It is essential for the health of the economy that banks extend credit to businesses and governments that can be used for investment and to expand their services.
However, too much exposure to a single company or government entity can potentially be risky for banks. It is a golden rule of business and investment that holdings be diversified and risk is spread as widely and as cost-effectively as possible. One of the causes of the persistent European financial crisis was the large exposure of financial institutions to the debts of governments which were unable to service their loans when they experienced economic problems. These concerns are behind efforts by the UAE Central Bank to restrict lending by commercial banks to state-linked entities and to increase the liquid assets financial institutions must hold to cope with any sudden withdrawal of funds or volatility in the financial system.
However, the UAE Banks Federation has correctly pointed out that the implementation of too strict restrictions on the extension of credit will deprive those in need of credit of an important source of funding. To accommodate Central Bank concerns, the Federation has recommended that bonds and sukuk — debt which is tradable — be considered liquid assets. This is a valid argument as long as the bonds can be cashed, at a reasonable market value, in good time. The suggestion that rather than having blanket restrictions on state-linked entities, the risk of exposure to each be individually tested, also has much to recommend it. There is no reason why well-managed businesses should not benefit from easier access to credit — for its own benefit and that of the banks.
Finally, the restrictions should be phased over a reasonable time, so that companies and governments have time to find alternative sources of funding and financial institutions alternatives investments. A sudden restriction of credit could have unforeseen consequences, like banks with excess liquidity moving funds into risky investments and a spike in the cost of credit for companies. The Central Bank and the Banks Federation must continue to work together to find a solution which will strengthen the UAE financial system.
