Higher interest rates to raise UAE Banks’ profitability
S&P Global Ratings expects banks in the UAE to benefit from the planned increase in interest rates by the US Federal Reserve, which the Central Bank of the UAE (CBUAE) will likely mirror because the UAE dirham is pegged to the US dollar.
S&P Global economists expect the Fed to raise rates six times this year starting in March, and five more times in total in 2023 and 2024.
These rate changes will increase revenues for UAE banks.
Overall, S&P expects the cost of risk to increase slightly in 2022 to around 120-130 basis points (bps) compared with 116 bps in 2021 as COVID-related support measures are lifted.
The rating agency believes the cost of funding will inevitably rise as some deposits migrate from no- or low-interest to interest-bearing products.
However, with around two-thirds of total deposits bearing no or limited interest, UAE banks’ funding will remain a strength. The net external asset position is also likely to shelter UAE banks against lower and more expensive global liquidity.
UAE banks to benefit from higher rates
As of Dec. 31, 2021, data from the top 10 banks in the UAE show that banks are likely to have an increase of 15% of their net income or an additional 1.4% of return on equity for every 100-bps increase in rates.
These numbers are on the stylized assumption that banks’ balance sheets remain static and the shift in the yield curve is parallel.
Banks in the UAE continue to benefit from a large proportion of current account and saving deposits (CASA), which accounted for two-thirds of total deposits as of Sept. 30, 2021.
Also, banks’ balance sheets have been positioned in a manner that makes them benefit from the increase in interest rates, with a higher amount of repricing assets than liabilities.
Increase in cost of risk
An increase in interest rates would imply a higher debt-service burden for retail and corporate clients, anywhere around the world.
In the UAE context, S&P Global sees two main sources of risk: retail loans (including mortgage and consumption loans) and exposure to SMEs.
For corporate exposures, S&P expects banks will adopt a pragmatic approach and would not reflect the full extent of the increase in rates if they feel this could push their clients to non-performance.
Retail loans for lending and consumption purposes accounted for 27.8% of total lending as of Sept. 30, 2021.
S&P estimates the residential mortgage lending exposure of UAE banks was around AED150 billion ($40.9 billion) as of Sept. 30, 2021 (almost one-third of total retail exposures). This was based on the data disclosed by CBUAE at year-end 2020.
S&P re-expressed its view that an increase in interest rates will benefit the UAE banks through higher profitability.
“We believe that banks will be more than capable of absorbing our projected increase in the cost of risk. Banks are also very efficient, with a cost-to-income ratio of around 36% for the top 10 banks at year-end 2021,” S&P Global said.
“While we expect a slight increase in costs for some rated banks, efficiency will continue to support their profitability. Finally, with an average Tier 1 ratio of 16%, banks in the UAE continue to benefit from strong capitalization, which will provide them with an effective cushion against unexpected credit risks.”
S&P’s rating outlook on all UAE-rated banks is stable, reflecting its view that capitalization and profitability will continue to protect these banks’ creditworthiness over the next 12-24 months.