Promising forecast for UAE banking sector in 2007, despite fall in earnings

According to a research report from leading investment bank EFG-Hermes, despite an end to stock market related earnings in 2006, the environment for core banking operations remains strong and 2007 looks set to be a year of growth for the sector.

By the middle of 2006 the industry witnessed the fall of IPO gains, asset management fees and income from available for sale securities. This in turn led to the depression of 2006/07 earnings growth and rapidly falling valuations. In addition P/E (price to earnings) ratios currently imply a market which is ex-growth, or banks which cannot profitably re-invest their cash flows.

However, the operating environment for UAE banks would suggest a far more positive outlook for 2007. 'The environment for core banking operations is extremely strong, based on solid economic growth, increasing financial penetration and with debt levels sustainable' explained Raj Madha, senior research analyst at EFG-Hermes.

In a move that highlights the industries ability to adapt to need, banks in the Emirate throughout 2006 began to focus on growing their core earnings, resulting in lending being a strong driver of growth. To ensure that slower deposit growth did not become a constraining factor, most banks launched multi-billion dollar medium term notes (MTN) programmes. Many banks are beginning to focus on diversifying their revenue stream, and taking advantage of cross-selling opportunities.

But this is not to suggest that banks are operating in a fiercely competitive environment. In fact evidence from the liquidity boom of the past few years' shows banks will compete aggressively on volumes and incentives, but not on price. The fact that return on equity in the sector (ROE) are good but not conspicuously so can be explained by the fact that banks are generally overcapitalised, make insufficient use of innovative financing solutions and have little service-related non-interest income.

'We do expect a slowing down of the loan market in the UAE and banks need to consider seriously how they will respond to this' warned Raj Madha. 'The risk is that overcapitalisation combined with weak growth, increased account portability and a plausible impact from adjustments to market regulation possibly driven by the Free Trade Agreement, will result in the onset of true competition'.