Bankers in the UAE often talk optimistically about the huge growth potential of the market, despite the global credit crunch and the domestic challenges of inflation and ever fiercer competition.

The opportunities in a market with a rapidly growing population and increasing wealth are indeed huge, but the dangers should not be over-looked. The UAE is already suffering from negative real interest rates, which encourage customers to borrow rather than save. This is hitting liquidity in the banking market, and short-term interbank lending rates have risen by about 40 per cent over the past month as banks run low on deposits and turn to other sources of cash.

Adding to the problem, banks have been finding ways around the weak lending restrictions that are in place, while customers seem happy to take on higher levels of debt as their incomes have increased.

But inflation and the negative real interest rate threaten this situation. Salaries and savings are declining in value. To avoid a bad debt crisis, the central bank needs to update its lending limits and close the loopholes that allow individuals to pose as small businesses.

It must also enforce a mandatory submission of information to a credit bureau. There should be full disclosure of a customer’s debt and repayment history, which would enable other banks thinking of making a loan to take a complete view of their credit worthiness.

In the short term, well-run banks that keep accurate records will lose out to those who exploit the weak rules to gain market share. In the longer term, however, banks that allow customers to borrow too much will suffer, while more mature institutions will emerge without losing too much on bad loans.

Either way, a review of the UAE’s retail lending regulations, which were last issued in 1993, is long overdue.