Govt helps prop up UAE Islamic banking sector

With more than 250 Islamic financial institutions operating worldwide, the global market for Islamic financial services, as measured by the Shariah Complaint Assets is estimated to have reached US$729 billion (RM2.57 trillion) in 2007, up 37% from US$531 billion in 2006.
There is still a large concentration of Islamic assets within the MENA region (accounting for 78% of the total), with the UAE (United Arab Emirates) being ranked fifth, according to The Banker, in 2007 with assets of US$49 billion.
As of 2008, out of the 52 commercial banks operating in the country, eight were full fledged Islamic banks with an estimated asset size of AED192 billion (RM184.33 billion) representing 13% of system assets, a 200 bps increase over 2004.
Our Islamic peer group, Dubai Islamic Bank (DIB) and Abu Dhabi Islamic Bank (ADIB), enjoys strategic holdings by either government controlled funds or by ruling families; the Dubai based SWF, investment corporation of Dubai, holds a direct 29.8% stake in DIB, whereas ADIB’s ownership includes a 7.6% stake held by the capital’s SWF, the Abu Dhabi Investment Council.
As of 2008, the two banks combined controlled 9% (AED136 billion) of UAE banking system’s aggregate assets. As we have explained the dynamics of the banking sector in our UAE Banking Sector report dated April 5, 2009, it is clear that the government’s decision to aid the banking system (via AED16 billion Tier 1 notes; AED70 billion deposits being converted into Tier 2 capital; and AED50 billion borrowing facility) was a positive step as 1Q09 witnessed the local banking sector’s Loan-Deposit (LD) ratio record 104% (600 bps q-o-q decline) and the Capital Adequacy Ratio rise to 16.2% (340 bps q-o-q increase).
Overall, we believe, that our Islamic peer group should face a tough year ahead due to high average NPL ratios (3.4%), cost-income ratios (40%), slow balance sheet growth, comparatively high exposure to sectors such as real estate (3% of assets) and larger provisioning (2009F 26% of operating profit), all of this combined with the primary factor of high fragmentation of assets (leading to lower margins).
Further, added pressure is expected to arise from real estate related income (2008 33% of operating profit), which we expect to half during the current year with growth forecasted to return only during 2010. Despite these shortcomings, we expect DIB and ADIB to report positive net profit growth rates in 2009 and believe that the longterm prospects of our peer group is promising, backed by strong ownership by the government, low LD ratios (77%) and little dependency on wholesale funds (5% of liabilities). All of this adds support to the continued infrastructural expansion plans (supported primarily by the government).
Amongst our Islamic peers, ADIB is expected to outperform with regards to profitability over our forecast horizon, with the bank firmly positioned in an aggressive growth phase of its business cycle, with financing income, in specific, expected to prop up bottom line numbers over the coming few years.

(Extracts from a note from research outfit Prime Holding, dated June 25, 2009)

(This story appeared in The Malaysian Reserve on July 6, 2009. The Malaysian Reserve is a daily business/finance newspaper published out of Kuala Lumpur, with a sectoral page on Islamic finance on Mondays, edited by Habhajan Singh)