Will reforms support dynamism in Abu Dhabi’s banks?

Despite the adverse effects of a low oil price environment over recent years, Abu Dhabi’s banking sector has remained well capitalised with a high degree of liquidity. Meanwhile, its financial performance has been characterised by rising net profits and lower cost-toincome ratios. A recent phase of consolidation has significantly altered the structure of the local market, with the larger balance sheets of financial institutions leaving them better positioned to make gains in an increasingly competitive domestic and international environment. Nevertheless, declining international oil prices and the effects of the global Covid-19 pandemic in early 2020 appear set to make for a challenging year for the emirate’s banking industry.

Local Market

The UAE’s federal structure means that Abu Dhabi’s banks compete with lenders across seven separate emirates. The national market accounts for nearly a third of all GCC bank assets, and consists of both an onshore and increasingly vibrant offshore segment – based in two free zones, Abu Dhabi Global Market (ADGM) and the Dubai International Financial Centre. As of April 2020 there were 22 national banks licensed to maintain onshore operations, six of which were headquartered in Abu Dhabi, according to the Central Bank of the UAE (CBUAE). While around 90% of the UAE’s total banking assets are held by locally owned financial institutions, the market also includes a busy foreign-owned segment made up of 38 licensed bank. Regional players, such as Al Ahli Bank of Kuwait, National Bank of Bahrain, National Bank of Oman and Bank Melli Iran, compete with global giants, such as HSBC, Barclays and BNP Paribas. Eight foreign institutions have located their head offices in Abu Dhabi, and all but three operate branches there.

The UAE’s regulatory framework allows for both dedicated Islamic banks and sharia windows operated by conventional financial institutions. Islamic banking accounted for about 18.4% of total sector assets in February 2020. The amount of sharia-compliant assets in the system, however, is higher than officially stated, as standard banks do not separate Islamic and conventional assets in their reporting. Abu Dhabi’s Islamic institutions are subject to the same regulatory oversight as their conventional peers, but the establishment of the Higher Sharia Authority in 2017 is increasing the level of segment-specific oversight applied to them (see Islamic Financial Services chapter).

Abu Dhabi’s banks also compete with around 20 non-bank finance companies, which together account for approximately 1.4% of the UAE’s banking sector assets. Five are bank-owned, and between them they claim nearly 30% of the total assets controlled by the finance company segment. Unlike formal banks, finance companies are not permitted to accept retail deposits, and their business activities are restricted to retail finance – including personal loans, car loans and credit cards – mortgage finance, wholesale finance and the distribution of third-party products.

Top Players

Abu Dhabi accounts for the second-largest share of gross banking assets in the UAE. In February 2020 banks located in the emirate posted aggregate gross assets of Dh1.4trn ($381.1bn), or 44.1% of the total, according the most recent CBUAE data. The emirate’s importance within the UAE’s wider financial sector is underlined by the fact that three of the nation’s five biggest financial institutions are based in the emirate. The largest of these is First Abu Dhabi Bank, a major regional operator that was created through the 2017 merger of National Bank of Abu Dhabi and First Gulf Bank. First Abu Dhabi Bank is the largest bank in the UAE by total assets, with around Dh822bn ($223.7bn) in early 2020, as well as one of the largest banks in the MENA region. Its domestic network extends across all seven of the UAE’s emirates, while its international operations span five continents, including operations in the UK, France, Switzerland, the US, Singapore, China and Malaysia. The bank’s position is supported by the presence of strategically important stakeholders within the institution’s ownership structure. These include the Abu Dhabi government’s investment arm – the Abu Dhabi Investment Council (ADIC) – which maintains a 33.4% stake, along with the emirate’s other primary investment vehicle, Mubadala Investment Company, which owns 37%. In a sign that the lender plans to further expand its operations within the MENA region, First Abu Dhabi Bank announced in January 2020 that it was in discussions with the Lebanon-headquartered Bank Audi to acquire its subsidiary in Egypt.

The emirate’s second-largest bank, Abu Dhabi Commercial Bank, has also participated in the recent consolidation trend, merging with Union National Bank in May 2019. The new entity also acquired Al Hilal Bank to form a new industry player with Dh405bn ($110.2bn) in assets as of late December 2019. The resulting banking group operates under the Abu Dhabi Commercial Bank name, although Al Hilal Bank has been retained as a separate Islamic banking entity within the group. The bank’s new asset base establishes it as the third-largest financial institution in the UAE, in addition to being the fifth-largest in the GCC. As with First Abu Dhabi Bank, Abu Dhabi Commercial Bank’s shareholder structure includes a strategically important government interest in the form of a 60.2% stake held by ADIC. The recent merger came at a strategic turning point for the lender, which in October 2019 announced that it would wind down its foreign operations in order to focus on its core home market. The newly enlarged financial institution expects to have completed the integration of its business operations by mid-2020.

Abu Dhabi Islamic Bank (ADIB) is the third-largest locally based banking institution in the emirate. Established in May 1997 by the government of emirate as the first sharia-compliant financial institution in Abu Dhabi, the bank is 39.4% owned by Emirates International Investment Company and 7.6% by ADIC. With total assets of approximately Dh26bn ($7.1bn) in early 2020, ADIB is the largest sharia-compliant bank headquartered in the emirate, and the second largest in the UAE. In line with many Islamic banking institutions, the operations of ADIB are primarily focused on retail lending, with 47% of its total assets in the retail segment in 2018, compared to 25% in wholesale. In recent years ADIB has passed a number of important milestones in its development, including a Dh1bn ($272.2m) capital-raising effort through the issuance of rights shares in 2019 and the appointment of a new CEO in 2019. In the domestic market the bank operates across all seven emirates, while overseas it has established a presence in the UK, Saudi Arabia, Qatar, Iraq, Sudan and Egypt.

Performance

Abu Dhabi’s banks have faced significant headwinds in recent years, including a low-growth global economy and a decline in oil prices which has the UAE’s fiscal position and slowed economic expansion. According to CBUAE figures, the combined credit facilities of the nation’s banking sector held relatively steady between December 2016 and December 2017, at Dh1.454trn ($395.8bn) and Dh1.453trn ($395.5bn), respectively. However, since 2018 a gradual recovery in oil prices has resulted in an improved scenario, with private sector credit growth reaching 4.1% that year, compared to the previous year’s more modest 0.9%. The recovery was primarily driven by lending to business and industry, which increased by 5.8%. After three years of heightened provisioning and deleveraging from risky sectors and asset classes, the majority of UAE banks entered 2019 well positioned to boost margins. The aggregate net profits of the 18 national banks listed on the UAE’s financial markets climbed from Dh21bn ($5.7bn) in the first half of 2018 to Dh24.5bn ($6.7bn) in the first half of 2019, an increase of 16.6%. Moreover, the aggregate net profit of the Abu Dhabi’s three biggest lenders grew from Dh15.8bn ($4.3bn) in 2018 to Dh19.9bn ($5.4bn) in 2019, an increase of 26%.

Lending

In 2019 credit facilities in the UAE market expanded by around 5.6%, from Dh1.509trn ($410.7bn) to Dh1.593trn ($433.6bn). It should be noted, however, that private sector credit growth remained relatively static at the national level, with aggregate claims on the private sector rising from Dh1.130trn ($307.6bn) to Dh1.134trn ($308.6bn), a gain of 0.4%. Abu Dhabi’s three largest financial institutions succeeded in expanding their aggregate loan book by 48% during this period to reach approximately Dh742bn ($202bn).

However, this gain was skewed by the 267% rise in loans and advances reported by Abu Dhabi Commercial Bank as a result of its merger. Meanwhile, First Abu Dhabi Bank and ADIB increased their loans and advances by 12% and 3.1%, respectively. The UAE’s banking system remains focused on traditional loan-based commercial banking activities, principally funded by deposits. Lending trends are therefore highly correlated to overall financial performance. The local banking industry is focused on the home market, with domestic credit accounting for 90.6% of the total credit portfolio at the close of 2019. The bulk of this credit is directed to corporate loans, which accounted for 51% of the total. Retail lending made up 21% of the aggregate loan book, while lending to the government and public sector comprised 16% and 12%, respectively. In terms of lending by economic sector, construction and real estate was the largest recipient of bank credit in 2019, accounting for 21.2% of the total, followed by personal loans for consumption purposes, at 21%. Other notable private sector lending areas were wholesale and retail trade (9.7%), personal loans for business purposes (6.3%) and manufacturing (5.1%). While national lending trends have remained relatively unchanged over recent years, at the emirate level government policy may have an impact on loan book composition in the coming year. For example, small and medium-sized enterprises (SMEs) are set to benefit from the Abu Dhabi government’s Ghadan 21, or Tomorrow 21, economic development package (see Economy chapter).

“A significant factor limiting lending to the SME sector is the lack of financial transparency and reporting. Banks are faced with the threat of SME business owners leaving the country without settling their debts,” Elissar Farah Antonios, CEO of regional international financial services subsidiary Citi UAE, Levant and Iraq, told OBG. “A new regulatory framework needs to be developed to protect banks from such a situation.”

While the banking industry of both Abu Dhabi and the broader UAE have fared well in the face challenges over recent years, the Covid-19 pandemic and concomitant fall in oil prices in the first quarter of 2020 will likely weigh on growth. Nevertheless, the authorities have acted swiftly to mitigate the impact of these two major challenges, with the government of the emirate launching a 16-point economic stimulus package in March 2020 to facilitate economic activity, reduce the costs of living and support businesses. The package pays particular attention to the emirate’s SMEs, allowing affected businesses to defer payments on existing borrowing for three months with a 50% reduction on any bank charges, among other measures. As part of this programme, a joint partnership between the Department of Finance - Abu Dhabi and the emirate’s three leading financial institutions was formed in order to provide sustainable finance options to SMEs. In addition, the CBUAE announced a Dh256bn ($70bn) stimulus package specifically for the banking sector in April 2020, with Dh61bn ($16.6bn) earmarked to support continued lending and liquidity management.

Financial Stability

The comparatively limited involvement of Abu Dhabi’s banks in investment banking, structured products and capital markets means that when it comes to calculating their risk exposure, it is their lending activity that carries the most weight. Indeed, risk-weighted assets represent nearly 80% of the total assets of the UAE banking sector, and credit risk makes up nearly 90% of that amount, according to the CBUAE. The prevalence of construction and real estate lending within the overall mix has therefore become a matter of concern to some industry participants. In October 2019 the UAE Banks Federation – the professional representative body of the industry – reported that it was reviewing draft proposals for limits on lending to the real estate sector. Although details have yet to emerge, the mooted lending caps would be industry-wide and aimed at protecting the broader UAE economy. While loan book concentration remains under discussion, UAE banks show strong financial soundness indicators. The CBUAE’s latest “Financial Stability Report”, published in February 2019, showed a capital adequacy ratio of 17.5% of risk-weighted assets, compared to the minimum requirement of 13%. These figures were achieved in accordance with the introduction of Basel III capital requirements in late 2017 and the implementation of the International Financial Reporting Standard 9 in early 2018 – both of which require the increase of capital adequacy levels. In January 2019 the Basel III framework was fully implemented.

Regulation

The CBUAE regulates all financial service providers in the country, and handles the licensing and regulation of the domestic banking system, including both national and foreign lenders. Financial institutions based in ADGM are subject to a distinct legal and regulatory environment, largely based on English common law and overseen by its own Financial Services Regulatory Authority. The CBUAE has consistently made keeping pace with international regulatory developments a high priority. For example, in June 2019 the UAE became the first country in the GCC to implement goAML, the UN-developed anti-money-laundering reporting system. The regulator has also significantly reformed domestic law governing the sector, introducing a new piece of primary legislation in 2018 onto which further regulations are being added on an ongoing basis. The primary effect of Federal Law No. 14 of 2018 has been to strengthen the central bank’s role with regard to monetary, credit and banking policy within the UAE. It granted the regulator a number of new powers over banks operating in the onshore environment, as well as the ability to exercise its authority over institutions outside the UAE or – in consultation with the relevant regulatory bodies – within the nation’s financial free zones. While all current CBUAE regulations, decisions and circulars remained in force after the initial application of the new law, the regulator is in the process of replacing them with revised versions, which it expects to complete by 2021. Unlike the old law, the new legislation does not specify minimum capital requirements for banks. Rather, it grants the regulator the ability to establish levels which it can subsequently increase or decrease, as well as the power to determine risk-based capital requirements. The law also has a strong consumer protection focus, imposing a duty on financial institutions to safeguard the confidentiality of customer data. The law gives the regulator the power to take over the management of an institution via an interim committee in order to protect depositors.

Fintech Revolution

As well as addressing its traditional regulatory concerns, the CBUAE is overseeing a wave of digital advances that has placed the UAE at the forefront of regional financial technology (fintech) innovation. In recent years, companies and institutions based in Abu Dhabi have played a central role in the development of this segment. For example, in 2016 ADIB partnered with Germany-based online financial institution Fidor to create the region’s first community-based digital bank where users can exchange financial advice and help co-create banking products. There has also been a rapid increase in the uptake of digital products by consumers in the UAE market, including mobile applications, contactless payments, full-service digital banking platforms and digital-only business accounts aimed at freelancers and start-ups.

Less visibly, fintech solutions are driving efficiency in a range of banking processes, including electronic know-your-customer operations, intelligent lending systems, client acquisition and wealth management. While the uptake of technology in the UAE has been rapid, the key challenge for most banks has been shifting from usage patterns that are mostly transactional to ones that will more directly benefit balance sheets and margins. Industry stakeholders have reported that customers are increasingly adopting technology solutions for many transactions, but some banking services – such as opening and maintaining bank accounts – are still largely conducted via traditional methods, rather than by digital channels. Overcoming this will be key to crossing the digital threshold.

New fintech tools capable of deepening interactions between banks and clients are arising from a number of global centres, including the GCC. The UAE is home to around 30% of the region’s fintech firms, and ADGM is emerging as an important centre for companies looking to serve the banking sector’s increasingly complex digital requirements. In October 2019 ADGM launched the Fintech Digital Lab to facilitate collaboration between financial institutions and fintech companies and start-ups, and address the challenges of replacing or integrating legacy banking systems with fintech innovations. The digital sandbox promises to speed up time-to-market for financial institutions by enabling product testing and verification prior to procurement.

The founders of the Fintech Digital Lab include the three largest banks in Abu Dhabi, along with AngloGulf Trade Bank, Dubai-based Etihad Credit Insurance, Chinese fintech platform OneConnect and US start-up accelerator Plug and Play Tech Centre. Anglo-Gulf Trade Bank was established in October 2018 as an ADGM-based joint venture between AGTB Holdings and Mubadala Investment Company. The institution is the world’s first digital corporate trade bank, and aims to facilitate trade-related financial and banking access to underserved corporate segments. The UAE Banks Federation is also playing a leading role in the expansion of fintech. Key initiatives from the industry’s representative body include the introduction of blockchain technology to enhance know-your-customer processes, boosting cybersecurity and the application of artificial intelligence to areas such as customer service, data analysis and decision-making. Furthermore, April 2017 saw the launch of Emirates Digital Wallet, a platform owned by 16 shareholding banks and developed through the sponsorship of the UAE Banks Federation. The firm has served as the driving force for the move towards digital payment, transfer and storage.

Outlook

Abu Dhabi’s financial institutions began 2020 in a strong position, with capitalisation standing at Dh164.1bn ($44.7bn) in February 2020 and its total credit allocation up 4.8% year-on-year. However, falling international oil prices and the disruption caused by the global Covid-19 pandemic will likely negatively impact sectoral performance over 2020. While the banking sector stimulus package launched by the UAE government in April 2020 is set to support liquidity, private sector lending and profitability could see declines. Abu Dhabi’s financial institutions have benefitted from the projects set in motion by Dubai’s hosting of Expo 2020. The delay of the international event until the following year could set the stage for an economic rebound in 2021. The anticipated eventual stabilisation of the macroeconomic situation should provide opportunities for Abu Dhabi’s well-capitalised banks to grow their balance sheets over the longer term. Indeed, national GDP is expected to recover from a 3.5% contraction in 2020 to 3.3% growth in 2021, according to the IMF. If this V-shaped recovery materialises, Abu Dhabi’s lenders are well positioned to take advantage of the recovery.