Banking, like practically all other industries has been a largely laissez faire business in the UAE. Banks have been allowed to do what they want, watched over by a free market-oriented Central Bank, with the guiding principles being self-regulation and good old-fashioned demand and supply.
Credit has therefore been determined purely by market forces. This is fine and works well in an economy where the provision of good quality information and a high level of disclosure are both mandated and well regulated, in that they are both freely available and the disclosure of basic data is mandatory.
The latter is likely to take a while in the UAE where the absence of tax, etc, has obviated the need for financial disclosure. The end result has been freewheeling lending, both on the personal and corporate fronts.
This has further resulted in massive losses this year, a fact that has been documented. This has happened for a simple reason from a credit risk point of view — reliance on imperfect and inaccurate information.
Basically, there are two facets to lending — credit processes within banks and the quality thereof, and, second, knowledge and information about borrowers, sourced from clients and other creditors.
The former has been subject to laxity owing to shareholder pressure (constant demand for growth) and the latter, given to appalling quality owing to a lack of mandatory disclosure norms plus the complete lack of cooperation among lenders, so essential in an unregulated market.
Multiple banking (where each bank is free to lend what they want to borrowers) that prevails in the UAE economy, has numerous advantages. It is a true testament to a free market, leaves market forces to decide returns, and promotes secrecy and the intense desire to maintain first mover advantages (in marketing and sales as well as recoveries).
This applies more to corporate lending as the Central Bank has introduced several controls to restrict lending to individuals. However, in an information-starved market, it has huge disadvantages too.
It has degenerated into a complete free-for-all, with no referee, no ground rules and no boundaries. While banks made money exploiting information gaps in a growing market, borrowers benefited even more, securing money from multiple banks, each of which did not truly know what the other — borrower included — was doing.
Borrower indiscipline, lack of control and exploitation of banks ensued.
Banks have come together to assist clients in trouble. While it is quite the case of shutting the stable door after the horse has bolted, it is better than nothing. Perhaps it is time banks started working together in lending to clients, i.e., work on a consortium basis and present one lending face to borrowers (of a certain size).
Perhaps the UAE Banks Federation can be used as a common platform to consider the advantages of consortium lending, which essentially means banks make some sacrifices in the common interest but secure better lending procedures. This can start on a small scale with consortium lending restricted to exposure levels of a certain minimum, and other parameters.
Consortium based lending offers numerous advantages that are significant, especially in light of the comments above, on the UAE market.
First, it entails a common lending approach to a borrower, a common strategy on exposure levels, with a regular and free sharing of information among lenders at regular intervals. This in itself will act as a preventive and deter misrepresentation by clients to a large extent.
This will also prevent excessive lending because a lack of competitor information can no longer be used as an excuse for profligate lending.
Second, ongoing monitoring of banks’ portfolios will be made easier with joint inspections, reviews and a collaborative approach if problems arise. This will result in a common and, hopefully, patient, approach to borrowers in trouble unlike the current practice of a mad scramble to claw back monies at the first hint of trouble.
Third, equitable sharing of collateral and security as well as cash flows can be secured, making for control over lending and avoid the illusion of a high degree of collateral when none may perhaps exist.
It is not without disadvantages. Nothing is.
Banks will no longer be able to resort to loan growth to achieve targets — their exposures will need to be restricted to consensual strategy. They will have to work harder to cross sell other services to make more money.
Second, a default/downgrade of a borrower at one bank will lead to a collective downgrade — this is a double-edged sword but in the long run, in the interest of banks.
Consortium based lending will plug several huge gaps in the lending business and can always be relaxed with the maturing of the economy and development of strong institutions. This fosters more knowledge sharing and in fact the disclosure of better quality information.
Until then, it is an approach worth considering as it has worked well in other economies.
The writer is Managing Director of Vianta Advisors.
