Islamic Finance

Fitch: UAE Islamic Banks Affected by Higher Financing Costs and Impairment Charges

| 09 August, 2017
Fitch: UAE Islamic Banks Affected by Higher Financing Costs and Impairment Charges

AUGUST 9, 2017 | 9:39AM EDT | LONDON

(The following statement was released by the rating agency)

Link to Fitch Ratings' Report: UAE Islamic Banks’ Results Dashboard here 

Fitch Ratings says in a new report that UAE Islamic banks' performance in 2016 was hit by higher funding costs and financing impairment charges (FICs).

Stronger financing growth than conventional banks continued. While the average Islamic bank's impaired financing ratio improved further to 5% in 2016, aided by rapid financing growth (above conventional banks), this ratio is skewed by the two largest UAE Islamic banks, which account for almost two-thirds of Islamic banking assets, and whose ratios have fallen sharply to around 4%. The other four Islamic banks have young, fast-growing franchises, and their impaired financing ratios are between 5% and 9%. FICs increased to 1.4% of financing in 2016 (2015: 1.1%) due to deterioration in the SME segment.

Islamic financing grew, albeit at a slower rate of 10% (2015: 19%), due to wider adoption and more innovative structuring of sharia-compliant products. 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 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 Islamic banks' average cost/income ratio was almost stable due to tight cost control. Higher FICs also affected profitability, consuming 38% of pre-impairment operating profit (2015: 33%). Tighter liquidity from 1H15 continued into 2016.

The average financing/deposits ratio rose to nearly 95%, and is now much closer to that of the conventional banks. 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.

UAE Islamic banks improved their capital ratios in 2016 despite financing growth, mainly through issuing additional Tier 1 capital and improving internal capital generation. Nevertheless, their average Fitch core capital ratio of 13% is below conventional banks' 15%, due to higher financing growth since 2012, and this ratio is low in light of high concentration risk (by single borrower and by sector).

Nevertheless, the FCC ratio varied significantly across Islamic banks, from 9% to 20%, at end-2016. The UAE central bank's centralised sharia board was further formalised in 2017.

In light of the Dana Gas declaring its sukuk non-sharia compliant, the mandate of a centralised sharia board and the extent of its involvement in sukuk standardisation are more important than ever. However, there is still limited clarity on the board's mandate and influence. Fitch-rated UAE banks have no exposure to this sukuk.

Fitch expects financing growth to slow to high-single digits in 2017 (still higher than conventional banks) and the recently granted financing portfolios to start seasoning, with a consequent mild deterioration in the Islamic banks' impaired financing ratios. Profitability metrics are expected to improve with lower FICs, but not return to previous levels due to persistently higher, albeit improved, funding costs.

More information is available in "UAE Islamic Banks - Results Dashboard", available at www.fitchratings.com or by clicking the link above.

 

Contact: Redmond Ramsdale Head of GCC Bank Ratings +44 20 3530 1836 Fitch Ratings Limited 30 North Colonnade London E14 5GN Bashar Al Natoor Global Head of Islamic Finance +971 4 424 1242 Media Relations: Rose Connolly, London, Tel: +44 203 530 1741, Email: rose.connolly@fitchratings.com. Additional information is available on www.fitchratings.com

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