBU, the Securities and Commodities Authority (SCA), and the Insurance Authority.

Financial Services Law

This state of affairs, however, is likely to change with the promulgation of a new Financial Services Law, currently in draft form, which could introduce the “twin-peaks” model of regulation seen in jurisdictions such as Australia. Under the new system, the CBU is most likely to play the role of prudential regulator, and the SCA that of the conduct-of-business regulator, and this coalescence of prudential authority in the CBU over the entire financial sector may make it possible at a future point in time for the FSU’s reporting to trigger direct action in terms of policy-making.

Market Trends

The steadily evolving regulatory situation has influenced the banks’ strategies for growth in the domestic market. While big-ticket corporate lending continues to account for the bulk of credit extension for the larger Abu Dhabi banks, such as NBAD, the post-credit-crunch economic environment and the regulatory curbs on exposure to GREs have encouraged banks to engage with as much of the economy as possible in a bid to secure income. As a result, small and medium-sized enterprise (SME) and retail lending are playing a more prominent role in the portfolios of Abu Dhabi’s banks, with ADCB, for example, reporting that its small business lending unit doubled its credit extension over 2012, from Dh2bn ($544m) to Dh4bn ($1.1bn). The trend of increased exposure to SMEs is likely to continue, driven in part by a new Dh330bn ($89.8bn) spending programme announced by the government of Abu Dhabi in January 2013.

The plan follows a governmental review of existing works in the health care and education sectors and envisages the large-scale development of new infrastructure and housing projects. While banks will be able to pursue the traditional lending opportunities that such large projects present, the prospect of servicing the private-sector, downstream businesses that these undertakings demand is an increasingly tempting one for local lenders.

Mid-sized firms, financially sophisticated enough to require services such as performance bonds, working capital financing and sizeable term lending, are of particular interest to banks as the economic development of the emirate continues.

“As the private sector begins to play an increasingly larger role in terms of its contribution to the overall economy, we anticipate the demand for financing from SMEs will increase. While there is greater risk associated with SME lending, if done properly it can certainly be profitable,” Mohammad Nasr Abdeen, CEO of UNB, told OBG.

Innovations

An important sector development, therefore, has been the creation of a national credit bureau, which, although still in the early stages, will greatly enhance the ability of banks to undertake proper risk-assessed lending in the burgeoning SME segment (see analysis). Al Etihad Credit Bureau, established in 2012, appointed its first CEO in 2013 and is in the process of implementing the first phase of its development strategy, which involves the collation of consumer data from the 12 banks that have signed up for its soft launch.

Another way in which banks are seeking to boost top-line growth is by utilising technology to bring new efficiencies to existing business. Larger lenders are introducing new technology platforms in areas such as transaction and trade banking. Using such technology to build relationships with customers and diversify sources of interest and non-interest income will play an increasingly important part in Abu Dhabi’s competitive banking sector.

Outlook

The evolving regulatory environment and the need to diversify revenue sources represent the two most significant challenges facing Abu Dhabi’s banks, but as they address them over the coming year the emirate’s lenders have the advantage of a favourable economic environment in which to work. Abu Dhabi’s hydrocarbons wealth, combined with the emirate’s history of fiscal prudence, has made it one of the most robust economies in the region, and the future growth of the banks headquartered in the UAE capital is underwritten by this fact.

Real GDP data released in 2012 revealed an overall growth rate of 5.6% for the year, and a 7.7% expansion of the non-oil sector, and with ratings agencies such as Fitch’s predicting Brent crude averages of $100 per barrel in 2014 and 2015, the outlook for a continuance of this growth trend is positive.

In line with this, the IMF also expects bank lending to continue to expand at a healthy rate, and it anticipates a rise of 8.4% for 2014. Abu Dhabi’s banks, with their strong liquidity positions and CARs, are well placed to play a leading role in the expansion.