In a report issued on 30 September, credit ratings agency Moody’s warned that the outlook for Dubai’s banking sector is less favourable than elsewhere in the region as the credit crunch is leading to slower growth and increasing concerns over banks’ real estate exposure.

The ratings agency says the outlook for Dubai banks is “stable to negative”, while for institutions in other Gulf markets it is “less positive than it was before [the credit crunch], but it is not negative”.

“What we have been worried about is direct and indirect exposure to real estate and real estate developers in Dubai,” says Mardig Haladjian, general manager of Moody’s Middle East.

The report comes as the region tries to cope with a dramatic drop in interbank lending, leading to an increase in borrowing costs.

The region’s bankers say that, while there are substantial risks for Dubai’s real estate sector, the industry will not be allowed to fail.

“Real estate is too big to fail, since the booming financial sector is booming precisely because of real estate,” says Mushtaq Khan, Gulf economist at Citigroup.

“The authorities realise that they cannot afford any panic in Dubai’s real estate sector as it underpins such a large part of the economy.”

He adds that trying to manage a soft landing for the real estate sector will dominate government policy concerns for the medium term.

The Central Bank of the UAE recently stepped into the market to offer banks a AED50bn ($13.6bn) liquidity fund, but stipulated that banks that use the fund must freeze any activity that would increase their cost base.

“The government is trying to make sure banks do not use the fund to expand lending,” says one Dubai-based banker.

“The central bank is trying to manage down banks’ loan-to-deposit ratios, and the structure of its fund is sending a message that banks need to start mobilising deposit growth to improve their positions,” says Khan.

However, banks are finding it hard to increase their customer deposits while real interest rates are negative, due to high inflation.