Global crisis affecting liquidity in UAE banking sector

The financial sector of the United Arab Emirates cannot remain immune to the global financial crisis, and Moody's Investors Service will continue to monitor the liquidity profile of UAE banks, according to a new report.
Moody's said that liquidity in the UAE banking system weakened during the nine months to September as a result of the departure of speculative money which was increasing in line with expectations of a revaluation of the UAE dirham; sustained disruption to foreign market funding; substantial irrevocable loan commitments to existing clients; and potential need for refinancing existing corporate debt as it matures.
"A continued rise in loan-to-deposit ratios and sustained challenges in global liquidity conditions will lead to an intensification of negative rating pressures," cautioned John Tofarides, a Dubai/DIFC-based Analyst in Moody's Financial Institutions Group.
In order to alleviate the liquidity shortage, the UAE government has intervened by providing a repo type facility from the Central Bank worth a maximum AED 50 bln (US$ 13.6 bln), and a direct deposits scheme from the Ministry of Finance for a maximum of AED 70 bln (US$ 19 bln). In addition, on October 13, the Federal Cabinet reportedly decided to guarantee banking deposits for three years, covering both national and foreign banks with significant operations in the UAE.
"Moody's believes that the government's measures contribute to providing a short-term solution and renewing confidence in the banking sector. However, liquidity stress may inhibit asset growth over the medium term. Moreover, the intense rivalry among banks to attract deposits is also creating large movements of deposits across banks, with clients 'shopping around' to place funds with the highest bidder," explained Tofarides.
According to Moody's, this price war coupled with the high level of deposit concentration creates additional volatility in the funding base, thus exerting pressure on banks to maintain more liquid (and often low return) positions and to raise funding costs, thereby affecting core profitability.
Looking ahead, Moody's expects the liquidity crisis to have the following impact on the UAE banking sector: (i) a slowdown in domestic loan growth for 2009, with some banks possibly showing negative growth; (ii) increased pressures on net interest margins due to high borrowing costs; (iii) stringent regulation by the central bank in terms of scrutinising loans and advances; and (iv) a restructuring of the project finance industry with large loan agreements being redrawn, restructured or postponed.
Unless debt capital market conditions improve in 2009, Moody's expects that a significant portion of the (announced) unexecuted projects will most likely be cancelled or postponed, especially in Dubai and the northern emirates. However, the rating agency expects less pressure on Abu Dhabi-based projects.