In delivering a particularly candid view of the UAE financial situation, the regional investment banking head of one of the biggest banks in the world does not want to be named.
“The big issue now is liquidity. After a year of low oil prices, the banking system is creaking. It is not at 2009 levels yet, but the alarm bells are ringing,” he says.
“It could be that we are only one black swan event away from a repetition of the financial crisis back then, when Dubai was a hair’s breadth away from insolvency.”
The two possible events that might trigger the next crisis were equally depressing, in the banker’s view – a further collapse in the oil price to US$20 or even $15 a barrel; and a local security incident that would hit Dubai’s retail, tourism or transport sectors. “In either of those scenarios, liquidity could dry up altogether, even if temporarily,” the banker says.
Liquidity is what keeps the financial system moving, like oil in a motor engine. The circulation of financial assets within an economy enables corporations to fund expansion and pay their employees; it allows individuals to pay their mortgages or rent and provide for their everyday existence.
Halt liquidity altogether and there is an immediate crisis. The ATMs do not hand out cash anymore. Credit card transactions are not honoured. Bills go unpaid.
But even a restriction in liquidity can have serious effects. During the recent Greek crisis, people were lining up outside banks to withdraw a restricted amount of cash. This is the most visible effect of a liquidity squeeze.
So how does the UAE banking system rate on the liquidity rankings? The investment banker is blunt: “It’s not at Greek levels, but maybe it could go to Italian or Spanish levels at the height of the euro crisis.”
Both countries experienced tough conditions a couple of years ago when the European authorities were dithering about central bank action over the European Union’s creaking financial system. Other experts agree that liquidity is likely to deteriorate as government oil revenue declines.
“The impact of the fiscal squeeze [from lower energy revenue] is likely to be compounded by a tightening of the monetary environment as US rates rise and the drawdown on government deposits in the banking sector puts pressure on liquidity,” says Simon Williams, HSBC’s chief economist for the Middle East.
That illustrates nicely how local liquidity conditions are affected by global macroeconomic conditions, as was the case most significantly in 2009.
A recent study by the ratings agency Moody’s Investor Services concludes that financial institutions in emerging markets, including the Middle East, are facing some serious headwinds.
“While banks in many countries have improved their capitalisation and strengthened their balance sheets, risks – including weakening asset quality in emerging markets – could derail progress,” says the Moody’s global managing director Greg Bauer.
“The prospects for banks next year will continue to centre on global growth and interest rates, the evolving regulatory environment and generally weak profitability, as well as regional considerations.
“Further deterioration – in the region and in other emerging markets – could occur if trade flows and/or commodity prices fall further than expected, or if rising interest rates undermine the ability of households and corporates to meet their debt obligations,” he adds.
On banks in the GCC, Moody’s says: “Prolonged high fiscal spending and low oil revenue would ultimately impact governments’ fiscal position and creditworthiness, which could in turn hit bank ratings.
“Funding costs will rise with tightening liquidity, as reliance on more costly and confidence-sensitive market funding increases,” the rater adds.
In blunt terms, that means lower oil prices will squeeze government spending and bank deposits, which could threaten a liquidity crunch. To maintain liquidity will require ever more expensive borrowings. The anonymous investment banker agrees, but believes there are some mitigating factors compared with the last liquidity crunch.
“In 2009 the whole global financial system was drying up, whereas that is not the case today. The US system is fine even if quantitative easing is ending, and Europe is recovering and still pursuing financial stimulus policies. So there is lots of liquidity outside the region that can be drawn on, even if Asia is looking weaker,” he says.
Regional governments, including the UAE, also have a vast pool of foreign reserves, built up during the years when oil was at $100 and above, to draw on, as well as the enormous assets held by their sovereign wealth funds.
And crucially, the banker does not see corporate debt as the black swan factor, as it was in 2009 when Dubai World’s $25 billion “standstill” angered and spooked global financial markets, sending the cost of borrowing soaring for the emirate.
“Dubai has cleaned up its debt act to a large degree. Dubai World has been restructured successfully, as had Dubai Holding,” he says.
“There is still quite a lot of central government debt, and Emirates NBD has one large government-related obligation that periodically causes some worry. But the rest of it is largely asset-backed, for example with the Investment Corporation of Dubai portfolio.
“The capacity for a corporate debt shock is not there this time. Dubai Inc is much cleaner,” he says.
That is, more or less, the conclusion reached by Moody’s, too. The rater has not changed its assessment of the UAE banking system since 2013, and recently reiterated its “stable” outlook for the sector, despite more than a year of drastically lower oil prices.
“This reflects our expectation that, despite the economic slowdown driven by low oil prices, banks’ credit profiles will broadly remain resilient,” it says.
“While we expect subdued credit growth and a modest rise in new problem-loan formation, strong profitability as well as the release of provisions related to the resolution of legacy problem loans will cushion the impact,” Moody’s adds.
“Likewise, although lower oil-related government revenue will continue to cause a modest slowdown in the flow of government deposits, the banks will maintain solid capital and liquidity buffers and, overall, a resilient credit profile.”
Moody’s says liquidity will tighten and reliance on market finds will increase. “On balance, however, the deposit-funded nature of the system will remain a key characteristic and strength at about 71 per cent of total non-equity funding.
“Despite a decline in the direct government deposits of 13 per cent since December 2014, the overall deposit share of both government and public-sector entities declined only marginally to 25 per cent as of September 2015, compared with 27 per cent as of December 2014,” Moody’s adds.
That means government, corporate and individual depositors are still putting sufficient cash into their accounts, despite falling oil revenue, to prevent any likelihood of a liquidity crisis in the near to medium term.
But do not get too complacent, the banker says. “By its very nature, a black swan event is something nobody could have predicted, and everybody is aware of the risk of further big decline in the oil price or of a terrorist attack.
“If it’s something else that hasn’t been factored in yet, that could change the whole picture.”
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