Bankers expect that a proposed increase in the lending limit to individual borrowers to up to 25 times their salaries or total income will increase money supply and fuel inflationary pressures.
The new rules, a draft of which has been circulated by the UAE Central Bank to banks and financial institutions for feedback, is expected to be implemented soon.
But opinion is divided among bankers about how effective the new rules will be, with some stressing that they will increase the burden on borrowers.
The draft introduces some important amendments to Circular No 12 for 1993, which currently regulates personal loans and defines them as “loans that are given to individuals for specific purposes, secured by assigning salary and end of service indemnity or any regular income from a well-defined source, and which do not exceed Dh250,000 in total value”.
The current regulations do not specify the period of settlement but ask banks to be prudent with the principal amount of the loan as well as monthly installments required in proportion to the individual’s salary.
On the other hand, the proposed rules are more specific, saying that loans should not exceed 25 times the salary or total income of the borrower and the period of settlement should not exceed 60 months.
Interest rates Where interest rates are concerned, Circular No 12 for 1993 gives banks the right to determine them through two main formulas.
The first of these is a “fixed” rate for the whole period of the loan with any changes being applicable to new loans only. Banks must also deduct a constant installment amount at the end of each month.
The other formula is through a reducing balance, where the interest is calculated afresh each month on the outstanding principal amount remaining to be repaid after the previous month’s EMI, or equated monthly installment, has been paid.
The proposed amendments will allow banks to determine the interest rate against personal loans, and also allow them to change the interest rate. The draft asks banks to notify the borrower in writing in advance about changes in interest rate.
Circular No 12 also considers car loans as part of personal loans because the repayment is based on and secured by an individual’s salary and end of service indemnity.
The new amendment considers car loans separate from personal consumer loans and puts a maximum limit of Dh250,000 for loans to buy cars. It also stipulates the maximum period of settlement for car loans as not exceeding 60 months.
The new rules propose no major amendments in personal guarantees. The current rules allow banks to accept personal guarantees from UAE nationals for loans granted to other UAE nationals, while banning guarantees from one expatriate for loans granted to another expatriate. Also, a personal guarantee from an expatriate for a loan granted to a UAE national is not permissible.
Guarantees Transferring a guarantee given by a UAE national on behalf of another UAE national is permitted, but transferring the guarantee given by a UAE national to a loan granted to an expatriate is not permitted. The proposed new rule preserves all these provisions.
What the proposed rule prohibits is taking the borrowers’ private houses as a guarantee for loans. This applies also to taking UAE nationals’ personal sponsorships as a guarantee when loans are granted to expatriates.
Expatriates are also banned from guaranteeing any personal loans granted by banks and financing companies. While the current rules allow banks to impose a penalty on early repayment of loans, which can total the interest amount deemed to be paid for the rest of the loan period until the maturity date, the draft rules fix this fine at no more than two per cent of the remaining balance when a borrower opts to settle his loan before the maturity date.
The new rule adds clauses for mortgage loans, setting a maximum limit of 85 per cent of the price of the property for a long-term loan to buy a new house or restoring an existing one. The maximum period of settlement should not exceed 25 years.
Some analysts expect that the draft, if implemented, will increase the individual’s ability to borrow, which in turn will increase the money supply and liquidity in the market. This will fuel domestic inflation and increase consumer prices, they say.
Hani Seif, Financial Analyst at Damac Securities, said: “If an individual’s salary is, for example, Dh15,000, he will be able borrow up to Dh375,000. When we add this amount to his eligibility of borrowing Dh250,000 to buy a car, coupled with his mortgage limit of 85 per cent of his house price, the total amount of an individual’s liabilities through loans will be very high.
“This will increase the artificial money supply in the country, creating more inflationary pressure on consumer prices which are already very high.”
However, Seif ruled out any relationship between the proposed rule and increasing cash flow in local banks. “If we look at the loans-to-deposits ratio of banks in the country, we will discover that this ratio exceeds 90 per cent. In some banks it is 140 per cent. So banks do not have high cash in their balance sheets and they do not need to inject more money for personal loans.”
Zahed Choudhury, Head of Research at Deutsche Bank, said increasing the ceiling for borrowers would increase consumer demand-led inflation.
“Massive government projects are under constructions or planned for 2008 and 2009. If banks have high cash flows, these projects will absorb all their cash and liquidity, so they do not need to increase their credit for personal loans.”
However, Jamal Saleh, Head of Risk Management at the Commercial Bank of Dubai, predicted that the draft regulations would reduce the individual’s ability to borrow and will control artificial cash flow into local markets.
“The first impression of the draft shows that the Central Bank is allowing banks to increase the ceiling of personal loans for individuals. In fact, it is putting in more controls on this process by introducing two important new measures,” he said.
Saleh explained that the first measure is specifying the repayment period as 60 months, or five years. “Banks stretch the repayment period through various facilities as it is not clear in the current regulations.
Personal loans can be stretched to eight years through giving borrowers grace periods of up to six months before paying the first installment and allowing borrowers to postpone payments three times a year.”
Limiting the settlement period would increase the monthly installment, he said.The second major restriction, according to Saleh, is fixing the maximum value of the monthly installment to be 60 per cent of the borrower’s salary. “In fact, the two regulations will limit the individual’s ability to borrow from banks.
“If we calculate the maximum borrowing limit of an individual, at 25 times his salary, then the monthly installments calculated over the five years in which the loan needs to be repaid will exceed 60 per cent of the said individual’s monthly salary. So banks will never lend that much money to an individual,” he explained.
Saleh also said that cash flow was never an issue for banks because they can supply any amount of required cash through inter-bank transactions.
“The real issue is the increasing pressures on banks regarding risk assessment and risk pricing. After international credit crunch, they are not willing to go for any more risks at this stage.
A year ago, the inter-bank interest rate was between 30 and 40 basis points above Libor [the London inter-bank offer rate]. Now it is more than 200 points above Libor,” Saleh said.
This has had an impact on the local lending market. Whereas the average interest rate for personal loans was around seven per cent six month ago, now it has reached eight per cent, and is expected to climb higher, Saleh said.
“Banks are not willing to go for high-risk clients and if they lend to such clients, the service charges will be very high because the risk pricing will increase.
“Recent studies have shown that when an individual borrows more than 12 times his salary as a personal loan, the potential of failure to repay his debts is high.
“This will push banks to increase interest rates for individual borrowers going for loans more than 12 times their salaries. In turn, this will make individual borrowers think twice before taking such loans,” Saleh added.
250,000: The current maximum personal loan amount
allowed, in dirhams
Proposed loan regulations fuelling inflation