The last six months have been a nightmare for Dubai based banks. The number of defaults, both wilful and otherwise, has been increasing with businessmen absconding, leaving behind huge debts. This contagion has been spreading across industries — scrap and foodstuff trading, oil products and related trades, jewellery and diamonds and so on.
In an article in the ‘Gulf News’ in January 2015, I wrote that delinquencies in the SME space would rise and the macroeconomic effects of the oil price crash, rouble depreciation and such, would hit the UAE, particularly Dubai, with a lag. This has indeed happened.
But on analysing the “skips” of the past six months, from the perspective of an adviser — my firm works with SMEs on financing strategy — it has become painfully obvious that macroeconomics is not the sole driver of the sharp rise in defaults in Dubai. I have been asking bankers as to the reasons in defaults.
The reasons are many but some critical ones have not been taken seriously — had they been, significant losses could have been avoided.
First are the macroeconomic factors — too well known to be discussed at length — oil, the rouble, regional geopolitical troubles and consequent fall-off in tourism and so on. These have had a significant impact on several sectors and resulted in serious pressures on companies struggling with falling sales and cashflows.
Second is largely the fault of banks — again a point discussed early this year. An over-banked market characterised by unjustified (given the size of this market) and baseless revenue growth targets.
This has put unrelenting and undue pressure on bankers to deliver loan growth and has naturally led to a toxic cocktail of poor underwriting standards, obfuscation of painful facts and results of due diligence investigations, and encouragement of malpractices among clients by some bankers. (For instance, by pushing for utilisation of credit facilities sanctioned to companies. Some bankers have been known to force clients to create false transactions to draw down loans).
An environment fertile for malpractices has been wantonly created and the directors and CEOs of banks must go back to the drawing board and address that fundamental question — how long can banks shun innovation and substitute that with pure loan growth?
How long can banks continue to growth their loan books at a pace far faster than is justified by a macro environment that points towards stagnancy at best? New banks continue to wade into the UAE. They will add fuel to the fire.
This has also led to laxity in underwriting standards and due diligence by banks. Risk management departments are under undue pressure to approve dodgy credits as well, leading to a possible deterioration in credit norms.
The fourth reason has assumed increasing significance in recent years. Age-old banking wisdom requires a careful study of the “ability and willingness” of borrowers, to repay lenders. The factors discussed in the previous paragraphs have led to improper/inadequate analysis of the “ability” part and, regrettably, a complete blind eye being turned to the “willingness” part.
It is difficult — but not impossible — to ascertain the willingness of borrowers, vide careful due diligence. There has been a significant increase in the criminal intent of numerous businessmen who have come in recent years.
Persons with fraudulent intent — of wantonly defrauding banks have flooded the market. These persons plan well, study the loopholes in the system and create a house of cards patiently over three to five years, before decamping and leaving banks with huge defaults.
Many of the recent “skips” in my view were as a result of careful planning. Let us take an example — the foodstuff industry has seen a spate of defaults and skips. This trade has presented numerous lucrative loopholes to fraudsters.
Here are some. Firstly, the food business was seen as a solid stable and growing one (as both resident and tourist populations were seen to be rising) — because everyone had to eat! But did any bank relate the actual importation of product vis-a-vis estimated local sales — banks have access to information (not perfect) to ascertain the basics.
If they had, they would perhaps found that the local sales far exceeded the value of export sales. Allowing for a product to genuinely change hands once or twice, my guess is that the multiplier (physical imports vs. sales generated) would have been way too high.
So, the fraudsters chose foodstuff as the preferred industry because banks loved it. Secondly, banks insisted on and looked for businesses with “local” sales and with stocks on the ground. This was another breeding ground for fraudsters — local sales are easy to fabricate.
An invoice and a delivery order would do the trick with no requirement of any physical trade of goods. This led to fake transactions building up sales of fraudulent companies, and concomitantly, bank borrowings.
Stocks are also easy to fabricate as few lenders conduct detailed stock audits. Third was that several banks acutely lacked market intelligence and did not have their ears close to the ground.
In short periodic, regular and/or random due diligence on practices of borrowers, their market reputation and so on, were not done. Bad signals come in many forms — companies reporting higher than industry margins, periodically selling below cost, dodgy buyers, too much dependence on local suppliers, etc.
Lastly, willingness is always evidenced by past behaviour — fraudsters are likely to have some history and banks do inadequate checks in the home countries of borrowers. Though not perfect, these checks could throw up interesting and unsavoury facts.
We might say the lending business will never be the same and that banks have burnt their fingers so badly that they will turn over-prudent. Sadly, that will not happen, as the pressure to deliver results is not likely to abate.
However, we can expect a tightening of lending norms in the SME space and an enhanced level of due diligence by banks, perhaps also aided by the assistance of outside agencies such as ours in this endeavour.
The writer is the Managing Director of Vianta, which works with SMEs in raising bank finance.