Deposits in the UAE banking system fell by 1.1 per cent in July compared to the previous month, as a seasonal slowdown in activity and the lack of new government deposits took its toll on the financial sector.

The latest figures from the UAE Central Bank also show that loans in the banking sector fell by 0.4 per cent in July and assets dropped by 1.2 per cent.

“Early in the year, there was a significant increase in government deposits in the banking sector and that has stopped in the past few months,” says Giyas Gokkent, chief economist at the National Bank of Abu Dhabi.

Between the beginning of the year and the end of April, bank deposits rose by 8 per cent as government deposits were put into the system. Bank deposits have subsequently fallen from AED1,128bn ($307bn) at the end of March to AED1,113.6bn at the end of July.

He adds that larger remittances during the summer could also have led to the decline in bank deposits.

Another factor could also be weighing on deposits in UAE. The Emirates interbank offered rate (Eibor) has been much higher than the interbank rates in other countries, and economists suggest some deposits in the UAE could have been profiting on the higher rates. As the liquidity situation has improved in the UAE, Eibor rates have fallen, making the interest rate arbitrage less attractive. The monthly Eibor rate was at 1.48 per cent on 20 September, down from 2.14 per cent at the beginning of the year.

“Some of the money which left the UAE in July was probably short-term money anyway, which had come in earlier in the year because interest rates were higher than most other places,” says one UAE-based bank analyst.

The liquidity situation of UAE banks has improved significantly over the past year. In July 2010, the loan-to-deposits ratio of the banking system was 102.7 per cent. The central bank has asked lenders to make sure they are under 100 per cent loan-to-deposit ratio and their liquidity has steadily improved. At the end of July 2011, the loan-to-deposits ratio had fallen 94.4 per cent.

This improvement in the liquidity of the banks has been a result of a concerted effort by the banks to attract more deposits, but also a dramatic slowdown in the pace of loan growth. In the first seven months of the year, bank loans have grown by only 2 per cent, while deposits are up 6 per cent. Gokkent says he expects the current trends in deposit growth and loan growth to continue for the rest of 2011.