The Central Bank of the UAE has recently implemented a number of measures to coax banks to lend to each other at cheaper rates. Interbank lending virtually dried up around the globe in the last quarter of 2008 and the beginning of this year as a result of the credit crunch. Like most other countries, the UAE was impacted, and interbank lending rates ratcheted sharply higher. Since then conditions have started to improve and rates have moved lower, but the central bank is trying to usher the process along after expressing dissatisfaction with what it sees as persistently higher interbank lending rates.
As of 1 September the central bank cut the interest rate on a liquidity support facility that is provided to banks to 1.5% from 2.5%. Launched in 2008, the facility is used to inject liquidity into the banking system by providing loans to banks against their holdings of first class securities. On announcing the move, the central bank said it anticipated that it would reduce the cost of economic activities in the UAE, particularly investment spending and contribute to sustained growth and support the national economy in general. Bankers are less optimistic, with one suggesting that very few banks were using the liquidity support facility, and that he did not expect this 1% cut to open the flood gates to greater use. However, another banker concedes that while banks were hardly lining up to use the facility its a step in the right direction if they can go to the government and access funding at a lower cost.
Eibor Panel Change
In addition to the interest rate cut on the support facility, the central bank has announced that it will change the composition of the panel that determines the emirates interbank offered rate (Eibor). Eibor is the UAE dirham equivalent of the London interbank offered rate (Libor), which is the base rate for many western transactions. In addition to interbank transactions for the dirham, Eibor is used, for example, as a base rate for domestic mortgages and also dirham-denominated project financings. The central bank announced in early August that it was discussing establishment of an Emirates Interbank Offered Rate (Eibor) under the aegis of the central bank.
Thereafter, it removed two international banks (Royal Bank of Scotlands ABN Amro unit, and Lloyds Banking Group) from the panel that sets Eibor and has added four local banks to the group (First Gulf Bank, Mashreq Bank, RAK Bank and Union National Bank). Emirates NBD, which was formed in 2007 from the Emirates Bank and National Bank of Dubai merger, has had its representation on the panel cut to one slot from two. The remaining six banks in the 11-strong group comprise Abu Dhabi Commercial Bank, Citibank, Commercial Bank of Dubai, HSBC, National Bank of Abu Dhabi and Standard Chartered.
The line up, which is scheduled to start determining Eibor rates in the middle of this month, is thought to better represent domestic market conditions, given the addition of a greater number of local banks. This made sense from a structural point of view, and there was tidying up that needed to be done, commented a domestic banker. In addition to this change, the central bank has also extended the application of its own official 1% repo (repurchase) rate from one week to one month. These changes will provide banks with increased liquidity at a lower cost, said the central bank when it announced them on 27 August.
As with the interest rate cut on the liquidity support facility, bankers are skeptical that this will help bring down the Eibor rate. These measures by themselves are not sufficient to push the rate lower, said a banker, although he noted that banks are trying to keep a lid on Eibor because they are mindful of the pressure being brought to bear by the central bank. One-month Eibor rates have already come down dramatically from the levels they reached after the collapse of Lehman Brothers in September 2008. This marked the peak of the crisis, when banks funding costs skyrocketed higher and activity ground to a halt amid a general distrust of counterparties as many feared another Lehman was about to be uncovered.
Confidence Returning
In October 2008 three-month Eibor had climbed to around 5%, outpacing the targeted US federal funds rate (given that the dirham is pegged to the dollar) which was at 1.5% (MEES, 27 October 2008). And at this point, even given the elevated levels for both Eibor and Libor, bankers were complaining that the true cost of interbank transactions were even higher than the published rates. Since then, both the Libor and Eibor rates have gradually fallen on the back of capital injections into the banking system, both globally and in the UAE, and confidence has started to return. At the end of last week one month Eibor was being quoted at around 1.775% and the three month rate was at 2.14%, with the federal funds rate at 0.25%.
Despite the Eibor fall, the level is still out of line with the federal funds rate and above what would be considered normal, yet some bankers point out that if anything, the published level is still on the low side in terms of representing the true benchmark for interbank trading. In order for the rate to come down it is necessary that banks restore balance to the relationship between lending and deposits and in the short term that requires higher rates to attract funds, said one local banker. A representative balance in the market is probably higher than published rates, he asserts. There is a demand and supply dynamic which means that the central bank cant just say this is where rates should be, independently of whats going on in terms of lending and deposit taking, he added, suggesting that time is the healer in this game and predicting we wont get normalization of rates until next year. However, the market is returning to balance and generally rates, including those for lending, mortgages and even deposits, are all in a downwards trajectory and lower than they were earlier this year, he added.
The latest data shows that banks attempts to attract more deposits are proving successful, climbing to Dh964.1bn ($262bn) at the end of July this year, compared to Dh961.7bn ($261bn) in the previous month and Dh857.5bn ($233bn) at the end of August 2008. Loans in July (net of provisions) fell to Dh1,007bn ($274bn) from Dh1,009bn ($275bn)in June, but are still up from the Dh925bn ($252bn) reported in August 2008, suggesting lending is gradually rising as banks gain more confidence as they emerge from the credit crunch. Provisions for non-performing loans (NPLs), unsurprisingly, given the financial and economic crisis, climbed to Dh25.3bn ($6.9bn) at the end of July, compared to Dh18.3bn ($5bn) in August 2008, although banks capital adequacy ratios climbed to 17.6% at the end of the second quarter, compared to 16.2% at the end of the first quarter and 13.3% at the end of 4Q08. Goldman Sachs commented on 24 August that many of the UAE banks saw second quarter profits decline due to provisions booked against a rise in loan defaults, suggesting that NPLs may remain elevated for the rest of the year. The main risks for the UAE banks are the continuous pressure on real estate prices and falling corporate profits, said the US investment bank, noting that investors remain concerned about the impact on shares, despite support from local governments which have helped to boost funding and capitalization.
Central Bank Delays Banks Capital Reserve Targets
The central bank delayed targets for increasing capital reserves and changed the amount of Tier one capital which banks must set aside in its 30 August circular, effective 31 August. It has now stated that banks need only have minimum Tier one capital of 7% (within a minimum total capital ratio of 11%) at end-September 2009 and 8% (within total of 12%) by end-June 2010. These apply to both national and foreign banks and are subject to review at the beginning of 2011. In October last year, the Ministry of Finance had stipulated Tier one capital ratio of 11% by end June 2009 and 12% by end June 2010. Fitch Ratings said that the clarification by the central bank appears to have been made to help stimulate bank lending, which virtually dried up in the first half of this year as banks tried to meet the ministrys targets, and became more cautious as the global economic crisis started to hit the Gulf. Fitch notes that if banks lower their capital ratios too near to the revised minimum levels, it would be viewed negatively and may affect their individual ratings. The ratings agency says it is unclear why they would lower their ratios, given that most have increased them already, and are still facing risks of higher impairments on their retail and corporate loan portfolios.
Copyright MEES 2009.
