A UAE government move to inject AED50bn ($13.6bn) into the banking market should stabilise interbank lending rates, say bankers.

The move was welcomed by the financial sector when it was announced on 21 September, although details of how it will work only emerged as MEED went to press.

Among the measures is a relaxation of rules that require banks to settle short-term positions with the central bank at the end of each week, and the offer of funds to cover differences between withdrawals and deposits at a rate of 5 per cent.

If funds are required for other purposes, the central bank will charge 7 per cent.

Financiers say it should cut interbank lending rates, which rose while the market waited for details on the fund.

The Emirates interbank offered rate was 3.68 per cent on 24 September, up from 1.87 per cent in June.

“A significant source of uncertainty has been removed and banks in the UAE know now that liquidity will be available and what the costs will be,” says Marios Maratheftis, regional head of research at Standard Chartered Bank. “This is likely to calm markets down.”

Speaking before the structure of the fund was announced, Sanjay Uppal, chief financial officer of Emirates NBD, said the fund could offer banks a cheaper source of funding than approaching international banks or the capital markets.

“The size of the fund should be more than sufficient to ease funding constraints for the UAE banking sector,” he said.

With the growth in deposits relatively slow at most GCC finance houses, many banks in the region have started turning to the capital markets to extend their range of funding sources.

Loans made by the banking sector are growing faster than deposits because the difference between inflation, which is predicted to reach 13.7 per cent in the UAE this year, and the official interest rate of 2 per cent, means that real interest rates are negative.

While the fund could offer an attractive alternative source of funding for banks, Giyas Gokkent, chief economist at National Bank of Abu Dhabi, says the rescue package is not enough to restore confidence to the sector. “There has been a breakdown in confidence between banks,” he says.

It is not clear if other central banks will follow the UAE’s lead. Although Bahrain has refused to do so, bankers there say such a move could be necessary to reassure the financial sector and stimulate activity.

The Kuwait Investment Authority, Kuwait’s sovereign wealth fund, has already injected fresh funds into the local stock market to boost liquidity.

In Saudi Arabia, the need for action is less urgent as its market is more insulated, but some bankers say the economy needs assistance.

“The Saudi Arabian Monetary Authority [Sama, the central bank] could lower reserve requirements for local banks, which have gone up three times this year, to fight inflation,” says a treasury trader at one major Saudi bank.

This would inject liquidity into the Saudi banking sector.