UAE banks sufficiently capitalised

A stress test of eight of the leading banks in the UAE, accounting for 70 per cent of the 2009 banking system assets, reveals that the country’s banking is sufficiently capitalised to withstand significant deterioration in asset quality, according to investment firm Shuaa Capital.

Under the base case scenario of the stress tests conducted by Shuaa, the average total capital adequacy ratio (CAR) for the sample stood at 14.9 per cent, well above the 12 per cent UAE minimum requirement, and average Tier 1 capital was at 9.8 per cent, above the eight per cent UAE minimum.

“Under our conservative ‘worst case’ assumptions, average total CAR drops to 11.8 per cent and average Tier 1 CAR falls to 6.5 per cent; both are still above the Basel II international standards,” Shuaa notes in the report.

The report stress tests eight local banks: Emirates NBD, National Bank of Abu Dhabi, Abu Dhabi Commercial Bank, Mashreq, First Gulf Bank, Dubai Islamic Bank, Union National Bank and Commercial Bank of Dubai.

The report focuses on what Shuaa considers to be the banks' riskiest assets on their balance sheets; these include real estate and personal loans extended in 2008, potential losses associated with banks’ exposure to Saad, Algosaibi and Dubai World, and ‘renegotiated loans’ which appeared on most banks’ financials.

The investment bank notes, however, that some UAE banks may need additional capital support.

“Additional capital injections would be required for individual banks in all our scenarios, ranging from Dh2.5bn ($669mn) in our base case up to Dh15.8bn ($4.3bn) in our worst case. We believe that the authorities have the capacity to provide this financial support, if ever required.”

Shuaa further notes that banks in the UAE remain risk-averse even though the economy seems to be recovering from the recession. “Although the worst of the recession appears to be behind us, UAE banks remain risk-averse and reluctant to extend credit to the private sector,” the report says.

Shuaa’s base case suggests that UAE banks are, on average, capable of absorbing the potential losses associated with more stringent default assumptions, thanks largely to the authorities’ efforts to strengthen banks’ balance sheets since the onset of the crisis.

The implied Non-Performing Loan (NPL) ratio rises from 3.3 per cent (actual 2009 ratio) to 8.4 per cent, while total CAR remains healthy at 14.9 per cent and Tier 1 capital remains above regulatory requirements at 9.8 per cent.

“Although Emirates NBD and ADCB would be the only banks needing a combined Dh2.5bn ($669mn) of additional Tier 1 capital to meet the stringent UAE requirements, all the banks in our sample comply with Basel II standards,” the report maintains.

“In our ‘worst case’ scenario where we assume what we considered to be the maximum default rates on both real estate and personal loans extended by banks in 2008, average total CAR is marginally below the Central Bank’s requirement, while the average Tier 1 capital ratio remains above the Basel II floor,” Shuaa said.

“However, in this (unlikely) event, we have no doubt that the UAE authorities would provide the required financial support to these banks, particularly as the government has already stepped in to recapitalise some UAE banks at the height of the financial crisis,” the report highlighted.

“As private sector credit growth is critical for a sustained economic recovery in the UAE, the current situation should be addressed directly. Uncertainty about the extent of future provisions and questions over banks’ ability to absorb potential losses will otherwise linger, undermining confidence and making it more difficult for banks to attract much needed funding to grow their loan books,” Shuaa noted.

The investment firm suggests that the UAE follows the Irish approach to encourage banks to resume lending. Ireland’s financial sector was heavily exposed to the real estate sector, which had fuelled its growth in the decade preceding the financial crisis. More than 75 per cent of the six Irish banks’ total loans were reportedly secured against property.

To overcome the crisis, the Irish government capitalised the banks in return for equity, in some cases nationalising the banks outright. Secondly, they created a National Asset Management Agency (Nama) to take on the riskiest assets of the banks, mainly real estate backed loans, in return for government securities.

These loans, with an estimated face value of €80bn as of March 2010, were purchased at a discount by Nama, and will be managed over a 7-10 year period to maximise the return for the taxpayer.

“We believe the Irish solution is one that should be seriously considered. Indeed, the UAE enjoys a relatively strong fiscal position that should enable it to fund the creation of a government-backed ‘bad bank’ to host local lenders’ most toxic assets.

Qatar has implemented a similar solution for banks' local equity and real estate exposures, which appears to have been relatively successful.

“By removing some of the riskiest assets from UAE banks’ balance sheets and replacing them with lower risk government paper, or cash, banks will be in a much stronger position to attract funding and resume lending to households and businesses,” the Shuaa report said.

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