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United Arab Emirates

Author(s):
International Monetary Fund
Published Date:
March 2003
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I. The Financial Sector1

A. Introduction

1. The United Arab Emirates has long played an important role as a regional financial center for the Middle East based on its location, the legacy of an open and liberal trade regime, and the proactive stance of the governments of the emirates to promote modern and technologically advanced infrastructure. The backbone of the financial system is the banking sector, which is one of the most developed in the region.

2. This section addresses issues relevant to the United Arab Emirates’ financial sector. These include a background of the structure of the banking sector, the performance trends of financial soundness indicators, and the ongoing efforts by the Central Bank of United Arab Emirates (CBU) to enhance regulatory and supervisory changes in line with the rapid changes in the increasingly global banking environment. The chapter also discusses the developments, reforms, and challenges in other areas of the financial sector, including the nascent equity, bond, and insurance markets. The last section highlights the progress in implementing the Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) legislation. In fact, this area of reform has advanced the most over the past year, as a significant amount of CBU resources have been devoted not only to revise and issue new legislation, but also to support and cooperate with several countries in international initiatives in this area.

B. Structure of the Financial System

3. The United Arab Emirates’ well-developed banking system is the second largest in the GCC in terms of total assets. This is illustrated by the degree of banking presence in the U.A.E. economy, with bank lending to private nonbanks representing more than 50 percent of GDP (Table 1). The financial system primarily consists of commercial banks, money exchange houses, insurance companies, and securities firms. In comparison to Kuwait and Saudi Arabia, there are more commercial banks per capita in the United Arab Emirates, with 21 domestic commercial banks, 26 branches of foreign banks, and 105 head offices of money changing houses, as well as one restricted licensed bank. National commercial banks are geographically distributed among the emirates with each one, except for Ajman, having its own national bank, although most of the banks are headquartered in Abu Dhabi or Dubai. Among the 21 national banks, 14 have some federal or local government ownership. Only very few commercial banks are wholly operating as Islamic banks, but the demand for Islamic banking services is increasing, with some non-Islamic banks allowed to offer Islamic products.2

Table 1.Commercial Banking System of Selected GCC Countries, 2001
BahrainKuwaitSaudi ArabiaU.A.E.
Credit to the private sector (in percent of GDP)46.668.126.852.3
Total assets (in millions of U.S. dollars)10,21852,056126,15077,288
Number of banks per 100,000 persons2.370.430.051.82
Sources: IMF, World Economic Outlook; IMF, International Financial Statistics; and national authorities.
Sources: IMF, World Economic Outlook; IMF, International Financial Statistics; and national authorities.

4. The structure of the banking sector has been stable for quite some time. Apart from one-off cases, there have been very few mergers among local banks, while a ban on new foreign entry has been in place since 1982. Some of the reasons for the dearth of mergers among the local banks are the following:

  • Profitability has been good and capital ratios have been healthy.
  • Large banks already have substantial market share and are generally not anxious to expand further, although they are aggressive in seizing opportunities to increase scale in certain products or areas, such as credit cards.
  • Family ownership of a number of banks has resulted in reluctance to forge consolidation.

5. There are signs, however, that the financial sector landscape could be poised for change. This is driven in the near term, by the increased competition from smaller banks to gain market share within the domestic market; in the medium term, by further liberalization of the financial services sector as part of WTO commitments and the development of capital markets. While the top five national banks still represent about half of the banking system’s total assets, along with deposits and loans and advances, their dominance has seen gradual erosion since the mid-1990s, with smaller national banks gaining share in all of these categories (Figure 1). Further competition is expected, since the United Arab Emirates will in all likelihood open up the banking sector to the GCC in the near-term. Alternative sources of financing, as the capital markets develop further, is also expected to put competitive pressure on the banking sector as corporations that have traditionally depended on bank borrowing diversify their funding profile.

Figure 1.Banking Structure in the United Arab Emirates

Share in Total Banking Sector Assets, Deposits, Loans, and Advances

Source: Central Bank of the United Arab Emirates.

C. The Banking Sector

Prudential regulations, bank supervision, and recent performance

6. Since the establishment of the United Arab Emirates as a federation of seven emirates in December 1971, there has been considerable progress in developing legislation supporting the development of the banking sector. The central bank supervises commercial banks, foreign branches, and money changers. One of the key elements of the current financial system is the strength of banking supervision, which has evolved in response to a series of high profile failures in the early 1990s. In this regard, the main findings of the 2001 Financial Sector Assessment Program (FSAP) mission are highlighted in Box 1.

Box 1.Key FSAP Findings on Banking supervision

  • The banking sector is buttressed by strong banking supervision.
  • Stress tests on banking sector vulnerability indicate that the system is well cushioned, with ample liquidity and a high risk-weighted capital adequacy ratio to withstand any significant shocks.
  • Banks are well managed and the CBU is largely compliant with the Basel Core Principles (BCPs) with only a few exceptions.
  • The CBU observes most good transparency practices in conducting monetary policy and banking supervision, but further improvement is needed in the area of transparency practices with regard to publishing more information on itself, its monetary operations, and financial sector developments.

7. Financial soundness indicators continue to point to a healthy banking sector, with all banks complying with prudential standards. Banks have shown strong performance in asset, deposit, lending growth, capitalization, profitability, and efficiency since the mid-1990s (Table 2). This trend continued in 2001, especially in the case of national banks, the leading ones posting double-digit growth in net profits, despite the downturn in global oil prices. Total assets and deposits of national banks also registered a sizable expansion, albeit at a slower pace relative to the previous year. Results reported for the first half of 2002 indicate that both national and foreign banks remained profitable with their asset quality registering further improvement.

Table 2.Banking Sector Soundness Indicators, 1996–2001 1/

(In percent, unless indicated otherwise)

Commercial Banks and One Restricted Licensed Bank199619971998199920002001
Risk-weighted capital to asset ratio 2/20.819.420.020.520.220.0
Gross nonperforming loans/gross loans15.214.413.513.612.711.2
Loan loss reserves/nonperforming loans88.689.689.586.186.088.5
Return on assets (commercial banks)1.92.02.01.5l.81.7
Return on equity (commercial banks)17.118.317.712.S14.914.6
Total expenses to total revenues35.036.335.438.337.538.3
Earnings per employee (in millions of U.A.B. dirhams)0.250.270.280.230.270.31
Liquid assets to total assets37.338.034.531.334.833.8
Deposits as a percent of M292.292.291.790.792.193.3
Foreign currency deposits as percent of M219.919.620.021.222.423.8
Loans to private sector as percent of total deposits101.5106.0116.8113.6105.491.9
Number of commercial banks464647474747
Local191920202020
Foreign272727272727
Source: Central Bank of the United Arab Emirates.

Includes commercial banks and one restricted licensed bank.

Represents BIS Tier I plus Tier II capital.

Source: Central Bank of the United Arab Emirates.

Includes commercial banks and one restricted licensed bank.

Represents BIS Tier I plus Tier II capital.

8. The credit culture is gradually evolving from collateral-based lending toward the global trend of risk-based approach to assessing credit. The fact that counterparty credit risk from corporate lending by banks are secured almost fully by collateral—usually real estate—indicates that most corporate balance sheets are still not very transparent, with substandard accounting practices and poor corporate governance. However, banks are increasingly moving away from the traditional practice of “name lending” in favor of considering potential credits with proper credit risk assessment, thereby gradually making the use of collateral as a means only to mitigate risks.3 To this end, the CBU is currently implementing a comprehensive risk management module for banks that encompasses market risk, operational risk, credit risk, and corporate governance.4 In essence, full implementation of this risk review process of banks will result in enhanced banking supervision through an early warning system, while moving the operational underpinnings of the banking system to a relatively more risk-based platform. This program is expected to emerge from its current pilot stage to being fully operational by the first quarter of 2003.

9. Some of the other reforms in banking supervision that were part of the FSAP recommendations are ongoing. There is now a concerted effort to provide adequate lead time to banking and other supervisors as well as market participants, to ensure that significant structural changes can be safely and effectively implemented (e.g., the implementation of the AML/CFT legislation). However, reforms are lagging in the area of debt recovery through foreclosure of the underlying collateral in the case of loan default. With real estate being the most widely used collateral in the emirates except for Abu Dhabi,5 there is a general reluctance to take land away from the debtor or even go to court to resolve such issues. Therefore, the modernization and enforcement of the bankruptcy law remains an important agenda of reform for the authorities.

Profitability

10. Indicators of profitability since the mid-1990s have compared very favorably to international standards. Net profits of the banking system have averaged about 12 percent since 1996, while the return-on-assets (ROA) of national banks has ranged between 1 percent to 3 percent, and return-on-equity (ROE) from 10 percent to greater than 20 percent (Figure 2). Foreign banks in the United Arab Emirates have also had high profits, averaging about 20 percent a year during the same period. Accumulated profits of banks over the past years have bolstered the capital positions of banks. Banking sector stocks, which form a significant part of the stock market capitalization, have performed strongly since their listing in the formal exchanges, rising by 14 percent in 2001.

Figure 2.Returns on Assets and Equity for Commercial Banks, 1996–2001

Source: Central Bank of the United Arab Emirates.

11. Net profits of commercial banks remained healthy in 2001. Aggregate data for national banks in the United Arab Emirates indicate that net profits grew by 8 percent in 2001, following a 12.5 percentage expansion in the previous year. Net profits of most foreign banks were also strong, although aggregate results showed a decline of 16.5 percent, driven mainly by the net losses of two large foreign banks, one of which increased its provisions for loan losses and wrote-off its bad loans from the Solo Industries debacle in 1999. The ROA for the banking sector as a whole registered 1.7 percent, while the ROE was 14.6 percent, a relatively good performance by international standards. Results from the first half of 2002 indicate that net profits grew by 11.5 percent and 40.9 percent on an annualized basis for national and foreign banks respectively.

12. The banking sector has been able to sustain relatively high profits, despite a large number of banks serving the domestic market.6 Some of the factors that have helped U.A.E. banks to maintain their profitability are the following:

  • Net interest margins at 2.5–3 percent over the past five years have been the primary reason for income. Margins for personal loans have risen as a result of increased loan demand, which has encouraged most banks to expand their business into retail banking (Figure 3).
  • Revenue diversification is another new source of profits for the banking sector. Income from fee business has risen, indicating that sources of income other than interest margins are on the rise.
  • Ample liquidity in the system from a stable deposit base has kept funding costs low, while banks have maintained their cost efficiency; the expatriate labor force still accounts for a significant portion of the total labor force in this sector.7
  • Banks have taken advantage of new business opportunities in the area of consumer lending (credit cards and auto loans) where margins are attractive. The demand for consumer loans is supported by the high level of per capita GDP in the United Arab Emirates and the demographics of the maturing population. For example, foreign banks, such as Citibank, have aggressively expanded in the credit card business and several other local banks have followed suit.

Figure 3.Interest Rate Spread Between Lending and Deposit Rates, October 2000–June 2002

Source: Central Bank of the United Arab Emirates

13. Domestic loan demand has risen significantly in the past years. This rise reflects the opening up of the residential property sector to foreigners in Dubai, the rapid expansion of the free trade zones, the booming tourism industry, and several large private and public sector infrastructure project financing.

14. The flexible wage structure has delivered efficiency ratios that are among the lowest in the world. While total expenses to total revenues have been on the rise, primarily due to expenditures on new technology, the cost-to-income ratio is very competitive (Figure 4).

Figure 4.Total Expenses to Total Revenues, 1996–2001

Source: Central Bank of the United Arab Emirates.

15. U.A.E. banks have been quite successful so far in developing business from non-interest income business, in particular, commission income (Table 3; Figure 5). Owing to the competition in the domestic banking system, banks have increasingly diversified their balance sheet into areas of investment banking, treasury and treasury-related services, wealth management through market-linked investment products to their retail customers and increased participation in syndicated lending. The U.A.E. banks are increasingly following their corporate clients in the area of investment banking by underwriting and providing advisory services on equity and debt financing, as well as providing facilities to trade securities. For example, the National Bank of Dubai and Emirates Bank International were co-managers in the Emirates Airlines local currency bond issue in 2001. Several banks arc already offering wealth management products such as insurance, asset management, and mutual funds.

Table 3.Sectoral Loan Concentration Ratios, 1999–2002

(In percent of total loans)

199920002001June 2002
Agriculture1.11.21.00.9
Mining and quarrying2.42.11.81.5
Manufacturing6.67.06.26.2
Electricity, gas, and water0.10.30,91.0
Construction15.515.716.516.1
Trade29.730.430.429.5
Transportation, storage, and communication2.83.03.13.1
Financial institutions (excluding banks)1.41.41.31.6
Government11.99.17.37.4
Personal loans for business and consumption22.423.024.925.4
Business11.512.414.214.6
Consumer10.910.610.710.8
Others6.16.710.77.2
Source: Central Bank of the United Arab Emirates.
Source: Central Bank of the United Arab Emirates.

Figure 5.Sources of Bank Profits, 1996–2001

Source: Central Bank of the United Arab Emirates.

16. U.A.E. banks also have a strong funding profile and manage excess liquidity quite efficiently to maximize returns. Most of the banks have ready access to a relatively stable deposit base, supplemented by a low cost of funds. In particular, the top five national banks get large deposits from government entities, such as Abu Dhabi National Oil Company, that have high cash flows. The big five banks that usually have a high level of excess liquidity, have also adopted a proactive stance in efficiently managing this liquidity through well-run treasury operations. The treasury operations of the National Bank of Dubai, for example, contributed significantly to its overall profits in 2001, and during the first half of 2002, by adequately hedging against a low interest rate environment and actively reducing the reliance on the interbank market in the portfolio mix.

Capital adequacy

17. U.A.E. banks continued to remain well capitalized during 2001 and the first-half of 2002. The risk-weighted capital adequacy ratio (CAR) of the overall banking sector remaining stable at 20 percent, significantly above the 8 percent minimum BIS capital adequacy ratio and the 10 percent requirement set by the CBU. The high CAR has been sustained partly by high profitability (profit retention) of commercial banks in the United Arab Emirates. Additional capital was also raised in the stock exchange by two banks via new issuance of stocks.

Asset quality

18. The improved trend in the asset quality of the banks’ portfolio has been a key development since the mid-1990s. The ratio of gross nonperforming loans (NPLs) to gross loans declined to 10.7 percent as of June 2002 from 15.2 percent in 1996 (Table 1). Given the strength of the prudential indicators of the entire banking system, the relatively high level of NPLs is partly due to the enhanced reporting requirements of NPLs, which date back to the 1980s. While most of these loans have not been written off, they are well provisioned for at close to 90 percent as of end-2001, mitigating the concern over the high NPL level. On this point, U.A.E. bankers seem generally reluctant to write down NPLs, because according to common practice in the country, once loans are written off, the legal basis for recovering any of these assets weakens considerably. To this end, it is worth noting that some of the claims by Mashreq Bank from the Solo Industries debt default have reportedly been recently recovered.

Sectoral distribution of credit

19. Credit activity to the private sector has been underscored by a significant increase in consumer and construction loans since the late 1990s, Consumer lending has largely been driven by personal business borrowings to fund small- to medium-sized enterprises, while other consumer loans, such as credit card loans, are on the rise as well. Other sectors that also contributed to the credit expansion were wholesale and retail trade as well as transportation and communication. However, credit to the manufacturing sector has declined over the past few years.

20. The shift in the lending profile of banks since the mid-1990s, with increased concentration in construction and consumer loans, has raised some market concerns because of the possible risk of default owing to an economic downturn8. This concern, however, is mitigated by the strict implementation of existing regulations and their ongoing refinement by CBU’s Banking supervision Department. Under the current regulatory practice, most personal loans are secured or are backed by collateral in the form of securities, real estate, wages and deposits. Current regulations limit personal loans to Dh 250,000 and new personal loans are reported to the Risk Bureau, where a central database of individual loan portfolio is maintained on a consolidated basis. A mechanism to calibrate loan limits to certain parameters of repayment capabilities like salaries is currently under consideration. Also, regulations for lending to the construction sector have been recently tightened in that banks can now only lend up to 20 percent of customer deposits to the construction sector. Moreover, any potential large exposure, prior to advance, will have to be first submitted to the CBU for a detailed analysis of the underlying collateral and the project under consideration.9 These ongoing refinements supplement already existing prudential regulations such as limits on large exposures and on-site inspections to verify that proper internal control systems are in place to identify and limit large exposures.

Liquidity

21. National banks in the United Arab Emirates are reasonably liquid, with a relatively stable deposit base and a high level of interbank placements in banks abroad. The fact that the United Arab Emirates is structurally a net creditor country with a fixed exchange rate has provided the banking system with a net accumulation of foreign assets, supporting its ample liquidity situation. Despite a decline in both oil prices and domestic interest rates, deposits of the banking system rose by 11 percent in 2001. This occurred while the net interbank placement of funds abroad as a proportion of total assets, which has steadily declined since mid-1990s, still constituted an important part of banks’ liquidity cushion at 14 percent of total assets as of end-2001. The ratio of liquid assets to total assets remained high at about 34 percent in 2001, while the liquid asset to short-term liabilities increased to over 60 percent. Another indicator of liquidity, the loan to deposit ratio, also declined to about 75 in 2001 from 89 during the previous year.

Foreign exchange exposure and dealings

22. The share of foreign assets in the total assets of the banking sector has remained stable at about 35 percent since 1998. Commercial banks were able to build on their net foreign asset position in 2001, despite a lower balance of payments surplus and lower interest rates. The share of foreign currency-denominated private sector deposits in total private sector deposits largely remained stable in 2001. Most foreign exchange operations of U.A.E. national banks are in U.S. dollars, but these pose no imminent exchange rate risk given the United Arab Emirates’ peg to the U.S. dollar exchange rate regime, which has lasted with only very minor adjustments since 1980, and is backed, by large official reserves and prudent macroeconomic policies. Exposure to foreign exchange risk in other currencies is limited, with the very low net foreign open foreign currency position in non-U.S. dollars.

Monetary policy, monetary instruments, and money markets

23. Given the fixed exchange rate arrangement, CBU conducts its monetary operations in an accommodative manner, whereby it stands ready to buy and sell any amount of U.S. dollars demanded at the announced official rate. Because of balance of payments surpluses, CBU has continued to build its net foreign assets by buying U.S. dollars mainly from the government and selling a large part of these funds primarily to commercial banks. The main monetary instruments currently used by CBU to smooth out fluctuations are the certificates of deposits (CDs) to absorb liquidity and foreign exchange swaps to inject liquidity.

24. Although the domestic interbank market is very liquid, further measures to enhance the intermediation of the domestic money market are under way. The relatively short reserve compliance period has encouraged banks to actively participate in the interbank market to manage their liquidity positions. Nonetheless, to further improve the efficiency and effectiveness of the money market, the CBU is currently considering increasing the issuance of CDs at the longer end of the maturity spectrum of the yield curve. Further measures to facilitate the maturing process of money markets would hinge on developing more market-based instruments to complement the current use of deposits and loans in the domestic dirham interbank market. In this regard, the introduction of repos could potentially increase the liquidity in that market. Given that repos are short-maturity collateralized instruments, repo markets have a strong linkage with the securities market and other short-term money markets, thereby laying the foundation for the development of a domestic bond market.

25. The reserve requirement has not been actively used as a monetary instrument in recent years other than the adjustment made in January 2000, to encourage the repatriation of deposits held abroad by banks. The reserve ratio on time deposits was lowered from 2–5 percent to 1 percent, and the ratio for deposits (current, savings, and call accounts) was raised from 6–8 percent to 14 percent. In addition, banks were already required to hold 30 percent of net short-term dirham placements with the CBU. As a result of the change in reserve requirements, some repatriation of funds from overseas branches of U.A.E. banks has taken place. Nonetheless, authorities have chosen to consider all the deposits of U.A.E. residents booked in the overseas branches to be part of domestic liquidity. The rationale for this decision was based on their observation that almost all of the funds that were deposited in overseas branches, to circumvent the lower but still existing reserve requirement, found their way back to the domestic banking system.

D. Other Segments of the Financial Sector

Securities markets

26. The U.A.E. authorities have taken important steps to address the volatility and malpractices that plagued the local securities markets in 1997 and 1998. These include the enactment of Federal Law No. 4 of 2000 (Securities Law), the creation of the Emirate Securities and Commodities Authority (the Authority) for brokerage houses, investment funds and the stock exchanges in Dubai and Abu Dhabi. The Securities Law requires that all intermediaries, exchanges and clearance and settlement facilities be licensed by the Authority, in addition to all shares being listed on a licensed exchange.

27. There has been a marked increase in activity since the establishment of the Dubai Financial Market (DFM) and the Abu Dhabi Securities Market (ADSM) in March and November of 2000, respectively. While the formal exchanges have seen a significant rise in shares traded, trading volume, the number of trades made and market capitalization have risen significantly, the activity in the non-listed companies that continue to be traded in the over the counter (OTC) market has seen a substantial decline during the same period. The number of listed companies in both stock exchanges has increased rapidly. Blue chip companies, such as Etisalat, have been listed to increase the depth and liquidity of the market. Out of the publicly traded companies, the banking sector has the largest contribution in terms of trading volume, followed by the insurance sector and the services sector in both the securities exchanges. The Emirates equity market index (Emnex) rose 25.6 percent in 2001 and a further 13.6 percent through end-October 2002, while total market capitalization of the DFM and the ADSM has risen from less than 20 percent of GDP in 2001 to over 35 percent of GDP as of end-September 2002 (Table 4).

Table 4.Securities Market Activity, 2000–02

(In millions of U.A.E. dirhams)

Abu Dhabi Securities MarketDubai Financial Market
20002001Oct. 200220002001Oct. 2002
Number of shares traded0.518.650.924.058.7129.0
Value of shares traded8.1534.11,086.7436.6981.02,471.3
Number of executed deals
(In thousands of dirhams)0.2025,79.16.613.623.0
Market Capitalization14,00021,20570,92328,39128,92533,244
Source: National authorities.
Source: National authorities.

28. Securities regulation in the United Arab Emirates is at the early stage of development, although the establishment of the ASDM and the DFM has strengthened the regulatory structure and its implementation. The Authority has already issued several sets of regulations covering its own structure and the operations; the licensing of securities exchanges; the structure and operation of clearance and settlement facilities; the membership of the securities exchanges; disclosure and transparency; and the use of alternative dispute resolution in securities and commodities transactions. Nevertheless, further amendments to the existing laws and regulations are needed, in order to bring them in line with current best practices. Strengthening corporate governance environment also remains crucial. In this regard, improvements in corporate transparency and accounting standards need to be addressed expeditiously. For example, the nonbank sector is yet to migrate their accounting practices to the IAS39, while most listed companies except for banks do not yet report quarterly results.

The development of the bond market

29. The local debt market in the United Arab Emirates is in its nascent stages, although recently it has been enhanced by several bond issues in the local market (Box 2). However, trading in the secondary market is not very active with only one of the bonds listed in the securities exchange market. Nonetheless, with more issuance in the pipeline, including the one by the Dubai government to fund infrastructure projects in 2003, activity in the bond market is expected to pick up in the period ahead.

Box 2.Domestic Bond Market

IssuerIssuedMaturityAmount
BMW199911/2002Dh 350 million
Abbey National2000CalledDh 400 million
Emirates200106/2006Dh 1,500 million
Source: Central Bank of the United Arab Emirates.
Source: Central Bank of the United Arab Emirates.

30. Notwithstanding the encouraging trend in the bond market, several factors have inhibited its development in the United Arab Emirates. Some of them are as follows:

  • The use of deposits and loans as the only instruments in the domestic dirham liquidity market has prevented the development of a repo market that is the key building block for debt markets.10
  • Inadequate issuance of government securities to provide a reliable benchmark yield curve and the collateral generally used for repos.11
  • Lack of transparency in the balance sheet of various corporations to form adequate credit assessment.
  • Financial legislation is not at par with international standards to discipline financial disclosures and high standards of corporate governance.
  • A major institutional investor in the National Pension Fund is largely absent from investing in the domestic bond market.

31. The motivation for developing debt markets, in the case of United Arab Emirates, would mainly be to make the functioning of financial markets more effective and diversify the undue dependence on the banking system for financial intermediation. The bond market could also allow banks to raise funds to finance projects that require longer term financing, thereby mitigating the possible asset-liability mismatches. Similarly, corporations could have the flexibility to finance the acquisition of long-term assets and fixed investment projects that are expected to yield returns only in the long term.

32. Another reason for developing the local bond market is to diversify the risk of sterilizing large inflows from oil into a wider spectrum. Currently, the sterilization of the large inflows from oil-related receipts, in the absence of a developed bond market, take place by the issuance of short-term papers by the CBU and the sizeable placement of short-term interbank deposits abroad by commercial banks. A liquid bond market could provide another conduit for risk diversification across the maturity spectrum, making liquidity management more efficient.

33. The development of capital markets would also provide opportunities for the significant pool of savings to be deployed into resources other than bank deposits. Institutional investors, including the National Pension Fund, other private pension funds, insurance companies, and asset management, would benefit from the development of capital market products.

Insurance

34. The insurance sector penetration in United Arab Emirates is one of the highest in the GCC. The FSAP report indicated that the insurance industry is well capitalized at the aggregate level, and there seemed to have been no systemic risk arising from the insurance industry to the banking sector. However, in contrast to the banking sector, the insurance sector is relatively small (though there are more than 50 companies), less systemically important, less developed, and inadequately supervised.

35. Several initiatives along the lines of the FSAP recommendations are currently being pursued. To this end, the Emirates Insurance Association (EIA), an organization originally set up to promote cooperation between member insurance companies and agencies, as well raise insurance awareness, has intensified its efforts recently.12 The ETA, in its unique capacity as a technical extension of the Ministry of Economy and Commerce (MOEC), has identified the key deficiencies in the insurance market, which include the Insurance Act of 1984, supervision and examination of the insurance sector, and the organization structure of the insurance industry. The EIA intends to recommend a very fundamental approach to reforming the insurance sector and not take a piecemeal approach. For example, the EIA has recommended that a separate and independent supervisory body be set up rather than just extend the staff of the Insurance Division of the MOEC, which goes beyond the FSAP recommendations.

E. Anti-Money Laundering and Combating the Financing of Terrorism

36. Several important steps have been taken in the past few years to address money laundering and financing of terrorist activities. The authorities established a Financial Intelligence Unit (FIU) in July 1998 (which was changed to the Anti-Money Laundering and Suspicious Cases Unit in November 2000), formed a National Anti-Money Laundering Committee in July 2000, and issued a circular in November 2000 to all financial institutions operating in the country to report suspicious transactions, scrutinize Letters of Credit and related documents, and stressed customer identification. Also, the CBU is in the process of registering and supervising the “hawaladars,” who are now required to provide details of remitters and beneficiaries as well as report suspicious transfers. In addition, authorities have extended full cooperation to other jurisdictions, including six investigation teams from the United States and other countries such as Germany, Pakistan, and the United Kingdom, some GCC countries, since September 11, to facilitate investigations relating to anti-money laundering and combating of terrorist financing.

37. The United Arab Emirates passed the Anti-Money Laundering Law (Federal Law No. 4) in January 2002, which criminalizes money laundering activity. This federal legislation fully incorporates the Financial Action Task Force’s FATF 40 recommendations and its 8 special recommendations dealing with terrorist financing. The Federal Law No. 4 also covers terrorism and money related to terrorism. It states that money originating from terrorists acts or vice versa is criminal money and subject to prosecution. The Federal Law empowers the CBU to issue freeze orders relating to funds that may be used to facilitate terrorism.

38. The National Anti-Money Laundering Committee was established in July 2000 to undertake the overall responsibility of coordinating the AML policy in the United Arab Emirates. This committee, headed by the CBU governor, is represented by the Ministry of Interior, Ministry of Finance and Industry, Ministry of Justice, Ministry of Economy and Commerce, Islamic Affairs and Endowments, the U.A.E. Customs Council, the Secretariat General of Municipalities, the Chambers of Commerce and Industry, in addition to as observers, a large number of banks and the three main moneychangers as observers. The authorities have also strengthened the Anti-Money Laundering and Suspicious Cases Unit by increasing its number of members, financial resources and its technological capabilities. The U.A.E. FIU also became the first full member of the Egmont Group out of the GCC in January 2002, which is expected to facilitate information exchange among the group members which are all implementing AML legislation.13

39. The U.A.E. compliance level on AML was assessed by the Financial Action Task Force Mutual Evaluation Team. It concluded that the United Arab Emirates has put in place a comprehensive regime of anti-money laundering law and regulations. Moreover, the country has fully implemented all UN Security Council Resolutions in this area since 1999. Moreover, based on the responses to the AML/CFT questionnaire, the IMF has also assessed that the U.A.E. authorities have a well-developed and comprehensive AML/CFT system. The law is not only meant for licensed financial institutions, but also covers other financial, commercial, and economic establishments in the United Arab Emirates, while the list of predicate crimes covers all offenses referred to in international conventions to which the United Arab Emirates is a party.

1This chapter was written by Mangal Goswami (MED).
2The National Bank of Sharjah transformed itself into a full-fledged Islamic bank in July 2002. This is the third Islamic bank in the United Arab Emirates.
3According to the BIS guidance note on Credit Risk Management (July 1999), banks need to be mindful that the value of collateral may well be impaired by the same factors that have led to the diminished recoverability of the credit.
4Implementation of comprehensive risk management was part of the FSAP recommendation.
5All land in Abu Dhabi is government owned.
6Smaller banks are becoming more aggressive to gain market share, generating intense pressure on banks to make more efficient use of their capital.
7The banking sector is the only one in the United Arab Emirates subject to mandatory measures to increase the percentage of nationals in their workforce—albeit flexibly applied. The expected increase will be 4 percent a year.
8For example, Standard & Poor’s Report (July 2002) on Bank Industry Risk Analysis: United Arab Emirates stated that “lending concentrations in the personal and construction sectors accentuate banks’ risk profiles.”
9A large exposure is defined as lending of greater than 7 percent of a bank’s capital to a single customer (defined as an individual, company, or group of companies under common ownership).
10An active repo market facilitates increased market activity in the OTC markets where most debt is traded. Without such collateralized borrowing arrangements, trading and position taking would have to resort to more expensive uncollateralized bank credit lines.
11Owing to the United Arab Emirates’ relatively large foreign asset holdings, there has been no need to issue government debt. However, cities like Singapore and Hong Kong, despite generally running budget surpluses, governments are developing the local bond markets to diversify risk.
12The Emirates Insurance Association was established in 1988 after a decree passed by the MOEC, which is the regulatory and supervisory authority for insurance companies and pensions.
13Since 1995, a number of the FIUs began working together in an informal organization known as the Egmont Group to provide a forum for FIUs to improve support to their respective national anti-money laundering programs by systematizing the exchange of financial intelligence.

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