Moody’s hails Central Bank’s new lending tool

A new lending tool announced by the Central Bank last week for banks in the UAE will allow them to borrow funds overnight and such a move is credit positive for the country’s 51 banks, Moody’s said on Tuesday.

The investors service was commenting on the September 3 decision by the Central Bank to create a new discount window called the marginal lending facility (MLF). The facility allows UAE banks to borrow intra-day or overnight funds from the Central Bank by discounting eligible assets from a pre-published list.

“This new monetary policy tool will improve local banks' liquidity management practices-- a credit positive,” Moody’s said in a statement.

It noted that UAE banks have historically used their holdings of certificates of deposits to draw liquidity from the central bank, either by entering repurchase agreements on those CDs or by posting them as collateral against loans.

In summer 2008, UAE banks faced intense liquidity pressures that exposed the limits of that framework in the aftermath of the global financial distress.

As a result, in addition to deposit placements from the UAE Ministry of Finance, the UAE Central Bank set up an ad hoc liquidity support facility in September 2008 to help mitigate the protracted market disruption.

“We expect the MLF to gradually replace the liquidity support facility and see this evolution as credit positive for UAE banks for three main reasons.”

Moody’s listed the following reasons:

- The MLF will clarify the framework within which local banks can access collateralised funding from the CBUAE. The central bank will publish a list of assets eligible for the MLF and we also expect the terms and conditions of borrowing to be agreed upon in advance, enabling UAE banks to maintain a portfolio of eligible assets for the provision of liquidity in stress scenarios. As of March, total domestic securities held by UAE banks amounted to around AED100 billion, or 5.8% of total assets. Given the regional sovereign or sovereign-related nature of many of these holdings, we expect a significant portion of them will be eligible for the MLF.

- The MLF will work on an electronic platform integrated with the UAE Fund Transfer System. This will reduce operational risk and ensure the robustness of the whole system during periods of acute stress. By constantly maintaining stocks of eligible assets on the electronic platform, UAE banks will be able to draw funds from the central bank quickly and with certainty.

- On a much broader level, the central bank has stated that the MLF will support the development of “long-term capital markets,” indicating that longer-dated assets will likely be eligible under the facility. Such eligibility will reduce the risk premium associated with longer-term issuance and may encourage UAE banks to undertake more term funding (e.g., at year-end 2011, market funding above one year was only 3.2% of total UAE bank liabilities).

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