A time for change: Regulatory reforms make for greater efficiency and security

A number of significant changes to the regulatory framework governing Abu Dhabi’s banking sector took place throughout 2011, as the central bank addressed potential market vulnerabilities revealed by the global credit crisis. Each reform carries implications for the emirate’s banks, but none more so than the new regulations in retail lending activity applied in May 2011. While their implementation had an immediate effect on the balance sheets of the affected institutions, the long-term implications of the new regulatory regime are of more interest to most observers.

NEW RULES: Regulation No.29/2011 Regarding Bank Loans & Services Offered to Individual Customers, which came into effect on May 1, 2011, applies to conventional and Islamic banks and financial institutions engaged in retail lending activity. This regulation encompasses personal loans and overdraft facilities, motor and housing loans, credit cards and loans made to sole proprietorship companies secured by the salary of the owner or partners in the firm. While it pertains to new and existing loans, its provisions were not retroactively applied to fees, commissions and fines levied prior to the date of its implementation. Under the new regulatory regime, customers can borrow up to 20 times their salary, a flexible cap that runs across the customer base and replaces a previous Dh250,000 ($68,050) lending limit on personal loans to expatriates. Loan repayment instalments must not exceed a combined total of 50% of an individual’s gross salary at any time, meaning that banks must take into account a customer’s other liabilities when calculating a repayment schedule. Repayment instalments for those over retirement age are further limited to no more than 30% of pension income. Credit cards may only be issued to customers with an annual salary of Dh60,000 ($16,332) or greater, and the widespread practice of accepting blank cheques as security for credit card issuances, loans and overdraft facilities is now prohibited. Car loans must not exceed 80% of the asset value, and a maximum repayment period of 60 months now applies. Conventional banks and financial institutions must also adhere to a central bank-mandated formula for calculating interest. Finally, and of most significance in the view of the financial community, the new regulations establish fixed fees, commissions, deductions and charges on loans, overdrafts and credit card balances. The fee caps are to be reviewed on an annual basis by the central bank, and no fee other than those outlined by the regulations may be levied without the regulator’s permission. Although many believed personal loans would be restricted as a result of the new regulations, they grew by 2.8% during the first half of 2012.

OBJECTIVES: The central bank offers a rationale for its decision to address the question of retail lending in the preamble to the new regulations: to establish a more transparent relationship between the banks and their customers “so as to boost confidence in banks and finance companies and enhance the credibility of the banking system”. In part, the move is a response to an altered economic landscape in the wake of the global credit crisis. The large loans and liberal lending criteria that characterised the market in the pre-crisis era became a systemic problem after the economic downturn, and bad consumer debt threatened to undermine the stability of the sector.

The new regulations are intended, therefore, to underpin a new era of profitable yet responsible lending. They are also an answer to the growing number of complaints received by the central bank regarding the high levels of fees and commissions that some parts of the sector were charging their customers; the new regulations introduce an unprecedented streamlining of fees across all banks and financial institutions.

REACTION & IMPLICATIONS: As an attempt to reinforce the sustainability of the sector and engender a more responsible culture of credit, Abu Dhabi’s lenders have broadly welcomed the reforms. “The regulations on the lending side will ultimately make the market better. What we need as a sector is patience during the re-basing period. But after 18 or 24 months, you will have a less leveraged market, which is a good thing,” Arup Mukhopadhyay, the executive vice-president and head of consumer banking at Abu Dhabi Commercial Bank (ADCB), told OBG.

IMMEDIATE EFFECT: The lifting of the Dh250,000 ($68,050) limit on lending to expatriates, in particular, is widely regarded as a progressive measure, and the new salary-linked regime that replaces it will open up new lending opportunities to Abu Dhabi’s large foreign community. Of more concern to banks, however, are the new caps on fees and commissions, which in the view of some will completely reshape the retail segment. Although the new regulation was introduced as recently as May 2011, its effect on the balance sheets of Abu Dhabi’s lenders was immediate. The emirate’s top five lenders – National Bank of Abu Dhabi (NBAD), ADCB, First Gulf Bank (FGB), Union National Bank (UNB) and Abu Dhabi Islamic Bank (ADIB) – all saw declines in non-interest income of up to 27% as the caps on fees and commissions worked their way through the system.

This short-term outcome, however, was foreseeable and scalable; of more interest to the banking industry are the less clearly identifiable long-term implications of the new regulatory framework. For example, the question remains as to how banks’ strategies will be reshaped in response to the new conditions. A partial answer came in late 2011 when ADCB outflanked the new regulations altogether by introducing free banking for its retail customers. Under its new policy, transactions and services on personal current and savings accounts are carried out at zero cost. This is a UAE first, and it has yet to be seen if the market will follow ADCB’s move with similar waivers on fees and commissions.

The prospect of a sector-wide shift towards free banking, however, raises further questions. In markets where the concept of free banking is already well established concern has recently arisen regarding its potentially pernicious effect on the banking system. Banks in these markets, it has been argued, simply transfer the cost to the consumer in a less visible way, such as through lower interest rates paid on current accounts or through aggressive cross-selling of other products, such as loan insurance. Some in the banking sector fear that in Abu Dhabi, where cold calling members of the public has been outlawed by separate regulations from the central bank, lenders who move to the free banking model will ramp up the telemarketing activity that is currently directed at existing customers. Hiding costs behind interest rates and attempting to bolster revenues by aggressively cross-selling products are both potential outcomes that would run counter to the original intent of the new regulations. Accordingly, ensuring that neither of these happens will be one of the regulator’s chief concerns in the medium term.

CREDIT INFO: The framework has raised questions regarding the availability of credit information. As banks are asked to take into account a customer’s accumulated liabilities when assessing his or her ability to meet a repayment schedule that fits within the central bank guidelines, the absence of a government-mandated credit bureau is a potential challenge.

Under the current system, banks are obliged to report defaults on loans after a 90-day period, and the “negative list” this creates can be cross-checked by other lenders in the UAE. Banks also have recourse to the services of Emcredit, a privately owned credit information firm established in 2006. While it has access to sources in the collation of its data, such as government departments and financial institutions, it does not have the regulatory sanction that would oblige banks to share data and verify its accuracy.

The difficulty of ascertaining a customer’s liabilities with other institutions is adduced as one of the reasons why elevated fees and commissions were necessary in the market. “In an imperfect risk environment, your good customers are actually subsidising your bad customers. If you had more information, risk-based pricing would become more efficient – this would benefit good borrowers and adversely impact more leveraged borrowers,” said Mukhopadhyay.

The possibility of establishing a federal credit bureau with which all lenders would be obliged to share data has been a talking point within the industry for some time. Some caution, however, that a credit bureau is no panacea: while it brings greater due diligence and transparency, it can also be misused to ramp up limits. Nonetheless, as Ala’a Eraiqat, the CEO of ADCB, told OBG, “An independent credit bureau would help improve on [the] existing tools and reports” (see interview).

Nevertheless, the requirements of the new retail lending regulations have brought more calls for a federal credit bureau capable of easing the due diligence burden on the banks. In March 2012 a meeting was held in Abu Dhabi by the board of directors of the proposed federal credit bureau to discuss its operating structure and the potential regulations pertaining to it as well as to establish a working plan by which its activities will be implemented nationally. In the meantime, the central bank will have the opportunity to assess the impact of its recent regulatory changes, while it continues to prepare for the next phase of its reform process.