Issues: Cheques becoming security certificates?

Though taking cheques as security is not an entirely new idea to any market, taking unvalued and undated cheques as security is fast gaining ground in the financial market of Dubai.

Most banks are now demanding cheques to meet the risk the banks take in issuing credit cards. Though some banks seek cheques as security selectively, some banks insist on cheques irrespective of the status of the applicant.

A leading national bank in the UAE collected unvalued cheques against the issue of credit cards recently, though the common practice now with most banks is to try to cover the value of the credit limit through cheques.

True, some banks insist on the cheque value to be 10 to 20 per cent of the credit limit allowed for the cardholder.

The cheque business came into existence through the post-dated cheque arrangement against auto loans, which was considered to be a very convenient system both for the bank as well as the borrower.

However, with corporate lending slowing down or the returns from them narrowing, more and more banks became aggressive on consumer lending. While the personal loan had the backing of compulsory salary transfer, credit cards, which are considered to be the most lucrative area for the commercial banks, naturally needed security.

The last two years saw several banks in the UAE come out with different types of credit cards. The incentives included air tickets, free insurance, discounts, road assistance, to name a few. Though the competition prompted banks to add on new features and services, very few compromised on interest and annual fee.

But RakBank, which charges only an annual interest rate of 12 per cent and a zero annual fee, instead offers Dh60 worth Etisalat card free to new cardholders, while most of the banks charge an annual fee of about 24 per cent.

The competition in the credit-card business has prompted banks to lower salary limits stipulated for prospective cardholders, raising the risk involved.

There were reports that one issuer had to stop issuing cards last year and concentrate on recovery because they failed to collect cheques as security. The blank cheque business has not only caught the fancy of credit card issuers, but even mortgage financiers.

The agreement letter of a mortgage finance said that the borrower should produce undated, unvalued cheques against the loan over and above the instalment cheques.

The issue has sparked debate in the financial market. Some say that since the loan has to be secured, the financial institutions have to pursue ways to safeguard themselves against risks. There are some who still believe that seeking unvalued, undated cheques is an unfair practice, if not illegal. Since bouncing cheques is a criminal offence, no one can afford to allow cheques to be dishonoured.