x Abu Dhabi, UAEFriday 28 July 2017

Interbank lending best left to private sector

Putting the Central Bank in charge of monitoring the only independent yardstick of liquidity may only raise more doubts about Eibor's transparency than it dispels.

You say "eether", and I say "either". You say "Eebor", and I say "Eibor". Banks in the UAE have been trusted to come up with the Emirates interbank offered rate, or Eibor, themselves, but now the Central Bank wants to call the whole thing off. Eibor, it seems, is too high for the Central Bank's liking. So it wants to oversee the reporting and compilation of the measure. Earlier this week, it called bankers into its headquarters to tell them it would be setting up a new, official interbank rate that will be "a fair representation of the prevailing market conditions".

Interbank rates such as Eibor refer to the rates that banks charge each other for very short-term loans, as in overnight. Banks usually trust each other more than they do any other borrower, and to the extent that they can trust each other, they trust that conditions are unlikely to worsen significantly overnight. Interbank rates are therefore the cheapest rates around, and serve as the basis for all other bank lending. Deposit rates, mortgage rates, corporate loans - you name it, banks typically set these interest rates at a margin over what it costs them to borrow from the interbank market. How much or how little they charge depends on how risky they consider the borrower and how much they need to compete for business.

Interbank rates tend to rise or fall depending on economic conditions and the health of the financial system. At the height of the financial crisis last autumn, interbank rates soared amid concerns that banks were succumbing to their own version of the swine flu epidemic. In fact, for one day the entire interbank market shut down completely. Interbank rates are therefore regarded as an important gauge of liquidity in an economy. Most importantly, central bankers use them to determine how well monetary policy is working. Central banks, as a result, don't normally set the interbank rate but instead try to influence it using a discount rate that they charge as a lender of last resort. Some, such as the US Federal Reserve, also announce a target for the interbank rate that they try to nudge by buying and selling government bonds.

The UAE Central Bank sets a repurchase rate that is supposed to achieve this purpose but that rate moves largely in line with the Fed's rates in order to maintain the dirham's peg to the US dollar, meaning the UAE has no monetary policy to monitor. Most interbank rates are determined by bankers themselves by polling each other for what they are charging, and averaging it out. The global benchmark interbank rate, the London interbank offered rate, is determined by the British Bankers' Association. Even the central bank in Singapore, which controls most aspects of its economy, lets the Association of Banks in Singapore determine the Singapore interbank offered rate.

What irks the UAE Central Bank is that, despite pushing its repurchase rate down, pumping government cash into the banks, guaranteeing interbank loans and deposits, Eibor seems stuck. After falling from its peak of almost 4.8 per cent in October, Eibor seems to have planted at about 2.4 per cent. Libor, meanwhile, has sunk to its lowest since 1986. The Central Bank is not the first to worry that Eibor does not accurately reflect the availability of credit in the UAE. Economists have suggested that liquidity is actually much tighter than Eibor would suggest. They say Eibor is being driven artificially lower as banks, reluctant to lend in an economic slowdown, lend their government cash to each other instead. That is pushing Eibor down, even though companies and consumers still find it difficult or prohibitively expensive to get a loan.

The Central Bank's gripe is that Eibor is artificially high. Indeed, bankers say that the real cost of borrowing from another bank has sunk to roughly 0.5 per cent. But many banks are reporting inflated interbank rates, they say, to keep Eibor high. Why? Because then they can keep their deposit rates higher, and lure more cash into the bank. It is no secret that most banks in the UAE face a shortage of deposits. Last year, when the global economy was booming and money was easy, funds poured into the UAE to capitalise on soaring oil prices, property prices and speculation that the Emirates would revalue the dirham at a higher rate against the dollar.

When the crisis hit, that money flowed back out in a hurry, leaving banks in breach of the Central Bank's rule that loans should not exceed deposits. Now liquidity is surging through global markets as investors feel that a recovery is imminent and that heavy US government borrowing augurs ill for the dollar. But the UAE has yet to see its share of this gusher. Dubai's stock market has risen roughly 16 per cent this year, far less than most. Peru's benchmark stock index has more than doubled in dollar terms; Indonesia's has almost doubled and Brazil's is up roughly 90 per cent.

Statistics from the Bank for International Settlements in Basel show that foreign credit to the UAE continued to decline in the first quarter. Making sure the UAE's banks are not inflating Eibor is like applying hair gel to a head wound. Part of the problem remains the peg: with no prospects for revaluation the UAE remains a dollar risk with no currency upside. But the real problem facing the financial system is that investors still consider the UAE a high-risk destination. After the collapse of the nation's property boom, investors want to know how much it is likely to cost local banks in failed loans and whether the Government will ensure foreign creditors are paid in full for lending money to government-related entities such as Nakheel.

Credit-default swaps on Dubai government debt remain among the most expensive in the world, despite the fact that the Central Bank appears ready to lend it whatever funds it needs. International investors rank Dubai's chances of defaulting as more likely than Kazakhstan or Lithuania, and only slightly better than Iceland. That is not a vote of confidence in the strength of the nation's financial sector.

The Central Bank's announcement about its plans for Eibor promises full transparency. Putting the Central Bank in charge of monitoring the only independent yardstick of liquidity may only raise more doubts about Eibor's transparency than it dispels. Providing greater clarity over how the Government and Central Bank plan to deal with the debts of government-controlled entities would be a bigger confidence booster.