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UAE Banking Sector Waits for Consolidation

The too-big-to-fail institutions and far bigger egos that lorded over them bit the dust. The brutal shake-up had been waiting to happen ever since the failed rescue of Bear Stearns in March 2008. But no one anticipated the sudden and systemic September shock. It was nothing short of a giant tornado sucking up liquidity and, along with it, a few premier institutions that had run out of cash. Probably, Richard Fuld Jr., Lehman Brothers’ former Chief Executive Officer, knew the consequences of its collapse.

And so he played hard the bailout game, but the US government probably calculated that it would cost more to rescue Lehman than to let it shut shop. Rightfully so: No institution should be allowed to use blackmail as a means to continue its existence.

Some have argued that letting the investment bank fail was the trigger for global panic. But precisely because it was allowed to collapse, the world is a lot saner and safer now. The global economy is slowly but surely turning around, and economic growth is set to return to normal in 2010.

Closer to home, many feel that September 15 was the day the crisis hit the UAE — but they are wrong. The initial signs of crisis emerged in the middle of June, when local stock markets witnessed dramatic declines as foreign investors began selling their holdings to cover overseas losses. The first sign of tightness in liquidity emerged when local interbank rates edged higher than the repo rate in the middle of July. But the euphoric mood, stoked by high oil prices, tricked everyone into believing this tightness was a seasonal effect and that money would soon return after the summer.

What everyone forgot was that this foreign money—which had entered the UAE looking for gains from an expected revaluation of the dirham—was leveraged, and the crisis put an end to all hopes of a change in the dirham-dollar peg.

What followed was a classic recessionary phase. Banks turned cautious as they had lent more money than they had in deposits. Companies, used to 30 per cent year-on-year growth, realised that the future might be not so rosy after all. Free-spending residents, especially in the buoyant construction sector, were jolted back to reality. The problems in one sector started to spread, and the bleak international situation accelerated the knock-on effect.

By December, it felt here, as it did everywhere else in the world, as though the end of the world, or at least of capitalism in its modern form, was nigh. Mercifully, neither happened.

Governments the world over have taken extraordinary policy measures to cushion the shock. The UAE has pumped Dh120 billion into the local banking system and taken a whole host of policy measures to shore up the economy. The finance ministry and the UAE Central Bank have been at the forefront of crisis management. But a year on, their job is nowhere near complete.

There is a lot more to be done to put the domestic financial sector on a firm footing. The eye-popping 23 per cent growth rate for nominal gross domestic product driven largely by an annual 49 per cent increase in loans was neither sustainable nor desirable. This year is all about paying the price for economic aberration in 2008.

When it comes to financial sector stability, tiny but super-efficient Singapore holds a lesson or two. The Singaporean government realised the strategic importance of having a small number of good-sized banks capable of absorbing systemic shocks after the 1998 Asian financial crisis. It forced local banks to merge, resulting in the island state’s having just three local banks. Although the government preferred having only two, it was satisfied with the end result, which made regulation and, more importantly, supervision of banks much easier.

Similarly in the UAE, given its concentrated population centres, the existence of 24 local banks with 614 branches competing amongst themselves and with 22 foreign banks with 82 branches of their own will continue to be a source of instability. There will always exist an element of risk that the over-lending that took place in the last few years might repeat itself. As history suggests, bankers, used to drawing bonuses that far exceed their annual salaries, have very short memories.

A stronger banking sector is imperative for the UAE if it is to reach its ultimate goal of having a more independent monetary policy, though this is probably another source of instability given the volatility of the US dollar. Waiting for the management teams at individual banks to make up their minds is futile, as what is best for them might not be ideal for the country.

· aruna@khaleejtimes.com