The UAE banking system has largely demonstrated its resilience to slower global economic growth and the recent collapse of three banks in the US, as well as the takeover of Credit Suisse, which precipitated a loss of confidence in the global banking system.

Banks operating in the country reported higher net profits in the first quarter of the year after a robust performance in 2022, as strong economic growth helped to drive an increase in margins and net interest income.

The aggregate net income of UAE’s top 10 lenders surged by 35.3 per cent quarter-on-quarter to Dhs18.3bn, driven by enhanced cost efficiencies and lower impairment charges, according to Alvarez & Marsal’s UAE Banking Pulse Q1 2023 report. This increase in profitability was further supported by a rise in non-core income.

The country’s banking industry has adequate capital and liquidity buffers to withstand severe shocks. It will continue to benefit from stable and strong capital buffers and good funding profiles. The UAE’s real GDP is projected to expand by 3.3 per cent in 2023, as the country remains relatively insulated from the global economic downturn.

“We expect the UAE’s economic growth to slow modestly in 2023 due to OPEC+ agreed oil production cuts and deceleration in the non-oil sector due to higher interest rates,” said Dr Mohamed Damak, senior director, S&P Global Ratings.

Higher oil prices, supportive government spending and a surge in non-oil business activity are expected to support GDP growth and reinforce banks’ creditworthiness.
S&P Global said the strong performance in the UAE’s banking sector in 2023 is being driven by higher interest margins, a supportive domestic economy and high oil prices.

On the digital front, the typical banking customer is changing. As a result, the UAE lenders must move with the times as the country’s banking sector is considered as one of the most pro-innovative across emerging markets.

The UAE Banks Federation (UBF) said that the adoption rates for digital banking services in the country have increased more than 100 per cent, driven by the advancements made in deploying innovative technologies.

The country is home to several digital banks focusing on streamlining operations to conduct high-volume digital transactions. Dr Damak noted that the adoption of neobanks is increasing in the UAE, but the digital-native banks’ current offerings are limited to plain vanilla products.

Digital banks in the UAE are actively improving straight-through processing methods to enhance customers’ digital experience and further leverage data to align products and services with customer expectations.

The UAE, particularly Dubai, is a key business and finance hub in the Middle East, and the country appears well-positioned to withstand any external shocks such as the ongoing global banking crisis. The country is also home to global financial institutions serving the region.

Profits pass the pre-pandemic mark

The UAE’s banking sector got off to a strong start in 2023 after experiencing landmark growth last year on the back of an improving operating environment marked by economic recovery and the central bank’s moves to tighten monetary policy.

Asad Ahmed, Alvarez & Marsal managing director and head of Middle East financial services, said that Q1 2023 has been a very strong quarter for the UAE banks and the sector is expected to maintain the gains of the first quarter for the balance of the year.

“Stable net interest margins (NIMs), improving cost efficiencies and lower impairments have led to record profits for the UAE banks in the previous quarter, although we witnessed mixed performance by some banks on the margin front.”

The combined net profits of the UAE’s top five banks – First Abu Dhabi Bank (FAB), Emirates NBD, Dubai Islamic Bank (DIB), Abu Dhabi Commercial Bank (ADCB) and Mashreq Bank – reached Dhs14.9bn in the first quarter of the year.

FAB’s Q1 2023 net profit jumped 70 per cent year-on-year (YoY) to Dhs3.9bn, Emirates NBD’s net profit soared 119 per cent to Dhs6bn, ADCB reported a net profit of Dhs1.88bn, up 27 per cent YoY, DIB’s net profit rose by 12 per cent to Dhs1.51bn while Mashreq registered a net profit of Dhs1.6bn.

S&P Global said profitability at UAE banks has recovered to pre-pandemic levels mirroring the performance of their peers across the GCC region on the back of higher interest rates and stable cost of risk. The rating agency highlighted that efficiency in the UAE banking sector remains strong, but inflation will likely drive up operating costs.

“UAE banks are ‘strong, capitalisation is in good shape’ with higher return ratios,” according to Alvarez & Marsal. However, it remains to be seen if the banks will maintain the strong momentum experienced in the first quarter throughout the year.

The Central Bank of the UAE (CBUAE) raised key interest rates on its overnight deposit facility by 25 basis points to 5.15 per cent from 4.90 per cent after the US Federal Reserve (Fed) delivered its 10th consecutive hike in May. The apex lender maintained the rate applicable to borrowing short-term liquidity through all standing credit facilities at 50 basis points above the base rate.

Fed rate-hiking cycles and their almost full replication by CBUAE and other GCC central banks resulted in higher aggregate NIM for the banking sector. “UAE banks are adopting a pragmatic approach in reflecting the increase in interest rates for their clients so that they do not push the client to default,” says Dr Damak.
“We expect the overall impact of higher interest rates to be positive for the banking system.”

S&P Global Ratings said the UAE’s central bank has mirrored all of the US Federal Reserve’s interest rate hikes in 2022, a trend that is expected to continue in 2023, which would benefit the country’s banking sector.

UAE’s financial institutions have adequate capital overall and abundant liquidity, while their asset quality has improved modestly from pandemic-era peaks. Similarly, the pegging of the dirham to the US dollar all but eliminates foreign exchange risk, a most valuable trait in emerging markets (EM) at a time when faltering commodity prices present a risk to the EM FX asset class.

Digital banking

The UAE banking sector is at a pivotal moment. Faced with changing consumer expectations, emerging technologies and new business models, banks are implementing digital strategies now to help them prepare for an artificial intelligence-powered banking ecosystem of the future.

Mainstream banks in the UAE were already at the forefront of innovation and digitalisation well before the pandemic. Most incumbent banks in the country have made significant strides in recent years to overhaul their digital strategies in a bid to not only counter the threat posed by challenger banks but also to streamline operating costs as customers turn away from branch-based banking in favour of smartphone-based alternatives.

“The great leap in digital banking adoption was achieved in line with the strategic vision of the UAE central bank, which is characterised by its proactive approach in setting the framework to keep abreast with the latest technologies and support for the banking sector in developing innovative solutions,” Jamal Saleh, director general of the UBF said in an address at a banking technology summit in Dubai.

Greenfield banks vs Neobanks

Mashreq trimmed its nationwide branch network from 34 in 2019 to just 10 this year. The Dubai-based bank is one of several UAE traditional lenders that operates ‘digital spinoffs’ offerings with its consumer-facing Neo and business-focused NeoBiz.

According to Dr Damak, “Banks have been cutting their branch network significantly and diverting the business to electronic channels.” He believes that the payment and money transfer business is being disrupted by neobanks and other fintech firms and traditional banks such as Mashreq have set up speedboats, greenfield banks or digital attackers to maintain a competitive edge and reduce operating costs.

Emirates NBD launched Liv., a digital-exclusive bank for millennials, in 2017. Building on this success, the bank unveiled E20 in 2019, a digital bank that caters to the needs of small and medium-sized enterprises. DIB also introduced its digital spinoff rabbit in December 2021. The Shariah-compliant lender’s digital banking platform, which is aimed at serving the banking need of tech-savvy customers, offers current accounts, globally accepted debit cards as well as payments and money transfer services.

Dr Damak says several UAE banks relaunched their digital banking platforms in 2022 to bolster service delivery, meet customers’ evolving demands and maintain a competitive edge in a highly competitive market.

“As consumers become more dynamic and demanding in the ways they interact with banks, commercial banks are seeking opportunities to deliver technology-enabled services that go beyond traditional banking,” said KPMG.

UAE banks are taking a more sophisticated approach to digital transformation by leveraging application programming interfaces (APIs) to maximise the value they derive from these digital workhorses. APIs are at the core of banks’ open architecture and play a significant role in UAE banks’ digital strategy.

Abu Dhabi Islamic Bank launched its first API developer portal in June 2022 to help fintech developers to build new products that interact with the lender’s platforms.
Emirates NBD also launched a ready-to-use API developer portal, ‘Emirates NBD API Souq’, to offer fintechs, developers and corporate clients an all-in-one ecosystem to build innovative financial solutions.

Digital banking has yet to reach mainstream adoption in the UAE, but the market is already showing an appetite for alternative solutions that enable customers to access banking services without stepping into brick-and-mortar branches.

Royal Strategic Partners-backed NAQD Community Bank is the latest neobank to join the UAE’s growing digital banking ecosystem after receiving preliminary approval from the CBUAE.
RAKBANK-backed YAP, ADQ-owned Wio Bank, Zand Bank and Abu Dhabi-based Al Maryah Community Bank are already dominating the UAE’s digital banking sector.

“The adoption of digital channels is on the increase, and the launch of the challenger banks has brought urgency to the digital transformation of the existing banks; however, it is still early days, and the impact of the challenger banks has yet to be fully felt,” says Ahmed.

The emergence of new innovative technologies and the initiatives that are also being implemented by the UAE’s financial hubs – Abu Dhabi Global Market and the Dubai International Financial Centre – offers banks a window to be more innovative and efficient in service delivery.

Pivoting Islamic banking growth

The structural characteristics of banks in the UAE are a diverse mix of conventional and Islamic entities as well as being both retail-focused and corporate-aligned in their stance. The country’s Islamic banking industry has evolved over the years, and so too have the product structures as the sector moves to offer tailored features to meet the needs of a growing investor base.

The UAE remains a key Islamic finance hub, and the sector accounted for 29 per cent of total Islamic financing at the end of 2022. Islamic banking growth outpaced conventional banks last year, driven by growing investor demand for Shariah-compliant products and deep distribution networks.

UAE Islamic banks grew by 8 per cent in 2022, higher than their conventional peers’ 3 per cent, according to Fitch Ratings’ UAE Islamic Bank Dashboard 2023 report. The sector’s operating profit/risk-weighted assets ratio improved significantly in 2022 on widening net financing margins and lower financing impairment charges.

Fitch projected that the credit fundamentals of UAE’s Islamic sector would continue to be supported by high oil prices and solid economic conditions in the medium term, which is expected to alleviate the impact of rising profit rates on borrowers.

However, the continued digitalisation of the sector will boost the need for further mergers and acquisitions to defend market share and find cost synergies, mainly among smaller Islamic banks that risk being left behind. The country’s major deal to date is DIB’s acquisition of Noor Bank in January 2020, a deal that created a Shariah-compliant mega bank with total assets of Dhs292bn as of March 31, 2023.

In this context, the outlook for the UAE banking industry looks reasonably bright, and the sector will likely benefit from stable exchange rates, relatively low inflation, buoyant non-oil business activity and major public and private investment programmes.

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