Moody's reports: Stable outlook for United Arab Emirates banks

However, these positive factors are counterbalanced by elevated credit risks associated with robust growth in the as-yet-unseasoned loan portfolio of banks, which may be tested in adverse economic conditions.

"High oil prices and escalating government spending on infrastructure, coupled with high private-sector involvement in real estate and the positive momentum in the country's stock and real estate markets, have created an overwhelming appetite for credit," says Peter Carvalho, Moody's Vice President - Senior Analyst and co-author of the report.

The cumulative effect of these factors has been a surge in the growth of the asset and loan base of UAE banks and in their profitability. Other financial metrics have also improved considerably, driven by a rise in capitalisation and improved asset quality and operational efficiencies.

This is reflected in solid investment-grade ratings, underpinned by a very high probability of systemic and shareholder support.

Moody's notes, however, that these same factors have also posed challenges for the banks, as the surge on stock markets in 2004/2005 was followed by a severe market correction in late 2005 and in Q1 2006. This was followed by an IPO boom in 2006, which significantly boosted brokerage and capital market fee and commission income, before dissipating in 2007. Moody's considers that UAE banks withstood these tests very well, demonstrating their resilience in segmented problem areas. The rapid growth in loans has driven increased profitability levels, while simultaneously raising banks' credit risk profiles.

Going forward, Moody's believes that the strong financial fundamentals of UAE banks and their fragmented franchises will continue to grow in the short to medium term as banks expand outside the UAE, pursuing geographical and revenue-stream diversification. The banking landscape will be changed by the creation of EmiratesNBD (the culmination of a merger between Emirates Bank International and National Bank of Dubai), issue of new licences and continued intense competition, which could lead to further consolidation in the UAE banking industry.

"The buoyant economy and confidence-boosting environment will continue to prevail, encouraging banks to embrace growth, albeit with oil and real estate price corrections and geo-political risks looming on the horizon as the unpredictable factors," says Mr. Carvalho. Notwithstanding these concerns, banks' profitability is expected to grow in 2008, albeit at a slower pace than in 2007. "Improved financial metrics and risk management systems coupled with good management should enable banks to withstand downturns," adds Antoine Yacoub, Senior Associate at the Dubai office and co-author of the report.