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UAE Islamic banking faces growing operating challenges- Fitch

The share of total bank gross financing held by the six largest Islamic banks and the Islamic windows of conventional banks was around 26% at end-1H16 (end-2015: 25%) and lending was up 4% yoy (based on UAE's 17 Fitch-rated banks). We expect growth of Islamic bank financing to be in high single digits in 2016, still higher than that of conventional banks.
The Islamic banks' average impaired financing or gross financing ratio was 6% at end-1H16, down from 11.5% at end-2012. Impaired financing ratios have materially improved from post-crisis levels, assisted by rapid growth of Islamic financing. However, this remains worse than the conventional banks' 4.9% at end-1H16. This is partly due to Islamic banks' large proportion of retail financing (including residential mortgages) of more than 40% at end-2015, which increases their vulnerability to a cyclical downturn relative to conventional banks.
Since 1H15 liquidity conditions have tightened in the UAE, mainly reflected in a higher cost of funding, but also some government deposit withdrawals from Abu Dhabi banks, which have partly receded in 2016. Deposit growth was fairly weak in 1H16, which has slightly pushed up the sector's average financing-to-deposit ratio, although it remains well within an acceptable range.
The central bank set up a central sharia board in early 2016 to provide unified supervision and guidance to financial institutions on Islamic finance. Islamic banks also have their own sharia boards, which can give different fatwas on product or bank activities. The new authority is positive for the Islamic finance industry, as it will introduce more transparency and harmonisation. It is not yet clear whether the new rules will increase or limit a specific bank's product offering.
Lower GDP growth, combined with less ample and more expensive funding, will continue to put pressure on Islamic banks' financing and revenue growth, as for the conventional banks. However, GDP growth will remain positive and most banks have been successful in repricing their financing books. 



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