Small businesses are facing a year of expensive loans as banks increasingly move away from using the official Emirates interbank offered rate (Eibor) to determine lending charges. Eibor is becoming more irrelevant as a benchmark for pricing corporate loans, say analysts, as lenders shift towards their own base rates to peg the cost of borrowing.
The need to maximise profits and build up enough capital to protect banks against bad loans is pushing up the cost of corporate lending to small and medium-sized enterprises (SMEs), which are struggling to return to growth after the global economic downturn. Nervousness about the economy's exposure to the debt restructuring of Dubai World has exacerbated the problem, say analysts. Amit Sandhu, the general manager of the Sharjah general trading company Al Sadaf Services, was shocked by the high interest rates charged by banks when he recently inquired about financing a Dh500,000 loan (US$136,124). The company may put the loan on hold until terms improve.
"It's disappointing," Mr Sandhu said. "We need a loan to help finance the business but all of the banks were charging above what we have budgeted for." The price of borrowing crept up during the financial crisis as banks passed on the extra costs of funding to customers. The Central Bank last year overhauled the system that set the Eibor rate to try to encourage lending. Although the three-month Eibor rate has dropped to 1.99 per cent from 4.8 per cent in October 2008, businesses have continued to complain that interest rates charged by banks are too high.
"In a normal environment, the interbank rate is reflective of lending costs but given the current economic environment we believe interbank rates are no more a reflection of the funding costs of banks," said Janany Vamadeva, a banking analyst at HC Securities in Dubai. Banks are increasingly relying on their own average rates calculated from their funding base, which takes into account the interbank rate, plus deposits and borrowing levels. Under such systems, small businesses are likely to face the steepest rise in lending charges because of their perceived credit risk.
"Banks will use the most profitable reference point for pricing their loans," said Jamal Alvi, the head of consumer risk management at Abu Dhabi Islamic Bank. "A customer has to understand that Eibor may be lower but it's for short-term liquidity and not reflective of longer-term financing." The corporate finance outlook for SMEs could remain bleak for the next year, say analysts. "Small businesses will continue for 2010 to pay a high cost irrespective of the cost of Eibor because banks don't have much liquidity and are risk-averse on loans," said Mahdi Mattar, the head of research and chief economist at the investment firm Shuaa Capital in Dubai.
The risk aversion on extending finance looks set to continue at least until lenders have identified all of the bad loans on their books. Even as the economy picks up, it could take between three and six months for bad loans to work their way through the system, said Ms Vamadeva. An anticipated improvement in the lending outlook has been stalled since Dubai World announced on November 25 last year that it was seeking to restructure $26 billion of debt with creditors, she said.
Concerns about how the process will pan out and its implications for the business community in Dubai will trickle down to lenders, keeping the cost of borrowing high. @Email:tarnold@thenational.ae