Hello, and welcome back to the latest episode of "As the interbank rate turns." In our last instalment, regular readers will recall, the Central Bank decided that if banks in the UAE weren't going to accurately report the interest rate they charge each other for short-term loans, then it would take control of the process itself. In the past, banks have been trusted to poll each other and compile what is known as the Emirates interbank offered rate, or Eibor.
Like any interbank benchmark, Eibor is an important rate, not just because many banks have traditionally used it as the basis for other loans and deposit rates, but because the Central Bank and investors look to it as a broad measure of liquidity in the economy. The lower Eibor goes, the easier money is. Last year, at the height of the crisis, when banks didn't trust each other to pay themselves back, Eibor rose to roughly 4.8 per cent.
The Central Bank responded by providing banks with a Dh50 billion (US$13.61bn) cheap financing facility and, eventually, guaranteeing interbank loans. Coupled with Dh70bn of Government deposits and, for Abu Dhabi's banks, capital injections from the Abu Dhabi Government, Eibor gradually declined to roughly 2.4 per cent. But then it became stuck, even as other interbank rates around the world continued to fall with improving liquidity conditions and because central banks, from the Federal Reserve to the Bank of England, were keeping their own lending rates at roughly zero in a desperate effort to keep the global financial system from cardiac arrest.
The Central Bank was peeved not just because its efforts to ease liquidity weren't being rewarded by a lower interbank rate, but because a sticky Eibor meant that lending rates to businesses and consumers weren't falling. And ultimately, that's what easing liquidity is meant to achieve. Central banks strive to keep banks healthy not so that they can keep their favourite golfing partners, but so banks can survive to lend another day to the economy.
The dilemma facing the Central Bank is this: despite its many efforts to boost liquidity and stimulate the economy, and despite the fact that oil prices have rebounded to around $70 a barrel, the UAE appears to remain stuck even as Asia and Europe move ahead. The problem for the banks was that while liquidity was easing, other obstacles to lending were not. First was the problem of deposits. Last year's boom in lending was fuelled by a surge in deposits from overseas.
International investors were betting on rising prices for oil and property and that the UAE might revalue the dirham upward against the US dollar to counter inflation. By July, when it became apparent that this was not going to happen and that the US subprime crisis was starting to spread to the global economy, those investors pulled back out. That left banks with more loans than deposits, in violation of Central Bank lending limits.
Bankers say the ratio of loans to deposits has fallen somewhat, to about 105 per cent from 110 per cent, but not enough. Thus many banks are still trying to lure deposits by offering relatively high rates to savers. Moreover, conditions in the economy and in the property market in particular remain weak. Property prices have fallen at least 30 per cent in Dubai and appear to be heading lower. Most banks remain reluctant to lend to property buyers regardless of how cheaply they themselves may be able to borrow. They already face the prospect of a wave of mortgage and credit card defaults that will weigh on profitability.
Hence banks' reluctance to be completely forthcoming on what they were charging each other. In fact, bankers say the interbank rate was close to 0.5 per cent even when Eibor was officially 2.4 per cent. With most loan and deposit rates set at a spread over Eibor, banks wanted to make sure they could lure depositors and charge borrowers according to both their overall cost of funds and in line with the risks inherent in lending under the current economic circumstances.
The Central Bank got wind of this, obviously. Rather than try to further improve deposit levels or reduce the prevailing risks of lending, the bank decided to gerrymander Eibor. Early last month it said it would soon release details on a new regime for Eibor, providing "full transparency". It hasn't yet, but the details have emerged nevertheless. According to press reports citing unnamed officials, the Central Bank has now established an 11-bank panel for setting Eibor, adding four local banks to the mix and ejecting two foreign banks, Lloyds Banking Group and the Royal Bank of Scotland.
Soon after the Central Bank called bankers in earlier this month to announce that it would be setting up a new, official Eibor, the old Eibor started tumbling. But lending rates have not followed. Those wily bankers appear to have outwitted the Central Bank yet again, because there is no rule that says banks have to benchmark their lending rates to Eibor, nor one that says that if they do, what the spread over Eibor should be.
So even as Eibor has tumbled, lending rates have remained high, to reflect the need to pay high rates on deposits and, therefore, the need to charge even higher rates when lending those deposits back out. Some banks have even taken the radical step of informing customers that they will no longer be basing lending rates on Eibor, but instead on their actual cost of funds. What cheek! Bankers say that some companies have responded by borrowing US dollars offshore, where rates are lower.
This week, the Central Bank took steps to ease the actual conditions facing banks, lowering the rate it charges them to borrow money from it and reportedly even lowering their minimum capital requirements. Tune in again, though, to see if any of these measures succeed in opening up the banks' vaults to borrowers. warnold@thenational.ae
