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New Federal Law to Back Banks’ Bonds

DUBAI - In a bid to boost liquidity in the banking sector and stimulate lending, a new law that extends a federal government guarantee to bonds issued by local banks is in the offing, according to UAE Central Bank Governor Sultan bin Nasser Al Suwaidi.

The governor said that he expects the government to discuss the proposed law this week. If the government approves it, the law could take effect within four weeks, Al Suwaidi said on the sidelines of the annual meeting of central bank governors in Switzerland on Sunday. The law would enable the federal government to guarantee various funding instruments that banks use to raise money, such as bonds, term notes and commercial paper.

Analysts said that the new law would not only shore up the banking sector but would also help develop local bond markets. “It is likely to be quite a major news story as it will dramatically increase the banks’ access to international capital markets, even under the current tough market conditions,” said Raj Madha, financial sector analyst with EFG-Hermes.

Eckart Woertz, programme manager for economics at Dubai-based Gulf Research Center, said that the planned law would help stabilise banks. “The central bank guarantee can considerably ease bond issuance of banks. It not only has the potential to improve their liquidity situation but could also contribute to a further development of a local bond market,” Woertz said.

Local banks have long issued bonds and notes denominated in foreign currency to fund their expansion. However, since the dawn of the global economic crisis, the international credit market remains frozen, and local banks have seen a dramatic decline in their deposit base after the mass withdrawal of speculative foreign money that had flooded in during late 2007 and early 2008 to profit on an expected dirham revaluation. The sudden outflow of foreign money left a large hole in bank balance sheets, as they had lent more than they had in deposits.

“The very fact that the central bank feels the need to rush through a law such as this points to a real problem in the financial sector,” said Karti Inamdar, an analyst at Capital Intelligence, a credit analysis and rating firm. “I think the slow growth in credit is a real worry for the authorities, and a stimulus such as the one being contemplated by the central bank is perhaps necessary to kick-start the economy once again.”

Since late last year, local banks are on a deposit-raising drive but have curtailed their lending. At the end of May, the difference between loans and deposits stood at Dh31.2 billion.

Total outstanding loans grew by Dh9.9 billion in the first five months of this year, an increase of just under one per cent compared to a full-year loan growth in 2008 of 40 per cent. The central bank has capped overall growth in credit for this year at 10 per cent. Moreover, local banks, bracing for an increase in their non-performing loans, have become very cautious about 
new borrowers.

Inamdar of Capital Intelligence is skeptical about whether the proposed law will have the desired effect restarting the credit flow. “I am not sure to what extent the banking sector will use such a guarantee,” she said. “The problem is not just that funds are not readily available but also that banks are wary of increasing their loans because of uncertainties.”

· aruna@khaleejtimes.com

· With inputs from Bloomberg