The UAE Banking Sector - Assignment Example

Table of contents UAE Banking Sector………………………………………………… page 2 Introduction:……………………………………………………………. page 2 Importance of Banking Sector in UAE……………………………………….. page 2 Concentration of Banks in UAE………………………………………………… page 2 Importance of real estate in UAE………………………………………………. Page 3 Find the ratio of household debt/household disposable income in UAE…. Page 3 Find the ratio of Housing Loans/ Housing Debt in UAE…………………….. page 4 What are the components of housing loans in UAE…………………………… page 4 What are the consequences of not paying the housing loans?...................... page 5 Analysis and Valuation……………………………………………………. Page 6 Current banking policy regarding real estate exposure in UAE …………... page 6 Stress testing…………………………………………………………………………. Page 7 Recommendations and Conclusion:……………………………………………… page 8 Works Cited………………………………………………………………… Page 9 UAE Banking Sector Introduction: Importance of Banking Sector in UAE In the UAE economy banks exist as either the local banks (21 banks) or the foreign banks (25 banks). The roles of the banks are significant in the development of both the economy and the lives of the people as they play significant roles in the main sectors of the economy (Low 2012 pg 33-5). The banks play major roles in the community development apart from being loan and credit instruments in the economy. In the total Arab banking the UAE holds 11.55 of the total Assets. This makes the banking sector in the UAE the biggest beneficiary of the strong economic growth in the UAE (Terterov 2006 pg 275). The banking assets stand at over AED 750,597,000,000 due to the strong growth in assets experienced. By the end of the year 2005, the consolidated assets had recorded a growth of 41.9% a value of AED 638.01bn. This makes the bank second after Saudi Arabia in terms of Assets. According to the last economic report in the UAE, GDP has a record growth of 25.6% (AED 485.5 bn) with the real GDP recorded at a growth of 8.2% (AED 357.6bn). The real estate and business services sector contributed to the GDP growth by AED 35,920mn while the financial sector contributed by 28,426mn (Parker 2007 pg 82-8). Concentration of Banks in UAE The banking system in the UAE is mainly of two categories, the local or national and the foreign. There are a total of 46 banks operating in the UAE currently according to the report. Among them 21 are local while 25 are foreign. The foreign banks are restricted from operating more than eight branches while all the 21 local banks are all listed in the Abu Dhabi Securities Market (ADSM) and Dubai Financial Market (DFM). UAE has the second highest number of banks in the GCC countries after Bahrain (Parker 2007 pg 64). With the anticipated growth in the real estate sector, this figure is likely to grow resulting in a lot of mergers and acquisitions of the monetary institutions. This will result from a lot of demand for loans and a lot of money that needs depositing hence a boom in the banking industry (Farah 2009 pg 67-9). Importance of real estate in UAE Using the available data, the per capita household debt went up in the UAE due to a rise in real estate borrowing. The most recent recorded debt per household stands at $12,000 with the household debt to household income stood at a highest 10% (Low 2012 pg 48-50). This percentage of household debt in the UAE provides a cushion to support consumption in the event there is rising consumption expenditure. This is very high as compared to those from the other segment economies like the G20 which stand at below 7% in most of the countries within that economy bracket (Parker 2007 pg 127). The components of the housing loans as issued by the banks in UAE entail the principle amount which varies according to the banks. Abu Dhabi Consumer Bank sets this rate at AED 10,000 minimum salary for a period of maximum 25 years. The maximum loan that can be offered is up to 90% of the amount which is up to AED 3.5 million (Low 2012 pg 134-5). Find the ratio of household debt/household disposable income in UAE The interest rates vary at a base rate of 2.5 % with life insurance requirement or loan insurance. The processing fee for the loan is 1% for a minimum amount of AED 5,000 with a repayment penalty of 3% of any outstanding amount. The amount or the repayment penalty goes up to 5% if the bank buyout and the valuation charge are up to an amount of 3,000. The other conditions are that the financing is done through property companies which are as well varied depending on the bank offering the loan. Before one qualifies for the loan they have to submit several documents ranging from passport copies, salary certificates and salary bank account statements accompanying the application form submitted (Parker 2007 pg 143-7). Find the ratio of Housing Loans/ Housing Debt in UAE. Dubai Islam bank has a record of bad loans which it needs to absorb hence it needs to boost its capital for the sake of such absorptions. The bank has since remained weak due to the quality of the loans that it offers to its clients through a very high loan to value ration of between 705 and 75% and sometimes runs up to 80%. Citibank which is a foreign bank provides a LTV of 80% depending on several factors which include the amount of the loan. The LTV is higher when the amount of loan taken is lower as compared to when the loan amount is higher. Therefore an LTV of 70% for example will be subject to a larger loan amount value with Citibank. This situation is the reverse for the local banks in the UAE whose LTV value is highly erratic. The LTV for Citibank is higher for UAE nationals and a little bit lower for the foreigners (Citibank. Version 2000 ed). What are the components of housing loans in UAE In the recent past Dubai Islamic Bank has had to deal with balance sheet weaknesses but still is focused to achieve a growth in profitability in the coming year. One of the strategies to make the bank perform is to shift its operations from real estate specific to consumer and wholesale banking. Within the UAE, a considerable amount of non-performing loans was recorded at AED 4.04 bn and the trend has been on the decline (Terterov 2006 pg 312-15). The highest recorded for non performing loans in the recent past is 14.5% and dropped to 12% at the end of the year 2012 and a further drop of up to 105 is anticipated. Among the European banks, Citibank ranks the six in terms of nonperforming loans at 3%, this shows the bank’s prudence and efficiency in terms of lending and collection of debts. The operations of the bank worldwide are also coupled with customer preference due to the excellent service provision to its clients (Citibank. Version 2000 ed). What are the consequences of not paying the housing loans? Not paying a bank loan has a variety of consequences on the defaulter if not just one. The consequences depend on the loan agreement and the type of loan that an individual is in agreement with (Muzafar 1989 pg 270). One fact one must be sure with is that there is never any criminal penalty as a loan is a civil matter between the banker and the person (Parker, Philip and Philip 2007 pg 232). One of the consequences is that in the event one fails to pay up a loan the amount becomes due in the first case and payable on demand at the same time of which the creditor can sue if the amount cannot be paid immediately. For the housing loan, the court would change ownership of the house and sell it to recover the amount. The property can as well be repossessed and auctioned (Farah 2009 pg 94-9). If the amount on which it is sold still does not cover the loan fully, the balance is still considered a debt. A debt repayment schedule is then drawn to enhance the payment on a monthly basis for the remaining loan of which a late interest still continues to accrue as time passes (Karasneh and Ayten 2005 pg 242-6). In case there was a guarantor for the loan, the court may order that the amounts be collected from them. If the house loan is not paid, any asset owned by the defaulter or owned by the debtor can be frozen and resold. Another grave consequence of failing to pay a house loan is the damage it has on the credit rating of the debtor and this may make it difficult or impossible to get such loans again in future (Bellini, Oscar and Laura 2008 pg 289). The current policy with regard to real estate in UAE is to ensure a balance between the deposits and the loans at bank. This is as presented by the “Regulatory Development Unit” and it contains the recent development when it comes to regulations governing the real estate sector. This has been due to the realization that loans and deposits have shown growth in the recent past (Low 2012 pg 163-4). As a percentage of deposits, the gross loans have realized a growth of more than 10% with still room for more expansion of the loan portfolio. This is because the banks are required by regulation to maintain an advance to deposit ratio of 1, a policy put forward by the central bank (Bellini and Daglio 2008 pg 230). The policy discusses issue which relates to liquidity levels and ratios which are set to help achieve a sustainable balance between deposits and loans. According to this policy financial ratios are set to be used across the countries in the UAE to control supply and demand. As well, it is used as a control tool during economic turmoil. There are recent changes in the liquidity coverage ratio to the Basle III standard. This standard takes into consideration piece meal implementation of polices used by the banks operating in the UAE (Terterov 2006 pg 329-33). Analysis and Valuation Current banking policy regarding real estate exposure in UAE The policies are to be implemented in a gradual manner include: - those on time span, those with regard to asset definition and the approaches used in arriving at the liquidity coverage ratios (Karasneh, Ibrahim and Ayten 2005 pg 278). Ratios contained in the large exposure reviews as stated in the large exposure limits regulation also are reviewed to meet the current exposure standards. This exposure limits take into effect the considerations of bank exposures which is aimed at making judgments on the applicable credit limits (Farah 2009 pg 134). The current platform upon which moneychangers take place in the UAE currently was also taken care of with the missing elements being fixed. This was geared towards realizing a change in the way the money changers are updated. This is to take note of the worldwide change in the manner these money changers are realized on the international platform (Terterov 2006 pg 298). Stress testing The stress tests by the two banks show a lot of health and any increase of the loan to value ratio would only act in the interest of increasing the value of the balance sheets of the two banks. An increase of 5% and 10% on each bank’s balance sheet has an impact of strengthening the balance sheet as any of the banks is able to secure more funding from the central bank and other larger banks to boost their operations. Doubling of the non performing loans on the other hand has a negative effect. While increasing the LTV by 5% and 10% for both the banks and doubling of the non-performing loans is likely to have the impact of a zero effect in nature as the impacts of the two actions may cancel each other (Powers 2007 pg 65). The balance sheets of the two banks will reduce with the same proportions and find a balance in the middle. Decreasing the LTVs of the banks has general negative effects on the banks in terms of the operation. If the rates go down by 5% and 10% respectively, the balance sheets of the two banks will also have the impact of going down with 5% and 10% respectively as well (Muzafar 1989 pg 295-8). Doubling of the rates would have a worse impact and they are likely to take the bank under in all the aspects. Doubling the NPL for Citibank’s will mean its operations in UAE may be closer to impossible given the harsh political and legal environment that it faces currently (Farah 2009 pg 218-20). Recommendations and Conclusion: Given the nature of operations experienced by the two banks currently, the NPL ratios require a drastic reduction mostly so for the Dubai Islamic Bank whose current ratio is so low. The banking sector in the UAE is embattled with several challenges and they are not seen to be coming to an end any time soon (Karasneh, Ibrahim and Ayten 2005 pg 301-5). This is indicted by a show of the bad health in the property market across the region with the real estate sector being on the lead. The housing prices and rent values are fast deteriorating and such property is constructed from loans from the banking industry at interest rates which were quite high (Farah 2009 pg 226). These challenges if not well tackled have the impact of harming the real estate sector and the economy at large given the number engaged in the sector and the contribution the sector has to the financial system (Terterov 2006 pg 277-9). This will exist in the form of the reconstruction of the loans which may be made cheaper as opposed to the original prices of such loans. Due to such renegotiations, the duration of loans and repayments will be longer and greater, respectively, and the rates charged well below the required figures (Muzafar 1989 pg 321-5). This has the likelihood of causing the rise of other unfavorable factors such as amounts of nonperforming loans. Such a scenario is harmful to the financial sector as the performance of the banks may decline due to reduced profits. The prospect of banks merging due to extreme growth is therefore curtailed (Powers 2007 pg 93-7). Works Cited Bellini, Oscar Eugenio and Laura Daglio. New frontiers in architecture: Dubai between vision and reality. Vercelli, Italy: White Star, 2008. Print. Citibank. Version 2000 ed. San Francisco, CA: Wet Feet Press, 1999. Print. Farah, Abdel Fattah M. Introduction to Islamic banking and finance. S.l.: Ajman Chamber Of Commerce, 2009. Print. Karasneh, Ibrahim al, and Ayten M. Fatheldin. Market structure and performance in the GCC banking sector evidence from Kuwait, Saudi Arabia, and UAE. Abu Dhabi: Arab Monetary Fund, 2005. Print. Low, Linda. Abu Dhabi's Vision 2030 An Ongoing Journey of Economic Development.. Singapore: World Scientific, 2012. Print. Muzafar, Muzafar Al Haj. Emiratization of labor in the banking sector of the United Arab Emirates. Singapore: Weigl Publishers, 1989. Print. Parker, Philip M. Executive report on strategies in the United Arab Emirates. New York: ICON Group, 2007. Print. Powers, Michael R. Focus on emerging markets. Bradford, England: Emerald, 2007. Print. Terterov, Marat. Doing Business with the United Arab Emirates. New York: Blue Ibex, 2006. Print. Read More