Beating state debt addiction proves hard for UAE banks

Banks in the United Arab Emirates are finding it hard to wean themselves off lending to the government, raising concern about the financial sector’s vulnerability if the state-dominated economy slows.

During the global credit crisis of 2009-10, UAE banks were hobbled by their links to heavily indebted companies that were wholly or partly owned by governments of the seven emirates in the UAE, especially Dubai.

To prevent any repeat, the central bank in 2014 required each bank to limit its exposure to local governments and government-related enterprises (GREs) to 100 percent of its capital, giving lenders a five-year grace period to comply.

The central bank met with banks early this summer to remind them of the importance of moving towards the target rather than waiting until the last moment, said a senior UAE commercial banker.

But recent data point towards growing links between banks and the government, suggesting some of the country’s biggest lenders may miss the deadline.

Banks’ exposure to the public sector as a percentage of capital stood at 128 per cent in May, up from 104 per cent in 2013 and the highest since the late 1970s, analysts at Bank of America Merrill Lynch (BofA) calculated.

“For banks such as National Bank of Abu Dhabi and Emirates NBD, it will be difficult to comply,” said Jean-Michel Saliba, economist at BofA.

In a statement, National Bank of Abu Dhabi said it was “fully compliant with the GRE exposure limits of the central bank”; it didn’t elaborate. Officials at Emirates NBD and the central bank were not available to comment.

The International Monetary Fund said in a report last month that it would be “challenging” for banks to obey the rule. The UAE banker estimated as many as five banks would be unable to comply by 2019.

RISKS

With sovereign wealth fund assets estimated at nearly $800bn, the government of the biggest emirate, Abu Dhabi, has plenty of money to intervene if needed to prevent any financial collapse, as it did during Dubai’s 2009 debt crisis.

Nevertheless, failure to enforce the state exposure rule could be seen by foreign investors as an indicator of risk in the UAE – and a worrying failure of the central bank to impose its regulatory will in the face of political obstacles. The central bank has not said how it might penalise banks that fail to meet the deadline.

Local governments own large stakes in most of the UAE’s big banks; this may make it harder for the central bank to assert its authority, especially if the banks are key to local governments’ economic plans.

Emirates NBD, 56 per cent owned by state fund Investment Corporation of Dubai, has increased its lending to the Dubai government by almost $2bn since the end of last year, according to its financial statements. The bank’s government exposure represents over 40 per cent of gross loans.

The Dubai government’s hunger for loans is only likely to increase in the next few years as the emirate prepares to host the 2020 World Expo. By then, Dubai’s debt may balloon to $168.5bn from $142bn in 2012, according to the Institute of International Finance.

Meanwhile, low oil prices are expected to slow economic growth, and the start of U.S. interest rate rises as soon as this month could complicate Dubai’s servicing of its debts.

Saliba said UAE banks had prepared for more difficult conditions. “Banks are in a better position to deal with reduced foreign liquidity than in 2008 as then their foreign liabilities were larger than their foreign assets, whereas now their foreign assets match their foreign liabilities.”

But reducing sovereign loan exposure does not appear to be a major part of many banks’ preparations.

One possible way for banks to meet the requirement would be for them to sell part of their loan portfolios to other banks; also, governments could reduce their reliance on bank lending by developing a UAE domestic debt market. But little progress has been made in either of these areas, the UAE banker noted.