U.A.E. Plans to Back Bank Bond Sales, Al-Suwaidi Says

June 28 (Bloomberg) -- The United Arab Emirates plans to guarantee bank bond sales, intensifying efforts to shore up the financial system after pledging 120 billion dirhams ($33 billion) to boost liquidity in the Arab world’s second biggest economy.

The proposed law, which would allow the government to guarantee bonds, medium-term notes, syndicated loans and commercial paper, is expected to be discussed this week and will “give banks an extra arm to extend credit,” central bank Governor Sultan Bin Nasser al-Suwaidi said in an interview in Basel, Switzerland today.

Banks in the U.A.E. faced a shortage of funds as the global financial crisis blocked their access to foreign borrowings and local liquidity dried up as foreign investors speculating on a currency revaluation withdrew money. The gap between commercial bank loans and deposits in the U.A.E. rose to 110 billion dirhams in March, before falling to 91 billion dirhams, al- Suwaidi said on May 7.

Residential real-estate prices in Dubai, the second largest emirate in the U.A.E, have halved since their peak, leaving banks exposed to non-performing loans. Home values may drop another 20 percent this year, Deutsche Bank AG said on June 10.

“Although it is not really a monetary policy instrument it can be viewed as an instrument that would enable the expansion of credit,” al-Suwaidi said. If the law is passed this week it may be put into action within four weeks.

Market Reaction

Dubai’s stock exchange was closed when news of al-Suwaidi’s statement was reported. The Dubai Financial Market’s index of bank stocks fell 57 percent in the fourth quarter of last year and lost a further 4.9 percent since then. Abu Dhabi’s bank index lost 40 percent in the fourth quarter and has risen 8.5 percent since then.

“We’ll need to see the details, but it sounds like a very significant broadening of already extensive government support for the local banking sector,” Simon Williams, chief regional economist at HSBC Holdings Plc in Dubai, said by e-mail.

The U.A.E. said on Oct. 12 that it would guarantee all local bank deposits and interbank loans. The central bank created a 50 billion dirham ($13.6 billion) credit facility in September and on Oct. 14 said it would pump a further 70 billion dirham into the banking industry. The central bank cut its key repurchase rate by one percentage point since the start of the crisis to stimulate lending.

Lending Portfolios

“The U.A.E. central bank and local banks are bracing for a challenging second half of the year, particularly regarding asset-quality deterioration and the management of the lending portfolios,” Alia Moubayed, a senior economist at Barclays Capital, said in a June 19 report. Non-performing loans are expected to increase in the third and fourth quarters and into next year, Moubayed said.

The Abu Dhabi government said on Feb. 4 that it would support five of its local banks by buying $4.36 billion in bonds. The action raised concern among investors that the same measures would not be offered to Dubai.

Abu Dhabi, the largest of the seven emirates that make up the U.A.E., issued $3 billion of bonds to fund companies hurt by the credit crisis on April 1. Abu Dhabi’s issue followed the Dubai government’s $20 billion bond issue, half of which was bought by the U.A.E. central bank. The second tranche will be issued by the end of the year.

The Abu Dhabi government bond sale set the benchmark for Abu Dhabi-based companies such as Mubadala Development Co., a state-owned investment firm that followed with the sale of $1.75 billion of 5- and 10-year notes.

A public debt law is also under way that limits the amount of debt the federal government and local governments can take to 45 percent and 15 percent of gross domestic product respectively.

“With this mechanism, we hope to have an articulated reduction of financial institutions and other corporate exposure or borrowings from international markets. We learned from the crisis that we can’t rely on borrowing from international capital markets,” al-Suwaidi said.