UAE banks will benefit from potential interest rates hike

Banks in the UAE and their counterparts from the GCC will also benefit from the expected US interest rate hike beginning in March 2022, experts say.

S&P Global economists economists expect the Fed to raise rates six times this year starting in March, and five more times in total in 2023 and 2024. These changes will be earnings-accretive for UAE banks because of the structure of their balance sheets. This is, however, predicated on the assumption that the shift in the yield curve is parallel, and that banks’ balance sheets remain static, according to the rating agency.

“We expect banks in the UAE to benefit from the planned increase in interest rates by the US Federal Reserve, which the Central Bank of the UAE will likely mirror because the UAE dirham is pegged to the US dollar,” said Mohamed Damak, primary credit analyst at S&P Global Ratings.

Credit cost to go up

The rating agency further said second-round effects of the increase in interest rates could come from a higher cost of risk and cost of funding. A higher loan charge could push some mortgage- or personal-loan clients to the edge of default, while at the same time pressuring small and midsize enterprises (SMEs) that are still healing from the impact of the Covid-19 pandemic. However, stress tests applied by banks to mortgages at inception in relation to an increase in rates, the granularity of the exposure, and salary assignments for retail lending will act as mitigants.

“For corporate exposures, we expect banks will adopt a pragmatic approach and would not reflect the full extent of the increase in rates whenever this could push their clients to non-performance. Overall, we project the banking sector’s Stage 3 loans will reach seven per cent of systemwide loans by the end of 2022 compared with 6.1 per cent at year-end 2021,” Damak said.

“We also expect cost of risk to increase slightly in 2022 to around 120-130 basis points (bps) compared with 116bps in 2021 as support measures are lifted and companies in still vulnerable sectors are reclassified. Cost of funding will inevitably rise as some deposits migrate from no- or low-interest to interest-bearing products. However, with around two-thirds of total deposits bearing no or limited interest, UAE banks’ funding will remain a strength,” he said.

Inflation role in focus

Atik Munshi, managing partner, FinExpertiza UAE, said it is likely that the Central Bank of the UAE may allow increase of interest base rate whereby banks in UAE will increase their rates which will in turn likely improve the banks bottom line.

“On the other side, borrowing will become more dearer and thus push inflation in the longer run. It remains to be seen as to which level the increase in rates is affected in reality,” Munshi told Khaleej Times on Tuesday.

Vijay Valecha, chief investment officer, Century Financial, said US consumer price index, which measures the costs of dozens of everyday consumer goods, rose 7.5 per cent compared to a year ago.

“This is in contrast with estimates of 7.2 per cent for the closely watched inflation gauge. The market is now pricing in six rate hikes for the year and the probability of rate hikes above 25 basis points has increased. Higher interest rates and rising treasury yields should be bullish for banking stocks since they boost earnings,” Valecha told Khaleej Times.

He said banks in the UAE and their counterparts from the GCC will also benefit from the expected US interest rate hike beginning in March 2022.

“Due to the peg, their currencies have with the dollar, a rise in US interest rates will reflect in lending rates in the UAE and other GCC countries,” he said.

Lower rates squeezing margins

Valecha said lower interest rates had been squeezing the overall margins and profitability of local banks previously.

“Early rate cuts heavily impacted the UAE banks as the lower rates were almost immediately reflected in the yields of floating rate loans while the re-pricing of corresponding deposits and other funding sources took much longer,” he said.

He said margins have stabilised for now and the cost of risk has dropped in comparison to last year.

“The cost of risk is foreseen to normalise over the next couple of years and margins to benefit from the expected increase in interest rates,” he added.

UAE banks to benefit

S&P Global also said the net external asset position is also likely to shelter UAE banks against lower and more expensive global liquidity.

“We rate five banks in the UAE, the ratings on which all carry stable outlooks, reflecting our view that their strong capitalization and profitability will continue to protect their creditworthiness over the next 12-24 months,” Damak said.

As of December 31, 2021, data from the top 10 banks in the UAE show that banks are likely to have an increase of 15 per cent of their net income or an additional 1.4 percentage points of return on equity for every 100bps increase in rates.

“While these numbers are on the stylised assumption that banks’ balance sheets remain static and the shift in the yield curve is parallel, it is a broad indicator of the direction and magnitude of the impact of rising rates,” according to the rating agency.

— muzaffarrizvi@khaleejtimes.com