At present, what is the level of constraint on interbank lending?

AZZAM: The impact of the international crisis on us is clearly going to be noticeable. We are all connected; what happens in Europe and the USA affects the Middle East and the rest of the world. Because of the inter-linkages and the connection between banks, if banks in the major European countries become risk averse, or tight on liquidity, they would not be able to place funds abroad, and would not have the appetite to finance existing maturing debt for countries in the region. So I would expect that countries that need to refinance would find it more difficult because of the international banks lack of willingness and ability to do so. There might be situation where interbank lines will be affected if banks in Europe are also experiencing tight liquidity conditions then the surplus funds they would normally deposit through the interbank market to other banks will be less. This is a global market, but different counties and different banks will feel it differently. Those who depend more on retail deposits will feel it less. Those who are wholesale banks, whose major deposit base is the interbank market, they will feel the heat. For example, GIB and ABC in Bahrain, these are wholesale banks without retail branches in the region – they depend a lot on the interbank market and they will feel it more than a bank like NBAD or ADCB or National Bank of Kuwait or NCB, those are banks that are dependent more on branches and retail deposits. So it varies from one bank to another and it varies by countries as well.

How will this region specifically be affected by the international crisis in comparison to the rest of the world?

AZZAM: We have a different set of problems in the region than the problems banks in Europe, the USA or the Far East are facing. In Europe, we are seeing huge exposure to markets in Southern Europe and Greece. There are non-performing loans for which they need to take provisions, they need to recapitalize, and there are problems with the Euro. We do not have these problems; we have minimal exposure to Greece and minimal exposure to Southern Europe. We are affected indirectly because the feeling of risk averseness has become wide spread. People are looking at what’s happening in Europe, they see the contraction, they see the high risk there; they will be affected. I cannot think of many businesses that are expanding today or going to the bank to seek additional credit to expand because people are becoming more worried and more risk averse. People do not want to expand right now and they are delaying decisions, not because of inherent conditions, but more because of the contagion with the international situation.

The connection between our region and the international market is always through the oil market. If, for example, the crisis in Europe blows up and we go into another dip or another recession, then clearly this will impact world demand for oil, more so if it affects the emerging countries. So we are affected through the oil price. We are affected through the exchange rates because our currencies are pegged to the dollar, and whatever happens to the dollar vis-à-vis the Euro and other currencies will affect us. We are also affected through the capital inflows, and through flow of people, whether tourists or businessmen. We are a part of the global economy. We have a different set of inherent problems that we need to adjust to that the central banks in the region are actively managing. For example, the requirements on banks to raise more capital and make provisions for non-performing loans. It is unlikely that we will have additional non-performing loans because of what is happening in Europe. Most of the banks in the region are well provisioned and they will keep on taking more of their profits as provisions going forward, I would say within the next 2-3 years the real estate problem will be solved and the banks will be on a stronger footing than they were before.

Where are banks currently most keen to invest in the UAE today?

AZZAM: The most important sector where banks are active in financing projects has been and will continue to be oil and gas. Anything related to oil and gas, including petrochemicals, construction, steel related, cement related, etc. These are the sectors that will continue to boom and generate opportunities for banks. Banks are very keen on any petrochemical related projects because it is a competitive advantage of the UAE and the region. The UAE’s competitive advantage is oil, petrochemicals. As we move from Abu Dhabi to Dubai, the emphasis would be on transport, infrastructure, tourism, communication, etc., and away from the usual construction of building and other real estate related projects, will continue to be attractive for banks to finance projects.

Do banks in the UAE particularly seek out opportunities in line with government visions?

AZZAM: Banks are mostly profit oriented; they are looking at opportunities where the private sector is active. It is not a centralized economy here in the UAE, it is not like in China where there is a central agency that decides everything and pushes banks to implement it. Here, banks react to market requirements. If the contractors who are working on fulfilling the government vision would require certain financing from banks and the projects make sense, then yes, there would be a common ground whereby the banks would finance them and provide the credit needed. But if you look at it from the perspective of the banks, who need to protect their depositors first and foremost, they would respond to the private sector more than the public sector. Whether the private sector is in sync with the government, I am not so sure. The government has a grand scheme. They have proven that they have a vision; they saw things and they fulfilled them, but without the participation of the private sector, this would not have been done. At the beginning it was mainly government-oriented activities that resulted in making the infrastructure happen. Now, we have built the infrastructure and you do not need the government again, you need the private sector to use the existing infrastructure, build on it and come up with different kinds of industrial services etc. So the banks will be responding in the coming few years to the requirements of the private sector rather than to the vision of the government.

How have Dubai’s ailing government owned companies fared in their sukuk issuance? What kinds of results did investors who partook in the issuance have?

AZZAM: In order to keep its commitments to developers and contractors, allowing them to proceed without paying cash, Nakheel issued a 5-year sukuk with a coupon rate of around 10% and after 5 years they will pay the whole amount. Contractors and developers took these sukuks. These people needed to pay their own subcontractors, they had an immediate need for cash, and they went to the market and tried to sell the sukuk in what we call a secondary market. Investors in the secondary market were willing to buy these sukuks, but at a discount. Today, after 2 months of being issued, they are being traded at a discount of around 25%. So the investor is making not only the 10% on the sukuk annually, but the 25% divided over 5 years, so an additional 5% per year. They are making 15% annually on the sukuk with the hope that, after 5 years, Nakheel will be in a better position to pay the principal amount of the sukuk. This is clearly a good investment for those who believe that Nakheel is credit worthy, for those who believe that, going forward, Nakheel will be more cash positive be able to pay back that principal. Apparently, there are many investors who believe so and this is where why we have a market. Some developers are selling the sukuk and investors are buying the sukuk at a discount – it is a win-win situation for the two.

How do you respond to Sultan bin Nassir Al Suwaidi’s calls for the creation of a secondary market for bonds by first-degree local companies?

AZZAM: The credit requirements of corporates in the UAE and the Gulf in general, most of it is still coming from banks. This is not the case in the USA and in Europe. In the USA, more than 50% of the financing requirements of the corporates come from the capital markets, through issuance of sukuk and bonds so they will not be fully dependent on banks. They need to develop an alternative source of financing so that corporates who have reached their limits with the banks can go to the capital markets and issue bonds or sukuks. We have started seeing sukuks come to the market, more so in the last few years, and this is developing. But, there is a constraint. So far, those people who are investing in sukuks are holding them to maturity. Why? Because these are rare products. They are paying good interest rates, and they believe that holding them to maturity will serve them best. In order to deepen this bond market, you need to have a secondary market, and in order to have a secondary market, companies need to be encouraged to issue more sukuks, and investors need to trade them more actively. Without a secondary market, as there is in the USA or Europe, a bond market will not become viable. To have a liquid secondary market you need two things, more companies need to issue bonds and you need investors that are aware of these opportunities.

There are companies that are good, such as Emirates Airlines and other companies, that have issued bonds in the local market. These are prime, well rated companies and there is demand for their bonds in the secondary market. We have the institutions, whether international or local, who are willing to structure and place the bonds and become market makers. What we need is more issuance from the highly rated companies. We need to encourage the highly rated companies to go and tap this new source of funding. It is happening, it will take time. You cannot convince investors to buy a bond if the bond is not rated. Companies that want to issue bonds have to go to the rating agency and accept to open the books fully to be rated. This is a process that is complemented by having rating agencies, a secondary market, all the other requirements that would make a viable bond market.  Without it, the regions capital markets would lack depth and versatility; over dependence on banks is not recommended.

How have political tensions in the region impacted business in the UAE?

AZZAM: The UAE, especially Dubai, will do well when the region is doing well as the country is the regional hub for re-exports, tourism, investment, transportation, banking etc. The UAE, and especially Dubai, will also do well when the region is not doing ok. When there is turmoil in the region, Dubai becomes a safe haven. People and capital seek to move here to benefit from the stability and the security that this place provides. We have seen it when you have trouble in Egypt, Syria, Libya, and Bahrain. You see regional institutions moving their hub from let’s say Bahrain to Dubai. You will see people moving some of their money from their own respective countries to banks in Dubai and in the UAE. So Dubai does play this role as a safe haven in bad times. In good times, there’s no problem, everything is doing well and Dubai is leading. In bad times, Dubai is also benefiting and therefore, we have seen money coming in seeking opportunities here in Dubai whether it is deposited with a bank or buying real estate. Looking around, it is a very unstable region, when you zero in more on the UAE; it is highly stable and therefore benefitting from this role as a safe haven for people and for capital.