As a result of the sharp oil price decline, which has caused weakening deposits, tighter liquidity, and higher interest rates, UAE banks are expected to witness negative earnings growth as well as bigger credit losses in 2016.
But, in contrast to the global financial crisis of 2008, global rating agency Standard & Poor’s believes that the UAE will undergo a gradual, longer deterioration in operating conditions and bank profit margins.
A lacklustre performance is also predicted for 2017, with IG Dubai analyst Hussein Al Sayed pointing out that recent oil price action suggests bears are in control and very aggressive.
UAE’s reliance on oil for a strong economy
Investors are comparing today’s tougher conditions for banks in the UAE to those during the global financial crisis starting in 2009. However, Standard & Poor’s believes that this time is different.
said Standard & Poor’s credit analyst Timucin Engin.
This is according to a report entitled UAE Banks: Earnings To Decline in 2016 As Operating Conditions Weaken. Along with falling oil prices, the previous financial crisis was also compounded by a steep decline in the value of real estate and the liquidity squeeze. This revealed excess leverage and weak funding structures for certain government-related entities in addition to a lack of proper underwriting practices at some UAE banks.
Although performance dwindled in 2009 and 2010, liquidity began to flow back in as oil prices grew stronger. Then, declining credit losses eventually made way for a recovery in bank earnings. But this time around, oil prices are markedly lower and could stay there for a prolonged period of time. As Al Sayed noted in mid-January, “US oil traded below $30 for the first time since 2003 testing a low of $29.93, extending losses over the first seven trading sessions to 19.04 per cent.”
On account of the fact that the UAE relies on this commodity so heavily, domestic economic growth is slowing down, which isn’t helped by continued volatility on the UAE equity markets and a correction on the residential real estate market.”
Adopting a more conservative stance
We believe the uncertainty about how long oil prices will remain weak will force businesses and government to adopt a conservative stance, which will weaken spending for infrastructure and private-sector investments, and rein in bank lending
One thing that will work in the UAE’s favour now is better regulation and strong underwriting practices compared to the previous financial crisis. This will make the banks less vulnerable to any sharp decline in asset quality. Also, S&P maintains a stable outlook for the UAE banks it rates in spite of an expected credit growth slowdown.
We don’t see a big threat to capitalisation. The banks we rate continue to operate with strong capitalisation, with Tier 1 ratios generally above 15 per cent.
However, from our discussions with banks, we believe that they will generally retain higher levels of earnings to ensure they have enough capital as credit losses increase. That means a cut in dividend payouts, which have been increasing over the past few years in line with profitability.