Towards Sufficient and Profitable Banking in UAE - Example

Towards Sufficient and Profitable Banking in UAE Name Institution Date Table of Contents Table of Contents 2 Abstract 3 Introduction 4 Overview of the challenges in the banking sector 4 Escalating competition 6 Corporate governance 9 Experienced human resource deficiency 11 High risk associated with capital market and real estates exposure 11 Rising cost of funding 12 Conclusion 14 References 16 Abstract This study explores that various efforts and strategies that being put in place by the players in the banking sector to ensure that there is growth towards sufficient and profitable banking in the United Arab Emirates. Like any other banking sector in the world, the United Arab Emirates banking sector is experiencing tremendous change as it tries to grapple with the impact of liberalization and increased bilateral ties. Following the implementation of the World Trade Organization agreement concerning financial services liberalization, the discrimination between foreign and local institutions carrying out their operations in the United Arab Emirates will eventually disappear. Escalating competition and mounting pressure from the governing body that is aimed at streamlining the activities of the banks to ensure that there is fair ground of operation, have sent the management boards of the banks to the drawing board to try and come up with new ways of performing their functions. The main agenda is to increase profitability and sufficiency of their operations so that they are able to attract more customers as opposed to their competitors. Well-functioning and sound banking system is crucial in creating provision for development and growth that is sustainable in this economically and politically vital part of the world as it will be seen in this paper. Introduction United Arab Emirates is fast growing economy that is supported by well performing industries which includes the banking sector. Prior to competition that has been hyped by the entry of foreign banks into the UAE banking sector, UAE banks were doing extremely well. With increased liberalization and multilateral trade there is need for changes to be done in order to increase the efficiency and profitability of the banking system in United Arab Emirates. This paper explores the pertinent changes that need to be done in order to resolve some of the challenges that are being witnessed in the UAE banking sector. With the entry of foreign banks into the UAE banking sector, the local banks were destabilized making them to have mixed priorities. Banks in UAE are able to utilize input resources in an efficient manner in they develop more branches, and more so, banks that are new are better in performance as compared to old banks. The employees’ experiences negatively affect efficiency and ownership by government tends to slow down efficiency. Overview of the challenges in the banking sector With the coming of foreign banks into the UAE banking sector, all banks are facing a challenge that is as a result of increased competition. To withstand competition, gain market share and expand operations, United Arab Emirates are getting into areas where there is possibility for high growth which include Islamic lending, personal lending and SME financing. Corporate lending is more likely to remain the huge portion of the bank’s lending owing to the size and number of the projects, which are in the private sector and government planning. Regardless of the fact that the banking sector is dominated by foreign banks, the local banks takes the lion share of the banking asset making up to 78% of a combined share. The dominance by the local banks is partly as a result of the limitations put in place by the United Arab Emirates Central Bank on the foreign banks (Ciampi, 2008). The banking sector of United Arab Emirates faces various adverse challenges in the face of the global financial crisis. On the domestic perspective, the slowdown in the economy and the burst of the real estate bubble were the main initiators. Credit downgrades happened at almost all degrees occasioning in a squeeze in liquidity and lending activities slowdown. Liquidity with local banks has usually been tight as compared to other markets that are emerging owing to strong growth in lending before 2009. In the wake of global financial turmoil and the economic activities decline especially in Dubai, liquidity has dried up and credit demand plummeted drastically. Following this backdrop, banks that are local were hesitant to give credit amid fears of imminent defaults and more asset quality deterioration. The slowdown is anticipated to persist to late this year in the face of credit regulations that are tighter and funding alternatives. The situation is made worse by liquidity that is tight in the banking sector with loans to deposits ration going beyond one hundred percent. The United Arab Emirates banks are trading at a large discount as compared to other banks to other banks in the same region given their bad debt exposure issue and the specifically weak performance of economy in Dubai. At prevailing prices some banks are penalized excessively regardless of possessing asset quality that is high. Escalating competition The bank’s margin in the United States Emirates have been going down over the last period, nevertheless they still preserve a healthy look suggesting that price competition has not taken a heavy toll in the banking sector. Price competition between banks has existed for a long time but previously it was not a disturbing issue. Banks depended on distinctive product offering, quality of service and levels that are convenient to create a mile edge in terms of competition. In order to diversify their projects banks are strongly venturing into other lines of business apart from corporate banking to gain a sizeable share in the market and contain the increasing competition. The best way that the banks are countering competition is through diversification of their products to ensure there is sufficiency and profitability. If a bank does not do any thing new then it will be rendered irrelevant it will lose its customers to banks that demonstrate more sense of being innovative. Banks in the United Arab Emirates have been in the process of making their product schemes wide to cater for the various needs of the customers. Having in mind that the customers have different tastes and preferences alongside differing incomes, the banks have embarked on designing a variety of products to that they attend to the individual needs of the customers and more importantly, no customer is left out on the available variety. Hiring of young and innovative personnel to bring in new ideas is now a common thing as more banks establishes databases to collect views and suggestions from the customer they serve on ways of becoming more satisfactory to their needs. Some of them have applied for Islamic window licenses or come up with subsidiaries of Islamic finance, this one of the input that the banks are venturing into to ensure that they cater for the needs of all their customers. The banks that had no Islamic finance are able to serve customers with strong belief in the Islamic teaching that uphold no interest on loans. The majority UAE citizens profess Islamic faith hence the need for putting up an Islamic finance subsidiary to cater for their needs. A good number of them have embarked on offering mortgage financing or the establishment of mortgage finance subsidiaries. Apart from that the Central Bank of UAE has given licenses to three Gulf Banks; National Bank of Kuwait (NBK), Doha Bank of Qatar, and Saudi American Bank (SAMBA). Besides, three Islamic banks started operating in the UAE in the year 2008. Competition is expected to intensify following the entry of new banks into the United Arab Emirates market which are looking forward to utilize opportunities that have been unexplored. Competition that is eminent will exert pressure on margins and spreads, particularly in the retail banking sector and this may also spark off a faster desire for consolidation, to come up with entities that are larger, that are organically able to compete in an international marketplace. Foreign banks are leading in terms of credit card offering, where as the local banks have a competitive edge high net worth and personal loans lending. The UAE banks consequently have an obligation of expanding in the areas that are strong and trying to diversify to other areas that they feel they are outshone by the foreign banks. United Arab Banks are facing competition not only from foreign competition but also from consumer lending entities which have gotten entry into the UAE market. The local banks have no alternative but to diversify their ways of gaining profits and establishing a formidable customer base and increased competition. The banks have to engage more in clear risk management vision and draw up management plans that will serve as a road map to the development of the banks. There should be more effort towards cutting down on costs to ensure profitability. The banks are aggressively seeking international acquisitions, setting up representative offices and overseas branches; this is a strategy of expansion as well as diversification of risks. When there is economic melt down in one economy, the other subsidiaries of the bank elsewhere in the world make the bank to continue existing instead of collapsing. National Bank of Abu Dhabi is a good illustration of international exposure that is strong; it has thirty eight branches in various countries around the world. This makes the bank not to be dependant on one market but to spread out the risks of its operation over a wide region. Apart from increasing its customer base, the bank is able to exploit operation niches that may exist in the other markets. Apart from National Bank of Abu Dhabi there are other banks that have diversified their operations. Mashreqbank has entered into nine countries besides the United Arab Emirates. Dubai Islamic Bank put up its operations in 2005 in Pakistan and signed an agreement with the Sudan government to acquire 52% ownership in Al Khartoum Bank. Union National Bank gained access into Egypt through the acquisition of and Alexandria Commercial and Maritime Bank. The increased competition results into banks coming up with very many numbers of products that they offer in a single market. Many banks are establishing Islamic subsidiaries to try and deal with the increased competition in the local market (Padmalatha, 2011). Corporate governance The main ruling families in the United Arab Emirates, namely Al Maktoum and Al Nahyan families, and the Abu Dhabi or Dubai government hold high stakes in averagely all of the major domestic banks in United Arab Emirates. Dubai Islamic Bank is owned 30% by the Dubai government. Abu Dhabi Investment authority owns 64% of Abu Dhabi Commercial Bank and 73% percent of the National Bank of Abu Dhabi. Union National Bank is partly-owned by both governments of Dubai and Abu Dhabi. AlGhurair family owns Mashreqbank, the banks is amongst the business groups in the United States of America. This kind of ownership that is very much concentrated brings about concerns as far as corporate governance is understood. The main issue of concern is that it enhances the degree of interbank transactions, credit concentration and single bank lending. There are high possibilities that the corporate governance ethics will not be observed and many banks are bound to fall into the trap of engaging into illegal malpractices that undermine the corporate governance policies of the banks. In the face of increasing competition from the foreign banks that have ventured into the market, this will cause the local bank coupled with concentrated ownership to take the dark side as far as observing sound corporate governance policies is concerned. The interbank transactions may be at the disadvantaged of a few individuals why other people are likely to be discriminated against. In order to gain a competitive edge, the banks can engage into malicious act to try to lock out other players that may be interested in the market. It is very is for the few players in the market to come up with unscrupulous ways of gaining a higher customer base as compared to their customers (Badr-el-din, 20O7). According to Manole and Grigorian (2005), there is need to decentralize ownership and allow more stakeholders or players to take part in the running of the banks. With the concentrated ownership trend, it is very easy for the owners to even influence who is to be hired and who should not be hired. Making the banks ownership cosmopolitan and dynamic will increase efficiency since there will no laxity in the running of the banks and every stake holder will do his best to see the bank’s performance improve. Concentration of ownership provide a good ground where unfair competition is encouraged since some of these banks have easier access to projects of the government. For sound corporate governance to be encouraged the ownership of the banks should be dynamic and varied to allow close scrutiny and accountability. When ownership is decentralized there will be more transparency and the banks are able to scrutinize their operations and critique them with the aim of identifying mistakes and correcting them in due time. In this manner the operations of the banks become more pragmatic and profit oriented. An effort of embezzlement of the banks’ funds can be detected in due time and the culprits apprehended because there will be no covering up in the name of belonging to a certain family. The high portion of government ownership among the banks is also not good because some banks get protection from the government when they go against some banking rules and regulations. The government should come in and set out laws that are regulated the amount of ownership that one entity can have in the banking investment (Ramachandran, 2007). Experienced human resource deficiency It has been established from the United Arab Emirates banks management that human resource is a huge challenge that is facing the banking sector. There are many challenges that are facing Islamic financial institutions. The experienced and trained experts’ shortage in Islamic banking has hindered expansion. This sparked off escalation in the cost of trained experts in Islamic finance. The banks have to come up with ways of increasing the trained experts. There is need to increase the funding for training institutions to be put up and the banks to send their personals for such training. There are increased managerial costs as many banks are not doing feasibility tests to ascertain viability of projects. The banks have too more branches, low ceiling target, high staff compensation and agency problems. Banks have to invest into feasibility testing. The banks need to go for quality as opposed to quantity which will make them cut down on cost. High risk associated with capital market and real estates exposure The mortgage market is still nascent. The biggest challenge facing banks in the United Arab Emirates is the Civil Law of the country that bars banks foreclosing legally on an owner of a property who is living in his property. More so, in accordance with regulations of the Central Bank, real estate exposure of the banks is not expected to go beyond twenty percent of their respective customer deposits, but owing to the currently small size of the segments, this may not be a problem in the short term. There is a concern that people purchase properties as tools for investment as opposed to residential purposes (Manole &Grigorian, 2005). Dubai Marina development has about 35% of unoccupied units of their whole project. There is slow pace is real estate growth in the medium term. There is need for the banks to carry out sensitizations promotions to encourage the people to venture into real estate for residential purpose as opposed to trying to make a profit that denies the bank the short term gains. This habit is bound to make the banks slow pace as far as real estate is concerned. Non-interest income is negatively being affected. Educative programs and forums should be carried out from time to time to make the people understand the real estate part. The many regulatory requirements should be streamlined to increase efficiency (Ramady, 2010). Rising cost of funding Jaffer (2005) says that deposits increased with a slight margin than credit from 2003-2006 which is equivalent to 30.6% to attain AED519 billion in 2006. Excess liquidity is a main challenge that is being faced with Islamic banks owing to short-term investment vehicles shortage. Islamic banks in the United Arab Emirates also are challenged with problems concerning regulations due to the fact that there is absence of Islamic banking supervision committee in the Central Bank. Funds majorly come from industry and business sectors, followed closely by deposits from individuals which constituted 32 percent of all the deposits in the year 2006. Of the total sectors’ deposits, 90 percent were placed by the residents whereas ten percent were from deposits coming from non-residents. Banks in the United Arab Emirates have recorded a very high utilization ratio, which is gross loans divided by the total deposits; some banks went beyond 100%. In the year 2006, the average utilization of the banking sector was 104% (Terterov, 2006). The Central Bank of the United Arab Emirates compels banks to maintain advances to stable ratio of resources at a maximum of 100%. Due to this banks in the United Arab Emirates are faced with a funding gap and have reverted to funds raising through Euro medium-term note program, Islamic Sukuk, subordinated debt, and syndicated borrowing. It is important that the banks also diversify to create n more ways of obtaining funding. The United Arab Emirates banks ratings that are favorable to borrow at rates that are lower. Funds that are borrowed are anticipated to grow further, provided the trend towards funding schemes diversifying (Oxford Business Group, 2009). According to Gonzalez (2008), an issue that plays a role in capping growth of funds is the deposits composition. Theoretically banks that hugely depend on retail segment as the major source of deposits are stable relatively as compared to those that rely on corporate deposits. However, a drop in corporate deposits is expected to escalate in times of scarce credit, which is the prevailing case in the United Arab Emirates. Corporate deposits dropped by a margin of o.9% in 2010 to AED 480.9 billion. Corporate deposits increased by a margin of 3.1% in the first quarter of 2010 to AED 289.3 billion. Deposits by the government have more so been declining beginning the early 2009 and they dropped by a margin of 10.6% during the first quarter of 2010 to about AED 172.4 billion; which is reported as being the lowest since the late 2008 (Reif, Ditterich & Ostrea, 1997). The banks in the UAE are faced by the challenge of asset/liability mismatch in maturity, where is a requirement for longer term funding among banks in the United Arab Emirates owing to the fact that most deposits of banks are short-term. With mortgage lending growing into a key focus for banks in United Arab Emirates over the next couple of years, banks will need to have sources of funds with a maturity that is longer in solving the mismatch which can be resolved through notes with loner-terms. Conclusion Following the economic meltdown that was experienced globally commencing from 2008, many economies in the world have been adversely affected and United Arab Emirates can not be an exception. In order to realize any growth in the sector there is need for changes to happen that will foster efficiency and profitability. Increased competition, funding problem, corporate governance issues, human resource deficiency, capital and real estate challenges are the main issues hindering steady growth of the UAE banking sector. There are measures that that can be undertaken to make the banking sector profitable and efficient. Some of these proposed changes that can be undertaken have been explored in this paper. It is expected that every bank can take steps that are appropriate to its own challenges. References Oxford Business Group (2009). The Report: Abu Dhabi 2009. Abu Dhabi: Oxford Business Group. Ciampi, F. (2008). Emerging Issues and Challenges in Business & Economics: Selected Contributions from the 8th Global Conference. Alabama: Firenze University Press. Gonzalez, G. (2008). Facing human capital challenges of the 21st century: education and labor market initiatives in Lebanon, Oman, Qatar, and the United Arab Emirates. California: Rand Corporation. Ramady, M. (2010). The Saudi Arabian Economy: Policies, Achievements, and Challenges. New Mexico: Springer. Jaffer , S. (2005). Islamic retail banking and finance: global challenges and opportunities. London: Euromoney Books Manole, V. & Grigorian, D. (2005). A cross-country non-parametric analysis of Bahrain's banking sector. New York: International Monetary Fund. Terterov, M. (2006). Doing Business with the United Arab Emirates. 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