The central bank of the United Arab Emirates will introduce on April 15 a mechanism allowing the country’s banks to borrow funds from it overnight, to help their liquidity management.
The Interim Marginal Lending Facility (IMLF) will let lenders use certain assets as collateral to obtain one-day loans, according to a letter to banks which was published on the central bank’s website on Tuesday.
Such mechanisms, common in developed money markets, are especially useful during times of market stress, when banks are reluctant to lend to each other because of a desire to maintain their cash holdings and out of fears that the borrower might default on the loan.
The UAE central bank originally announced in September 2012 that it would set up the so-called discount window as a way of developing its monetary policy framework.
Banks accessing the IMLF must borrow a minimum of Dhs10 million ($2.7 million) and will be charged 100 basis points over the official UAE Repo Rate for doing so, according to a separate document on the central bank’s website.
Eligible assets that can used as collateral include bonds, sukuk and securities issued by the UAE federal government or authorities in individual emirates, as well as banks and corporations based in the UAE.
For assets to qualify, they must be tradable and carry a rating from one of the three main international rating agencies, except in the case of securities issued by local governments in the UAE – an important caveat as the Dubai government currently doesn’t have a rating.
Securities issued by foreign governments, banks, corporates and supranational agencies can also be used as collateral, but must carry a minimum A rating from rating agencies.
Collateral will be held by either of the main international depositary firms – Clearstream or Euroclear – and cash will be provided to banks through the UAE Funds Transfer System.
A sharia-compliant version of the IMLF for Islamic banks in the UAE will be launched “in the coming weeks”, the letter added.
“It is just backing by the central bank to have contingency plans in place in case of any micro or macro crisis,” said a treasury official at a commercial bank in Abu Dhabi.
“If banks have exhausted all options they can fall back on this liquidity scheme rather than defaulting…It is good also because it gives assurances to outsiders that banks here have a back up facility from the central bank. So, a confidence-building measure too.”