UAE borrowing costs soar

The cost of borrowing for consumers, companies and banks in the UAE has increased dramatically in the past month.

Expensive money: interbank loans have seen rates rise by nearly half in less than a month.

The cost of borrowing for consumers, companies and banks in the UAE has increased dramatically in the past four weeks because banks are running low on deposits and cannot easily tap international markets. Borrowing rates for banks have risen by up to 45 per cent in the past month, which has filtered down to higher rates for consumers and companies. Analysts say the tight situation could dampen growth in the economy, which relies heavily on borrowed money.

"When interest rates go up, clearly there is a dampening effect on economic activity in general," said Fabio Scacciavillani, an economist at Dubai International Financial Centre. "But I would think that, given the pace of economic expansion in the UAE, these kinds of movements - which are spillovers from a situation in the international cash markets - will have only a minor effect here." Interbank loans, or loans made between UAE financial institutions, have seen interest rates increase by nearly half in less than a month. A 30-day interbank loan now costs from 2.6 to 2.9 per cent, according to banking sources, up from about two per cent a month ago. The one-month Emirates Interbank Offering Rate (Eibor), a benchmark against which most loans in the UAE are priced, has risen from 2.02 per cent at the beginning of June to 2.59 per cent yesterday, an increase of 28 per cent.

Rates on short-term commercial loans used by businesses to finance day-to-day activities have also increased by 0.5 to one per cent in recent weeks, by one estimate. A variety of loans, from mortgages to unsecured personal loans, have also gone up in price as a result of the general rate rise. The rise is partly attributable to a decline in speculative foreign money flowing into bank coffers based on a now unlikely bet that the UAE will revalue its currency, bankers say. Thinking that the UAE might drop the dirham's peg to the US dollar, speculators last year bought millions of dirhams with the idea that such a decision would push up the currency's value and net them big gains.

That led to a rise in deposits that local banks could then lend out. But Gulf countries including the UAE have since affirmed their commitments to the pegs ahead of a planned monetary union. The speculative money has ebbed away as a result, forcing banks to borrow money to continue to satisfy growing loan demand. Borrowed money, however, comes at a higher price than deposits, leading banks to charge higher interest rates.

"At the end of last year and the beginning of this year, there was a lot of speculation that the currency would be revalued, and that brought a lot more money into the interbank market, which of course was not needed," said John Eldgride, the group manager and treasurer at Emirates NBD. "Some of that has gone out again, tightening up the local liquidity conditions a bit, and interbank rates have gone up."

Liquidity, or the amount of money readily available for lending, might seem like a minor concern in a country flush with cash from oil revenues. But much of the oil revenue is being funnelled overseas, keeping deposits off the balance sheets of local banks. And as loan growth continues to outpace deposit growth across the banking sector, raising money to lend out has grown more difficult as conditions in global markets have deteriorated in the wake of the credit crunch.

"I think there is a general concern that the liquidity in the UAE banking market is not as great as it was," said Michael H Tomalin, the chief executive of National Bank of Abu Dhabi (NBAD). "The huge sum of money that's coming into the country is invested elsewhere. So while there is a growing demand for loans, it is more difficult to finance them, and at the end of the day banks have to borrow too."

The banking industry has turned in record profits in recent quarters on the back of consumers' and institutions' insatiable appetite to borrow, but banks now worry that they need to attract new depositors to fund their loan business. In the last quarter, NBAD, the country's second-largest bank, saw its loans grow 63 per cent to Dh106 billion (US$28.8bn) while deposits picked up a mere 15 per cent, rising to Dh89bn. Most other banks also reported that their loan growth outpaced deposit growth. In the first half of this year, the industry's deposits rose 37 per cent from a year ago, while loans rose 56 per cent.

"Where do they make up the gap? They all have to go borrow in the market," said Deepak Tolani, an analyst at Al Mal Capital. "Deposits are the cheapest source of funding for your loan business, but some banks are having issues because loans are growing so fast." Mr Tomalin said the competition for deposits had already picked up, especially because of higher reserve requirements by the UAE Central Bank, which recently adopted rules requiring banks to keep deposits of at least 12 per cent of the value of their loan portfolios.

A price war is also afoot to acquire and keep big depositors. Mr Tomalin said foreign banks, reeling from the credit crunch, were luring the UAE's biggest depositors, making the competition for deposits that much harder here. Sofia el Boury, an analyst at Shuaa Capital, said that because of strong borrowing and reserve requirements, banks needed to start strengthening their deposit base. "It's the key thing for a bank to have sufficient capital to respect and cover its commitment," she said. "[Capital reserves] have gone down from 19 per cent in 2004 to 14 per cent in 2007. We can see that this ratio is going down even further, so it needs to be watched." @Email:[e-mail] @Email:[e-mail]