The Central Bank of the UAE’s latest effort to lower the cost of borrowing in an attempt to stimulate the economy is likely to fail, according to economists in the region.
From mid September, the central bank will start to calculate the Emirates interbank offered rate (Eibor) from the average interest rate charged by a panel of 11 banks.
The central bank announced the move at the beginning of August. At the time the bank said it wanted to “facilitate a process whereby the rates fixed are a fair representation of the prevailing market conditions”.
The move was widely seen by the local financial community as an attempt to reduce Eibor rates.
“Eibor is going to fall as liquidity improves, but even by year end it will still be higher than the Saudi rate”
Simon Williams, economist, HSBC
The new system will replace the current panel of 10 banks. It is not clear how many of these 10 will join the new panel as the central bank has declined to name the members of either panel.
The central bank’s earlier efforts to lower Eibor by depositing up to AED120bn ($32.7bn) in local banks have largely failed.
Economists say the latest move is unlikely to lower the cost of borrowing either.
“I do not see the new panel having a significant bearing on Eibor,” says Simon Williams, chief economist for HSBC in Dubai.
“Eibor is going to fall as liquidity conditions improve, but even by year end I expect to see Eibor higher than the Saudi interbank offered rate (Saibor).”
There is already a debate within the UAE’s financial services sector about the accuracy of Eibor. One senior executive in the treasury department of a UAE bank says Eibor is “artificially high”.
However, others say the interbank rate reflects genuine fears about the quality of credit, particularly in Dubai.
“The market still perceives that there is some structural risk in the UAE, with concerns about Dubai and the need to continue to attract deposits in local banks meaning liquidity is still tight compared with the rest of the region,” says John Sfakianakis, chief economist at Banque Saudi Fransi.
The three-month Eibor rate was 2.14 per cent on 7 September, while the UAE central bank base rate was just 1 per cent.
In August 2007, before the credit crunch began, the inter-bank rates of the UAE and Saudi Arabia were close to each other, and also close to central bank base rates.
Interbank lending rates in the UAE can differ widely.
One regional economist says HSBC quoted 1.3 per cent for a one-month loan on 7 September, while Abu Dhabi Commercial Bank, Emirates Bank and National Bank of Dubai quoted 2.35 per cent.
Economists have welcomed the new measure to calculate Eibor as it formalises the way the interbank rate is calculated.
Compared with the Central Bank of the UAE, the Saudi Arabian Monetary Agency has successfully lowered Saibor, which peaked at nearly 4.7 per cent in October last year.
Its rate has now fallen to 0.65 per cent, while the US dollar‑denominated London interbank offered rate (Libor) is 0.71 per cent.
According to Sfakianakis, the Saudi banking system has received plenty of liquidity injections, and Saibor remains low because the banks are getting a steady flow of cash as the Saudi government repays its outstanding debts to local banks.
The kingdom’s banks have also lent less money since the third quarter of 2008, contributing to the low cost of interbank lending.
In Saudi Arabia, the level of deposits is about 16 per cent higher than it was a year ago, while in the UAE deposits are growing at only 4.5 per cent, says Howard Handy, chief economist at Saudi Arabia’s Samba.
He adds that banks in the UAE are struggling to rebalance their books following the withdrawal of large amounts of money by speculators who had hoped to profit from a currency revaluation last year.
This failed to happen because of the financial crisis in the third quarter of 2008.
In July, bank deposits in the UAE totalled AED964bn, while loans totalled AED1,007bn.
Because five of the six GCC currencies are pegged to the US dollar, interbank rates are usually similar between GCC countries and the US.
Currently, however, Eibor is much higher than either the US rate or those of the other GCC countries with the exception of Kuwait, which is pegged to a basket of currencies.
“The rate is higher in the UAE because liquidity is significantly more strained than in Saudi Arabia,” says Williams.
Lowering the interbank rate is a priority for the Central Bank of the UAE because a high rate could deter lending and slow down the country’s economic recovery.