Dubai: The UAE’s banking system remains resilient despite a challenging operating environment due to the fallout from the COVID-19 pandemic, according to the findings of the UAE Central Bank’s latest Financial Stability Report (FSR).
Core banking indicators indicated adequate funding and liquidity positions and sustained lending capacity. However, the vulnerability of the banking sector remained as the economic slowdown weighed on asset quality.
Higher depreciation charges and lower operating income reduced profitability. However, the aggregate capital buffers remained adequate and well above regulatory requirements.
The UAE’s banking system has entered the pandemic from a position of strength, enabling banks to provide targeted relief measures to affected customers.
“Financial soundness indicators reflect the overall resilient position of the UAE banking system, supported by adequate capital and liquidity buffers, which have been maintained during the pandemic. Nonetheless, uncertainties remain about the pace of the economic recovery and the associated pressures on asset quality, ”said FSR.
The assets of the UAE banking system increased by 3.4% in 2020, reaching 3.2 trillion dirhams. Overall loan growth remained positive in 2020 at 1.2% year-on-year, despite the economic contraction. Loan growth moderated at the end of the year due to the rebalancing of the loan portfolio and loan repayments to businesses.
The funding profile of UAE banks has remained classic, primarily through deposits representing 68.6 percent of total liabilities. The deposit base of UAE banks consisted primarily of resident deposits denominated in local currency.
The use of interbank financing remained low, representing 5.4% of total commitments. In addition, overall, the UAE banking system has remained a net lender in the non-resident interbank market.
Risks related to the quality of assets
The economic contraction during the pandemic had an impact on the growth rate of all non-performing loans (NPLs). Higher non-performing loan ratios in the UAE were also affected by old non-performing loans that were already provisioned and by the restructuring of a few large borrowers during the year. As a result, the net NPL ratio and the NPL ratio increased to 3.5% and 8.1% year-on-year at the end of 2020.
“While the pressures on asset quality from the global pandemic have remained, the likely economic recovery should gradually ease credit quality problems, but with a delayed effect,” the FSB report notes.
Provisions for prospective loan losses increased in 2020 against a backdrop of a sharp contraction in economic activity. Overall, total provisions increased 18.4% year-on-year. Of the total increase in provisions, specific provisions increased 18.2 percent and general provisions increased 19 percent year-on-year.
Solvency stress test
The CBUAE said that in 2020, the bottom-up stress test was postponed to 2021 to ease the operational burden on UAE banks. Instead, the CBUAE performed frequent top-down solvency and liquidity stress tests using a number of hypothetical adverse scenarios at different stages of the COVID-19 crisis.
Solvency stress tests combine the impacts of the baseline scenario and adverse scenarios on banks’ balance sheets and income statements, focusing on the projected capital adequacy.
In the last descending solvency stress test, banks remained sufficiently capitalized with an average CET-1 ratio above 14.4% in the baseline scenario. The banking system’s average CET-1 ratio fell 243 basis points, from 14% to a low of 11.6% in 2021 in the adverse scenario.
The CBUAE conducted quarterly sensitivity tests based on its analysis of the most vulnerable economic sectors in the context of the COVID-19 pandemic.
Based on international evidence and analysis of UAE data, the hospitality, wholesale and retail, transportation and warehousing and construction sectors were identified as the most vulnerable. In the most severe assumptions, an additional constraint of 50% has been applied to the risk parameters of the worst historical values for the vulnerable sectors. The results showed that a significant part of the credit risk losses was attributed to the hypothetical adverse scenario of vulnerable sectors.
Liquidity stress test
The UAE banking system continued to have adequate levels of liquid assets and a stable deposit base during the year. Strong liquidity cushions allowed banks to cope with withdrawals when businesses depended heavily on bank funding when the COVID-19 shock hit.
In response to the stressful situation resulting from the pandemic, the CBUAE took steps to maintain financial stability through the TESS [Targeted Economic Support Scheme]. It has provided banks with liquidity on a scale necessary and efficient to support the functioning of the market.
The CBUAE uses liquidity stress tests to assess the resilience of the banking sector to liquidity shocks. Liquidity stress tests were carried out monthly as one of the heightened risk monitoring measures taken by the CBUAE to ensure that liquidity risks could be detected early and addressed promptly.
The latest results of liquidity stress tests have shown that the banking system has the ability to withstand sudden changes in the deposit base without encountering liquidity problems. However, some banks relying on wholesale funding and having a higher concentration of depositors would be more vulnerable in crisis conditions.