The Central Bank has refused to push back a deadline for capping local banks' exposure to government bodies, placing it on collision course with lenders struggling to meet the rules.
Banks have to comply by September 30 with the regulations aimed at stopping a repeat of the debt crisis that crippled many lenders during the global financial crisis.
"The deadline hasn't changed and it will stay," said a Central Bank official familiar with the matter, who asked to remain anonymous. "Most banks agree the rules are a positive for the economy and would like to comply."
Under the rules, announced last month, lending to governments and their non-commercial entities will be limited to 100 per cent of a bank's capital and at 25 per cent for lending to individual borrowers.
The move is aimed at bolstering banks' balance sheets and safeguarding them from the risk of similar losses to those they faced after Dubai World and several other state-linked firms restructured debts.
Some banks, including Emirates NBD and National Bank of Abu Dhabi (NBAD), have appealed to the regulator for leeway in complying with the rules. The Central bank chairman Khalil Foulathi indicated a more conciliatory tone when he was quoted by the Al Khaleej newspaper last week as saying there could be some room for heavily exposed banks to extend the compliance deadline. But he insisted the rules would come in as planned in September.
However, analysts say the number of banks likely to fall short of the requirements outweighs the number of those who can comply. As a result many feel the entire deadline should be delayed.
"For several banks there's no way they can comply with this," said Timucin Engin, the associate director of financial institutions for central and Eastern Europe, the Middle East and Africa at Standard & Poor's."Everyone knows there's exposure in the market and the last thing you want is for banks to be affected negatively when they are recovering."
The problem banks face is that they have played a central role in bankrolling the rapid growth of government-linked companies that have shaped the economy.
In turn, such firms have taken up the lion's share of their loan books.
As much as Dh54 billion (US$14.7bn) of NBAD's Dh56bn related-party exposure is to the Government of Abu Dhabi , its major shareholders and its management, according to the bank's first-quarter results this year. It would have to offload Dh26.5bn to comply with the rules, Arqaam Capital estimated in a report last month.
Although the bank said it agreed with the general direction of travel set by the Central Bank, it said it had some issues it was discussing with the federal lender.
"We would argue that exposure should not include highly liquid, marketable rated bonds which are held as part of the bank's liquidity portfolio," NBAD said.
Emirates NBD faces a similar challenge. About 40 per cent of its loan book is made up of government and government-related entity debt, estimates Arqaam Capital. The bank may have to consider selling Dh14bn of exposure, or 7 per cent of its loan book, hurting its income, Arqaam said.
The bank declined to comment on the rules.
Smaller banks in other emirates are also likely to be effected.
As the September deadline looms, banks are expected to raise their efforts to offload part of their government-linked loan book.
But even that process is fraught with uncertainties, warn analysts.
International banks would be more likely to snap up "high-quality" debt from entities such as the Investment Corporation of Dubai, the Abu Dhabi National Energy Company or the International Petroleum Investment Company, said Raj Madha, an independent banking analyst.
"If they do have to decrease their exposure, the most likely buyers would be international banks or a syndicated loan facility," said Mr Madha.
"But they may have trouble getting rid of the assets they would like to get rid of, namely property assets."
Correction: An earlier version of this story reported that National Bank of Fujairah's exposure to the government was believed to be top-heavy. In fact, the bank's annual financial report for last year show the bank's exposure is small. Under 2 per cent of its total credit risk relates to the government sector.
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