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04 June 2023

'Banks have to guard against becoming overcapitalised’

By Nitin Nambiar



Ajman Bank will become the seventh lender in the UAE’s growing Islamic banking sector when it begins operations in June this year. The bank, which announced its plans to sell 55 per cent of its equity in an initial public offering (IPO) earlier this week, opened its offer on Sunday.

The Shariah-compliant bank – the first to be headquartered in the emirate of Ajman – is the second Islamic bank to be launched in the UAE in the space of two months. Emirates Business spoke to Yousif Khalaf (pictured above), the bank’s chief executive, about the environment for Islamic banking in the region.


In the wake of Abu Dhabi Commercial Bank’s announcement of sub-prime write-downs, and a subsequent estimate from HSBC saying the underlying exposure could be much greater, do you think banks in the Gulf can evade exposure to the US sub-prime crisis?

Firstly, what you have seen recently from some banks such as Abu Dhabi Commercial Bank and Arab Banking Corporation’s announcement of write-downs, is not necessarily representative of the entire banking industry in the Gulf. How much of the exposure is actually disclosed depends entirely on the accounting and auditing standards that may vary within the GCC.

As long as the auditing standards are clear and properly regulated, there is no question of banks hiding their exposure to these bonds. I think the UAE’s disclosure model is competent.

Secondly, what is evident from the aftermath of the sub-prime crisis is that I am yet to know of any Islamic bank that has been exposed to these risky bonds. There are probably two or three banks in Bahrain including ABC and another couple of local, commercial banks, that have taken a hit on their bottom lines. But none of the Islamic financial institutions I know have reported such exposure.

Why have Islamic banks been relatively insulated from sub-prime exposure?

Well, most of these sub-prime-related products, sold to banks in the form of collateralised debt obligations, or CDOs, have a very complicated structure. Only sophisticated banks can be involved in such transactions, since it requires a specialised understanding of such products and a high risk-bearing appetite – although, by their very nature, they are typical transactions for Islamic institutions, since they are asset-backed.

But Islamic banks do not indulge in high-risk transactions. They are limited in their risk appetite. And also, there are issues with regard to their compliance to Shariah principles. Shariah scholars do not approve the structure of most of these transactions, though they do seem very appealing for conventional commercial banks given the spreads are so good and in most cases, they were even assigned very high ratings.

So how do Islamic banks like yours go about raising funds in the current environment of high liquidity?

Leveraging against the capital base is an important tool for raising money for Islamic banks. It basically implies that you can raise up to 10 times your capital base through deposits and other sources.

According to UAE regulations, the capital adequacy for banks is 10 per cent. So, for every dollar you have in your capital base, you can raise another nine dollars to buy assets. Leveraging is important to achieving a good return on equity. The average return on equity for Islamic banks is between 5 and 15 per cent.

Again, Islamic banks in the UAE leverage four to five times their capital base, while conventional banks leverage eight to 10 times of the capital base, which is again entering the high-risk zone. The capital base represents about 10 per cent of funding sources for conventional banks, as opposed to 20 per cent for Islamic banks.

Although Islamic banks seem to be growing fast, they don’t seem to be doing as much in terms of actual revenues compared to conventional banks. Why is that?

If you look at the Islamic banks, they have two books – the on-balance sheet and the off-balance sheet. The off-balance sheet is basically the funds they manage for other sources. The money in this case is taken from the investor for a specific investment and for a specific period and then the bank and the investor, on the basis of the agreement, share the profit. This is basically the off-balance sheet, which is sometimes significant compared to the on-balance sheet.

That is why the balance sheet for Islamic banks sometimes looks smaller compared to conventional banks. But I am sure if you put both the on-balance sheet and the off-balance sheet together, it would be a very different story. Shareholders in Islamic banks stand to gain much more because they use the off-balance sheet as a basis for the return on investment for the on-balance sheet.

Do you think banks in the UAE have the expertise to protect themselves from exposure to risky bonds, vis-à-vis the sub-prime crisis?

When you talk of risky bonds, there are two categories. One is the low-risk bonds, which are relatively safe from the crunch, and the second is the high risk one. Banks that invested in the low-risk assets have been quite safe from the effects of the crunch. The ones that invested heavily in the high-risk products were the ones that have suffered the most. Obviously, the returns looked very good. In most cases, they had good ratings and they were all asset-backed.

The interesting thing is the returns were so good, that it should have raised some caution among the banks. The banks soared in profits over the past two years [before the meltdown] because of these investments and then they lost everything they made in the past five years following the sub-prime crisis. This is where the risk management ability of the banks comes in.

So, as banks you need to be cautious of investing in assets in unknown markets. You need to have good knowledge of the market you are operating in and focus on them and you need to ask yourself the simple question: “Why are these assets paying such high returns?” Lack of expertise is part of the reason. Plus, the risk-management of the banks, which has to be good… you need to ask yourself, “Why is this paying me 400 or 500 basis points over when usually you would only get a fraction of it?”

Has the liquidity in the region also contributed to these rather high-risk investments?

Yes, that is also part of the reason. When there is so much liquidity, you don’t know where to put it. So that is also a major part of the reason for bad investments.

Given the negative interest rates scenario, do you think banks in the UAE are under pressure to raise capital?

Raising the capital base is not just driven by the liquidity, it is also driven by your need to grow and expand. When you have a scenario where the capital adequacy ratio is slipping below 10 per cent, that’s when banks tend to think in terms of raising the capital base in order to boost their balance sheet.

The other issue is the cost of funding. If it is easier to fund deals from external sources, then they would prefer it to raising their capital base.

Another issue is what we call the maturity mismatch – that happens when the yield on the money market account surges to a higher level than the yield from the bank’s assets. In this case, the banks may consider launching bond issues. They may choose to cut the dividends. The banks usually weigh all options before resorting to raising capital. Having said that, while liquidity is high, the opportunities to invest are also high. Over the past two years, the banks have nearly doubled their capital base. What banks have to guard against is being overcapitalised.

The banking industry is currently benefiting from higher margins due to the negative interest rates. But analysts have predicted that there is a chance of revaluation or de-pegging in the second quarter of this year. Do you think that is likely?

When you talk about revaluation, you have to consider the long history associated with it. While industry executives and investment banks have been fierce in their support of a revaluation over the past year, I don’t think any government can act in an impatient way. I am sure they are having a close watch on the scenario.

There are political as well as economic issues attached to it. I don’t see a revaluation happening any time this year.

You’re on the threshold of an IPO launch. What do you make of the appetite for IPOs in a year when the markets are looking so volatile?

I think the appetite is still very good, especially for regional banks. We are seeing good returns on bank IPOs and most IPOs launched in the past two years have been very successful. Given the current low interest-rate environment, I think you are going to see increased interest from investors.

What’s your outlook for banks this year, both globally and regionally?

We are going through the cycle at the moment. Even as global banks have taken a hit, regional banks have performed very well. I think this year will see most of the losses of last year being recovered.

The fundamentals and overall economic forecast is still strong. So the outlook is good. Even though growth may not be at the same level as last year, the industry will continue to grow at a healthy rate.



Yousif Khalaf

Chief Executive, Ajman Bank


Before his appointment as Chief Executive of Ajman Bank, Yousif Khalaf was the CEO of Bahrain Islamic Bank from 2004 to 2007 and Ithmar Bank, Bahrain from 2003 to 2004.

Khalaf has occupied senior executive positions both in conventional and Islamic banks. From 2000 to 2003, he held the position of Group Head, Finance & Support Services, in Shamil Bank of Bahrain, and between 1988 and 2000, he was assistant general manager, risk management and financial planning in Bank of Bahrain and Kuwait.

Khalaf started his career in the auditing field with Peat Marwick Mitchell, an international firm of accountants and consultants. Khalaf is a certified accountant from the Association of Chartered Certified Accountants (Acca) in the United Kingdom. He holds a higher national diploma in business studies from Salford College, UK, and an ordinary national diploma in business studies from Fielden Park College, Manchester, UK.

Between 1994 and 2007, Khalaf served on the Board of Directors of various companies, including Bahrain Commercial Facilities, BBK Financial Services, Al Khaleej Islamic Investment Bank, Shamil Bank of Yemen and Bahrain and Meezan Bank (Pakistan).

Khalaf is a Bahraini national, born in 1956.