Two sets of rules on UAE interest rates

Eibor rates may be falling, but that is not translating into a lower cost of borrowing for bank customers.

Illustration by Lee McGorie / The National

Falling interbank rates - the price that banks pay to borrow from one another - should mean consumers have better interest rates on their loans and credit cards.

Put simply, if interbank lending becomes cheaper, the cost of borrowing for the man on the street should follow.

However, the personal finance market indicates a very different scenario.

In addition to the shrinking yields from interest enjoyed by retail depositors and investors, the squeeze is on customers to find the right personal loans as banks work harder to generate returns from their retail banking businesses rather than lower rates.

"Frankly," says Julien Faye, the head of Middle East financial services at Bain & Company, "I don't know why other actors, retailers in particular, are not pushing a bit harder to try to disrupt this environment a bit."

Over the past few years, the UAE's banking sector has become awash with liquidity because of record low interest rates at the US Federal Reserve and a tide of deposits from countries affected by unrest such as Tunisia, Egypt and Syria.

That has sent the Emirates Interbank Offered Rate (Eibor) falling steadily for the past four months to historic lows.

But though headline rates are falling, customers are not seeing the benefits as banks try new strategies to make money.

"Banks use Eibor as a reference for their prices on mortgages," says Ambareen Musa, chief executive of Souqalmal.com. "But for a lot of banks in the UAE, it isn't the only way they look to how they price loans."

Take HSBC's recently launched personal loan offer, designed to entice those jetting off to cooler climes for the summer months thanks to an array of travel incentives that come with the loan.

The bank declares an annual interest rate of 6.99 per cent on its new personal loans. But the bank has raised its rates since six months ago, when similar loans could be had for 6.49 per cent.

HSBC's loan pricing is based upon many factors, says Raman Muralidharan, regional head of customer value management at HSBC Middle East.

"Our internal cost of funding [different from Eibor] is one of them, and that has remained unchanged over the past several months," he explains. "Other factors include our assessment of a borrower's credit worthiness, the tenure of the loan and overall market prices."

The bank is offering free credit insurance, free hotel stays and travel vouchers as an incentive to take up the loan, though it says its rates are "in line with the market".

The average annual interest rate on a UAE credit card is 41.3 per cent, according to data from Souqalmal.com. Three months ago, the average rate was 37.75 per cent. That was already more than 20 percentage points higher than the average rate on credit cards in the United Kingdom.

Borrowers for personal loans are also being sought by banks that do not receive their monthly salary transfers, Ms Musa adds. These customers are usually riskier from the banks' perspective, which tend to charge higher interest rates.

Personal loans to residents rose by 3 per cent during the first four months of 2013, more than double the rate of growth during the same period last year, according to Central Bank data.

The increase in lending comes as banks find themselves flush with cash, but struggling to generate returns as a result of the historic lows in interest rates. Which is perhaps why they are unwilling to lower rates in line with the Eibor.

Eibor was launched in 2009, and consists of a panel of 11 banks following the withdrawal of Citibank this month. Banks submit rates to the Central Bank, which removes the two highest and two lowest rates before calculating the average for a series of terms ranging from one week to one year.

Theoretically, it is the average interest rate that banks would be charged if borrowing from other banks, though many use an internally set rate plus a margin of a few percentage points. That margin has been coming down on banks' lending books for some time.

At the same time, the amount of money entering the UAE from overseas lowers the amount banks feel they need to pay as interest on bank deposits to attract customers.

Mr Faye says the banks have been increasingly attempting to generate higher margins from personal lending to offset falling returns from corporate lending.

"The competition is still relatively modest," he says.

Whether it is a good time to borrow is another story.

How rates behave over the course of the year ahead has been one of the biggest unknown factors of 2013, says Marios Maratheftis, the global head of macro research at Standard Chartered.

"The question is are they going to continue to come down, or are we in an environment where rates are going to spike?" he asks. "I think we're in a period of consolidation - I don't see a big increase in liquidity or inflows into the region that would drive rates lower. At the same time I don't see a big tightening either, I don't see the Fed tightening rates any time soon."

Obliged to track the equivalent US dollar interbank rate because of the dirham's peg to the greenback, Eibor is unlikely to increase sharply until the Federal Reserve lifts rates, Mr Maratheftis adds.

For the savvy borrower, it may be better to postpone that round-the-world trip for a few months, when the Al Etihad Credit Bureau becomes operational. The establishment of the federal credit bureau is a major step forward for the country's financial system, allowing banks to have a fuller perspective on the indebtedness of borrowers.

The Ministry of Finance believes customers who have a strong track record of making repayments on time will be rewarded with lower rates, which should lower interest rates across the industry.

"According to the statistics compiled from the World Bank and International Financial Corporation, hopefully we will see at least a 30 per cent reduction in a very short time," Younis Al Khouri, the bureau's vice-chairman and undersecretary of the Ministry of Finance, said last month.

It is unknown if the credit bureau will have the same effect here as elsewhere, or how long it will take before banks make changes. However, for those bank customers that have to borrow now, they should take care to ensure they do not sign up for a loan with high early settlement fees, which could complicate their efforts should they wish to pay off the debt early, Ms Musa adds.