UAE Banking Perspectives 2016 - KPMG | US · PDF file—The UAE’s oil and gas...

KPMG in the UAE

UAE Banking

May 2016

2016Perspectives

Looking at challenges to drive improvementBanks in the UAE operate in a highly competitive and dynamic environment where change is one of the few constant factors. Doing business is made more complicated by continuing regulatory and accounting changes. The relevance and reliability of tried and tested business models is being threatened in a digital era with new market participants who are encroaching on traditional hunting grounds. New threats, like cyber security, are on everyone’s radar. The quality of talent available to help executives navigate through these challenges can be variable. But banks with a real competitive advantages will be those that use these challenges as impetus for improvement.

The articles in this perspective focus on some of the most significant challenges the financial sector is facing. The biggest challenge, both globally and in the UAE, is the ever changing regulatory environment which is putting significant pressure on banks’ operating models, from both a revenue and a cost perspective. Our article on regulatory developments highlights new and expected upcoming reforms with a specific focus on liquidity frameworks which, given the inevitable effect of the drop in oil prices, should become fundamental components of every bank’s business and risk management strategy. This is overlaid by fundamental accounting change, covered in a separate article on IFRS 9 which will have a significant aspect on almost all aspects of a bank’s operations.

Abbas is a banking specialist and focuses on audit and advisory services within the financial services sector. He has considerable experience of working with banks (both conventional and Islamic), sovereign wealth funds, investment and asset management companies and private equity funds. He has a particular interest and experience in the accounting, regulatory and control aspects of banking operations (from risk assessments to full reviews of front office supervision, product control, treasury, risk and operations functions), including extensive work with regard to derivatives and structured transactions. Abbas qualified as a chartered accountant (ICAEW) while with KPMG in London.

Abbas BasraiDirector

Rajesh provides advisory services for our banking and financial services clients. He has worked with financial services clients across the Middle East for more than 17 years. He has advised clients in a number of areas including business strategy, performance improvement, operational and service excellence and business transformation. He has advised banks (both conventional and Islamic), investment and finance companies regulated by both the Central Bank of the UAE (CBUAE) and the Dubai International Financial Center (DIFC). He has a particular interest in helping banks be more agile, customer centric and focused on achieving success in the new age of disruptive banking.

Rajesh PrasadDirector

The banking sector is changing rapidly. The banks that look at the challenges to drive improvement, rather than just complying with what they think is necessary, are the ones that will succeed in the coming years.

In our article on talent challenges, we suggest that, to help fully realize value across all the topics covered in this perspective, banks must proactively design a talent strategy. The general presumption in the market is that demand will outstrip supply, and that this gap will need to be bridged by hiring the required skill sets. We also focus on the challenges faced within SME financing portfolios during the second half of 2015. We discuss the importance of a key principle of responsible banking by going back to basics: know your customer.

Our cybersecurity article focuses on positively managing cyber risk, not only to help take control of uncertainty across the business, but also to turn it into a genuine strategic advantage. While no bank is questioning the value of digital, our article on digital explores why so few banks have been able to unlock its full value.

In the KPMG Lower Gulf Financial Services practice, we continually consider and localize global observations. The industry faces real, fundamental challenges. Turning them to advantage will not be easy, but the potential is great. We hope that this collection of articles on the UAE banking industry casts some helpful light on these issues, sparking fresh conversations. We look forward to discussing the articles with you and suggesting how you might capitalize on the opportunities now on offer in this increasingly complex and fast-changing world.

Luke EllyardPartner I Financial Services

1

Luke Ellyard is a financial services assurance partner in KPMG’s Dubai office. He specializes in the audits of local and international retail and corporate banks and investment management firms, including a leading global sovereign wealth fund, UAE exchanges, private equity houses and a significant number of entities registered with the Dubai International Finance Centre [DIFC]. Luke has also provided specialist control and understanding input to a number of local, regional and global financial institutions and advised on UAE buy-side due diligence exercises. While working in London and Japan, he has also worked widely with European and Asian global investment banking clients.

Luke EllyardPartner

Insights

Lower oil price— The UAE’s oil and gas industry is largely centered in Abu Dhabi and contributes

significantly to both overall GDP and government revenues. Over the past year, hydrocarbon prices have slumped, reducing oil receipts, lowering nominal growth and negatively impacting the non-hydrocarbon sector.

— Despite what may become the ‘new norm’ in oil prices, the UAE remains resilient. Government spending is expected to remain significant. The UAE, as an important trade and logistics hub, continues to invest in an increasingly diversified economy.

Liquidity and margin compression— The significant drop in hydrocarbon prices is inevitably tightening liquidity. The

government and government-related entities (GREs) are normally key sources of liquidity but are currently using any excess cash to balance their books.

— Banks are relying on more expensive deposits to maintain liquidity. Expensive deposits negatively impact margins. When added to stock market volatility, pressures in real estate markets, changing tourist demographics, SME stresses, changing interest rates and fees on advances and trade finance products, it is no surprise that margins are under stress.

Non-performing loans and overall impairments— Impairment charges against loans and advances declined in 2015, although exposure

to the SME, real estate and construction sectors still causes some concern.

— NPL ratios have improved, with the corporate sector stable and no major defaults or significant restructuring requests in the UAE’s banking sector. This can be linked to improved credit underwriting standards following the 2008 credit crisis.

SME impairments— As in many developing and developed economies, the UAE’s SME sector forms the

backbone of economic development, private sector employment and GDP growth. The SME sector (which represents around 4% of total loans and advances) has been negatively affected by tighter liquidity, plunging commodity prices and delays in payment from GREs.

— A number of SME owners (particularly those focusing on commodities, food and beverages and sub-contracting) are reported to have ‘skipped’ in 2015. Local banks have had to make significant provisions. The lack of a bankruptcy law – which leads to the criminalization of default – is one reason owners may consider fleeing the country rather than sitting with creditors to find mutually agreeable solutions.

Cost-to-income ratios— The cost of doing business has risen during 2015 as banks look to invest. Eight

of the banks we analyze here have reported an increase in their CIRs in 2015.

— In the second half of 2015, a number of local and international banks laid off staff to keep costs at manageable levels.

Global markets— Global markets significantly impacted UAE banks due to volatility and a lack

of big structured deals. Tighter liquidity also impacted the number of major deals.

…into the year gone by

UAE banking perspective 20161

Net profits increased11%

Net impairment charges decreased9%

Average NPL ratios dropped4.1%

Total assets increased11%

Capital adequacy ratios remain above the regulatory minimum (12%)

18%

Share pricesgenerally declined

Average cost:income ratios increased

Average ROEfell slightly17.3%

Average ROAdropped marginally2.2%

Source: KPMG analysis of the published 2015 results of the UAE’s top 10 listed banks

Outlook

Regulatory reform— New regulatory requirements for UAE banks will mean new challenges but also new opportunities.

The banks that most efficiently and effectively embrace these reforms will be better prepared and placed in the long term.

— Regulatory challenges means that banks must continue to invest in their resources, such as human resources and operating systems. Anti-money laundering (AML), anti-bribery and corruption (ABC) and know your customer (KYC) have always been key for banks – and a central focus for regional regulators.

Prudent provisioning— IFRS 9 will impact banks’ balance sheets, accounting systems and processes

— Adapting to IFRS 9 will need significant investments of time, effort and money.

Back to basics banking— Declining liquidity within the banking system is causing banks to take a more conservative lending

posture, restricting credit lines for both individuals and companies. “Back to basics” banking practices could quickly re-inject some sorely needed confidence into the business environment.

— Banks must understand the entire customer journey, from acquiring a customer and monitoring customer satisfaction levels through covering risk and providing a value-adding journey to closing a customer account, no matter which customer segment they belong to.

Securing cyber— Cyber security continues to be a key sector concern. A recent incident in Sharjah – where a

malicious hacker demanded US$3 million in return for not releasing confidential information –should have sharpened awareness across the sector.

— Financial organizations across the region should significantly improve emergency response and contingency plans so that they can effectively respond to, and recover from, cyber breaches.

Digitize or die— UAE banks have bought into ‘digitize or die’ with a resulting focus on innovation and efficiency.

— Experience confirms that digital transformations deliver major results - cost-to-income can reduce by more than 30% and customer metrics such as the net promoter score can increase by 20-25%.

— Digitalization is interlinked with banks’ desire to enhance customer satisfaction and help overcome challenges related to multi-generational customers with differing financial needs and technology appetites.

Tapping talent— Challenges across the banking sector are increasing the pressure on banks to find the right talent

and skills to address regulatory and risk management pressures and technological advances. Today’s leaders need to keep pace with a rapidly changing financial landscape, both regionally and locally.

2UAE banking perspective 2016

Developed economies grew less quickly than many analysts expected in 2015 with early optimistic estimates steadily revised downwards throughout the year. The global economy will probably continue to grow in 2016, but at a more modest rate. Economic performance was muted in the Eurozone. Growth slowed in sub-Saharan Africa, largely due to low oil and commodity prices. China has entered a period of greater uncertainty as it transitions from being an export-led to a consumer- and services-focused economy. The Middle East was affected by both geopolitical tension – with Yemen, Syria and Libya of particular concern – and economic volatility. The future of energy dominated decision making across the GCC in 2015 with countries reviewing budgets and long term plans. However, despite what some are now calling the ‘new norm’ in oil prices, GCC economies remain resilient. Government spending is expected to remain healthy, although unlikely to match previous years. The UAE, as an important trade and logistics hub, continues to invest in a diversified economy. The UAE’s banking sector has a crucial role to play in advancing the UAE’s position internationally, maintaining liquidly in domestic markets and supporting local business and people.

US$404 billion. A capital adequacy ratio of 18.3% reflects the strong capital base of UAE banks. Results are mixed for the 10 national banks analyzed for this report. Half of the banks increased their net profits. Net interest income and lower impairment charges boosted profits for certain banks. Banks with declining profits saw ROA and ROE adversely affected. In this overview of the UAE banking sector, our market-leading banking experts examine how the different forces at play set out above are simultaneously accelerating and disrupting the industry.

The banking sector – both globally and in the UAE – is currently facing a number of strong headwinds. Globally, institutions are focusing on enhancing regulatory capital. Digital and broader technology advances are challenging the customary ways of doing business. New market participants - non-bank financial institutions - are encroaching on traditional hunting grounds. A new generation without traditional customer loyalties have different expectations and are using social media to connect, communicate or complain. This is putting pressure on banks to find the right talent (page 19), while they belatedly enter the skills race to address regulatory and risk management pressures and technological advances. Today’s leaders need to keep pace with a rapidly changing financial landscape, regionally and locally.

Liquidity is tightening. This is inevitable with the significant drop in the oil price. Governments and government related entities (GREs) have been key sources of GCC liquidity. However, governments are now using any excess liquidity to balance their own books. The UAE’s banking sector is likely to feel squeezed as drawdowns continue while weaker oil prices filter through into the non-oil economy. We are already seeing the effects on the SME sector. The last 12 months has clearly shown that banking on the back of post-dated checks is unsustainable and banks will need to go back to basics (page 11). Add to this stock market volatility, pressures in the real estate market and changing tourist demographics and it is understandable that banks are looking to reduce their exposures to riskier segments.

49 banks operate under the auspices of the Central Bank of the United Arab Emirates (CB UAE), of which 28 are foreign banks. Most national banks are listed and seven operate as Islamic banks. In 2015, according to KPMG’s GCC Listed Bank Results 2015 – a new paradigm gross bank assets increased by 7.4% on a year-on-year basis to US$673 billion. Credit increased by 7.8% to

The UAE continues to invest in a diversified economy. The UAE’s banking sector has a crucial role to play in advancing the UAE’s position internationally, maintaining liquidly in domestic markets and supporting local business

“”

Executive summary


Abbas Basrai

However, there is continued interest in growing secured portfolios. Increasing competition amongst lenders for quality assets should lead to continued competitive options for consumers. We have noted changes in credit standards, driven by the economic outlook, the quality of institutions’ asset portfolios, the change in risk tolerance, and current - and anticipated - regulatory reform (page 5).

We recently highlighted regulatory changes in Bank structure: the search for a viable strategy where we investigated how regulatory and commercial pressures are changing the banking rules of the game. Following on from the international regulatory drive, various reforms have been rolled out here in the UAE, offering both challenges and impetus for improvement, such as introducing a credit bureau for the retail sector and a governance and control framework for EIBOR submissions. IFRS 9 (page 8) impact and gap assessments will identify a road map for full implementation by 2018. Basel III capital reforms will build buffers and increase the quality and level of required capital. Introducing a leverage ratio (based on Basel III) will tighten leverage in the banking sector. New disclosure requirements relating to regulatory capital, remuneration packages, leverage ratio, buffer requirements and liquidity have been – or are about to be – introduced. New regulations against excessive risk taking are based on new risk management and corporate governance rules aligned with international standards. Additional requirements are expected for (domestic) systemically important financial institutions (D-SIFIs) once they are identified.

The focus remains on banking operation transformation and cost optimization. Anti-money laundering (AML), anti-bribery and corruption (ABC), know your customer (KYC) and cyber security have always been key. Recent cyber attacks in Sharjah – with a malicious hacker demanding US$3m in return for not releasing confidential information – and Doha should have sharpened awareness across the financial sector. Recent and significant fines slapped on international banks have brought compliance even more sharply into focus.

In November 2015, we launched a cyber-security survey (page 13) in the UAE to better understand cyber security arrangements and preparedness to respond to a cyber-attack. Many organizations in the UAE – including financial institutions – continue to struggle in a number of different areas. Developing an adequate investment case to recruit the right level of expertise is a key concern. So is implementing appropriate security technologies, even against a backdrop of an increasing number of cyber security attacks in the region. UAE financial organizations should significantly improve their emergency response and contingency plans so that they can effectively respond to, and recover from, a cyber-breach.

Today’s leaders need to keep pace with a rapidly changing financial landscape, regionally and locally“

”Banks have to stay relevant. ‘Digitize or die’ is a motto we are seeing across the sector, giving an immediate focus on innovation and efficiency. Every bank in the GCC is either undertaking or planning a digital transformation. Digital (page 16) is on the agenda for every executive and every board. While no bank is questioning the value of digital, very few banks so far have been able to unlock its full potential. KPMG’s experience confirms that a successful digital transformation delivers major results. Cost-to-income can be reduced by more than 30% and customer metrics such as the net promoter score (NPS) often increase by 20-25%. To realize the full potential of a digital transformation, every bank should focus on three leading practices: defining what digital means to them; developing a dual-speed operating model; and ensuring that all stakeholders understand that digital is everyone’s responsibility.


Globally, the ever changing regulatory environment is piling further pressure on banks. After an international regulatory drive, various regulatory reforms have been or are expected to be rolled out in the UAE. These entail numerous challenges but also provide new impetus for improvements. Changes include the introduction of a credit bureau for the retail sector and a governance and control framework for EIBOR submissions. An IFRS 9 impact and gap assessment to identify a road map for full implementation by 2018 is already in focus.

Other regulatory reforms expected to be rolled out across the UAE include:

— New capital reforms (Basel III) which will increase the quality and level of required capital and build buffers outside stress periods which can be drawn upon if losses are incurred. Internationally, a full implementation is planned in the run up to 1 January 2019. The Central Bank of the UAE (CB UAE) has not yet published requirements or a timeline for UAE banks but is most likely to follow the international timeline.

— A leverage ratio (Basel III) which will restrict leverage across the banking sector. Leverage is measured by dividing tier 1 capital by the bank's average total consolidated assets (the sum of the exposures of all assets and non-balance sheet items). According to the international timetable, final calibration should be completed by 2017. The CB UAE has not yet published requirements or a timeline for UAE banks.

— New disclosure requirements relating to, among others, regulatory capital, remuneration packages, leverage ratios, buffer requirements, exposures to securitization and other off-balance sheet vehicles, and liquidity. International authorities will enforce these disclosure requirements from the end of 2016. The CB UAE has not yet published requirements or a timeline for the UAE.

— New regulations against excessive risk takingaligned with international standards. The CB UAE’s new risk management and corporate governance rules will focus on board and management responsibility and accountability and is expected to be published by the end of 2016.

— Additional requirements for (domestic) systemically important financial institutions (D-SIFIs), that is, banks which have an important impact on the domestic financial system and economy. The CB UAE is currently working on criteria to identify these institutions but has not yet announced the D-SIFIs for the UAE.

Regulatory reform Dr. Sandra Weidenbach

The ever changing regulatory environment is piling further pressure on banks“

”


In 2015, the Central Bank published qualitative and quantitative liquidity management requirements for UAE banks. The quantitative liquidity requirements are categorized into:

— UAE specific: the eligible liquid asset ratio (ELAR) and the advances to stable resources ratio (ASRR)

— Basel III: the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR).

UAE banks can either apply UAE-specific ratios or (with CB UAE approval) Basel III ratios. Banks wanting to apply Basel III ratios must demonstrate that they have the necessary governance, controls and processes frameworks in place and show they comply with qualitative liquidity standards.

— The entire liquidity framework, including processes, procedures, roles and responsibilities, controls, documentation, data availability and sourcing, can be reviewed

— A “single rule book“ enhances transparency and comparability by introducing a level playing field

— The expectations of a wide range of stakeholders –including shareholders, investors and rating agencies – can be simultaneously satisfied

— International industry-wide standards are complied with

In order to implement the new qualitative requirements and comply with minimum LCR and NSFR levels, banks must have a deep economic understanding of their internal liquidity risks. Only then can requirements be applied accurately and in accordance with a bank’s size, type, complexity – and the risks inherent in its business activities. This deep understanding is also necessary for the LCR and NSFR, which go far beyond the detail and complexity of current liquidity reporting (such as ELAR and ASRR).

LCR and NSFR implementation, while not currently mandatory, is highly recommended for banks with a current or planned international presence. Early adoption factors to consider include the time and cost involved; the requirement to hold more high-liquid and short-term low-yielding assets which may have a negative impact on KPIs (such as ROE); uncertainties about the availability of sufficient high quality liquid assets; and an increase in funding costs as long-term funding opportunities are limited.

However, the advantages are significant:

— Additional comprehensive stress scenarios can be embedded in the wider liquidity risk identification, measurement, monitoring and management frameworks

The advantages of implementing LCR and NSFR are significant“

”


Questions and challenges regarding the implementation of the requirements include the detailed information and data required to calculate the LCR. Efficiently implementing LCR from a technical, operational and organizational and governance perspective will be a challenge.

While fulfilling regulatory liquidity requirements is a primary objective, these should become fundamental components of every bank’s business and risk management strategy. Topics such as identifying profit

Liquidity management

Regulatory ratios (LCR,

NSFR)

Framework & organization

Liquidity transfer pricing

Liquidity reserve

Funding sources

Measuring, managing & monitoring

Intraday and foreign currency

liquidity management

Stress testing & contingency

plans

— Gather and report data— Manage ratios

— Measure risk concentrations

— Limit and monitor funding concentrations and intragroup funding

— Identify liquidity risk drivers

— Develop methods to manage risks

— Limit and monitor

— Develop a system— Embed system into business

activities and pricing management

— Develop strategy, policy and guidelines

— Collaborate

— Identify and analyze risk— Develop a liquidity maturity

statement— Identify risk tolerances and

limits— Report to responsible functions

— Develop stress scenarios— Define stress parameters— Determine contingency

measures

— Calculate reserve size and composition

— Manage and validate reserve

and risk drivers from a liquidity perspective, planning liquidity needs, estimating the impact of the LCR and NSFR, closely monitoring refinancing structures and allocating liquidity costs appropriately are all key elements in liquidity (risk) management – and also profitability drivers. The goal of each and every UAE bank, therefore, should be to quickly identify key issues in the setup of its current liquidity management practices and in the compilation of quantitative regulatory measures and to determine development needs in a timely and structured way.


As highlighted in the previous article, IFRS 9 is a change that will significantly impact banks across the globe, as well as here in the UAE. In fact, the biggest accounting development for banks today is likely to be IFRS 9, as it will significantly impact balance sheets, accounting systems and processes. Ongoing deliberations on how to implement IFRS 9’s new impairment model –conducted by the ITG, a discussion forum set up for this purpose by the IASB – will be of particular interest.

IFRS 9: Financial Instruments was issued on 24 July 2014. The standard is a game changer for banks and other financial institutions. After long debate about this complex accounting area, implementation efforts have finally begun in earnest.

Prudent provisioningYusuf Hassan

The standard is a game changer for banks and other financial institutions“

”In general, financial instruments include loans, investments, debtors, receivables, creditors, payables and derivative instruments like forwards, swaps and options. As these instruments become progressively more complex, their accounting has increasingly baffled many, including auditors and accountants.

The new standard revises guidance on the classification of financial assets, and supplements the new hedge accounting principles published in 2013. Guidance on impairment – that is, provisions for loan losses – are significantly different from current practice.

In the past, observers have suggested that provisioning for loan losses was 'too little, too late'. The new expected credit loss model which recognizes and

Key considerations for CXOs

Chief Executive Officer— How will the effects of IFRS 9 be included in

your business planning and forecasting?— Have you considered the impact that IFRS 9 will

have on your product pricing?— Have you considered how IFRS 9 will affect

other aspects of your business?— Have you determined whether your key

performance indicators need to be adjusted?

Chief Finance Officer— Do you know your ECL under IFRS 9?— Have you considered the effects on your

regulatory capital?— Have you considered how the volatility in

provisions will affect your bottom-line?

Chief Risk Officer— Have you considered leading economic indicators

in your PD, LGD and EAD models?— Are your models sensitive enough to ensure that

variables that may trigger impairment are identified?

Chief Information Officer

— Do your systems have the data required for IFRS 9’s modelling and disclosure requirements?

— Have you considered how the required data will be collected, cleansed, integrated and housed?

Chief Compliance Officer

— Have you considered how IFRS 9 will affect your governance frameworks?

— How will your business ensure that the required controls are in place and operating effectively?


measures impairment should address most, if not all, of these concerns. It accelerates the recognition of losses by requiring provisions to cover both already-incurred losses and some future expected losses.

As well as being bigger, provisions are likely to be more volatile. A major issue for banks – and their stakeholders – will be how the new standard affects regulatory capital ratios. Banks will need to factor this into their capital planning. Stakeholders will be looking for information on expected capital impact in financial statements.

IFRS 9 is going to be a genuine paradigm shift for banks, not just in the UAE but worldwide. This is not an issue that affects only the finance or risk functions. The ripple effect of IFRS 9 will be felt across the organization. Higher provisioning will force banks to review their capital requirements. Product mixes and business models will also need to be evaluated. On the operational side, systems, processes and other infrastructure will need to change. Since significant judgment and estimates are required, banks must set up an appropriate governance mechanism. Again, all of this is likely to need time and money.

Although the standard is applicable to accounting periods beginning on or after 1 January 2018, the changes are so pervasive and far reaching that institutions should start acting now to comply with their requirements. Many, if not most, banks will require all of the time left to prepare for the expected credit loss requirements.

If a bank provides a home loan, any number of events could result in a non-performing loan, such as the customer losing his job or suffering a serious injury. Under the current incurred credit loss model, the bank provides for a loan loss when such an event occurs. However, under the expected credit loss model, the bank is expected to anticipate that such an event could occur and therefore provide for losses earlier than previously

Adopting the new principles will require a lot of time, effort and money. The new standard requires banks to provide for expected credit losses over the lifetime of the loan on the date the loan is first recognized, based on the level of default expected over the next 12 months. Where credit risk is assumed to significantly increase, loan loss provisioning must be recognized based on the level of defaults expected over the expected life of the loan. This should lead to higher provisions, more complexity and deeper risk management involvement.

The ripple effect of IFRS 9 will be felt across the organization“ ”


Classification and measurement: IFRS 9 uses a logical, single classification and measurement approach for financial assets that reflects the business model in which they are managed and their cash flow characteristics.

Some of our global banking clients have been working on IFRS 9 implementation projects since the new standard was released and are now nearing the end of the adoption process. Most UAE banks have at least started studying the impact of IFRS 9. A few local banks have begun preparing for implementation. While most UAE banks don’t have particularly complex portfolios or operations, there is now only a very limited period of time to adopt the new standard. Any errors in preparation or implementation will compromise a bank’s ability to comply with the standard in time. Both CFOs and CROs are walking a tightrope.

With IFRS 9, standard setters have taken significant steps to address some of the concerns that were being raised by users of financial statements. While the IASB’s intentions were unquestionably good and significant time and effort has been invested during the standard setting phase, the proof of the pudding may be in the eating.

Impairment: The forward-looking expected credit loss (ECL) model – to recognize loan losses more quickly – applies to all financial instruments subject to impairment accounting.

Hedging: The standard includes an improved hedge accounting model to better link the economics of risk management with its accounting treatment.


The blooming of the UAE over the last 50 years –in terms of economic growth and diversification, infrastructure development, and demographics, amongst many others – has been one of the most striking success stories that the world has ever seen. The role of the financial sector has been key – from helping to raise the equity and debt needed to fund much of that development to the training and employment of thousands of Emiratis and other residents. Tighter liquidity within the banking system is causing banks to take a more conservative lending posture, triggering issues for both individuals and companies as credit lines are restricted. It is quite possible that some long forgotten leading practices might quickly re-inject confidence into the business environment.

Back to basics banking Rajesh Prasad

In o

rder

of

acce

ptan

ce

Factors that affect lending

Higher risk of business failure

Governance

Insufficient collateral

Financial factors

Absence of audited financial information

Absence of viable exit strategy

Tenure of business

Source: KPMG analysis of externally published data

Some long forgotten leading practices might quickly re-inject confidence“

”

SMEs form the backbone of the UAE’s economic development, with over 280,000 companies generating the vast majority of revenue and employment opportunities for both nationals and residents. The sector has been particularly dynamic and is industry-agnostic –there are SMEs in every sector of the UAE’s economy, from trading to car repairs. Unfortunately, over the last six months, the SME sector has reported a rise in “skip” cases.

The SME sector has been relatively underserved by banks and other financial institutions for some time. SMEs have always been seen as more likely to fail than larger organizations. Banks are more reluctant, even in good times, to lend to SMEs. But perhaps the biggest issue has been the ability of financial organizations to accurately assess the risk of financing SMEs. One of the key reasons has been the inability of banks and other financial institutions to understand who their customers are – and what they want to do.


Evaluate and manage risks

Innovate and provide tailored

solutions to customers

Align product offerings with

bank’s strategyServe the

credit needs of SMEs

Build relationshipsand strategic

alliances

Provide competitive

rates

Select and maintain

sector focus

A key principle of responsible banking was, is and will continue to be, know your customer. This means understanding your customer’s profile, industry and business. It means, wherever possible and necessary, setting up face-to-face meetings. And – more basically –it means lending based on a clearly understood ability to recover the loan. One key area where this basic adage rings true is with small and medium sized enterprises (SMEs).

Some of the banks in the UAE have struggled with the entire customer journey. From onboarding customers through monitoring performance to the (hopefully mutually satisfactory) end of the banking relationship, banks need to understand not only what customers are looking for – whether this is an inspiring digital relationship or a face-to-face connection – and the risks that the customer faces – and therefore exposes the lender to. Every customer segment and every industry sector faces its own unique challenges. Banks must start interacting with and monitoring their customers on a more regular basis. Not only will this give relationship managers – who have a significant part to play in this process – a much better idea of the current and future circumstances of their clients, it will also make it much easier for the RM to cross-sell more of the bank’s services.

The role of relationship managers is key. Too often, they have been motivated by sales targets with little accountability. They need to leave ‘skin in the game’ and track customer behavior throughout the tenor of a loan. They also need to learn that similar clients are not the same – lending on name, experience with similar clients or other banks’ experience with similar clients – has nothing to do with a relationship and even less to do with managing.

Not only are SMEs a vital part of the UAE economy, but a recent federal law requires federal authorities and ministries to contract at least 10% of their procurement budgets to purchasing from, consulting to, and servicing SMEs. Banks should also leverage the Al Etihad Credit Bureau (AECB), which gives lenders a much more holistic view of the loans and other financial obligations of their clients and prospective clients.

The AECB is, in fact, a significant pathfinder. No bank can be expected to lead from the front – or to act on its own. Banks will need to work together with their customers who are finding it difficult to service their loans. Banks can help their clients by sharing data with each other and by devising client-centric strategies. Businesses will become more sustainable, looking towards long-term success and we will see more profitable relationships based on trust.

A key principle of responsible banking is to know your customer“

”

Quick facts on SMEs

SMEs in the UAE282,000 +

SME contribution to UAE employment90%

Bank lending to SMEs4%

Contribution to GDP40%

Rate of SME loan rejections50%-70%

Typical interest rate for an unsecured loan15%

Source: KPMG analysis of externally published data


The news that banks in the UAE are targets for hackers and other malicious actors will not come as a significant shock to most key decision makers in the financial services industry or to or to key service providers, like KPMG, to the sector. In November 2015, we surveyed a broad range of KPMG clients in the UAE to better understand their cyber security arrangements and their level of preparedness to respond to a cyber-attack. What we learned clearly showed that many organizations in the UAE – including financial institutions – continue to struggle in a number of different areas.

Securing cyberCristian Carstoiu

In a sign that this is a real, not a theoretical, risk, one third of respondents indicated that they had been hacked in the previous 12 months – and had taken between two weeks and a month to recover from the security breach. Another third reported they wouldn’t know if they had been hacked, even though the UAE is in the top 10 nations targeted by cyber criminals! Over half of the respondents that had been hacked didn’t know before

The UAE is in the top 10 nations targeted by cyber criminals“

”There were a number of key insights from our survey, ranging from development and preparedness to monitoring and reporting. Our survey showed that many UAE organizations find it difficult to develop an adequate investment case to recruit the right level of expertise and to implement appropriate security technologies, even against a backdrop of increasing concern over cyber security attacks in the region. We believe many organizations in the UAE need to improve their emergency response and contingency plans in order to appropriately respond to, and recover from, a cyber breach. Organizations in the UAE also need to better understand their threat profile: who, when and why they are likely to be targeted. Enabling actionable threat intelligence is a cornerstone of an effective cyber security strategy. Enhancing and improving the effectiveness of cyber breach monitoring will help UAE organizations to detect both potential and actual security attacks and breaches. A final finding was that many boards in the UAE – where the ultimate responsibility for cyber security lies – do not have a comprehensive or accurate view of their cyber risks, often because threat intelligence and cyber monitoring have been inconsistently implemented.

The threat actors

HACKTIVISMhacking inspired by ideology

Motivation: shifting allegiances – dynamic, unpredictableImpact on business: public distribution, reputation loss

ORGANIZED CRIMEglobal, difficult to trace and prosecute

Motivation: financial advantageImpact on business: theft of information

THE INSIDERintentional or unintentional?

Motivation: grudge, financial gainImpact on business: distribution or destruction, theft of information, reputation loss

STATE-SPONSOREDespionage and sabotage

Motivation: political advantage, economic advantage, military advantageImpact on business: disruption or destruction, theft of information, reputational loss


they were hacked that they were being targeted by cyber criminals. Of those that had been hacked, reputation and the administrative time to recover were cited as the most important damage. The findings from the UAE survey were in line with global top five reasons for unsuccessful incident responses. Incident response teams often lack a proper balance between skill-set, size, and management oversight. Processes and procedures relating to incident response are not tailored to the organization. Incident response tools are inadequate, unmanaged, untested, underutilized, or absent. Relevant data is not readily available. Finally, the incident response team lacks authority and visibility within the organization.

As a global leader in cyber security, KPMG’s incident response process is aligned with internationally accepted frameworks and was developed using real-world experience. Our response to security breaches focuses on actionable results and rules of evidence, with technical security analysis and testing throughout the process. Our methodology consists of six phases:

1. Prepare and train - one of the most common causes of a failed response is the lack of adequate preparation. KPMG can help establish clear lines of communication, policies and procedures, and rules of engagement, to set the groundwork for a successful response if, or when, an incident occurs. On a parallel track, our teams work continuously to keep current on the latest methods, tools, and certifications for incident response.

2. Detect and initiate - a technical alert, an indication of fraud, or communications from law enforcement or an internet service provider may act as a trigger. Our incident response (IR) professionals help execute plans. They investigate whether an organization has been breached and whether the activity is continuing, evaluate potential damage, and help understand the need to begin notification and self-reporting.

3. Contain and investigate – our IR professionals can help determine the source, method, and impact of a breach, while working with you to limit ongoing damage, balancing between investigating and eradicating the threat. Our professionals can either allow the malicious actions to continue – to facilitate evidence-gathering – or immediately suppress malicious actions to limit damage.

4. Recover – we focus on returning the environment to normal operations.

5. Resolve – our IR professionals assess vulnerabilities and weaknesses that may be exploited by malicious activities to determine the root causes of any malicious activity. We can then recommend improvements to a client’s technical and governance environments, helping to mitigate the risk of similar events in the future.


6. Report and pursue – the final phase may include ongoing support activities related to legal or civil pursuits of individuals or groups.

At KPMG, we believe cyber security should be about what clients can do – not what they can’t. Positively managing cyber risk not only helps take control of uncertainty across business; it can be turned into a genuine strategic advantage. We understand that this area is often clouded by feelings of doubt and vulnerability so we work shoulder-to-shoulder with clients to turn it into a real sense of security and opportunity.

Reputation and the administrative time needed to recover were the most important damage

“”

What is being targeted?

VALUABLE INFORMATION

Customer, supplier and personal data

Intellectual property Business processes

BUSINESS CRITICAL INFORMATION

Financials Business plans New products New markets

CRITICAL BUSINESS TRANSACTIONS

Raising finance Mergers and acquisitions Joint ventures Divestitures


Virtually every bank and financial services institution in the GCC is either undertaking or planning a digital transformation. Digital is on the agenda for every executive and every board. While no bank is questioning the value of digital, very few banks so far have been able to unlock its full value. Nevertheless, KPMG’s experience confirms that a successful digital transformation delivers major results. Cost-to-income can be reduced by more than 30% and customer metrics, such as the net promoter score (NPS), often increase by 20-25%.

Digitize or dieFarhan Syed

Without articulating the target experience, executing any change will be difficult. The risk of delivering sub-optimal results increases. The target experience should be designed by extensively engaging with customers and understanding their motivational needs and behavior. As an example, before designing a web or mobile origination capability for personal loans, a bank needs to understand the motivational drivers for customers wanting a personal loan. Banks should pay particular attention to the moments of truth and pain points and address them while implementing the target experience. If a customer is applying for a personal loan to fund a child’s school education, then why doesn’t the bank design the experience so that the documents submitted at the school are used for the loans application process too? If the personal loan is for a family emergency, why not design a tool that proactively notifies the customer at every step of the application process to reduce anxiety levels and keep the customer informed.

The whole end-to-end target experience – from awareness and origination to fulfillment and servicing –needs to be thought through to identify and inculcate the capabilities required to deliver that experience. Understanding the changes required and sequencing implementation are a prerequisite for transformation into a digital bank.

Develop a dual-speed operating model – Digital is unknown. The speed of change in customer expectations, combined with rapidly evolving technology, means key decision makers must feel they can fail fast and scale quickly. Traditional delivery, approval or procurement processes tend not to be agile. As a result, digital challenges banks’ traditional operating models. To build digital capabilities, banks will have to embrace agile development methods and change operating models across marketing, procurement, vendor management,

Very few banks so far have been able to unlock the full value of digital“ ”

To realize the full potential of a digital transformation, every bank must focus on three leading practices:

Define digital - The biggest issue that most banks face is the ability – or inability – to articulate and explain what ‘digital’ really means. Is it a mobile banking app, or a Twitter or Facebook account, or building enterprise data warehouses and analytical capabilities - or all of these? Defining what digital means by articulating it from a customer perspective - by envisioning the target experience that the bank will deliver at the end of the transformation to its customers - is the single most important success factor. The customer experience should be aligned with the bank’s brand promises and aim to deliver its financial and strategic objectives.


security, finance and even human resources. Banks then should be able to source and deploy technology, talent and other resources agilely, quickly and efficiently.

If – having opted for digital - a bank finds it needs new technology, it won’t be able to source that technology in time if procurement takes four months to write and issue an RFP and source the desired vendor. This clearly is not agility. Equally, some projects with fully understood, highly complex requirements will require traditional (waterfall) approaches. That is why digital transformations tend to require dual speed operating models which allow banks to cater for all types of project delivery needs.

Make digital everyone’s responsibility – Many clients hire a head of digital or transformation and expect that person to exclusively drive change and deliver value. While a single role increases focus, responsibilities for a successful digital transformation must be shared. The CEO sets the mandate. The CMO and Head of Channels drive the customer engagement transformation. The COO and the CIO typically lead the operations and IT transformations, focusing on modernizing legacy systems, building solid foundations in data, analytics, security, mobile and a service oriented middleware and

KPMG’s experience confirms that a successful digital transformation delivers major results

Cost-to-income can be reduced by more than 30%

Customer metrics such as the net promoter score (NPS) increase by 20-25%.

Source: KPMG Nunwood


transforming middle and back office operations. The CRO governs and mitigates compliance, operational and regulatory risks. The CFO allocates the required capital and maintains a strong focus on benefit realization. The CDO or CTO drives and orchestrates the change, working closely across the C-suite.

Digital transformation requires an extremely coordinated approach across all business functions. Without a collective effort and shared responsibility, no bank can be fundamentally transformed.

No one should assume that digital transformation will be easy, nor that it is a panacea that cures all of the problems that banks are facing. But three things are very clear. Banks that get left behind are going to find it very hard to catch up. Banks that don’t get the transformation right are going to get left behind. And banks that don’t adopt, adapt and learn from leading practice are unlikely to get the transformation right.

To realize the full potential of a digital transformation, every bank should focus on three leading practices:

Digital transformation will not be easy, nor is it a panacea that cures all problems“

”

Develop a dual-speed operating

model

Define digital

Make digital everyone’s

responsibility


The right talent is key to success in every organization. The banking sector is facing a number of key mega trends. Digital and broader technology advances are challenging the traditional ways of doing business. New market participants – such as non-bank financial institutions – are entering the sector. A new generation without traditional customer loyalties have different expectations and are using social media to connect, communicate and complain. This is putting pressure on banks to find the right talent, forcing them to enter the skills race to address regulatory and risk management pressures and technological advances. Today’s leaders need to keep pace with a rapidly changing financial landscape, regionally and locally.

Tapping talentMuhammad Amjad Amin

obtain capital working lines. To capture the right talent, talent risk has to be incorporated into wider risk management governance and reporting frameworks. Banks need to answer a very important question – does people risk have the same prominence on board and executive committee agendas as credit risk or operational matters? Banks need to identify critical functions and roles where investment is required to get –and retain – the right people. In our dynamic, globalized world, banks need to develop a mechanism to retain quality staff which:

— Responds to the challenges the banking sector is currently facing

— Identifies, recognizes and understands the skills needed to effectively use modern technology

— Thinks outside the traditional banking approach

— Has the right attitude to risk.

Another key topic which is on the agenda of boards and executive committees across the region is enhanced customer satisfaction. In this continuously changing world, banks are struggling to simultaneously grow and satisfy customers. These challenges includes multi-generational customers with different financial needs and varying appetites for technology.

Banks need to have the right talent and approach to understand customer needs. Helping customers means helping them make the most of their finances – from getting them the best rates for remittances through selecting the best car for their needs to easing how they

A new generation of customers have different expectations and are using social media to connect, communicate and complain

“”


This is easier said than done, not least because the current banking culture tends to be risk averse and focused on procedures and hierarchies, rather than being creative or agile – as outlined in the previous article.

Banks need to build, buy and borrow workers to develop a digital environment. They need to identify the capabilities required to support and maintain a digital transformation and identify gaps in their current skill sets. Banks need to proactively design a talent strategy. Is there sufficient supply to cater for the need of all banks and financial institutions? The general presumption is that supply will be much less than demand and that this gap will have to be bridged using contract workers with the required skill sets. To attract and retain the right talent, banks need to align compensation and benefits more closely with leading technology companies. Once the right talent is identified and hired, the next challenge is to retain. Banks are going to have to transform both their culture and their HR practices, including new appraisal methods and training.

Staff recruitment

and retention

Risk attitude

Current challengesDigital

skills

New mindset


Does people risk have the same prominence on board and executive committee agendas as credit risk or operational matters?

“”

A strong corporate culture will underpin success in the new era of digital banking. That culture will need to be driven by strong leadership and genuinely held values –focused on integrity, trust, and respect for the law –keeping the customer’s best interests at the heart of a bank’s business model, and encompassing a social responsibility which maintains market integrity and financial stability. A successful culture must recognize that there are significant challenges to be reconciled when balancing customers’ interests with shareholder returns, and in defining how a firm and its employees behave in the ‘grey areas’ where careful judgments will always need to be made.

Customer satisfaction

Growth and

shareholder returns

Banks need to develop a plan for modern digital banking which focuses on how employees are utilized. Digital banking will diminish the importance of certain roles. This will be viewed by some as a threat and by others as an opportunity. Winners can focus on higher value tasks, risks and customer advice. Relationship managers should spend less time capturing customer details and more time giving valuable advice. Hiring people with digital knowledge is not enough. The challenge is to improve the culture and to embed an approach where staff understand the advantages and the risks of new technology.



The data in this publication has been taken from KPMG’s GCC Listed Bank Results, a report authored by Omar Mahmood, KPMG’s Head of Financial Services in the Middle East and South Asia. The GCC Listed Bank Results aims to provide banking industry leaders with succinct analysis to help compare banking sector financial results across the GCC, and provide forward-looking views and insights.

The report analyses the published financial statements of 56 leading listed commercial banks across Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates. It covers over 90% of the region’s listed banking assets, and indicates that the regional banking sector has entered a new paradigm where we see margin compression, tightening liquidity, moderate asset and profit growth, limited capital market activity, a greater focus on cost reductions and a widespread need for greater capital and funding.

The report is available at www.kpmg.com/AE/en/IssuesAndInsights/ArticlesPublications/Pages/GCC-Banking-Results.aspx

Contributors

Luke EllyardPartner | Financial ServicesT: +971 50 240 2553E: [email protected]

Luke Ellyard is a financial services assurance partner in KPMG’s Dubai office. He specializes in the audits of local and international retail and corporate banks and investment management firms, including a leading global sovereign wealth fund, UAE exchanges, private equity houses and a significant number of entities registered with the Dubai International Finance Centre [DIFC]. Luke has also provided specialist control and understanding input to a number of local, regional and global financial institutions and advised on UAE buy-side due diligence exercises. While working in London and Japan, he has also worked widely with European and Asian global investment banking clients.

Dr. Sandra WeidenbachManager | Financial Risk ManagementT: +971 56 520 5376E: [email protected]

Sandra joined our practice from KPMG Zurich where she was part of the Regulatory and Basel III team. She has managed engagements focused on liquidity coverage ratios, net stable funding ratios (NSFRs) and Basel principles for sound liquidity risk management and supervision for a range of sizes and types of banks. She has worked closely with regulators and is a member of the Global KPMG Treasury and Liquidity Centre of Excellence.

Abbas BasraiDirector | Financial ServicesT: +971 56 683 3197E: [email protected]

Abbas is a banking specialist and focuses on audit and advisory services within the financial services sector. He has considerable experience of working with banks (both conventional and Islamic), sovereign wealth funds, investment and asset management companies and private equity funds. He has a particular interest and experience in the accounting, regulatory and control aspects of banking operations (from risk assessments to full reviews of front office supervision, product control, treasury, risk and operations functions), including extensive work with regard to derivatives and structured transactions. Abbas qualified as a chartered accountant (ICAEW) while with KPMG in London.

Rajesh PrasadDirector | Management ConsultingT: +971 50 553 1067E: [email protected]

Rajesh leads management consulting solutions for the banking and financial services sector for KPMG in the Lower Gulf. He has over 17 years of consulting experience across the Middle East.

Rajesh has actively engaged with boards and CXOs of leading financial institutions across the GCC on diverse issues. He has assisted a number of financial services institutions in the Middle East region with business and strategy development and implementation, target operating models, business transformation, business performance management, operational improvement, system selection and project management.


Contributors

Yusuf HassanPartner | Risk ConsultingT: +971 50 167 5443E: [email protected]

Yusuf leads our Accounting Advisory Services function for the Lower Gulf firm and is widely recognized as a leading IFRS expert. He assists KPMG audit teams and clients with technical IFRS issues, in particular advising on: the interpretation and application of IFRS to specific transactions and scenarios; the implementation of the latest IFRS developments; standard setting processes: and regional IFRS issues.

Yusuf has provided IFRS assistance to a wide range of blue chip clients in various industries across the Middle East. He has conducted IFRS training in South Africa and across the Middle East and has presented at a number of regional IFRS seminars.

Muhammad Amjad AminSenior Manager | Financial Services T: +971 56 683 3045E: [email protected]

Amjad manages a diversified portfolio of banks and financial institutions. As well as identifying and assessing the impact of new IFRS, IAS and AAOIFI rules and regulations on banks, he advises clients on complicated accounting matters. As a senior leader of KPMG’s Islamic Financial Group, Amjad advises on the structure and accounting treatment of various Islamic products.

Cristian CarstoiuDirector | Management ConsultingT: +971 50 619 8131E: [email protected]

Cristian specializes in mobility, omni-channel transformations, analytics, process consulting and the project management of large and complex implementations. He has worked extensively on strategy and digital transformation engagements, having worked across Europe and the Middle East with blue chip clients. Cristian has also led multiple mobility and omni-channel strategy and delivery engagements for banking and government clients across the GCC and North Africa. He is widely recognized as a leading subject matter expert on a range of IT risks, and has a particular interest in cyber security.

Farhan SyedPartner | Management ConsultingT: +971 56 520 5377E: [email protected]

Farhan leads our digital transformation practice in the Lower Gulf. He specializes in helping clients understand the implications of digital forces, determine opportunities and threats, formulate strategy, transform businesses and bridge performance gaps.

His functional skills include developing digital customer experiences, determining the capabilities required to deliver a digital experience, re-architecting operating models and developing agile transformation plans.


The information contained herein is of general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation and circumstances.

© 2016 KPMG, KPMG LLP and KPMG Lower Gulf Limited, registered in the UAE and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. Printed in the United Arab Emirates.

The KPMG name and logo are registered trademarks or trademarks of KPMG International.

Abbas BasraiDirectorT: +971 56 683 3197E: [email protected]

Rajesh PrasadDirectorT: +971 50 553 1067E: [email protected]

Contact

kpmg.com/ae

Luke EllyardPartnerT: +971 50 240 2553E: [email protected]

UAE Banking Perspectives 2016 - KPMG | US · PDF file—The UAE’s oil and gas...

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