Dubai: The recently adopted Federal Law (Law No 14) of 2018 regarding the Central Bank & Organisation of Financial Institutions and Activities comes with more responsibilities for the central bank in managing and safeguarding monetary policy and helping the government achieve its fiscal policy objectives through the volume of credit and liquidity in the banking system.

According to the new law, UAE policy aims to maintain a sound monetary system, in order to ensure stability and the required confidence in the national economy.

The law empowers the central bank to determine monetary tools and operational means to achieve monetary policy objectives, including policies relating to the management of the exchange rate of the national currency and money markets in the country.

Under the provisions of the new law, the central bank, with the approval of the UAE Cabinet, will determine the national currency’s exchange rate regime. To achieve this objective, the central bank is empowered by the law to take necessary steps.

As part of the management of the exchange rates, the apex bank, in line with monetary policy objectives and the current and forecasted status of liquidity, will determine minimum reserve requirements for each type of deposits, or the total deposits held by deposit-taking licensed financial institutions. The law leaves the responsibility to determine the manner in which ratio of the reserve requirements is calculated to the board of directors of the central bank.

Credit & liquidity

The new law empowers the central bank to manage the overall liquidity and credit availability in the financial system. The central bank has the mandate to set regulations which determine the limits of credit facilities extended by licensed financial institutions to their customers, compared to the total of their stable resources or to the total deposits of their customers.

According to the provisions of the new law, the central bank and the Ministry of Finance will establish a mechanism for coordinating monetary policy and fiscal policy for the purpose of achieving balanced growth in the national economy.

The role of the central bank in liquidity management has become more powerful in the context of the new Federal law on public debt aimed at managing liquidity in the financial system through a vibrant local currency-denominated debt market for both government and corporate bonds.

While local currency government bonds will emerge as an important source for the funding of key government-funded projects, the creation of a government bond market is expected to provide the Central Bank of UAE with an additional instrument for managing liquidity through the conducting of open market operations in the context of the dirham’s peg to the US dollar.

For banks, government bonds work as collateral that could be used for interbank operations and borrowing from the central bank to manage their liquidity. Additionally, these instruments would help create a yield curve at long-term tenors to provide a benchmark for bank lending.

Domestic government debt issuance could help develop a domestic corporate bond market. It would provide a useful pricing benchmark and firms would have an opportunity to diversify their finances. As the market develops, smaller companies could follow larger ones in issuing debt, supporting economic diversification.

Finally, developing the domestic debt market could attract more foreign investors, thus stimulating domestic activity.

Highlights of the law

• The central bank will determine monetary tools and operational means.

• The central bank will control the liquidity of banks through reserve requirements on deposits.

• The central bank to set regulate limits on credit facilities offered by banks

[This article is part of a five-part series on the new UAE Banking Law]