RoE taking the hit as bank profit falls while capital still remains large
ABU DHABI/September 30: Are the balance sheets of the UAE banks cloyed by excess capital acting as a deterrent to maintaining a healthy return on equity (RoE), a gauge widely used to measure a bank’s efficiency?
The capital that sits on the banks’ books is well above what is required to hold their assets. By the end of second quarter, total capital adequacy ratio (CAR) stood at 17.6 per cent.
“This is well above the 13 per cent CAR, including the 2.5 per cent Capital Conservation Buffer requirement and the 8.5 per cent Tier1 ratio, prescribed by the Central Bank regulations in compliance with the Basel III guidelines,” a Central Bank statement noted.
Most large national banks flush with deposits seem to be left with limited lending avenues even as deposits, both retail and governmental, keep flowing into the banks faster than they get deployed in building assets.
Obviously, a good portion of these funds are ultimately getting parked with central banks within UAE and elsewhere, albeit incapable of generating the desired returns, as these banks are obviously left with little options if not to lend arbitrarily and run the risk of heaping bad assets.
Banks have thus landed themselves up in a ludicrous situation whereby their capital base keeps expanding even as profitability fails to catch up with that growth or even de-grows, at times, in the absence of growth in lending, essentially pulling down their return on equity (RoE), one of the key ratios that savvy investors rely on while making investment decisions.
Let’s take the example of the largest UAE bank, First Abu Dhabi Bank (FAB). While the total assets expanded by more than 25 per cent from AED691.66 billion to AED865.99 billion during the two-year period between June 30, 2018 and June 30, 2020, the loans and advances grew by only a little over 11 per cent from AED344.68 billion to AED384.58 billion during this period.
A good part of this loan book is built in favour of government and government entities that attracts zilch or minimal capital charge as their risk weight is far less than the risk attached to the private credit
A big chunk of FAB’s funds, AED198.99 billion, remained parked in Central Banks in the UAE and outside the country as of June 30, 2020.
During this two-year period, while the average equity (capital) expanded from AED99.63 billion to AED103.03 billion, the net profit for the first half between the respective years declined from AED6.08 billion to AED4.82 billion bringing the return on equity (RoE) down from 12.21 per cent to 9.33 per cent during this two-year period.
Most national banks, especially the larger ones, followed the same trajectory as far as the RoE trail is concerned.
While Emirates NBD’s RoE fell from 16.89 per cent to 10.03 per cent, ADCB’s RoE declined from 14.79 per cent to 5.30 per cent.
The RoE of Dubai Islamic Bank (DIB), the largest and the oldest Islamic bank in the country fell from 15.91 per cent to 11.47 per cent, during the period under review.
Of course, there are views expressed in the market that the larger national banks where government owns controlling stake can’t go for long-term lending as their deposit base could be mostly of short-term nature.
These deposiuts are ideally destined to be parked with Central banks.
Right time for Share Buyback
On the one hand, the larger capital base fails to get leveraged and on the other, it results in lower RoE for the banks.
Many banking experts are of the view that this is an ideal time for the banks to think of doing a share buyback, which can be used to kill two birds with one stone as this will also ramp up the earnings per share (EPS) and hence the market price.
Talking to businessbenchmark.news, Pradeep Chandra, a seasoned banker, who has spent decades in the GCC markets, said if banks don’t find sufficient avenues to lend, obviously banks need not have to expand their capital base further.
“If the banks believe that they are more than sufficiently capitalised, they can even consider doing a share buy-back, which will improve their return on equity (RoE) and earnings per share (EPS),” Chandra added.
Credit to government v/s private sector
While the deposits at national banks grew by more than 11 per cent from AED1.33 trillion to AED1.48 trillion in the past two years, the growth in credit facilities was a shade lower at 10.6 per cent – from AED1.32 trillion to AED1.46 trillion.
But excluding the loans to government and government entities, the credit exposure to private sector, which attracts higher capital charge, has hardly grown during the said two-year period – from AED977.25 billion to AED1000 billion.
And more strangely, the credit to private sector during the past one year has shrunk by about AED8 billion.
This obviates the need for additional capital as the government or government supported credit carries no risk or much lower risk compared with private sector credit that carries higher risk weighting and hence larger capital charge
But despite this, the capital and reserves (equity) or the ‘Capital Base’ of these banks expanded disproportionately in the past two years by about 17 per cent to AED328 billion as of June end, 2020, hammering down the return on equity (RoE).