High interest rates and reduced non-oil sector activity slowed credit growth in the United Arab Emirates (UAE) in the last quarter of 2023. However, banks are reporting exceptional full-year 2023 profitability on the back of lower provisioning requirements and higher interest margins. Furthermore, liquidity improved as deposit growth outpaced new lending.

Nevertheless, with higher-for-longer rates, cash flow pressures could eventually weigh on corporate credit quality and further weaken demand for new credit. In addition, the uncertain geopolitical situation could pose risks to the overall economic sentiment in the region. Still, the outlooks on our rated banks in the UAE are stable. Here, S&P Global Ratings responds to questions from investors on the UAE banks' asset quality, profitability, funding, and liquidity in 2024.

Frequently Asked Questions

How do you expect the UAE's economy to perform in 2024?

S&P Global Ratings expects increasing oil production, and supportive non-oil sectors, will fuel economic growth in the UAE this year. Under our base case--notwithstanding volatile supply-demand dynamics--we expect oil prices to remain broadly stable in 2024. The non-oil sector GDP will likely continue expanding, albeit at a slower pace than in 2023, mainly thanks to the hospitality, real estate, and financial services sectors. Overall, we expect real GDP to expand by 5.3% in 2024, compared to the 3.4% estimated for 2023. For this growth forecast it is assumed that the current round of OPEC+ oil production cuts will expire at the end of March.

What are the key risks for the UAE banking system?

Postponed rate cuts due to persistent inflation in the U.S. and geopolitical unrest pose key risks for the banking system. Prolonged higher interest rates may result in lower-than-expected lending growth and weaker asset quality for banks. Although the Israel-Hamas war and Red Sea conflicts currently pose a limited downside, a sharp escalation involving direct conflict between key actors could change the picture. UAE banks with exposure to Egypt face potential risks, but our base case scenario does not foresee any shock that the banks could not absorb. Furthermore, while risks in Turkiye remain high, they are abating, and exposures are relatively contained at the system level.

Nevertheless, investors could shy away from the region, which may be another indirect impact of the uncertain geopolitical environment. However, we consider the UAE banking system to be in a very strong net asset position and able to withstand our stressed outflow scenario (see "GCC Sovereign External Balance Sheets Remain Strong Despite Higher Banking Sector External Debt," published Nov. 13, 2023 on RatingsDirect).

How do you think credit growth will evolve in the UAE this year?

We expect UAE banks to report slightly lower credit growth than the 7% reported last year (see chart 1). New lending eased in the last quarter of 2023 and we expect this trend will continue in the first half of 2024 as borrowing costs remain high and growth in non-oil sectors slows. We also note that the Dubai government has been deleveraging over the past few years, owing to higher revenue and lower financing needs. On the other hand, we expect retail borrowing to remain strong as banks continue expanding in this profitable segment.

Chart 1

How is the real estate sector performing?

The demand for residential property in the UAE has recovered strongly since the end of 2020. This is supported by a new visa regime, liberalization of social laws, and new business ownership rules, resulting in positive demographic trends. Furthermore, favorable oil prices and a solid rebound in international tourism has underpinned economic growth across various sectors, enhancing consumer sentiment. As real estate prices in Dubai approach previous peaks (see chart 2), the risk of a cyclical reversal mounts.

We anticipate a gradual market slowdown in Dubai over the next 12-18 months. Additionally, we think that price increases could decelerate and potentially slightly reverse. Nevertheless, we believe the risk for banks is contained since most property transactions (exceeding 80% in 2023) are in cash. Meanwhile, developers are strengthening their liquidity buffers in preparation for the next cyclical trough as they continue to report healthy pre-sales, thereby further reducing the risk for banks. Though not expected, a prolonged and more pronounced correction could strain both the real estate market and the banking system.

Chart 2

How will UAE banks' asset quality fare?

We expect asset quality to remain broadly stable, with only a slight increase in nonperforming loans and credit losses. Stage 3 loans for 10 of the largest UAE banks improved to 4.5% of the loan book at year-end 2023 from 5.5% at year-end 2022 (see chart 3). This is due to banks cleaning up their loan books by writing off some fully provided exposures. The cost of risk declined to 74 basis points (bps) from 98 bps during the same period. We see potential pressure on asset quality from leveraged corporates and small to midsize enterprises, due to recent monetary policy tightening. However, we believe the solid performance of non-oil sectors and banks' precautionary provisioning will help maintain the stability of Stage 3 loans and credit losses.

Chart 3

What were the drivers of record profitability for some UAE banks in 2023, and what are your expectations for 2024?

Some UAE banks booked record profits in 2023 due to strong credit growth in a high interest rate environment. Also, an improved economic environment meant that requirements for new loan loss provisions remained low. A bottom-line increase was also supported by growth in non-interest income, reflecting increased business and trading activity. However, we expect the banking sector's profitability will reduce slightly as margins start contracting toward the end of the year. This is assuming a 100 bps rate cuts by the U.S. Federal Reserve (Fed) during the second half of the year. In accordance with the UAE dirham's peg to the U.S. dollar, we expect the Central Bank of the UAE to mirror the Fed's movements. At the same time, we believe interest rates will remain higher for longer, and this will support banks' net margins. Coupled with a broadly stable cost of risk, the profitability of UAE banks is likely to remain strong, albeit lower than last year.

Chart 4

Do you see any risks in the banking sector's liquidity and funding positions?

Banks in the UAE maintain high liquidity, with an average of 21.8% of the 10 largest banks' assets being cash and money-market instruments at year-end 2023. Strong core customer deposit bases--which increased by about 12% last year--and limited reliance on external funding contribute to UAE banks' funding structures. The non-oil economy's positive impact on corporate cash flow translated into higher bank deposits in 2023. With sustained high interest rates and a supportive economic environment, we expect strong deposit growth to continue.

Chart 5

Do you expect an increase in hybrid capital issuance?

Capitalization is a strength for UAE banks. The average Tier 1 and capital adequacy ratio for the 10 largest banks reached 16.0% and 17.3% respectively at year-end 2023. We foresee further strengthening of banks' capital buffers due to strong internal capital generation on the back of higher profitability. The reopening of the hybrid market, fueled by clearer rate projections, provides banks the opportunity to replace their instruments at lower cost when interest rates decline. At year-end 2023, hybrids contributed on average 12.2% to the capital structure of the 10 largest UAE banks, compared to 12.9% in 2022.

Are UAE banks vulnerable to external capital flows?

UAE banks remain in a strong position regarding net external assets, which strengthened to 27.9% of systemwide domestic loans as of Nov. 30, 2023, from 9.6% at year-end 2021. Since domestic demand for credit remained lower than deposit growth, banks used their extra liquidity to invest in international securities, which increased by more than 20% last year. We also observed that some banks opportunistically tapped into international capital markets in 2023, and we expect this to continue in 2024. External funding outflows could emerge in case of unexpected higher geopolitical risks. However, we note that UAE banks are more than capable of withstanding substantial stress, as defined in our recent study (see "What A Regional Escalation Could Mean For MENA Banks' External Funding," published Nov. 13, 2023).

Chart 6

How important is sustainability for UAE banks?

The largest UAE banks are already making sustainability part of their strategies and risk management frameworks. Part of this includes offering sustainable products to their clients. First Abu Dhabi Bank (FAB) and Abu Dhabi Commercial Bank (ADCB) are frontrunners in this arena; they are the only banks in the Gulf Cooperation Council (GCC) region that have signed up for the Net-Zero Banking Alliance (NZBA). But this is just the beginning. During the recent COP28 UN Climate Change Conference, the UAE Banks Federation committed to providing AED1 trillion in sustainable financing by 2030. However, in terms of credit risk exposure, we estimate that local banks operate with relatively limited direct lending to sectors vulnerable to the risks of energy transition. Historically, this figure is about 11% of total lending on average. Indirect exposure (via the overall dependence of the UAE economy on hydrocarbons) is significantly higher.

Where do you see your UAE bank ratings heading in 2024?

Our UAE bank ratings all carry stable outlooks. We also see stable trends for economic and industry risk under our Banking Industry Country Risk Assessment of the UAE. A key risk that may affect these trends is an unexpected escalation of geopolitical risk--although in the case of the UAE, this could be beneficial in the short term because oil prices may increase. Another risk stems from the potential volatility of oil prices if global economic prospects prove bleaker than we currently project. A drop in oil prices could restrict the UAE economy's headline growth and erode consumer sentiment.

Related Research

• GCC Banking Sector Outlook 2024: A Relative Bright Spot Among Emerging Markets, Jan. 31, 2024
• How Will Saudi Banks Fare In 2024? Feb.5, 2024
• GCC Sovereign External Balance Sheets Remain Strong Despite Higher Banking Sector External Debt, Nov. 13, 2023
• What A Regional Escalation Could Mean For MENA Banks' External Funding, Nov. 13, 2023
• Banking Industry Country Risk Assessment: United Arab Emirates, Oct. 9, 2023