The Central Bank has told lenders they will need to start complying with the Basel II regulations on capital adequacy for banks from next year. The move represents the first major step to bring UAE banks in line with their US and European peers which have largely introduced the new rules. "This step helps to confirm what the market has been expecting," said Raj Madha, an analyst at EFG-Hermes.
"In principle, this should assist banks in encouraging better risk-based pricing." Banks are also expected to become more transparent. Basel II, in addition to differentiating further between types of risk, also requires lenders to improve their disclosure, for example by showing different kinds of risks on their balance sheets. Banks have been preparing for the step by improving their procedures on risk assessment and information technology.
They had initially expected the Central Bank to start demanding full compliance as early as this year. But until yesterday's directive, the Central Bank had not clarified when the new regime would begin. "A phased introduction of Basel II has been adopted with the Standardised Approach to be implemented immediately," the regulator said. Depending on the exact interpretation by the regulator, who can decide to treat certain transactions more aggressively, banks could see their capital adequacy ratios fall. The capital adequacy ratio of some banks has fallen after implementing Basel II.
The average capital adequacy ratio of local lenders stood at 18 per cent at the end of last month, up from 13 per cent a year earlier, and far above international regulatory requirements. However, the economic crisis and the collapse of property prices have led the loan books of some banks to suffer, highlighting the need for an extra capital cushion. The most immediate impact of Basel II will be the requirement of banks to pay far more attention to risk control and management, Mr Madha said.
A bank's capital is a "cushion" for potential losses, which protects its depositors or other creditors. Basel II is the second of the Basel Accords, a set of recommendations on banking laws and regulations by the Basel Committee on Banking Supervision. One of the core rules requires a bank to set aside a certain amount of money as a cushion in case its clients default on their loans. The purpose of Basel II, published in 2004, is to tighten regulations on how much capital banks need to set aside to protect themselves against risks.
Most importantly, it differentiates more between various types of risks such as credit, market and operational. Different countries are at various stages of implementing the rules. About 100 regulators have indicated that they would implement Basel II in one form or another by 2015. However, the financial crisis has highlighted shortcomings of the new system which has been blamed for not paying enough attention to liquidity, leading to some bank failures during the crisis.