The weak global economy and slowdown in Abu Dhabi will represent new headwinds for the UAE banking system, according to Fitch Rtaings.
“Whilst the fragile real estate sector and the ongoing problems in Dubai government-related entities and several UAE corporates continue to pose significant asset quality challenges for the sector, banks will face new headwinds,” Fitch said.
The UAE operating environment is not immune from global issues and this threatens the recovery in the banking system. Fitch is particularly expecting several key economic sectors, such as trade, tourism and services to be negatively impacted.
Abu Dhabi has been cutting its spending on construction-related projects, owing to concerns about the significant oversupply in the real estate market, an increase in the Emirate’s financial commitments, and the slowdown in the global economy. Key projects remain in the pipeline, but some contracts have been delayed or possibly cancelled, as the Abu Dhabi government has prioritised major infrastructure projects. Fitch views this as positive and to benefit the economy in the long-run. However, this sharper-than-anticipated slowdown in the construction sector in Abu Dhabi could have some implications for the banks’ asset quality in the short-term.
The significant increase in the renegotiated private sector loans hides the true extent of the banks’ asset quality problems. Whilst fundamental credit issues in the operating environment remain unresolved, some of these loans may re-emerge as non-performing loans. Ultimately, the success of the various restructuring and renegotiating plans accepted by the banks depends on recovery in both the UAE and globally.
Overall, UAE banks remain profitable to date, despite weaker asset quality and slow loan growth. Core earnings benefit from lower funding costs. However, Fitch anticipates core earnings will decline given low business volumes and the recent Central Bank of the UAE rules on retail banking. Nevertheless, Fitch recognises the ability of pre-impairment income to continue to absorb high credit costs.
Customer deposits decreased significantly in the past three months with the outflow of unstable deposits (hot money) and some large government related deposits. As a result, the system loans/deposits ratio climbed back to the 100% mark in September 2011. However, Fitch believes that liquidity pressures remain manageable at a time when loan growth is slow.
The key challenge for liquidity is the banks’ ability to raise long-term funding. It is clearly more costly, especially for Dubai based banks, when global markets are less liquid. Combined with a relatively tight loans/deposits ratio, Fitch expects continuing funding constraints.
Positively, high levels of capital and healthy core earnings provide banks with a solid cushion against a potential increase in non-performing loans. This underpins the banks’ Viability Ratings.