V.Ramkumar, Senior Partner at CEDAR Management Consulting provides an outlook on the UAE banking sector for 2017.
The year 2016 has been an interesting and challenging year for banks and the overall economy. Banks that have been successful understand the pulse of change, and the mantra for success has been the ability to be adapt. Evidence of this is the increase in UAE’s banking asset book growth of 10 per cent the last year, although the return on assets has been in the range of 1.7 to two per cent.
Performance and implications
The movement of oil prices has played in important role in the liquidity context as well as in the banking sector. Slow economic growth and reduced public spending impacted corporate lending, which grew by a modest five per cent in 2016 against 14 per cent growth the year before. However, retail banking assets managed to post 23 per cent growth.
There has been a marked increase in nonperforming loans (NPL) in 2016, reflecting stress on the portfolio, especially on retail, SME and mid-market exposure. With a fair bit of clean-up happening in 2016, the prospects for the new year 2017 may be based on how well banks respond to the opportunities that may be emerging in respective segments, and how the initiatives that may be critical to drive the cost ratios well in control. With the top five UAE banks contributing to over 55 per cent of the total assets, the approach to addressing growth opportunities could be significantly different for the large players, vis-à-vis mid-size and smaller banks.
Outlook for 2017
While the new year has its own promises for banks based on positioning, profile and portfolio, it is pertinent that the approach to addressing the market should align with its opportunities.
Corporate lending is expected to show modest growth, between four to six per cent in 2017. The sectors that are likely to see a higher growth are those that are consumer driven essentially—including healthcare, retail, real estate and F&B. The mid-market segment, which includes companies with AED 100-250 million in turnover, contributes to over eight per cent of the banking portfolio, and is likely to see a higher focus both from large and mid-size banks. Primary differentiators that are likely to emerge as strong value proposition would be end-to-end transaction banking and cash management services, with enhanced digital offerings that allow for innovative customer service.
Seen as a risky segment given their experience in 2016, most banks would look to reduce their exposure to the SME segment. Furthermore, the exposure is likely to gravitate more towards the “M” segment, especially with sectors that have a higher propensity to supply to the Government or the public sector. While there are an estimated 300,000 SMEs across 12 sectors and 57 industries, there are at least 18 industries involved in supplying to government agencies. A focused lending strategy for SMEs participating in government supply chain may well be the winning mantra for 2017.
2016 saw a fair bit of upheaval in the job market, driven by both the downsizing drive across large firms as well as the disturbances in the SME segment, which is the biggest employer. The impact of this has been reflected both in the rise of NPL in the retail segment, and the reduction in the lending growth rates—especially in the unsecured category. Retail portfolio is likely to see stiffer competition for the secured lending book, (auto, home, salary transfer loans, etc.) and the game would be beyond just the rates. Product innovation will most likely be driven by micro-segmentation; analytics based customer preferences assessment and product differentiation. Liquidity would be a key success factor, and mobilising cost effective deposits through an effective HNI and Wealth sector will emerge as focus area. Wealth from HNWI has grown 14 per cent last year and with a similar projected growth in 2017. Quite naturally, this is likely to remain a hot sector to stay focused on.
There are eight Islamic banks and 11 Islamic windows operating in the UAE, with a 19 per cent share of Islamic assets out of total assets. With an estimated five per cent year-on-year growth, the competition for driving this growth is likely to be stiff. Sukuk transactions are also likely to increase in value to AED 180 billion this year, given the initiatives to raise public debt by GCC governments across the region. An important trend likely to emerge during 2017 would be innovation in Islamic products—to be driven both by Islamic banks and Islamic windows, focused to drive higher penetration into the Islamic banking segment.
With increasing NPL trends creating a significant erosion to bank profits, the dependency on process efficiency to drive profitability is seen to become highly significant. The operational expenditure/interest income of most banks operate in the 35-40 per cent range, and banks with a higher operational expenditure are likely to drive cost effectiveness both at the branch and central operations to bring in efficiencies. Large banks are also making significant investments in digital technology and robotics to automate processes and drive efficiencies. The other consistent trend observed is in differentiating customer experience, through innovation in customer facing processes, both at the branch and channel fulfilment.
The introduction of IFRS 9 in the UAE will affect the three main areas of asset classification, impairment and hedge accounting. The changes in asset classification driven through IFRS 9 is also likely to increase bank’s expected loss provision considerably. This would have a direct bearing on the drive for higher effectiveness of credit function, and the underwriting framework. The impairment experiences, particularly in the SME segment would also necessitate the need for a distinct credit policy framework focused on the SME portfolio, and the risk-based pricing models.
With the bottom-line growth coming under pressure, banks had to shift their focus on optimisation of staff costs in 2016, which were in the range of 65-75 per cent of total operating expenditure. Changes to the leadership and driving a leaner organisation structure, supported by a strong centralisation model may well be the theme for most of 2017. Synergies driven through bank mergers would also augment this trend, well through 2017. The key to success would be to leverage technology to drive a leaner organisational model.
While US banks have been estimated to spend $143 per customer, the MENA equivalent is about $24. However, significant investments are made by banks to drive digital presence and provide an omni-channel experience to customers. While most banks have already invested in large core banking platforms, 2017 is expected to witness significant dollar spend to drive channel enhancement, branch automation, digital enablement and technology driving customer experience. Additionally, it is highly likely for to 2017 witness the entry of “digital only” in the UAE market.