Global crisis is affecting liquidity in UAE banking sector, says Moody's

This is the key message of a new report by Moody's entitled "The Impact of the Global Crisis on Liquidity of UAE Banks'".

Moody's observes that liquidity in the UAE banking system has weakened during the nine months to September 2008 as a result of the following factors: (i) the departure of speculative money which was increasing in line with expectations of a likely revaluation of the UAE currency (dirham); (ii) the sustained disruption to foreign market funding; (iii) the substantial irrevocable loan commitments to existing clients that need to be serviced; and (iv) the potential need for refinancing existing corporate debt as it matures.

"A continued rise in loan-to-deposit ratios and sustained challenges in global liquidity conditions will lead to an intensification of negative rating pressures," cautions John Tofarides, a Dubai/DIFC-based Analyst in Moody's Financial Institutions Group. As international debt capital markets are now effectively closed to most issuers and overall risk tolerance is reduced for financial institutions, risks related to liquidity and external funding needs have increased.

In order to alleviate the liquidity shortage, the UAE government has intervened by providing two forms of liquidity support: (a) a repo type facility from the Central Bank worth a maximum Dhs50bn, and (b) a direct deposits scheme from the Ministry of Finance for a maximum of Dhs70bn. In addition, on 13 October 2008, the Federal Cabinet reportedly decided to guarantee banking deposits for three years, covering both national and foreign banks with significant operations in the UAE.

"Moody's believes that the government's measures contribute to providing a short-term solution and renewing confidence in the banking sector. However, Moody's also notes that liquidity stress may inhibit asset growth over the medium term. Moreover, the intense rivalry among banks to attract deposits is also creating large movements of deposits across banks, with clients 'shopping around' to place funds with the highest bidder," explains Mr. Tofarides. According to Moody's, this price war coupled with the high level of deposit concentration creates additional volatility in the funding base, thus exerting pressure on banks to maintain more liquid (and often low return) positions and to raise funding costs, thereby affecting core profitability.

Looking ahead, Moody's expects the liquidity crisis to have the following impact on the UAE banking sector: (i) a slowdown in domestic loan growth for 2009, with some banks possibly showing negative growth; (ii) increased pressures on net interest margins due to high borrowing costs; (iii) stringent regulation by the central bank in terms of scrutinising loans and advances; and (iv) a restructuring of the project finance industry with large loan agreements being redrawn, restructured or postponed.

Given the global constraints in external funding, the task of raising long-term finance for projects in the Gulf has become challenging. Unless debt capital market conditions improve in 2009, Moody's expects that a significant portion of the (announced) unexecuted projects will most likely be cancelled or postponed, especially in Dubai and the northern emirates. However, the rating agency expects less pressure on Abu-Dhabi-based projects.

Moody's will present a more detailed assessment of the UAE banking sector's dynamics and prospects in its Banking System Outlook on the UAE, which is scheduled to be released in early December.