I got quite a response last week when I wrote about the "green shoots" of economic recovery that are appearing in the UAE - concerted government action, stabilising money markets, bottoming out of the property sector and freeing up of the loans business. All seem to be headed in the right direction - or at least stopped falling in the wrong direction - in comparison with international benchmarks, I concluded.
Some readers agreed wholeheartedly; others felt I had overstated the positive aspects of the economic situation. Those who fell into the latter category were mainly bankers, who thought I was especially and unrealistically optimistic regarding the outlook in the banking sector. So it's worth a closer look at this key indicator of financial health.What the financial crisis has shown above all else is that an economy cannot function without healthy banks. The crisis may have been caused by the property "bubble" and complex financial instruments associated with it, but the impact was felt most directly by the banks.
Maybe they brought it on themselves, but when they suffered as a result of write-offs of bad debts, it had an immediate and tangible effect on the real economy through mortgages, business investment, personal finances and all the other ways in which we rely on our banking infrastructure.In the West, this has presented itself as a question of capitalisation. Even now, nine months into the crisis, the likes of Citigroup and Bank of America are still in need of fresh capital from shareholders, or from governments. In the UK, the likes of RBS and Lloyds/HBOS have already swallowed huge amounts of public money, and may need more.
So it is important to recognise at the outset that UAE banks do not share this problem. The Basel accords stipulate a minimum Tier 1 capital ratio, the key indicator of a bank's financial health, of 8 per cent.According to analysts at the UAE investment house Al Mal Capital, going into the crisis UAE banks showed a range of between 10 and 13 per cent Tier 1 capital. They were characterised then by over-capitalisation, rather than under-capitalisation.
The crucial question now, after two full quarters of crisis-hit business, is how far that position has been eroded by non-performing loans, and the answer is: not as bad as the rest of the world.At year end, non-performing loans, what we regard as "bad debts", were about 1 per cent of the total loan book. That seems almost insignificant, but it translates into an awful lot of money. The overall loan book of UAE banks amounts to some US$278 billion (Dh1.02 trillion).
If the country's banks had to write off nearly $3bn in aggregate from their profits, it would be a big hit indeed. But not life-threatening.Estimates for how much more bad debt there is in the pipeline vary considerably. Some think it will peak at 3 per cent of total next year, others think it will be lower than that. Over at Al Mal, they think the next set of quarterly results, for the six months to the end of June, will show non-performing loans at about 1.4 per cent. A rising trend, but still not disastrous.
There is room for confusion and variation in these figures. The biggest item in any bank's loan book is corporate lending, which accounts for between 60 and 70 per cent of the total.How far those corporate borrowers are invested in the property sector is a worry for the banks. While bank lending to the property sector is in theory capped at 20 per cent of the total, if corporate clients have used banks loans for speculative forays into property it may not show through as such immediately, and could throw the best calculations out of the window.
Another big item is public-sector debt, running at maybe 25 per cent of the total. Ordinarily, this would be regarded as rock-solid, but in the present environment no such guarantee anywhere can be taken for granted. However, the $10bn Dubai government bond will have done much to assuage worries on this account, and judging by recent reports, the next $10bn tranche will be through soon, with broader international investment support. So we can park that question to one side.
The big imponderable is personal finance - loans, credit cards and other consumer debt. This is estimated to account for perhaps 7 per cent to 8 per cent of the total loan book, and is perhaps most prone to potential default. If you agree with the prognosis that sees a sudden departure of expatriates from the UAE this summer, that potential increases.But the jury is still out on that issue and we will not really know until later this year, after the summer holidays and holy month of Ramadan. Also worth noting is that the effects of a great expat departure is likely to be felt more keenly by the international banks operating here, rather than by UAE financial institutions.
There will be big provisions at the half-year stage and bigger ones again at full year across the banking sector. But no UAE bank is in danger of going bust. The political will to prevent this happening is apparent, though the same political imperative might encourage further consolidation. No bad thing I think my optimism about the UAE banking sector is entirely justified but it is too early to say we are out of the woods yet.