Dubai: The UAE banking system remains resilient, despite a challenging operating environment from the aftermath of the COVID-19 pandemic, according to the results of the UAE’s latest Financial Stability Report (FSR). Core bank indicators indicate adequate funding and liquidity positions and sustained borrowing ability. However, the vulnerability of the banking sector remained because the economic slowdown outweighed the quality of the asset. The increase in impairment costs and lower operating income reduced profitability. However, the total capital buffers remained adequate and remained well above the regulatory requirements.
The UAE banking system entered the pandemic from a strong position, enabling banks to provide targeted assistance to customers. ” Financial reliability indicators reflected the overall resilient position of the UAE banking system, backed by adequate capital and liquidity buffers, sustained during the pandemic. “Nevertheless, uncertainty remains about the pace of economic recovery and the related pressure on asset quality,” the FSR said. The UAE banking system assets expanded 3.4 per cent to Dh3.2 trillion in 2020. Total lending growth remained positive at 1.2 percent year-on-year in 2020, despite the economic downturn. Loan growth moderated towards the end of the year due to rebalancing of loan portfolios and repayment of corporate loans. UAE banks’ funding profile remained conventional, mainly through deposits accounting for 68.6 per cent of total liabilities. The deposit base of the UAE banks consists mainly of resident deposits in the local currency. The dependence on interbank financing remains low and represents 5.4 percent of total liabilities. Furthermore, the UAE banking system remained a net lender in the non-resident interbank market
Asset Quality Risks
The economic contraction during the pandemic had an impact on the rate of growth in the overall default performance loans (NPL). The higher NPL ratios in the United Arab Emirates were also affected by the already poorly performing loans, and the restructuring of some major lenders during the year. The net NPL ratio and NPL ratio consequently increased by the end of 2020 to 3.5 percent and 8.1 percent on an annualized basis. “While asset quality pressures have persisted due to the global pandemic, the likely economic recovery is expected to gradually ease concerns about credit quality, although it is lagging behind,” the FSB report said. Foresight provision for loan losses increased in 2020 amid the sharp contraction in economic activity. Collectively, total provisions increased by 18.4 percent year-on-year. Out of the total increase in supply, specific provisions grew by 18.2 per cent, while general supply increased by 19 per cent year on year.
Solvency stress test
The CBUAE said the stress test had been postponed from bottom to top in 2020 to 2021 to ease the operating burden of the UAE banks. Instead, the CBUAE conducted regular 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 effects of baseline and unfavorable scenarios on banks’ balance sheets and income statements, with a focus on projected capital adequacy. In the latest solvency stress test from above, banks remained adequately capitalized with the average CET-1 ratio above 14.4 per cent below the base scenario. The average CET-1 ratio of the banking system fell by 243 bps from 14 percent to a trough of 11.6 percent in 2021 in the unfavorable scenario.
The CBUAE conducted quarterly sensitivity stress tests based on its analysis of the most vulnerable economic sectors under the COVID-19 pandemic. Based on international evidence and data analysis from the UAE, the hospitality, wholesale and retail, transport and storage and construction sectors have been identified as the most vulnerable. Among the most serious assumptions, 50 percent additional stress was applied to the risk parameters of the worst historical values for the vulnerable sectors. The results showed that a significant proportion of credit risk losses were attributed to the hypothetical negative scenario for the 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 buffers enabled banks to accommodate withdrawals when businesses relied heavily on bank financing when the COVID-19 shock hit. In response to the stressful situation due to the pandemic, CBUAE has taken action to maintain financial stability through the TESS [Targeted Economic Support Scheme]. This provided the banks with liquidity on a scale that was necessary and effective to support market functioning. The CBUAE uses liquidity stress tests to determine the resilience of the banking sector to liquidity shocks. Liquidity stress tests were performed monthly as one of the increased risk monitoring measures taken by the CBUAE to ensure that liquidity risks can be detected early and addressed immediately. The latest results for the liquidity stress test showed that the banking system has the ability to withstand sudden shifts in the deposit base without tackling liquidity challenges. However, some banks that rely on wholesale financing and have a higher concentration of depositors will be more vulnerable under stressful circumstances.