Pressure to ease on UAE's Islamic banks

The UAE’s Islamic banks will this year continue to grapple with impairment charges and funding costs higher than those experienced by their conventional peers, but at a lesser extent than in 2016, according to a new report from Fitch.

The ratings agency said it expects financing growth at the country's Islamic banks to slow to high-single digits in 2017, but that such growth would still be higher than for their conventional counterparts, even as impaired financing ratios are likely to experience a "mild deterioration" during the year.

“Profitability metrics are expected to improve with lower [financing impairment charges (FICs)], but not return to previous levels due to persistently higher, albeit improved, funding costs,” Fitch said in the report.

FICs at Islamic banks rose to 1.4 per cent of financing in 2016, compared to 1.1 per cent in 2015, due to the headwinds facing SMEs in the UAE. Islamic financing also slowed last year, growing 10 per cent compared with 19 per cent growth in 2015.

The high FICs level dented banks’ profitability, consuming 38 per cent of pre-impairment operating profit, compared with 33 per cent in 2015, Fitch said.

“Higher funding costs in 2016 put pressure on most Islamic banks' net financing margins and operating profitability metrics, despite many banks successfully repricing their financing books,” the report said. “The main reasons for the increase are UAE banks' high reliance on profit-bearing time deposits and lower liquidity in the system due to lower oil prices.”

The banks’ average financing/deposits ratio rose to nearly 95 per cent, and is nearly on par with that of the conventional banks, according to Fitch.

“Islamic banks tend to have higher levels of deposit funding than conventional banks, as their retail focus gives them a larger influx of retail customer deposits, although this has reduced with further sukuk issuance in 2016,” the report added.

Meanwhile, the creation of a central Sharia board is expected to standardise issuance of Islamic bonds or sukuk, which has gained importance after Sharjah-based energy company Dana Gas declared its US$700 million sukuk non-Sharia compliant.

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While the profitability of UAE banks has been dented in recent years because of low oil prices, the industry remains in better shape overall than its global peers, according to a report on the UAE banking sector by Alvarez & Marsal.

The global consultancy also said in an April report on the country’s banking sector that there are increasing signs of recovery following several dismal years characterized by a rise in bad debts and lacklustre lending growth.