Macroeconomic Conditions and Soundness of UAE Banking Sector

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The British University in Dubai (BUiD)
Using a panel data for 19 UAE national banks covering the period 2005-2010, this research analyzes the impact of selected macroeconomic and bank-specific variables on financial soundness indicators (FSIs) related to banks. Capital adequacy, Assets quality and profitability are key indicators for banks’ soundness and they are believed to have a robust correlation with business cycle and other macroeconomic indicators. The study finds that banks’ FSIs are strongly related to the business cycle and inflation rate. Banks tend to increase their capital ratios in downturns while reducing them in upturns causing a pro-cyclical effect on the business cycle. Also, inflation rate has a strong negative relationship with capital ratios due to its impact on banks’ costs and profitability. Probability of default tends to increase during adverse macroeconomic conditions and thus increases non-performing loans in the banking sector. Moreover, some bank-specific characteristics showed significant relationship with soundness indicators of banks. Cost of adjusting capital and risk appetite of banks have significant impact on the CAR ratios. Also, higher spread between lending rate and deposit rate increases the debt servicing burden on borrowers and thus increases the probability of default, while banks with lower leverage ratios can be more profitable due to their low cost of funding.
macroeconomics, banking sector, United Arab Emirates (UAE), UAE national banks, assets quality, profitability