Buying bank loans makes economic sense

Today's column was originally scheduled to discuss the economic consequences of jumping taxi queues, a subject of increasing urgency in Abu Dhabi, where cabs are as rare as rain, and of increasing irrelevance in Dubai, where reports are emerging of taxis stalking pedestrians. Suffice to say that the solution involves the well-placed application of a cricket bat. It has been suggested, however, that recent developments in the nation's efforts to blunt the impact of the global economic crisis may deserve a considered view. In particular, officials have been suggesting an imminent conclusion to the long-delayed merger of Dubai mortgage lenders Amlak Finance and Tamweel into a federal bank.

Some reports have suggested that the Government may help out the merged bank by buying some of its existing loans. This would establish a positive precedent for how the UAE might be able to help other banks that fall into trouble as the crisis deepens. If nothing else, the problems afflicting the UAE's banks illustrate how pointless it is to argue over whether or not nationalisation of banks is good or bad. Most banks in the UAE are already majority government-owned.

That hasn't kept them from ending up virtually paralysed after becoming overexposed to property and over-reliant on foreign funds. Now pumped up with government capital, government loans and government deposits, they still won't lend. Bankers, it seems, can be trusted to behave like bankers whether their pay cheques bear the national emblem or not. The dilemma facing the UAE's financial sector also illustrates a conundrum shared by governments everywhere as they try to prop up banks with taxpayer funds and then hope they lend those funds back out: you can lead a bank to liquidity, but you cannot necessarily make it lend.

For those just joining our programme, let's review: banks in the UAE went on a lending spree over the past few years, particularly in 2008. With a torrent of foreign funds pouring into the country in anticipation of an upward revaluation of the dirham, the banks shovelled money into new real estate investments and other projects. When foreign capital markets began to seize up last autumn and it became clear that the dirham's peg was going nowhere, those funds receded, leaving the banks with more loans than deposits. That put them in violation of Central Bank limits on lending. This week, the Central Bank Governor, Sultan al Suwaidi, put a number to that gap - Dh110 billion (US$29.94bn).

One might ask how the banks managed to hand cash back to withdrawing depositors if they had already lent the money out. The answer is that they turned to the interbank market, borrowing cash from each other and from banks abroad. But then the global credit crunch hit and that market dried up, too, driving up the cost of borrowing as banks edged away from each other like hypochondriacs in a flu epidemic.

Now the UAE's banks say they are on an especially sticky wicket. They need both capital and liquidity. They need capital to protect them against the likelihood of write-offs they may need to make as property prices fall, forcing down the value of collateral and sending some borrowers into default. And they need liquidity to lend out and keep the country's economy moving. If they lend out their money, they can't set enough aside. And if they set it aside, they can't lend it.

So far so good on the capital front. Abu Dhabi's injection last month of Dh16bn of capital into five of its banks buoys them towards the Central Bank's new requirement that all UAE banks boost their capital adequacy ratios - a measure of a bank's capital against its loans or other investments of that capital - to 11 per cent by the end of June and to 12 per cent a year after that. Best of all, the new capital is money the banks can lend.

The latest moves by Emirates NBD and National Bank of Abu Dhabi to convert deposits from the Ministry of Finance into subordinated loans present a new wrinkle. The ministry deposited its initial Dh70bn in the country's banks with the stipulation that the money be used to lend out to existing projects. It later gave banks the option to convert the deposits into subordinated loans. Bankers say other banks are likely to convert as well.

By converting the deposit into loans, banks successfully shores up their capital base, but reduce the amount of cash they have to lend out. Other government moves to boost bank liquidity and lending have largely fallen flat. The Central Bank's Dh50bn liquidity facility has gone largely unutilised by banks because it carries what bankers say are onerous conditions. Instead, banks are busily competing for new retail deposits by offering higher rates. As they try to get deposit levels to catch back up with loans, however, they aren't making new loans. Weakening economic conditions, moreover, makes them leery of lending to anything or anybody, frustrating local businesspeople and starving businesses of funds.

Rather than lend their new deposits out for risky investments, therefore, banks are offering to lend them to other banks in the overnight interbank market, bankers say, pushing down the interbank rate. Mr al Suwaidi recently hailed the falling interbank rate as a sign of easing liquidity; on the contrary, bankers say, it is a sign of a liquidity trap. Unless the banks can raise new capital from the Government or other investors, they will need new liquidity injections. Earlier this week, Mr al Suwaidi called for a new stimulus plan for banks and the economy in collaboration with the Ministry of Finance.

Instead of finding new ways to pump more cash into banks so they can resume lending growth, however, it might make more sense to find ways to reduce the banks' overall number of loans. A growing number of bankers and financial experts are warming to the idea of having the Government buy existing loans from banks, whether bad loans as they are created, or good loans they already have. Reducing the overall number of loans at banks is more consistent with the economic climate. And by reducing the banks' exposure to extravagant projects designed for the boom years, banks would arguably be able more quickly to resume lending to projects tailored for today's trimmer economic landscape. [e-mail]