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The United Arab Emirates has one of the most vibrant banking and financial sectors in the Middle East. The country’s banking industry is heavily influenced by Islamic financial principles. There are also several foreign banks operating in the country which follow western financial principles. The UAE Central Bank controls banking and financial services in the country. The industry has both indigenous and foreign banks that engage in different forms of financial activities. The UAE financial industry is an active participant in global financial activities. This paper discusses the status of the United Arab Emirates banking industry in a global context.
State of the Banking Industry
The reforms which were carried out in 2003 in the banking industry made it more competitive. Most local banks were either formed in Dubai and Abu Dhabi, and they control a large share of the market. Foreign banks were not allowed to have more than eight branches before 2003, but the reforms eased these restrictions. Foreign banks require special consent from the authorities for them to operate more than eight branches in the country (Hashmi 2007, p.77). These reforms have opened up competition in the banking sector because foreign banks have more freedom to transact than before. Foreign and local banks that offer different services have made the UAE have a very most vibrant financial sector.
All regulatory and supervisory functions in the financial sector are performed by the Central Bank. The country has witnessed rapid growth in Islamic banking by both local and foreign-owned institutions. Hashmi (2007, p. 78) states that Islamic banking laws in the UAE require banks not to charge fixed interest rates on savings and credit. This practice ensures that financial services offered are measured through variable rates of interest. Islamic banking has led many banks in the country to experience positive growth in revenues. This success is due to the fact that Islamic banking is not vulnerable to volatility compared to other forms of banking.
Abu Dhabi and Dubai are the largest financial centers in the country. The bulk of the country’s hydrocarbon reserves are located in Abu Dhabi. Oil and gas exports have made the UAE and other countries in the region to become prosperous. This makes the emirate to have a big influence on economic activities in the UAE. Dubai has a well-developed finance and service industry, which is reputed to be the largest in the Middle East (Hashmi 2007, p. 82). The two emirates have a big influence on financial transactions done in the region. The UAE government has pursued expansionary policies to diversify the country’s earnings from dependence on oil and gas exports. Operations of many financial institutions in the country have, for a long time, been driven by this macroeconomic policy. The banking sector in the country is more exposed to global financial activities than ever before.
Impact of the 2009 Financial Crisis
The 2009 global financial crisis had a big impact on the banking sector in the UAE. Foreign-owned investment banks faced a lot of external and internal pressures. Many international investment banks were forced to shift their operations from the country. This issue brought changes in the way banks operate in the country. Large local banks have prepared themselves to fill the gap that was left by the exiting foreign investment banks. Zaki, Bah, and Rao (2012, p. 122) reveal that many investment banks have scaled down their operations to focus on small areas of business in order to stay relevant in the market. The crisis created liquidity problems in the country’s financial sector. Many banks are still recovering from the effects of the crisis.
Some investment banks are shifting their focus to asset management and financial advisory services. These banks are no longer keen on retail brokerage because of the numerous risks it has. They intend to cut down their investments in retail brokerage because the effects of the economic downturn led to a reduction in their profits. These banks are reducing their operational costs to focus on investments that guarantee higher rates of returns. Many banks have restructured their operations to conform to new market realities (Zaki, Bah & Rao 2012, p. 124). These banks have reduced their operations in research to focus more on property markets in the country. Banks are rushing to reduce their vulnerability to problems caused by global financial factors.
Many clients in the region are looking for ways in which they can liquidate their assets. Investment banks are taking up clients seeking these services. These clients target to liquidate their assets in the form of real estate, businesses, and other property because of high levels of uncertainty in the market. However, there are signs of recovery in the country’s financial markets. Many banks restructured their operations after the economic downturn to focus on being more efficient (Zaki, Bah & Rao 2012, p. 126). Some financial services firms are experiencing substantial growth patterns because investors’ confidence has been regained. The future outlook remains positive.
Financial institutions in the UAE now face bigger challenges than before as a result of their reduced access to international financing. The banking sector has become constrained, and it can no longer match the ambitious expansionary macroeconomic policies that the UAE has been accustomed to. Liquidity support programs by the government to the financial sector have brought about an increased level of stability. After 2009, the government acted fast to forestall any problems arising in the financial sector due to the global economic downturn (Mayer 2012, p. 134). Capital injections into major banks have improved the levels of liquidity in the financial sector. Banks have a higher level of capital adequacy than before, which has improved investors’ optimism in the financial sector.
Impact of Asset Financing on Profitability
Many banks have experienced an improvement in their earnings since the downturn. This has raised the quantities of capital they hold. They have a greater ability to take in non- performing loans in their operations. Thus, the level of stability banks have within the market has improved. However, the asset market continues to experience poor performance. There was an increase in nonperforming loans in the asset market in 2010. This had a negative impact on the performance of financial institutions in the country (Mehta 2012, p. 381). This has resulted in banks rescheduling payment terms with their clients to limit default on loans. As a result, loan portfolios remained stagnant in 2010 and 2011. The ratio of nonperforming loans to all loans increased sharply between 2010 and 2011.
Asset financing in the UAE continues to face serious challenges which have impacted negatively on the profitability of many financial institutions. Mehta (2012, p. 382) says that some real estate investors have rescheduled their payment terms on loans they owe financial institutions. Some borrowers face difficulties in servicing their loans, and this has reduced the lending ability of many financial institutions. Interest rates on loans are likely to go up in the future. This is because banks will look for ways to compensate for losses caused by non-performing loans to remain profitable. Banks have become aware of the need to evaluate their relationships with customers and how these relationships contribute to profitability. Many banks have established risk evaluation procedures to withstand the problems they face in their daily operations.
The increase in the cost of lending has resulted in the stagnation of profit margins in the economy. However, banks are expected to recover because many are restructuring their operations. The reduction in the number of borrowers is likely to reduce the exposure of banks to non- performing loans. Banks in the country are likely to focus more on strong customer relations with their clients to improve their performance. Many banks will look at satisfying their clients and improving the quality of services they offer to increase their competitive edge in the market (Mehta 2012, p. 383). There is a possibility of banks introducing innovative products that open up new fronts for competition within the market.
The banking sector in the UAE needs a radical shift to ensure that it maintains its revered standing in the Middle East. Problems in the real estate market have exposed vulnerabilities in financial institutions in the country. Mehta (2012, p. 386) argues that rescheduled loans have led to a reduction in the profitability of many financial institutions in the country. Banks in the country need to look at new ways of making income and profit to reduce their overdependence on asset financing. Banking operations need to stabilize to ensure that financial markets in the country regain the confidence of investors and traders.
Shift to Retail Banking
The 2009 financial crisis has made some banks to opt for retail banking as opposed to corporate financing. There are projections that show that retail banking has the potential to grow at a faster rate than corporate banking. Retail banking is less volatile, with fewer risks compared to corporate banking. It is estimated that banks in the UAE get 30 to 40 percent of their earnings from retail operations. The UAE’s population just like many countries in the region consists mainly of young people. This market segment has increased the demand for banking services in the country (Al-Hassan, Oulidi & Khamis, 2010, p. 123). Most young people are active in small and medium enterprises which play an active role in the economy. These enterprises need financing and as such, retail banking offers a reliable source of credit for their operations.
Many banks are taking advantage of the opportunities in retail banking to improve their profit margins. Banks have been encouraged by the high volumes in retail finance. This has led to an increase in lending targeting small and medium enterprises. Banks are taking advantage of the rise in numbers of the middle class in the country to provide financial products which satisfy their needs and expectations. The shift to retail banking is intended to encourage people to go for products that offer flexible repayment terms (Al-Hassan, Oulidi & Khamis, 2010, p. 125). Retail banking therefore helps banks to overcome the short term risks they have experienced. This shift to retail banking is likely to improve the levels of liquidity in the market. This will also reduce interest rates that are charged on loans by banks.
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Corporate Social Responsibility
Islamic banks participate in many charitable activities in the country. This is thought of as corporate social responsibility. The banks follow the Islamic tenet, zakat in their activities. Malin (2009, p. 244) reveals that zakat requires the rich to share a percentage of what they earn every year with the less fortunate in the society. The banks release the funds either directly or through public organisations which distribute contributions to those who need it. The Islamic principles further forbid people who take part in charity from publicizing their actions. Islamic banks interpret this to mean that they are meeting their CSR objectives. The understanding of CSR by many banks in the UAE has been informed by their participation in charity and philanthropic initiatives in the society.
Some financial institutions have become interested in integrating other aspects of CSR to be part of their operations. The government in Dubai has encouraged banks to participate more in CSR and to make it part of their core operations. Malin (2009, p. 247) adds that several CSR initiatives in the country have led to the development of projects which have changed the quality of life for the poor. Banks together with other major corporations in the country contribute to different projects which have improved the welfare of people in the society. These projects include medical facilities, educational scholarships and construction of public amenities for disadvantaged communities. The impact of CSR in the UAE has brought direct benefits to those that depend on the projects initiated.
Dubai Islamic Bank has played a major role in CSR in the country. The bank has scholarship programs which encourage UAE citizens to become more educated. It has made the UAE citizens aware of the benefits of education and professional development. The bank supports citizens who are facing hardships by sponsoring health, education and housing projects. The National Bank of Abu Dhabi has a formal CSR program that is part of its strategy which helps the needy in the country. The bank’s employees volunteer their free time to participate in different CSR activities in the country (Malin 2009, p. 254). The two banks are very active in CSR activities and this has improved the quality of life in several communities.
The initiatives that have benefited most from CSR are medical care, education, environmental management and conservation, renewable energy and sports. Other CSR activities include cash donations, community programs and other forms of philanthropic activities. Several financial institutions are actively involved in community welfare programs. However, few institutions have formalized strategic CSR plans because the practice is still not seen as integral to their operations (Malin 2009, p. 257). Few local financial institutions report their CSR activities because they believe in zakat which forbids publicising of one’s involvement in charity. Few companies encourage their employees to take part in volunteer CSR activities in the country.
In conclusion, the UAE banking sector has made great strides in the past two decades. Banking institutions need to reform their operations to ensure greater stability in financial markets. The industry is still young and will experience better performance in future.
Al-Hassan, A, Oulidi, N & Khamis, MY 2010, The GCC banking sector: topography and analysis, IMF, New York.
Hashmi, MA 2007, ‘An analysis of the United Arab Emirates banking sector’, International Business & Economics Research Journal, vol. 6, no. 1, pp. 77-88.
Malin, CA 2009, Corporate social responsibility: a case study approach, Edward Elgar Publishing, New York.
Mayer, CW 2012, World right side up: investing across six continents, Wiley, Hoboken, NJ.
Mehta, A 2012, ‘Financial performance of UAE banking sector: a comparison of before and during crisis ratios’, International Journal of Trade, Economics and Finance, vol. 3, no. 5, pp. 381-387.
Zaki, E, Bah, R & Rao, A 2012, ‘Analysis of financial crisis in UAE financial markets’, International Research Journal of Finance and Economics, vol. 83, pp. 120-133.