UAE’s Local Banks Aggressively Grab Market Share

UAE banks have aggressively expanded their corporate loan books in recent years, a surge that many say could signal a long-term shift in local financial services.

Mostly, it’s been a case of filling the gap left by international lenders since the 2008 downturn. European banks have been on life support for a while now and have increasingly retrenched to tend to worsening conditions at home.

Walid Aradi, CEO of Tahseen Consulting, says: “They were seeking to limit their exposure [to the Middle East], focus on rebuilding their competitive advantage in their home countries, and improve their balance sheets. This left the local banks, which came off a period of consolidation, ready to pick up the slack should the economic conditions improve.”

He says with UAE economic growth hovering around four per cent, and an increased appetite to lend due to the introduction of loan caps and more defined lending criteria, local banks responded by aggressively marketing their existing products, and offering new ones. They have also benefited from an increased pace of government infrastructure projects.

Other favourable conditions have opened up the local market for UAE lenders, including a return of excess cash in the system as the impact of the UAE housing crisis faded. This boosted the liquidit positions of most banks, who were also bolstered by strong capital inflows caused by the Arab Spring.

Analysts say domestic financial institutions have shaped up their portfolios and are starting to offer more sophisticated products in conventional and Islamic banking than before. As a result, they’ve been eating up market share and have witnessed buoyant growth recently.

The UAE Monthly Banking Indicators, published by the UAE Central Bank, show that despite experiencing modest year-on-year growth of 2.6 per cent in 2012 in loans and advances, the increase in the first seven months of 2013 exceeded 4.3 per cent. Championing this growth were local banks such as ADCB, Emirates NBD, Mashreq and First Gulf Bank, which have been some of the most aggressive players in filling the gap left behind by the downsizing of operations of some internationals.

Lending to government-related entities (GREs) is currently well above the ceilings envisaged by the UAE central bank last year, which has led to concerns about a repeat of Dubai’s corporate debt crisis. According to a recent Merrill Lynch research note, UAE banks’ GRE exposure is at its highest level as a percentage of capital since the 1970s.

New figures show the domestic banking sector has extended $42 billion in credit to the government and GREs since the banking crisis of 2008.

As a result, exposure to the government and non-financial public enterprises as a percentage of bank capital is at 104 per cent.

Few will forget the negativity that rained down on the UAE, particularly in the international media, following the Dubai World and Nakheel defaults.

The GREs relied heavily on local banks to support the restructuring process in the aftermath of the Dubai property crash.

The Merrill Lynch note says: “This fully compensated for the foreign outflows but increased the banking sector’s exposure as percentage of capital by 26 percentage points. The credit stock also suggests very roughly that about 50 per cent of Dubai Inc debt is owned domestically.”

In 2012, the central bank tried to introduce rules as part of a drive to reduce risks and prevent any recurrence of Dubai’s 2009-2010 collapse, but the decision was dropped after banks complained the regulations would slow banking growth and cause major losses.

However, last month, Abdulaziz al-Ghurair, head of the national banking industry association and chief executive of Mashreq, said the central bank had ‘re-tabled’ the caps on GRE lending and was announcing a revised set of sanctions later this year.

It’s an important development due to the size of the loan market that’s now up for grabs.

According to Arno Maierbrugger, editorial director at Inside Investor: “The personal loan market has a size of around Dh25 billion a year and together with the corporate loan market the overall size of the lending market in the UAE is an estimated Dhs2.5 trillion, and loan growth in 2013 so far was enormous against 2012. Local banks can probably get a slice of as much as 60 – 70 per cent of that market.”

Meanwhile, analysis by Frost & Sullivan suggests that if the state of the global economy does not improve foreign banks might have to pull back their operations in the UAE even further, which is expected to create a funding gap. It has emerged that European banks lent around 25 per cent of the UAE economy’s GDP as of September 2011, according to the consulting firm.

While this may seem an added opportunity for local banks to further strengthen their presence, banks in the UAE are facing an issue of declining margins in the corporate lending segment as huge companies are increasingly demanding lower borrowing rates. Hence, UAE banks may not find corporate lending an attractive opportunity and could instead focus on other segments such as retail loans.

But if a funding gap is created in the future, companies might be willing to undertake higher borrowing costs in the wake of a shortage in credit supply making corporate lending attractive for the UAE banks.

The safe bet is that it’s likely that the market share of local banks will increase marginally in the future while foreign banks will try to retain their current loan book size in the UAE.

What is certain though is that overall, local banks that managed to increase their share of the corporate and consumer lending markets recently will find it increasingly difficult to maintain past levels of profitability.

This is partly down to the level of future economic growth in the UAE, which is not likely to reach the heady heights posted in 2005 or 2007. And measures, like Al-Ghurair’s caps on state entity lending and changes to capital and liquidity requirements, could have a dampening effect and raise cost pressures on the banking sector.

Local lenders are facing pressure to improve products and services if they’re to keep momentum up in their corporate lending business.

Sheetal Kothari, research analyst, Business & Financial Services Practice, Frost & Sullivan, says: “We recommend domestic banks in the UAE focus on relationship management skills, ensuring continuous credit assessment of the borrower and innovate customised product offerings and strategies for cross selling to improve their margins in the corporate lending segment.”

Others insist that UAE banks must do more to attract global talent and form greater alliances with global banks to overcome their limited international footprint.

There is a chance that local players in the UAE could make their gains in recent years permanent. However, without fully seizing the opportunity, local banks will find themselves having to fend off pressures from global banks when their appetite to invest in emerging markets returns as a consequence of improved market conditions in their home countries.