Banks should resist lowering their capital adequacy ratios after the relaxation of Central Bank rules because of continuing economic uncertainty, analysts say.
Banks advised to protect capital
Banks should resist lowering their capital adequacy ratios after the relaxation of Central Bank rules because of continuing economic uncertainty, analysts say. This week, the regulator told banks they could significantly lower their capital-adequacy ratios, or the capital they hold to back up their lending, in the government's latest attempt to increase liquidity within the banking system and help stimulate lending.
"Those quotas should not be lowered right now in the middle of a weaker economy and as non-performing loans are still going up," said Deepak Tolani, analyst at Al Mal Capital. Freeing up reserves may spur lending but it would be safer not do it at this time, Mr Tolani said. "One part of me says that there should not be too much capital sitting in the banks doing nothing, but the other part of me says that it should stay in the [capital reserve] bucket and put investors' worries to rest," he said.
Although freeing up reserves could boost lending and help to expand the economy, analysts say banks should remain focused on building deposits to cope with rising bad loans. New lending has almost come to a standstill in the UAE as banks scramble to raise new deposits and reach capital requirements set by the Ministry of Finance. International funding has also been squeezed because of the global economic slowdown.
Fitch Ratings has warned the new measures could backfire by increasing uncertainty and leading to a reappraisal of the credit ratings of banks. "While Fitch does not expect UAE banks to rush quickly towards the new minimum ratios, if any rated bank does the agency is likely to view such action negatively and may downgrade its individual rating," the ratings agency said. The Central Bank said it took the step "in view of the existing global financial crisis which continues to adversely impact various economic sectors".
Regulators typically ask banks to set aside a specific amount of capital that can be used as a buffer in case of difficulties. There are two classes of capital that apply to the ratio: Tier 1, which usually consists of shareholders' equity and also is known as "base capital"; and Tier 2, which commonly comprises medium-term notes or syndicated loans with a maturity of more than five years. "Seven per cent (Tier 1 capital) is more aligned to international standards," said John Tofarides, a banking analyst at the ratings agency Moody's Investors Service. "Changing the rules gives banks some leeway to increase lending.
On average, UAE banks have capital ratios of about 20 per cent, which is high when compared with other banks around the world. In view of growing defaults, local banks have already been forced to raise their provisions. Emirates NBD, the largest lender, has warned that non-performing loans could reach 2.5 per cent of total lending next year. Under the new directive sent to local and foreign lenders, the Central Bank said banks should set aside 7 per cent of Tier 1 capital by September 30 this year and 8 per cent by June 30 next year. Overall capital adequacy ratios must reach 11 and 12 per cent respectively.
A Ministry of Finance directive issued last October asked banks to hold 11 per cent of Tier 1 capital by the middle of this year and 12 per cent by the middle of next year if they wanted to receive support loans. The deposits were part of various government support measures to boost bank lending after foreign investors withdrew an estimated Dh180 billion (US$49bn) from local bank deposits and stocks last year.
* with additional reporting by Tom Arnold email@example.com