DUBAI // Emirates NBD, the nation's largest bank, said yesterday it is converting Dh6.3 billion (US$1.71bn) in government deposits into a loan to strengthen its balance sheet as banks brace for a potential wave of property declines and borrower defaults.
The bank said it was exercising a new option granted by the Ministry of Finance to convert long-term deposits made by the ministry last October into a debt instrument. That will enable Emirates NBD to include the money in its most important measure of financial strength, its capital adequacy ratio, boosting it to 14.3 per cent from 11.3 per cent, well above the Central Bank's mandated target. "The terms are quite attractive," said Sanjay Uppal, the chief financial officer at Emirates NBD. The subordinated debt will pay the Federal Government 4.5 per cent interest for seven years. "It helps the capital adequacy ratio of the institutions."
The conversion is part of a move by the Federal Government to boost support for the country's banks, shoring up their capital base on lines similar to Abu Dhabi's injection of capital to five of its own banks last month. Analysts said other banks were likely to follow with conversions of their own. "All banks will certainly be looking at taking advantage of this offer," said John Tuke, the head of treasury and asset liability and management at the Commercial Bank of Dubai.
However, analysts said that converting the deposits was a double-edged sword. While converting the deposits into a loan succeeds in boosting the bank's capital adequacy, it reduces the bank's liquid assets, essentially locking up money that the bank might otherwise lend to the nation's cash-starved businesses. Banks have been struggling with a severe liquidity crunch since last autumn, when foreign funds began pouring out of the country as the global financial crisis spread. That has led to a near freeze on lending to the country's businesses and consumers.
The Central Bank in September provided banks with a Dh50bn liquidity facility, but according to Mr Uppal it stipulated as a condition that the banks would have to boost their capital adequacy to 11 per cent this year and to 12 per cent by next year. In October, the Ministry of Finance injected Dh25bn into banks as long-term deposits that paid the higher of either 4 per cent per year or 1.2 percentage points over the yield on five-year US government bonds. In November, the ministry followed up with another Dh25bn tranche.
Emirates NBD received Dh6.3bn in each of those tranches. Its decision to convert the first tranche of deposits is subject to shareholder approval. The bank has called an extraordinary shareholders meeting on March 25. But the liquidity measures from the Central Bank and the ministry's deposits have had little impact, bankers and executives said. "Banks are unwilling or unable to lend," said Giyas Gokkent, economist at National Bank of Abu Dhabi.
So last month, the Ministry of Finance amended the conditions on its deposits, according to bankers and analysts. The ministry notified banks that until March 31, they could convert the first Dh25bn of its deposits into what is referred to as Tier 2 capital. While Tier 1 capital consists largely of equity and cash, Tier 2 includes supplementary capital such as subordinated debt - or debt that in the event of liquidation gets paid back only after holders of the firm's bonds are repaid.
Banks can use Tier 2 and Tier 1 capital to determine their capital adequacy, but Tier 2 capital is considered less secure than Tier 1. Tier 2 cannot be used to cover losses that the bank incurs from borrower defaults. Instead, it has to sit untouched in the bank's reserves as an emergency fund to prevent liquidation. According to bankers and analysts, the Ministry of Finance stipulated that in the event of a bank default, it would be able to convert any deposits that banks had converted into shares. Analysts said it remained unclear whether banks would be able to convert the second tranche of ministry deposits, or under what terms.