Businesses and consumers are likely to be able to borrow money more easily as the credit crunch abates.
The rate at which banks lend to each other, known as Eibor, has declined from a peak of 4.8 per cent in October 2008 at the height of the crunch and now stands at just 2.075 per cent, its lowest level in more than a year. Analysts are attributing the fall to the steady replenishment of liquidity in the financial system as the economy improves and banks become more flush with cash deposits.
"A drop in rates could and should translate into improved lending appetite and that will be manifested in lower costs or a relaxation in risk parameters," said Rahul Shah, a banking analyst with Deutsche Bank in Dubai.
Lower rates will spur credit growth, a big driver for economic growth, after two years when lending drained to a trickle.
Business customers are likely to be the first to see the benefit of lower Eibor because it is used as a benchmark for pricing many corporate loans, including loans used to maintain working capital.
For retail consumers, the benefits may take longer to feed through the system. Credit cards and other retail products are often priced on a bank's own benchmarks, say analysts.
"Indirectly if the cost of funding falls ... retail rates will fall as well and that would increase retail lending," said John Tofarides, a Moody's analyst.
Eibor's move downwards comes as other signs emerge of improving lending conditions in the UAE.
During the past two years the cost of securing finance crept up as banks became more risk-averse during the global financial crisis.
"Banks have definitely become tougher; wanting lending to be backed by letters of credit and stricter on any slight increase of limits," said a spokesman for World Wide Power Services, a supplier of generators to oil fields, based in Jebel Ali. The company has about Dh5 million (US$1.3m) of loans with various banks.
But lending conditions may start to ease now.
Loans and advances by banks rose to Dh1.04 trillion in February, the latest figures available, a 3.1 per cent increase over the previous year, according to the Central Bank. Bank deposits rose 12.5 per cent to Dh1.07tn during the same period.
"We are hearing that risk premiums are falling as liquidity positions within the system improve," said Raj Madha, a banking analyst at Rasmala Investment Bank.
One of the reasons banks became more selective about lending was they were trying to cleanse their balance sheets of bad loans.
They also had to contend with a drying up of deposits as foreign investors pulled out of the country. Lenders pushed up costs to help preserve their profit margins.
As a result, credit growth sank to 2.3 per cent in 2009 and 1.4 per cent last year from 37.6 per cent in 2008 before the downturn, according to Moody's.
But banks are slowly returning to more robust health.
Banks' loans-to-deposit ratio was 97.2 per cent at the end of February, down from 103.6 per cent in December 2009, Central Bank data show. Deposits rose 9.8 per cent to Dh1.1 trillion over the same period.
How far Eibor will fall is open to debate. The dirham's peg to the US dollar means, ideally, Eibor should match the London interbank offered rate (Libor), the international equivalent rate.
However, the gap between the two widened during the downturn despite injections of liquidity by the Federal Government in a bid to narrow the difference.
The spread between three-month Eibor and Libor, currently about 180 basis points, had "plenty of room to fall further", Tim Fox, the chief economist at Emirates NBD, wrote in a research note released on Wednesday.
Some banks began abandoning Eibor as a benchmark in the past year or so as they claimed it did not fairly reflect the cost of securing funding. Instead, lenders started using their own internally set base rate to determine the cost of loans.
