Interest rate cuts to impact UAE, Saudi banks' profitability in 2020

The interest rate cuts announced by the UAE and Saudi Arabia will put pressure on their banks' profitability and reduce their net interest margins this year, say analysts.

The Central Bank of the UAE cut interest rates by 50bps on March 4 and then again by 75bps on March 16 to support the banking sector and economy against the impact of coronavirus. The Saudi Arabian Monetary Authority (Sama) also cut its official repo rate by 50bps on March 3 and by a further 75bps on March 16 - the lowest level ever. The UAE's rates were cut in line with the US Federal Reserve's decision to cut rates due to the pegging of the UAE's dirham to the US dollar.

"The sizeable cut in interest rate will reduce UAE banks' net interest margins [NIMs] because gross yields earned on loans will decline more than the funding cost paid on deposits, and because the rate cut is unlikely to materially increase credit volumes in the current difficult operating environment," said Mik Kabeya, assistant vice-president and analyst at Moody's Investors Service.

Moody's expects the coronavirus pandemic to generate a broad-based shock to the economy, hurting tourism, transportation, trade and real estate.

UAE banks' net interest income, which depends on NIM as well as on lending and borrowing volumes, comprised around 70 per cent of their total revenue.

"Weaker profitability from lower interest rates and NIMs will compound existing pressure on profitability from our expectation of low credit demand and higher provisioning requirements for UAE banks this year, amid challenging operating conditions," Kabeya added.

But Moody's expects Dh100 billion stimulus package rolled out earlier this week mitigate the impact on local banks and keep some borrowers' liquidity issues from becoming solvency issues.

The global ratings agency noted that local banks in the UAE will witness a decline in gross yields because they have to reprice their loans and around 81 per cent of which were corporate, government and public sector loans, which typically have floating rates.

Fitch Ratings said Saudi Arabia's banking sector faces extra pressure on margins as a result of the US Federal Reserve's latest interest rate cuts. "Banks could also see rising funding costs and stressed liquidity if the Saudi government withdraws deposits to fund a widening deficit. The US rate cuts in response to the coronavirus outbreak exceeded market expectations," the ratings agency said.

"Lower interest income will affect banks' profitability further amid the spread of the coronavirus. Credit growth will be challenged by a softening operating environment due to lower oil revenue," Fitch said, adding that the pressure on NIMs will be higher than in 2019, when rates were higher at the start of the year and rate cuts were lower and spread over several months.