JEDDAH, 3 October 2004 — With a booming economy to support, a number of large long-term financing contracts, and the growth of Islamic financing, the future looks bright for the United Arab Emirates’ banking industry, according to the Kuwait-based Global Investment House report on the UAE’s Economic and Strategic Outlook — Monetary Policy and Banking.
Significant long-term developments such as Dubai International Financial Center (DIFC), Burj Dubai and Dubailand projects would further fuel the growth of the UAE’s already robust economy, and in turn increase opportunities for banks. However, the emergence of DIFC could also increase competition, as many of the large foreign financial institutions like Deutsche bank, Credit Suisse and AON have already expressed their interest in joining DIFC, said the report released yesterday.
The UAE’s monetary policy, as implemented by the Central Bank, is to ensure the dirham’s stability and to control inflation, which has been kept under 3 percent per annum in the previous years. The Central Bank manages growth by aligning interest rates with those abroad, and by issuing certificates of deposit (CDs) to commercial banks.
Money Supply: In 2003 broad money (M2) grew by 15.5 percent, which is substantially higher than the non-oil GDP growth of 5.8 percent. Broad money growth has been higher than the GDP growth in the last few years, showing that economy is in a growing stage and is nowhere near saturation. Growth in 2003 was primarily due to the above average growth in narrow money (M1). There has been a 26.7 percent increase in monetary deposits, while quasi money, comprising savings deposits, time deposits, CDs and foreign currency deposits, increased by just 12.4 percent, reflecting the inclination toward holding fast money in a low interest rate scenario. The robust growth in money supply continued in the first quarter of this year too.
Open Market Operations: One of the methods that the UAE’s Central Bank uses to regulate money supply is issuing and buying back of CDs. In the last few years, there has been a major reduction in the liabilities corresponding to CDs of the Central Bank. This shows that either the Central Bank has been issuing fewer CDs, or buying them back from the market, in turn increasing the money supply. The consistent expansionary policy adopted by the bank confirms its view that the economy has good growth potential.
Interest Rates: Looking at the rate movements, the deposit rates in the UAE reached very low levels, in fact giving negative real returns, in spite of the sharp increase in the last quarter of 2003, and the first quarter of 2004, reducing the differential with the US rates. On the other hand, lower borrowing rates have been a boon for the economy, which saw good credit growth and robust investments. With the competition within banks stiffening, we do not expect a commensurate increase in the borrowing rates, even if the inter bank rates increase in the future, following the global trends. In the second half of 2003, even when the inter-bank rates remained stagnant, the borrowing rates continued its downward trend. However, it should be noted that there has been an increase in the borrowing rates in the first quarter of 2004.
Banking Sector
High liquidity growth in the country was reflected in the magnitude of its aggregate banking assets, which formed 184 percent of the non-oil GDP in 2003. The sector had an excellent year in 2003, and the good performance has been carried on in first half of 2004. Good times predominantly owed to the high credit and deposit growth on the back of low interest rate environment, high oil prices and a flourishing economy. Consolidated assets of the banking sector grew by 10.7 percent to AED366.9 billion, thanks to the total credit growing by 18.4 percent to AED226 billion. Led by robust growth in deposits and credit, overall size of the balance sheet increased by 10.7 percent to AED366.9 billion.
In terms of asset size, the UAE’s banking sector is second only to Saudi Arabia’s, within the GCC. Asset size of all the national banks put together increased by 9.9 percent to AED278.6 billion, while that of the foreign banks increased at 13.1 percent to AED88.3 billion.
Deposit Growth: In a conducive environment, total deposits in banks increased by 13.3 percent to AED237.56 billion in 2003. Deposits as a proportion of total liabilities stood at 65 percent, which is one of the highest within the GCC countries. The business sector rather than individuals led the growth in deposits in 2003. Private sector, which contributed to almost 30 percent of the total deposits, grew by 13.3 percent, while public sector, which contributed to around 9 percent almost doubled in 2003. These compensated for the relatively lower 8.2 percent growth of the individual deposits, which forms around 40 percent of the total deposits.
Credit Growth: The consistent increase in deposits endowed the banking system with abundant liquidity. However, cashing in on a business upturn, banks were able to increase credit to residents by an even higher rate. Total credit increased by 18.4 percent to AED226 billion, with the credit to residents growing by 18.9 percent to AED196.9 billion.
Though the credit growth in the country has been robust, quality of credit has always been a concern. Gross non-performing loans (NPL) at 14 percent of total loans remain high, compared to other GCC countries.
However, banks in the UAE have become increasingly prudent at improving the quality of their earnings, raised provisions, thus bringing down the net NPL to around 2 percent. In order to combat the problem of insufficient credit history of borrowers, the Central Bank has initiated a project to create a credit bureau, to enhance data collection on all major borrowers, and to make it available to banks.
Profitability: The banking sector in the country is extremely competitive, which led to a consistent decline in the interest rates on loans, further exacerbated by the decline in the overall interest rates. Even when the deposit rates plateaued in the later part of 2003, loan rates continued their downward movement, bringing down the interest rate spread from 5.6 percent in 2002 to 4.7 percent in 2003. Loans at rates less than 8 percent formed 73 percent of the total loans in 2003 compared to 67 percent in 2002 and 60 percent in 2001.
A decline in spreads did not prevent banks in the UAE from recording excellent growth figures in 2003 and in the first half of this year. Aggregate profits of the 12 listed banks in the country grew by 15.2 percent to AED4.09 billion in 2003.
The performance was even better in the first half of this year, with the profits growing by 26.1 percent to AED3.01 billion.
However, everything in not hunky dory for the banking sector in the UAE. Even though the banks have a strong home presence, they are extremely low on diversification in terms of geographical, customer and product point of view. Currently, the UAE market is clearly overcrowded and the situation is exacerbated by the lack of incentives for consolidation.
