If banks can borrow cheaply, why aren't mortgages lower?

Borrowing is cheaper for banks, but savings are not passed on to customers and rates remain high. Why? It's complicated ...

Banks argue that Eibor does not reflect the risks they are taking in offering mortgages.

If banks can borrow money more cheaply, why are mortgage rates not falling sharply as well? It's a good question, with a fairly complex answer.

In recent months, the Emirates interbank offered rate (Eibor), the average rate banks charge to lend to one another, has fallen to its lowest in a year, at 2.3725 per cent for six-month loans. But most UAE mortgage lenders still charge borrowers more than 7 per cent.

Majed Azzam, a property analyst with Alembic HC Securities, said: "There is definitely a disconnect."

The reasons for the discrepancy are varied. For one, last year banks moved away from using Eibor as a means to establish interest rates because they said it did not reflect their true cost of funding. So there is no longer a direct connection between Eibor and lending rates.

At the same time most banks set their mortgage rates only every three or six months.

Dean Biddulph, the general manager of the mortgage broker Independent Finance in Dubai, said: "They would not change them straight away [when Eibor drops]. There is a bit of a lag." Mr Biddulph said rates on average dropped about 25 basis points in the fourth quarter.

In any case, the banks also argue that Eibor does not reflect the risks they are taking in offering mortgages, with the UAE still reeling from the effects of the financial crisis.

In good economic times, banks are willing to charge just a point or two above their borrowing costs if they feel relatively confident the borrowers will repay.

When the economy is uncertain, as it has been for the past two years, they charge a higher spread, known as the "risk premium", to compensate for the higher possibility that borrowers will default. For many foreign banks, the risk premium they are charging has been smaller recently because of signs of recovery in the global economy.

These banks also have exposure to a variety of markets around the world, which are in various stages of recovery, and therefore provide them with a degree of diversification in their loan portfolios.

Some UAE banks, in contrast, are mostly exposed to local and regional property markets where values remain depressed and have probably not yet hit bottom, most experts say.

This is why some of the lowest rates available are from foreign banks. Barclay's is touting a 5.99 per cent loan that the customer can fix for up to three years, while Standard Chartered and HSBC are offering rates below 7 per cent.

That is not to say all local banks offer higher rates. Mr Biddulph says Mashreqbank and Dubai Islamic Bank now offer competitive products. Another exception among local lenders is Abu Dhabi Finance, which is offering rates below 6 per cent for qualified customers as well as a range of options, such as payment holidays and interest-only plans.

But Abu Dhabi Finance was established by the Government to ensure there is adequate financing available for the property market, so in effect those loans are subsidised. This is not particularly different from how the US government bolsters the mortgage market by guaranteeing most property loans that meet certain underwriting standards, but it still shields Abu Dhabi Finance from the forces that dictate the lending decisions for other banks.

As another means of mitigating risks, almost all active UAE lenders are demanding down payments of at least 20 per cent, along with proof of a high monthly salary.

But analysts say the banks are much more willing to lend to those customers than they were six months or a year ago, when mortgage lending was near a standstill.

Mr Azzam said his company recently hired two new employees and neither one had difficulty securing a mortgage. "[Banks] are very selective in their profiling of potential candidates," Mr Azzam said. "But they are happy to lend to you if you have a good history."