The UAE banking sector is still in a recovery stage, after the 2008-09 real estate crisis in Dubai. However, the financial performance of banks has stabilized especially in recent years. UAE banks, particularly Dubai-based banks, face asset quality challenges, as reflected in their high proportion of non-performing loans and low provisioning levels. On the other hand, Abu Dhabi-based banks appear relatively less challenged by these problems due to their relatively less exposure to real estate and greater exposure to oil-based industries, which did well in an environment of favorable oil prices.
Key concerns related to UAE banks include i) concentration in loans and deposits, ii) high proportion of related party exposures, iii) transparency / limited data availability, and iv) stiff competition from industry. In addition, the performance of UAE banks has been limited by the real estate and construction sectors that are still recovering. Although banks maintain a strong presence in their local markets, the banking sector has limited diversification and shows concentration in terms of geographies, products and clients.
That said, most UAE-based banks benefit from a strong ownership structure backed by local governments. Furthermore, most of these banks are in the process of restructuring their problem loans. Dubai’s economy has shown encouraging growth in the last two years. All key sectors of the economy, including real estate, commerce, tourism and services, have shown considerable improvement. The better performance of the core sectors would lead to the reclassification of some of the non-performing loans as outstanding loans, which would reduce the pressure on the banking sector in the medium term.
Recent political unrest in some countries in the MENA region has benefited the United Arab Emirates due to its status as a safe haven in the region. Dubai has strengthened its position as a regional financial center and has become a key channel for investment in the MENA region. This has directly helped local banks. The key characteristics of the UAE banking sector are as follows.
i) Strong links with local governments: The UAE banking sector has been heavily dominated by the governments of Abu Dhabi and Dubai. The ruling families also participate actively through their investments in the country, generally through their holding companies. The government’s significant involvement in the UAE banking system proved beneficial during the global financial crisis. The authorities responded quickly when necessary and supported local banks in 2008 and early 2009. The UAE Central Bank has provided liquidity and deposit support to banks in the past to ease funding pressure. Markets expect continued support for UAE banks from local governments in the future, if needed.
ii) Strong capitalization: The UAE banking sector exhibits a very strong level of capitalization. Its capital levels are supported by consistent profitability, strong earnings retention, and capital injections from the government in times of need. The sector’s total capital adequacy ratio has exceeded 20% in the last three years, the highest in the Gulf Cooperation Council countries. However, the high levels of capital are also justified by the high proportion of non-performing loans from some banks, which require a higher than average level of capital.
iii) Weak asset quality: UAE banks are challenged by poor asset quality. Most of the Dubai-based banks have shown a very high level of non-performing loans and insufficient provisions. Moody’s expects NPL loans from UAE banks to remain in the 10-12% range in 2013. The agency also stated that despite the recovery in major industries, loans in NPLs to decline rapidly in the medium term due to banks. ‘Great exposure to troubled borrowers, especially in the real estate industry.
iv) Dependence on oil prices and global macroeconomic conditions: The performance of the UAE economy, especially Abu Dhabi, is highly dependent on oil prices. Any sudden drop in oil prices could result in lower public spending by the Abu Dhabi government. This could affect the performance of Abu Dhabi-based banks, which have been heavily involved in financing government-led projects. Furthermore, in the event of a sharp drop in oil prices, the resulting economic recession may further affect the lending activities of banks. On the other hand, Dubai largely derives its growth from the real estate, commerce, tourism and services industry. The performance of most of these sectors is linked to the global economy. Any deterioration in the global macroeconomic environment would directly affect Dubai’s economy and its banking sector.
v) Limited credit differentiation: It is difficult to differentiate between UAE banks just by looking at their credit metrics. Most of these banks are closely linked to local governments. Differences in asset quality and franchise value are the only primary distinguishing factors for banks in the country.
vi) High competition: the United Arab Emirates is a region with excess banking services. There are currently 51 banks operating in the United Arab Emirates. This has led to stiff competition in the industry and put pressure on banks’ net interest margins.
