Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
WorldOctober 1 2013

UAE CBG looks to utilise macroprudential toolkit

The central bank governor of the United Arab Emirates says the country is looking to the tools in its macroprudential toolkit to increase the economy’s resilience to any future shocks. 
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
UAE CBG looks to utilise macroprudential toolkit

The United Arab Emirates economy is rapidly recovering from the aftermath of the global financial crisis, supported by high oil prices and an increase in real estate activity, tourism and other services. The credit cycle has also passed its lowest point and credit growth is in line with growth in gross domestic product (GDP).

A systemic risk assessment of the banking system, from the absolute level of GDP-to-loan ratio, the credit-to-GDP ratio gap or the liquidity levels, shows no indication of a vulnerability build-up as of June 2013. A traditional review of the International Monetary Fund’s key financial soundness indicators shows continuous improvement. In particular, non-performing loans (NPLs) have reached their peak and are expected to decline from this point onward. Provision coverage of NPLs continues to remain adequate and profitability levels of banks are healthy.

UAE banks remain highly capitalised with a capital adequacy ratio of 19% as of the end of June 2013, and Tier 1 capital stands at 17.2%. Liquidity is also robust as the ratio of liquid assets to total assets has shown remarkable improvements from a low of 8.5% in 2008 to more than 12% in June 2013. Banks in the UAE continue to be profitable, generating a total profit of Dh26.5bn ($7.21bn) during 2012. The first six months of this year has also shown a robust 25% increase in profits compared with the first six months of 2012.

The UAE real estate market has developed rapidly in the past 10 years. The growth has been mostly driven by very high population growth rates – between 2003 and 2012, the UAE's population grew by 173%, or by more than 5.8 million people. The UAE’s real estate market is characterised by price volatility. It has been a driver of the economic recovery in the country in 2013 and the challenge ahead is to ensure that growth rates do not reach unsustainable levels.

Regulatory development

The central bank is reviewing and upgrading existing regulations to bring them in line with international best practice and to take account of the specifics of the structure of the UAE economy and market. 

Over the next few years, the regulatory reforms introduced by the Basel Committee on Banking Supervision under the Basel III framework will significantly influence the development of the capital and liquidity regulations for banks operating in the UAE. Meeting liquidity coverage ratio requirements will not be an issue, but meeting the net stable funding ratio as it currently stands will be more of a challenge in view of the limited domestic capital market depth. Enhancing consumer protection will also remain a priority for the central bank in the development of the regulatory framework.

Macroprudential policy

The global financial crisis has prompted intense debate regarding the role of macroprudential policies in limiting the accumulation of risk and imbalances. Focusing on the stability of individual institutions has proven to be insufficient in managing risks to the financial system as a whole.

Macroprudential policy focuses on the interactions between financial institutions, markets, infrastructure and the wider economy. It complements the microprudential focus on risk positions of individual institutions. In the UAE, the use of macroprudential policy and associated tools is especially important given the limited scope of monetary policy (with the dirham pegged to the US dollar) and the limited availability of debt capital markets and risk management tools.

A number of macroprudential instruments are already at the disposal of the central bank and some will be introduced as part of new regulations in the foreseeable future.

In times of significant credit expansion, to increase the resilience of UAE banks and their ability to withstand a downturn, the central bank could consider increasing the regulatory minimum capital adequacy ratios. This was done in 2009 when capital adequacy ratios for banks were increased in response to the global financial crisis. On the other hand, capital-based tools have limited usefulness to control the credit cycle given the high excess capital buffers held by UAE banks.

The advances to stable resources ratio (ASRR) and the reserve requirement were never used as macroprudential tools previously. However, the central bank sees potential for these tools – and the upcoming Basel III liquidity ratios – to be used to achieve macroprudential objectives. Previous experience during the credit boom of 2007 and 2008 saw banks pushing towards the ASRR regulatory limit of 100%. In hindsight, we believe the ASRR could have been useful in slowing credit growth. These tools also enhance the resilience of banks and thus the capacity of the financial system to absorb liquidity shocks.

The central bank has in place a maximum debt-to-income ratio for retail customers of 50%, which could be varied up or down to impact the credit cycle. The central bank also intends to introduce a loan-to-value ratio, which will limit the amount banks can lend against certain types of collateral. This could help address excessive increase in property prices fuelled by cheap credit from banks.

Unconventional tools

It is important to note that these measures impact the economic cycle through the availability of credit. When a property or a stock market boom is fuelled by cash purchasers and speculators, the traditional macroprudential tools already mentioned have limited impact. In this case, other measures outside the scope of the central bank’s direct control should be applied.

A number of alternative tools that are outside the scope of the supervisory authorities and central banks have been used in other countries with a mixed degree of success. Those measures include a capital gains tax on the profit from the sale of real estate assets used to slow real estate market growth, and a financial transaction tax designed to discourage capital inflows.

To determine when a tool or a combination of tools should be applied, a number of financial stability indicators and/or an index combining a number of indicators can be used to signal the build-up of vulnerabilities that increase the likelihood of a crisis. The UAE central bank is currently monitoring those indicators. We have also commenced working on the development of a financial stability index, which will be used to monitor stability conditions and recommend the implementation of macroprudential measures to prevent excessive build-up of risk in the financial system.

A key challenge in using an indicator or index approach to recommend action is determining the appropriate thresholds or buckets for the indicators and how signals are interpreted in the overall financial stability context. This requires a careful trade-off between capturing the build-up of vulnerabilities early enough to avoid a crisis and maintaining an environment supportive of long-term economic growth.

Macroprudential tools to manage a crisis and to some extent maintain financial stability have long been used by developing economies. It was not until after the global financial crisis that their virtues became more widely accepted among developed countries as a means to achieve financial stability.  

The UAE central bank has a range of macroprudential tools at its disposal but has previously chosen not to use these tools even when there was market pressure to do so. This is no indication of future policies, as the UAE central bank intends to continue to remain vigilant and use the measures required to safeguard financial stability.

Sultan bin Nasser Al-Suwaidi is the governor of the central bank of the United Arab Emirates.

Was this article helpful?

Thank you for your feedback!

Read more about:  Middle East , United Arab Emirates