UAE banks don't trust borrowers: Survey

Restrictive lending criteria is also holding back growth of the sector

UAE banks’ low confidence levels in the ability of the borrowers to repay loans, as well as the ongoing, high-profile restructuring in the region and lack of clear insolvency laws have emerged as the biggest constraints to bank lending in the UAE, according to a global survey by Norton Rose, a leading international legal practice.

Respondents acknowledge there is still a degree of nervousness in parts of the Middle East, with nearly half (47 per cent) of poll respondents attributing the minor rise in UAE lending in the first five months of 2010 to a lack of confidence in borrowers, while a further 47 per cent mentioning high profile restructuring in the region, according to the survey which offered respondents multiple choices.

“Some 41 per cent also say restrictive lending criteria have held back lending,” the report points out.

“The responses to this question demonstrate what many of us already know: that confidence amongst borrowers, whether personal, corporate, conventional or Islamic has been hit, so a reluctance to borrow is not surprising,” said Neil D Miller, a Dubai-based partner in Norton Rose.

“Other relevant factors in the UAE include, at both personal and corporate levels, the increasingly widespread knowledge that defaulting borrowers may end up in jail since the main technique for recovering bad debts involves action through the penal system rather than civil courts,” he added.

“The business community also awaits the outcome of several major restructurings here and elsewhere in the Middle East region to imbue a sense of confidence that positive outcomes are possible. Ongoing, high profile restructuring in the region,” Miller said.

One of the local respondents to the survey said: “The problem is that banks have taken risks and now they have no money.” Another said: “I think there is a lack of supply and demand. At the retail level in the UAE there is a lack of demand, it used to be backed by real estate but it has evaporated, as has supply.” Only 6 per cent of respondents mentioned lack of borrowers as a problem, however.

“The survey results indicate that until some of the high profile restructurings within the UAE are completed, there will continue to be caution amongst lenders with the knock-on effect of reduced confidence in borrowers,” added Patrick Bourke, partner and head of dispute resolution, Middle East, Norton Rose.

Bank lending is especially important in the Middle East because, as respondents pointed out, few companies have access to capital markets. Despite its slow growth, nearly two-thirds of respondents (65 per cent) say conventional bank finance is the source of liquidity most likely to be available to their clients. Over 60 per cent mentioned Islamic finance as a likely source of liquidity over the next 12 months, while sale and leaseback was mentioned by 29 per cent and private equity by the same number.

Nearly 18 per cent said export credit agency finance is likely to be available, while the same number mentioned conventional debt capital markets and 12 per cent identified equity capital markets as an important source of liquidity.

“As anticipated the survey confirms a reduced appetite for structured products and derivative-linked products in particular for capital raising purposes,” said Daniela Schluckebier, Dubai-based senior associate at Norton Rose.

“Derivatives in conventional or Shariah compliant form are deployed for hedging purposes in the context of financing transactions. This is due to the more moderate risk appetite and market uncertainties as a result of the financial crisis,” she added.

“On the Shariah compliant side, while there clearly is a demand for liquidity management, structural and documentation issues remain such that structured products are not (yet) a readily available tool for liquidity management purposes.”

Miller added: “We are certainly beginning to see signs of more activity and most of what we are doing at the moment is Islamic. It will be interesting to monitor this activity in order to gauge how deep this resource is. It will be important for potential beneficiaries keen to tap this resource to devise business propositions that are commercially viable, Shariah compliant (in both purpose and structure) and legally robust.”

The head of the legal firm’s Islamic finance practice added: “We are also witnessing greater rigour post GFC with regard to the secular enforceability of Islamically structured deals.”

Anthony Pallett, Norton Rose (Middle East) LLP partner in banking and Islamic finance in Dubai commented on the return of liquidity to the market: “In the last six months we have seen a marked increase in the number of conventional and Shariah-compliant financings in the region.

“The deal sizes are much smaller than pre-crisis and tend to be bilateral or club deals rather than full syndications. Having said that, we are being asked to include agency and syndication provisions when documenting the ‘bilateral’ transactions as the financial institutions involved plan to sell down the facilities in the not too distant future. Financial institutions are increasingly focussing on the big names in the private sector and are requiring greater levels of tangible security.”

Restructuring has been a strong theme since last November and most respondents believe it will continue over the next 12 months. Some 73 per cent said distressed companies are likely to be carrying out more debt restructuring, while 53 per cent said such companies would be selling non-core assets.

Two in five (40 per cent) of respondents also mentioned separating out good assets from bad while a further 40 per cent mentioned retrenchment as strategies to be followed by distressed firms in the coming 12 months. Only 13 per cent expected distressed companies to raise more equity capital.

As one respondent said: The restructuring will be “rescheduling mostly, not much equity raising, usually one shareholder bailing out institutions.”

Successful restructurings have so far been held back especially by cultural and political issues arising from a different view of indebtedness, 50 per cent of respondents said, while nearly 19 per cent mentioned lack of creditor rights and the same proportion say there is lack of flexibility in applicable laws.

The insolvency laws indeed vary across the region. As one respondent said: “There is a definite lack of creditor rights” although “some countries have introduced laws re. Chapter 11.”

Another said: “The lack of a legal framework for a workout has been of immense relevance. Dubai World was sorted by a specific decree – this type of insolvency regime must have general applicability and across the entire Middle East.”

It will be interesting to see over the coming years whether the current insolvency legislation in the various GCC states will be revised, the report states.

“Increasing business confidence in the region is perhaps reflected in the view that more M&A activity is expected, although this may also be triggered by both restructuring or refocusing on core business, as much as by renewed confidence,” said Campbell Steedman, a Dubai-based partner at Norton Rose.

“What has been clear in practice over the past 18 months is that there is a clear focus by businesses on core business – both by sector and geography – and it is this which is likely to stimulate deal activity in the next 12 months,” he said.

Adam Vause, counsel in dispute resolution for Norton Rose (Middle East) LLP in Bahrain commented on complying to corporate governance codes: “Middle Eastern financial institutions are of the view that complying with corporate governance regimes (even if compliance is not mandatory) is something that adds value to their organisation. Three quarters of those polled were of this view and respondents noted that effective corporate governance increases credibility, reduces risks and is good from a reputational and a business point of view.”

Globally, the survey’s findings show that the question of whether the global financial sector can still be described as being in “crisis” is a matter of perspective, depending on a number of factors, including where you are located and which sector of the global financial sector you are operating in.

The global response to the crisis is becoming increasingly polarised between, on the one hand, those countries which needed to bail out their banks and those which did not. The breakdown in the drive for consensus raises the threat of regulatory arbitrage, encourages migration away from those centres where reform is at the most extreme and therefore, according to the majority of respondents, the risk of another global financial crisis has not yet been effectively addressed.

“In the aftermath of the collapse of Lehman Brothers in September 2008 the consensus was that a co-operative response was needed across the globe to deal with the problems caused by the threat of a global meltdown. But now, as countries are experiencing dramatically different economic circumstances, particularly across the G20, respondents are feeling that appetite for global cooperation on regulatory reform has diminished, with some countries pressing ahead with plans for levies, transaction taxes, bonus caps, regulatory and structural reform and others reverting to the status quo,” said James Bateson, head of financial institutions at Norton Rose LLP.

Global key findings

- 73% agree or strongly agree polarisation is increasing between countries where support of the financial services industry was needed and those where it was not.

- 87% identify Asia (including China) as the main region offering the best prospects for business in the current financial landscape, followed by Australia (27%) and South America (26%).

- 66% agree that the appetite for global cooperation on regulatory reform has diminished and therefore the risk of another global financial crisis has not been effectively addressed.

- 77% expect prospects for this recovery to be long and shallow (48%) or flat for the foreseeable future (29%). Only 22% fear double dip, down from 29% from the previous Norton Rose Group survey, which was fielded during Q4 2009.

- 74% think it will be more than 12 months before there are clear signs of liquidity returning to pre-crisis levels in the banking system, substantially higher than in previous surveys during 2009, where this group represented 36% (during Q4) and 34% (April).

The report also reflects that a variety of risks rather than economic factors, such as inflation and deflation, still critically impact financial institutions’ business planning. The highest number, 39%, identified market risk as most likely to impact their business in the next twelve months when choosing multiple options, closely followed by liquidity risk (34%) and regulatory risk (31%).


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