Interview: "The GCC region is faring better than any other region in the dollar clearing business"
His Excellency Mubarak Rashed Al Mansoori, governor of the Central Bank of the United Arab Emirates discusses the impact of de-risking, anti-money laundering measures as well as the decline in oil prices on the gulf state’s economy and financial markets.
Emmanuel Daniel (ED): There is a lot of interest from the international community in the way the UAE is responding to the global economic crisis, specifically in de-risking, dollar-clearing and AML. What is the Central Bank’s opinion on these issues?
Mubarak Rashed Al Mansoori (MR): When we look at the current economic situation it is with a vision towards actionable objectives. The vision is in line with the UAE government’s medium to long term plan which has emphasis on the health care and educational sectors to make these industries more cost effective while providing enhanced service.
The objectives of the Central Bank revolve around diversification of the economy, which will rely less on oil going forward. The Central Bank plays a critical role in promoting monetary and financial stability through sustainable economic growth with more emphasis on this in the coming years.
ED: Given the goal of diversification of the economy, what are the tactical responsibilities assigned to the Central Bank?
MR: The primary task is to ensure financial stability, supervising and regulating the banking sector while ensuring the banks retain a strong capital adequacy ratio. What we will do differently going forward is to encourage more growth within the private sector. This will be bank driven and will also focus on the small and medium size enterprises (SME) sector. In order for the economy to grow and diversify there needs to be further focus on the private and SME sector.
ED: This is exactly the sector that is being underserved at the moment. What do you think the problem is and what do you think needs to be done?
MR: There is not a problem but lack of incentives as banks are not incentivized to lend to the private sector or SME sector as they are perceived to be risky investments. There are many administrative issues surrounding these sectors and the banks would rather deal with large corporates and government entities due to their size and shareholder base which differs greatly from the private and SME sector.
ED: The credit and liquidity in the marketplace has experienced healthy growth. Does this area need to be further incentivized?
MR: Banks have been lending but we must look at tackling the issue in a more efficient way which includes building an ecosystem. The creation of an ecosystem brings together law and regulatory institutions and also investors to further expand the credit offering. In addition, the SME sector needs further improvement in skill sets and financial literacy in order to meet the reporting requirements of these institutions.
ED: Non-performing loans (NPLs) are being managed well but is the composition of the NPL an issue and is the Central Bank willing to take on a higher NPL in order to gain more access to funds for banks?
MR: The NPLs reported are higher than the actual values as several banks do not write off their provisional loans and these remain on their books, therefore the actual ratio is closer to that of 3% instead of what we report in our banking indicators, around 6%. This is attributed to the behavior of the board of directors at banks as they feel they will lose their legal right to claim the money but there is no correlation of this according to the banking law.
ED: In this case then governance requirements make board more conservative than necessary.
MR: Yes, the International Monetary Fund also accounts for this variance but some banks feel more comfortable maintaining their current practices of not writing off fully provisioned NPLs. Overall, the Central Bank is comfortable with the current NPL ratio which has been on a downward trajectory since the financial crisis, notwithstanding this recognized variance subject to write offs.
ED: Where is the Central Bank in the implementation phase of Basel III?
MR: We have fully implemented Basel II, and certain elements of Basel III pertaining to the liquidity coverage ratio which was implemented last year. The Central Bank is working with the UAE Banks Federation to complete the full implementation of Basel III within the required deadline of 2018.
ED: Are you confident that with the full implementation of Basel III, coupled with the banks’ responsibility to their shareholders, it will be complementary and that the banking sector will remain attractive?
MR: We continue to see high yields and returns on equity to shareholders, therefore banks remain attractive. In addition, our banks are well capitalized so the adjustment for Basel III will not be problematic. The design of the different ratios under Basel III will impact the banks most under Basel IIII. Capital adequacy ratio affects tier 1 capital and is not a current issue within the banking sector as we are not falling back on Tier 2 capital where issues may arise.
ED: Looking at international agendas such as money laundering, FATCA and de-risking there is a lot of pressure from the United States. What is the most pressing issue to ensure that the UAE banks are meeting international standards?
MR: The upgraded law on AML issued in November 2014 puts a comprehensive set of rules and regulations for banks and also exchange houses. There is significant focus on non-bank institutions becoming fully AML compliant. When the law came into effect it was presented to the Middle East & North Africa Financial Action Task Force and it was recognized that UAE had fulfilled the requirements.
ED: Are there issues unique to UAE in the area of remittances and being that of an international financial centre that must to be taken into consideration?
MR: They are unique to the GCC region but not just UAE as the region has a large amount of money exchangers which fulfill three key functions including money exchange, wire money and more specific to UAE as per labour ministry, all employers are required to pay employees through banks and/or money exchangers. Many companies send their employee salaries to the money exchange houses where employees can directly remit their salaries. This is especially useful in the construction and transportation industries.
ED: Have local banks been coming to you with concerns about international banks de-risking with concerns on dollar clearing?
MR: This is a global phenomenon and the Central Bank is following up closely with the counterparty banks conducting dialogues between local and international banks. The Central Bank raised the issue with the US authorities in November 2015 at the New York Conference. What was brought out of the conference was that the GCC region is faring better than any other region in the dollar clearing business.
There is still a gap but banks are working on closing these gaps and so are corresponding banks who are finalizing the upgrading of their systems, which is time consuming. During the upgrade there were institutions that were deemed high risk as the global banks did not have the capacity to manage them at an administrative and financial level. Therefore, certain banks streamlined their relationships. However, now banks seem to be re-connecting with their previous counterparts and there has been an improvement.
ED: Then you believe it to be more a systems issue not a perception or origin issue of where the money is coming from? Which may be from disputed areas?
MR: Maybe but if the system is transparent then it is easy to distinguish between the genuine and not so genuine origins of business. The banks have been fulfilling the requirements but the requirements for clearing have become more demanding and the banks now need to take further steps to enhance their operations.
We have requested for a gradual phasing in of this new change so as not to have any issues which may encourage people to use informal channels.
ED: How does the Central Bank look at financial inclusion?
MR: Financial inclusion requires that even the smallest players having access to the financial system. One way is working with exchange houses as a medium for employees to be able to receive their salary through these outlets. If issues do arise then we will have to change the system but for now the system seems to be satisfactory.
The other initiative is on creating a digital payment system and putting the regulations in place that will encompass all players. The digital payment system would be low cost for low wage employees but may be costly for other institutions to access such as banks and telecommunication companies. This legislation is being put in place in line with the new regulations covering this broader spectrum of institutions.
ED: How do you consider the recent Standard & Poor’s downgrades?
MR: The S&P downgrades may attributed to specific banks but is largely due to the overall decline in oil prices impacting the macro-environment of the region. Financial strengths of the banks are better as they have been taking appropriate provisions in line with the Central Bank’s recommendations.
ED: Then you feel there is no need to re-engage with the rating agencies to see what the issues are or their areas of concern?
MR: We should re-engage with the agencies to discuss the discrepancy and further explain to them the situation taking place within the region. Rating agencies also take into effect the future projections and if the oil price does continue at a low rate as it was at the end of 2015 then there might be an issue. However, oil prices have recently increased and we do not see issues with NPLs overall.
ED: Is there any pressure on the UAE government to remain pegged to the dollar?
MR: The UAE government is determined to remain pegged to the US dollar and the views from the market are consistent with this despite the low oil price. Countries have already started fiscal consolidation at a gradual level and this has taken place in the UAE and will continue further. The key component is the lifting of subsidies which has already taken place in the oil sector and will be taken further to include water and electricity which will help towards further fiscal consolidation.
ED: The UAE and GCC have had to run a budget deficit, how concerned are you with the widening of the deficit?
MR: As mentioned, fiscal consolidation here is taking place and an important clarification is that government spending is driving growth. And when oil price declines, government spending is reduced to a reasonable level to accommodate the decrease in revenue, leaving a reasonable deficit to be financed using existing financial buffers as there has been no tapping into reserves.
Also, only 30% of the GDP is attributed to the oil industry while the other 70% is non-oil related growth. Government borrowing is around 20% of the balance sheets at banks but government deposits represent less than 15%. A withdrawal of these funds would not have a huge impact on banks’ balance sheets as in other countries in the region, given ample excess liquidity and the growth of private deposits, particularly those of non-residents.
ED: The whole region is discussing the depletion of sovereign wealth funds, what is your take on this topic?
MR: Looking at the whole region it is possible but the UAE is in a different scenario with the largest sovereign wealth fund in the region and a reasonable size of fiscal deficits, relative to existing resources and options for financing.
ED: As this was the main perception in the marketplace do you feel this issue needs to be corrected further?
MR: We have not seen the government significantly reduce deposits in the banking system, notwithstanding some drawdown. When there was a big noise about reduction in deposits the actual numbers showed a growth in deposits of almost 3% during some parts of 2015. Further, overall deposit growth continued at a robust rate, albeit more moderate compared to previous years, despite the government deposit withdrawals. This was largely attributed to the increase from the private sector which mitigated the effect of deposit decline by the government on the overall system.
ED: Thank you, your Excellency for your time and insights on the current markets and the impact on the financial services industry.
Keywords: GCC, UAE, Anti-money Laundering, Economic Crisis, SME, NPL, Basel III, Deposits