Overexposure to the "highly speculative" real estate sector and highly leveraged companies has eroded asset quality of UAE banks, and the percentage of bad loans on the country's banks' books could go up to as much as 10 per cent, according to the Washington-based Institute of International Finance (IIF).
The ratio of non-performing loans (NPLs) to total loans has almost doubled from 2008 to 2009 in Kuwait and the UAE, and is expected to increase further this year, the IIF maintains in its regional overview of the GCC economies.
The institute reckons that the UAE's NPL ratio, which was at 2.5 per cent in 2008, surged to 4.8 per cent in 2009 and is forecast to reach 8.2 per cent by the end of this year. It could rise even further next year but are likely to remain below 10 per cent, according to Dr Garbis Iradian, Deputy Director (Africa/ME Department) with the IIF, and co-author of the report.
"The balance sheet of many UAE banks, especially those in Dubai, have large exposures to the real estate sector and also Dubai World and other government-related entities that are facing problems and might go for some kind of [debt] restructuring," Dr Iradian told Emirates 24|7 during his recent visit to Dubai. "That could affect the balance sheet of major banks," he added.
He said that while the actual level of NPLs depends on the economic recovery, "it would be highly unlikely that the NPLs would exceed 9 or 10 per cent next year. I would say they would remain between 8 and 10 per cent," he said.
The IIF report states that the UAE's banking sector is very exposed to the "highly speculative" real estate sector, with a quarter of total loans being extended to the property/construction sectors. With property prices in the UAE and across the world declining significantly over the past two years, the value of such assets and debt remains doubtful.
"Of course, a large proportion of [UAE] banks' balance sheets is exposure to real estate, and with real estate declining, there lies the problem," Dr Iranian said. "Overexposure to real estate and highly leveraged companies has eroded asset quality," the IIF report states.
"In the UAE, the banking system is significantly exposed to the construction and highly speculative real estate sector (25 per cent of total loans). Overall exposure to Dubai World by domestic banks is estimated at about $12 billion, equivalent to about 25 per cent of capital," the IIF report points out.
Dr George Abed, Senior Counsellor and Director of the IIF's Middle East-Africa Department and Dr Garbis Iradian, Deputy Director, have authored the semi-annual GCC Regional Economic Overview, including 2010 and 2011 forecasts by individual countries.
Dr Iradian told this website that he expects the UAE's NPL levels to peak in forthcoming quarters. "Usually, as experience in other economies shows, NPLs lag a recession, and we still don't know the true picture of the NPLs," he said. "Some banks may have classified certain loans as performing while they in effect might be non-performing," Dr Iradian said, adding that it depends on what definition of NPL a particular bank may be following.
Last week, though, the UAE Central Bank clarified norms regarding NPL classification, and has asked banks in the country to follow a tiered approach to classifying loans as non-performing and take appropriate provisioning.
The UAE Central Bank has asked banks to make a provision of 25 per cent of the outstanding loan where instalments are due for 90 or more days (but less than 120 days), 50 per cent provisioning if instalments are due for 120 or more days (but less than 180 days), and 100 per cent provisioning if instalments are due for 180 or more days.
The IIF report says that higher provisioning has impacted regional banks' bottom line. "The profitability of the banking sectors have been affected in 2009 and the first half of 2010 by the higher provisioning requirements related to the exposure to the two Saudi family-affiliated conglomerates, some deterioration in corporate loan portfolios, and defaults in personal loan and credit card portfolios," the report states.
The report also maintains that "GCC banks remain well capitalised and profitable with system-wide capital and liquidity cushions that helped them weather the global financial turmoil in 2009. This is largely due to solid economic performance in 2003-2008 that helped strengthen balance sheets, stronger regulation (Saudi Arabia and Oman), and high government participation in banks, ranging between 13 per cent in Kuwait and 52 per cent in the UAE."
According to the IIF, the average capital adequacy ratio was above 15 per cent for every banking system in the region although variations among individual banks are at times significant. According to the agency, UAE banks' regulatory capital to risk-weighted assets are reckoned to be the highest in the GCC for this year, at 20.3 per cent, compared with 16 per cent for Oman, 16.5 per cent for Qatar, 17 per cent for Saudi Arabia, 18 per cent for Kuwait and 20 per cent for Bahrain.
The IIF is the leading global association of financial services firms with over 450 members, including 50 institutions based in the GCC. The IIF's mission is to support the financial industry in prudently managing risks, including sovereign risk in developing best practices and standards; and in advocating regulatory, financial, and economic policies that are in the broad interest of its members and foster global financial stability.