Why 2018 will be an interesting year for the UAE's banking industry

The aggregate net profit of UAE banks increased by 6.3 per cent to $7.8 billion at the end of the third quarter of 2017 compared to $7.3 billion at the end of the same period last year.

The UAE banking industry started off the year with the issues of tightening liquidity and deteriorating credit quality in the SME sector. Apart from these concerns, weaker credit growth as a result of slower economic growth and business activity was another major challenge faced by the UAE banking industry.
Nevertheless, the banking sector, which witnessed some recovery in 2016, post the rout in 2015, have maintained the positive momentum in 2017 as well.
 
Profitability
UAE banks, post the rate hike and with improved credit conditions, witnessed a marginal expansion in interest margins, resulting in improved earnings so far in 2017. The relatively stable performance can be attributed to growth in the non-oil economy, improved liquidity and stable funding conditions. However, sluggish credit growth and lingering credit quality issues particularly in the retail and small business portfolios are negatively impacting its profits.
The aggregate net profit of UAE banks increased by 6.3 per cent to $7.8 billion at the end of the third quarter of 2017 compared to $7.3 billion at the end of the same period last year. The four leading UAE banks, which account for in excess of 60 per cent of the banking assets, have managed to remain profitable in 2017. However, First Abu Dhabi Bank's net profit contracted marginally as of the third quarter of 2017 compared to the same period last year. Ganks were able to reprise loans in line with the rising interest rate scenario, resulting in higher net interest income.
 
Liquidity
Funding and liquidity in the banking industry was supported by stabilising oil prices and sovereign bond issuances to some extent as the year progressed. UAE banks' deposits stood at $432 billion at the end of October 2017, against $405 billion at the end of October 2016 easing the liquidity crunch in the domestic banking system. The biggest surge in deposits came from the government sector, which increased by 39 per cent to $60.5 billion as of October 2017, compared to $43.5 billion at the end of the same month last year. With the rise in government deposits and contraction in loan growth, the sector returned to be a net depositor in the banking system.
 
Credit
Credit offtake remained subdued during the year with a marginal increase of 0.9 per cent between the third quarters of 2017 and 2016. Credit growth was supported largely by government borrowing, which grew by 4.3 per cent at the end of the third quarter of 2017. However, loan growth from government-related entities contracted the most (6.7 per cent) during the same period. The private sector witnessed a positive but weak credit growth of 0.4 per cent between the third quarters of 2017 and 2016, while the contraction in the retail loan segment continued. Retail loans stood at $90 billion at the end of the third quarter of 2017 against $93.4 billion at the end of the third quarter last year.
 
Assets
Between the third quarters of 2016 and 2017, the total assets of banks operating in the UAE increased by 3.7 per cent reaching $714 billion. The increase in the assets was largely supported by the growth in investments (10 per cent) by UAE banks, especially investment in the debt securities. The anaemic credit growth, surge in deposits and also booming regional debt market, seem to have driven UAE banks to invest in debt securities.
 
Conclusion
The UAE has hiked interest rates twice this year in response to the US doing so. With the US economy stabilising, it is anticipated that the Fed might raise rates by 0.5 per cent to one per cent in the next one year. This will create a trickle effect in the UAE banking sector as well and we can continue to expect a rising trend in 2018.
Credit offtake is expected to soften in the following quarters due to the lull in the economy. Slower economic growth and increasing non-performing loans will pose challenges for UAE banks going forward. However, these challenges have pushed banks into a consolidation mode and to take aggressive steps towards improving profitability and cost efficiencies. Banks are also actively looking to merge within the UAE and improve economies of scale; this could be an interesting development to watch out for in 2018.
The writer is managing director of Marmore Mena Intelligence. Views expressed are his own and do not reflect the newspaper's policy.