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Sat 7 Sep 2013 11:27 AM

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Are asset bubbles on the horizon for the UAE?

Jonathan Morris, chief executive of Standard Chartered UAE, says policymakers need to avoid a repeat of 2008.

Are asset bubbles on the horizon for the UAE?

If any proof were needed of the importance of the UAE to Standard Chartered, then you need look no further than the bank’s gleaming new headquarters in Emaar Square. Set to be fully completed by the end of the year, the $140m purpose-built tower is something of a statement of intent in a market that has seen other international lenders falter in recent months.

HSBC has cut lending to small businesses in the country, as well as slicing out retail and wealth management services in a number of Middle Eastern countries as part of a strategic global review. Last week, Barclays announced it would be selling its UAE retail business, and has been cutting staff. Lloyds sold its small operations in the country to HSBC last year, and on the investment banking side a number of global finance houses have retrenched as big local players start to take a larger slice of the pie.

Buoyed by its focus on emerging markets in Asia and the Middle East — where it makes roughly four fifths of its earnings — Standard Chartered has steered a relatively smooth path through the credit crunch.

“Globally, we’re in the right markets, with the right strategy, on which we’re executing,” says Jonathan Morris, chief executive of the bank’s UAE operations. “Standard Chartered wasn’t in the US, so we weren’t involved in the sub-prime crisis, and we’re not a major bank in Europe, so we weren’t involved in that.

“We’re in those parts of the world that are growing faster than others, and we have a long-term commitment to those markets, so perhaps for some of the other banks it’s a more peripheral business.”

That said, the story in recent months has been of weakening emerging markets growth, as the US looks to ease back on its $85bn-a-month bond-buying programme. India has been hit worst, with the rupee diving to unprecedented depths against the greenback. Surely this is a concern for Standard Chartered? Not so, says Morris.

“We’re very comfortable with our exposure in places like India and so on,” he says. “But it’s relative — China, India and all our core markets are continuing to grow. They’re not growing perhaps as fast as they were a few years ago but they are still continuing to grow, and I certainly I would far rather be in the faster-growing markets of Asia, Africa and the Middle East as a banker today, than being a banker in Europe.”

Last month, the bank reported a four percent rise in operating income to $9.75bn, although net profit slumped by 24 percent to $2.13bn, partly due to a goodwill impairment of $1bn in South Korea. Morris describes the global performance as “resilient, against what are increasingly difficult economic conditions”. In the UAE, which is the bank’s fifth-largest market, Standard Chartered reported pre-tax profits rising by 55 percent, helped by a positive credit environment.

“What we’re seeing in the UAE is increased liquidity in the market, so our volumes are growing extremely nicely — our trade and foreign exchange, our core commercial banking products, were up in the high teens,” says Morris. “But because of margin compression, caused by increased liquidity, we were broadly standing still from an income perspective, so, if you like, we were having to run harder to stand still.”

Morris adds that this trend — wholesale banking staying flat due to recent deleveraging and heightened competition, while consumer banking rises due to higher demand for credit — was reflected across most local banks’ performances. A further factor causing problems for wholesale bankers is the fact that local lenders are increasingly taking over debt capital markets — an area previously held almost exclusively by the big international players.

“Typically, on a deal in 2011, you’d see an average of three mandated lead arrangers on a bond issue,” Morris says. “Now you see four or five, with the local banks starting to come under those mandates, build their position and enter into markets where the international banks were previously dominant. So we’ll see that competition increasing, and when we talk about competition as a bank, we increasingly talk about local banks rather than the traditional competition.”

On the retail side, the story is different. Consumers in the UAE are back in the market for credit, and the banks are happy to lend. Data from the central bank showed that lending for the first five months of 2012 matched that of the whole of last year, and the fear is that the country is heading for yet another consumer credit bubble.

Perhaps unsurprisingly, Morris doesn’t agree — although he does point out that household debt-to-GDP is up at six percent as opposed to 5.5 percent last year, while household debt to assets is at 25 percent against 23 percent in 2012.

“The economy is creating jobs — that’s the good news,” he argues. “And to the extent that people are taking mortgages and borrowing to create personal wealth, that is a good thing. But the risk, of course, is interest rates. We have for some time been in a low interest rate environment and the risk is that when rates increase, what sort of impact will that have?”

The UAE central bank has clearly targeted consumer debt as an area of concern, and has clamped down on personal loans (by capping them at 20 times a borrower’s monthly salary from 32 times). It is also considering a mortgage cap for expatriates that could end up at around 25 percent of the total cost of a new home. Morris says that the personal loans sanction affected Standard Chartered quite considerably when it was launched in 2011, but that this was exacerbated by the fact that it took pace “at a time of relative economic weakness”. He says that the country’s first credit bureau, which is set to be rolled out next year, is “absolutely critical” and could lead to even cheaper borrowing for many consumers.

But Morris denies that asset bubbles — either on the consumer debt side or the property side — currently exist in the Dubai market. “To have an asset bubble, you need rapidly growing prices, and you need credit growth,” he argues. “At the moment, credit growth is still relatively muted. So what we’re seeing is a normal market driven by demand — specifically mortgages and house prices — and demand is underpinned by a much stronger jobs market.

“The key for the housing market will obviously be supply going forward, so we’re watching it carefully to make sure the dynamics maintain that balance. At the moment, I would say it’s a normal market, so price increases are driven by demand.”

However, Morris admits that some issues need to be tackled to prevent the market from overheating in the future. He points out that only about 30 percent of properties in Dubai are bought using mortgage finance, with the rest being funded entirely via cash.

“So we’d like to see speculation taken out of the market,” he says. “Some of the ideas that we see in Asia, like in Hong Kong and Singapore, where there’s a tax on properties that are flipped over a short period of time could work, just to dampen any trend for speculation.

“At the moment, it’s a healthy market but more broadly the challenge for the government is managing growth over the next couple of years, whether it be inflation, whether it’s asset bubbles or consumer debt.

“This is a very different market to pre-2008; speculation was rife and credit growth was at around 30 percent. We’re not in that sort of market at the moment, but what we’re keen to see is the government put in place mechanisms to control this, should the market start to overheat.”

Another key area that the government needs to look at, Morris argues, is what he refers to as institutional infrastructure. The UAE is working at finalising a companies law that has now been decades in the making, but the fact that bankruptcy legislation has still not been confirmed is a serious problem for many would-be foreign investors.

“The UAE has built this incredible infrastructure that it is leveraging brilliantly,” Morris says. “What is lacking at the moment is the institutional infrastructure. What we really need is an effective bankruptcy law, an effective companies law, a banking law, the ability to take mortgages and so on — to bring the institutional infrastructure to world-class standards. If they can do that, I think the level of investment, of FDI, is going to go through the roof.”

So how will Standard Chartered attempt to build on its position in the UAE? The chief executive says that on the retail side, it will focus more on priority banking, private banking and small- and medium-sized enterprises (SMEs). Unlike rival HSBC, which cut off lending to a swathe of smaller firms earlier this year, Morris says that lending to SMEs is one of the fastest-growing parts of the bank’s business, and estimates that Standard Chartered will have around AED2.5bn ($681m) worth of exposure to this segment by the end of the year. Other areas of interest include pursuing the Arab expatriate market, revamping the lender’s cards business and improving its digital services, especially as foreign banks in the UAE are only allowed a limited number of branches.

On the wholesale side, Morris is trying to deepen ties with large family firms, working closer with governments and government-related entities, and trying to garner more work outside Dubai in places like Abu Dhabi and the northern emirates.

Other areas of interest include private banking, including Islamic private banking, and private equity, which Morris says is “not a major business for us right now, but one that’s of real interest”.

Private equity has a tough time in the region in recent years, crimped in part by the lack of public listings on local bourses. But the chief executive says all that could soon change, pushed by the recent decision to promote both the UAE and Qatar to the emerging markets bracket of the MSCI index.

“We need deeper markets here to be able to support an IPO market, and to the extent that we’re seeing more depth in the capital markets — which MSCI will hopefully bring — not just the fact that we’re rated as an emerging market rather than a frontier, but just the profile, and the perception of greater transparency,” Morris says. “I think all that’s going to feed on itself in a virtuous way.”

Elsewhere in the Gulf, Standard Chartered is pushing into Iraq, opening up three branches in Erbil, Baghdad and Basra in the next two years.

But the elephant in the room is Saudi Arabia. Standard Chartered has a Capital Markets Authority (CMA) licence in the kingdom, and was reported to have applied for a full banking licence there last year. Morris won’t comment on whether or not the application was submitted, or what its status is, but he does acknowledge that it’s a vital market.

“It’s the largest market in the region, and as a major bank in the Middle East it is a missing piece of the jigsaw,” he says.

“We got our CMA licence in 2011 and we’re making good progress under that. So you will now see us being active in the debt capital markets there.”

Back in the UAE, and Standard Chartered is predicting GDP growth of around 3.5 percent for this year and 2014. Morris says he is a fan of the Dubai bid for the 2020 World Expo - which he describes as "the catalyst for the next phase of infrastructure growth for the UAE - and also points out that he has no concerns over Dubai’s debt burden, and says the market remains a “fundamentally attractive one” for the bank.

“The debt repayments over the next couple of years are actually pretty light — we don’t see any problem with the Dubai government being able to meet those,” he says. “And sentiment is improving, so values are rising as well, and that makes asset strategies from an asset-sale perspective that much more easy as well, and values can be realised.

“I’m pretty optimistic about the UAE at the moment. We are in an interesting phase economically of managing growth, which brings challenges. But I’m absolutely confident the government and the banks alike will be able to manage those risks.”

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