Posted: April 4th, 2015

Factors affecting the Efficiency of Financial institutions in UAE

Abstract

The Financial sector and UAE’S economy as a whole have experienced a remarkable growth since the global crisis. Banks have embraced technology and have expanded to offer customers easy access to products and services. However, there have been inefficiencies resulting from competition, poor risk management and poor quality of assets. Such inefficiencies including regulations and ownership by the government hinder expansion. With the recent growth in the recent past, competition is a significant threat to the institutions in this sector. This sector is extremely significant to the UAE’s economy since it is the second best performer after the oil sector. Other inefficiencies occur in the real estate markets, the returns on assets and the total margins which may slow down growth. Focusing on these inefficiencies helps the institutions in this sector anticipate for challenges and plan well.

Factors affecting the Efficiency of Financial institutions in UAE

Introduction

The banking sector throughout the world experienced a lot of crises towards the end of the twentieth century. This is attributed to poor banking practices, inadequate revenue diversification and capital, credit risks and currency mismatches among others (Ozkan-Gunay & Tektas, 2006). These shortcomings prompted the introduction of liberalization and reforms in the banking sector in 1991. Since the initiation of these changes, the financial sector has undergone significant changes to become more efficient, competitive and profitable since the introduction of reforms and liberalization. Financial institutions have also grown in capital adequacy and the quality of assets as well as risk management (Rao & Tiwari, 2008). The UAE is one of the regions that have experienced a fast growth in the banking sector. Investors have been attracted by the favorable trade conditions created by globalization, advanced technology and deregulation impacts. This research aims at identifying factors affecting the efficiency of financial institutions in the UAE.

Objectives

This study aims at identifying the challenges experienced by banking institutions in UAE. Through research and analysis of secondary data, this study will compare the UAE financial sector with that of the western world economies. Through this comparison, it will establish the inefficiency factors that have affected the banking sector in UAE. The research objectives include:

1. Establishing the major in efficiency variables of banking in the UAE
2. To find out how the in efficiency factors affect the financial sector in UAE

III. To establish the effects of the financial inefficiencies on the national economy

1. To establish measure that can be created to solve the issues experienced in Banking

Banking Industry

Dynamics in the world economies have resulted in changes in customer behavior, changes in employee needs, advance technology and a lot of competition among the financial institutions. This has consequently led to a lot of organizational restructuring, in the in the banking sector (Hu, 2008). The conception of the World Tourism Organization (WTO) has significantly impacted on banks both positively and negatively across the world. It is evident that the WTO has expanded the financial institutions competitive field. Banks are forced to adopt international marketing systems to survive under the enlarged competition ground. Therefore, the evaluations and measurements of banking efficacies become an integral part for better market performance (Rao & Tiwari, 2008).

The UAE’s economy heavily depends on the oil sector and the continued growth and expansion of the segments in the financial sector. Bank institutions based in the Middle East have recovered from the global crisis through the changes established in the market structure, increased and diversified financial products, liberation and openness in the financial operations and the accommodating institutional environments. UAE benefited a lot from these changes and has been ranked among the best financial performers in the world. The foundation of the Dubai International Financial Center (DIFC) to become a free financial zone which is separate though interlinked to the country’s financial sector contributed to the major leap in financial performance. This has attracted considerable international financial institutions , and there is a promise for future expansion if the current trend continues (Mosesov & Sahawneh, 2005).

UAE commercial banks

The UAE Banking sector experienced a growth of about 30% between 2005 and 2007. The loans grew by 32% reaching a total of USD 609 in the close of 2008. The deposits, however, experienced a slow pace of 27% and reached USD 725 at the end of 2008. The country’s growth and profitability were hindered by inadequate wholesale funds available during the global crisis. The investment portfolio securities were also under pressure. Profitability was also affected by the local real estate markets which had plummeted as well as the deferral of loan agreements by the projects on real estate. The performance of the UAE banks was materially impacted by the global crisis. The area that was affected most is the returns generated from total assets. Other areas include the reduction in the total margins and slow growth. This affected both Islamic and non Islamic banks both local and international (Mehta, 2012).

It is evident that the financial sector is focusing on reaching a greater number of customers through expansion. This sector has benefited from the advanced technology and concentrates on quality customer service. Competition has also increased as more foreign investors join the industry. This has industry has grown due to the increase expatriate population. Both domestic and foreign banks have invested a lot in low cost distribution channels like internet banking and automated teller machines. They have increased their asset/liability figure gradually. The period between 1996 and 2003 is very significant, the figures moved from AED 192, 532 million to AED 334, 743 million. The Islamic banks have exhibited mixed characteristics, some have fast growth whileothersare slow. Dubai Islamic Bank (DIB) AND Abu Dhabi Islamic Bank are the largets in terms of market capitalization. They are also the most traded of all the domestic banks. They therefore have a potential for fats growth registering about 77-83% in asset growth. Hoiwever, they have low loan deposit ratios of 63-81%. This implies tha they attract deposits easily but are very conservative on the issue of loanapproval. According to the financial valuations, UAE domestic banks in general are mixed with and have the lowest market capitalization when compared to deposit ratios in the world. The dividend yields are reasonable although there is a great potential to grow dividnd in the future. For these banks to increase on their financial performance, there is a need to balance deposit growth with lending (Hashmi, 2007).

The banking system in the UAE has developed to include 23 commercial banks as of 2011 with a branch network of about 768. The electronic customer service units were 26, and this is a significant growth in the UAE’s banking system. In 2011, Deutsche Bank AG and the Industrial & Commercial Bank of China acquired a license to operate wholesale banks. There was also an addition in investment banks; Arab Emirates Invest Bank and HSBC Financial Services Limited which began their operations in the same year. This is an indication that the international investors are attracted to invest in the UAE. The following is a table representation of UAE’s current status in the development of the financial sector.

Significance of the Study

Many studies have been carried out to determine the factors affecting the banking sector. Although these studies have been carried out in the developed nations, it is evident that the banking sector is imporotant in the economies. Sun & Kobeissi (2010) carried a research to determine the banks performance and ownership in North Africa and Middle East. This study showed that private banks performed better than the public ones. Consequently the study indicated tha foreign banks had better performance than the internal institutions. The study was limited by the geographical coverage and therefore the data collected was considered to be too small to study the universe. On the other hand, (Hamadi & Awdeh, 2012). carried out a research to compare the performance of domestic banks with that of the foreign ones in Lebanon. His study discovered tha there existed a very minimal variation. However this study assumed tha the findings were universal for the whole of middle east, it disregarded the regional diversity in those countries.

Another study carried out in Japan indicated that governmental policies influence the banking sector a lot. However this study was in adequate since it is not appliocable in the developing nations (Hanazaki & Horiuchi, 2003). Sufian (2009), determined the profitability of banks in the developing economies of Malaysia. This study showed that credit concntartion had an impact on profitability of the banks. Therefore profitanbility was determined by a bank’s level of investment. Lastly, Al-Tamimi & Charif (2011) identified liquidity and concentration ratios as the factors affecting performance of convenctional and Islamic banks. Branch numbers and their costs also affected the banks performance. From the study gaps left by researchers, it is evident that the fast growing developing econmy of UAE has not been covered adequately. Significantly, UAE presents bothe developing nation’s financial institutions as well as the fast growing Middle Eastern economy. On socio-demographic grounds, UAE depicts a good Islamic economy for studies (Hashmi, 2007). This research can be used to analyze several banking sectors in Asia and Africa. Furthermore , the research aims at filling the major efficiency gaps left by the previous researchers.

The banking sector contributes a lot to UAE’S economy as it is second after the oil production. Therefore, it is essential that the challenges affecting this sector to be addressed to ensure that the chances of experiencing crisis are minimized. It will also help in establishing whether the structural reforms that have been put in place have contributed to the growth experienced in the economy. Since the UAE’s financial sector was affected by the global crisis in the past, this study is relevant in establishing the causes of such crisis. It helps in illustrating the various factors that are likely to cause under performance by the financial institution. This information is suitable for institutions to anticipate for future challenges and plan on ways to counter such challenges.