United Arab Emirates financial industry has approximately 50 banks operating, half of which consists of local financial institutions while the other half is comprised of foreign banks. There are also other financial institutions, for instance, monetary and financial intermediaries and insurance firms among others that together with the commercial bank make a robust financial industry.
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At the helm of the UAE’s financial industry, is the UAE Central Bank, which is a government financial supervisory and regulatory authority (the regulator). The Central Bank mandates are streamlined with the purpose of having a strong currency and standardization of financial policies (Trade Office 1).
Of interest to note is that, although Dubai is part of the UAE, it has a different autonomous regulatory system referred to as the Dubai International Financial Centre.
Government regulation on the financial industry in the UAE
The UAE government has put in the following legal measures to ensure that the financial industry is regulated and supervised.
The UAE Federal Law No. 10 of 1980
This the core legal regulatory tool enacted by the UAE government to regulate the financial industry. The law gives an elaborate understanding of the Central Bank, the monetary system, and the organization of banking in the UAE financial industry.
The Central Bank
The UAE Central Bank has the mandate of “directing the monetary, credit, and banking policies and overseeing the policies implementation in line with the state’s general policy to help the economy and stabilize the currency” (Trade Office 1).
In the process of directing and supervising monetary policies, the Central Bank is solely mandated to issue currency and, therefore, regulating money circulation in the economy. The Central Bank also buys and sells foreign currencies from the public at the rate it determines.
The Central Bank registers banks that meet the set requirement based on banking policies, laws and regulations. It regulates these banks and deregisters them when they operate beyond or violate the provided laws and regulations. Additionally, the Central Bank sets credit limits of the commercial banks operating in the United Arab Emirates.
Organization of banking
The law stipulates the functions of and gives definitions of financial institutions, which include commercial banks, investment banks, monetary and financial intermediaries among other financial institutions. For instance, a commercial bank gets its definition from its function of receiving funds from the public, while the law defines an investment bank as a bank that only takes deposits for a maturity period exceeding two years.
As mentioned earlier, the Central Bank is mandated to regulate, supervise, register and deregister both commercial and investment banks according to the provision of the UAE banking laws and regulations.
The law states that the UAE government, through the Central Bank, will provide and circulate currency in the economy. The main aim is to control the economic aspects such as inflation. The Central Bank has done well even getting global recognition.
The UAE Federal Law no. 6 of 1985
The government enacted this law to give a provision for financial establishments that use Islamic law, Sharia Laws. The commitment of the Sharia law should inclusively be outlined in the articles and memoranda of association of the financial institution under this category. The law regulates the said institutions with the ultimate benchmark being the UAE Federal Law no.10 of 1980. The provisions given include the guidelines for Islamic Banks and Islamic institutions.
These institutions are subject to the Central Bank licensing, supervision and inspection. Additionally, the cabinet has formed a higher Sharia authority to undertake more extreme supervision to ensure that only legitimate transactions, according to Sharia laws, are carried out.
Having met the regulatory condition set regarding Islamic banking, the banks carry out activities similar to those carried out by commercial banks in the UAE Federal Law no.10 of 1980.
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Islamic banking institution
These institutions are in the business of money lending together with other financial operations. They also carry out investments in movable assets in accordance with the Sharia laws.
The UAE Federal Law no. 18 of 1993
Embodied in this law are provisions on the day-to-day commercial activities, which include guidelines on how to conducting financial activities, and who has the legal capability of doing so. The law provides basic details, including the definition of banks among others.
Time to time circulars from the Board of governors of the UAE Central Bank
Apart from the above-mentioned set of laws, the UAE Central Bank provides circulars to financial institutions to give directives and regulations from time to time as needs arise. The Central Bank publishes circulars in the official government gazette and, therefore, avail them to all financial institutions for action.
Ministry of Economy and ESCA
The Ministry of Economy’s jurisdiction in financial regulation is in the insurance industry. The ministry issues operating licenses to qualified insurance companies. ESCA, on the other hand, regulates the two UAE security exchanges and commodities’ markets.
Dubai International Financial Center
This is a financial zone in the UAE with an autonomous financial regulatory structure, the Dubai Financial Services Authority. DFSA regulates a full range of financial institutions and services including, banking, insurance, security business among others operating in the DFIC zone. However, federal criminal laws apply within the zone.
Weakness of regulations
The regulatory system has driven the UAE financial industry for more than three decades. However, it has some weaknesses most of which are related to dynamisms in the industry. Some of these weaknesses are discussed as follows.
Openness to and restriction to foreign investors
Though there are reports of improvements on the openness and restrictions of foreign investment, the current circumstances are in favor of local investors. For instance, the number of foreign banks surpasses that of the local banks, and it is not prudent for the regulatory and supervisory systems to harm foreign investors.
Islamic banking regulations
Islamic banks have become an integral part of the UAE banking industry, given the predominance of the Islam religion in the region. However, the Central Bank does not have proper regulatory policies, especially on short-time liquidity provisions.
Real estate and the related risks
The real estate industry is highly dynamic, especially in the UAE. However, equivalent changes in the banking regulatory systems have not been realized. This has exposed the lenders, especially banks, to related risks.
Regulation in the insurance sector
The insurance sector is relatively new in the UAE financial Industry but with extremely high growth and dynamism. However, the set regulatory measures are not sufficient. The inadequacy of regulation for the sector hinders effectiveness and growth.
New regulations and their potential impacts on the financial industry
Given the current regulatory challenges in the UAE financial sectors, the Central Bank of the UAE should introduce new regulations to improve the sector. In this regard, the strategic objectives of these new regulations should ensure that the current regulatory system is revamped. As such, these new regulations should lead to a sound and robust financial sector in the UAE. Second, they should improve consumer protection and protect the sector from mismanagement. Third, they should encourage investments, including foreign investors and tap best practices noted in the global markets. Finally, these new regulations will foster the growth of the sector with prudence.
It is therefore necessary for the regulatory authority to assess the current practices and update its laws and regulation to match the international best practices while recognizing unique attributes of the UAE financial market and cultural practices. These new regulations will help in filling the gaps identified in the sector.
The proposed regulations
International regulation provisions
The UAE economy is expanding rapidly. Besides, the country has regional importance. However, the UAE banking practices have not fully accounted for international practices in the financial industry. Currently, there are internationally recognized best practices in the financial sector. However, the UAE has not been keen to prioritize such provisions. Hence, it is important to introduce new regulations to fill the current gaps on international banking practices. Such new regulations should focus on capital and liquidity alongside ownership structures to facilitate investment.
As the financial sector evolves and becomes more complex, there is always the need to formulate new regulations to protect consumers. Consumer protection remains one of the most important regulations, particularly for deposit-taking financial institutions. Hence, new regulations on consumer protection should focus on the following areas. First, financial institutions, specifically banks require adequate capital base. On this note, it is imperative for the UAE to review its current capital requirements in order to improve the sector by creating a more resilient industry. The capital requirement, for instance, should focus on a specific limit while providing new standards for leverage ratio. In this regard, a new definition of capital should be introduced to account for the paid-up capital, full disclosure and earnings. These regulations should be precise and strict to avoid violation.
New regulations for liquidity
The financial sector requires proper liquidity to ensure healthy, resilient sectors. In this case, regulations must focus on individual banks to ensure that they enhance efficiency as they seek for profits. The new regulation should focus on effective liquidity and related risk management policies. It would reduce stress associated with low liquidity while minimizing overall impacts on an institution if such risks are experienced (International Monetary Fund 28).
Thus, the UAE financial institutions will be required to have adequate liquid assets to cover short-term obligations and demonstrate that an institution has adequate liquid assets to handle short-term financial stress.
Moreover, such provisions should focus on protecting customers during liquidation.
Financial institutions face major risks and therefore should diversify their risk portfolio. In this regard, new regulations will focus on defining new limits of exposure specifically for large lenders because of negative consequences of default. The regulator should seek to introduce provisions that protect lenders against bad debts by introducing an upper limit of loans against deposits, for instance. The cap is meant to protect financial institutions from massive failures when recovery is not successful while maintaining their solvency position.
Connected parties or any single large borrowers are regarded as sources of business and threats to liquidity. Off-balance sheet provisions and arrangements should be considered as methods of spreading risks to limit massive exposure. For instance, financial institutions should not lend more than 80 percent of their capital to any government or 50 percent to a single borrower (Ahmed and Agrawalla 179-184).
New regulations for the mortgage lending
The UAE real estate industry has grown tremendously over the decade. However, the financial sector regulations have not been adjusted to reflect the new realities. Individual borrowers often face difficulties due to lack of transparency in transactions. In addition, banks require effective underwriting approaches to protect their business from losses.
Such regulations should account for the debt burden and provide a maximum limit based on the value of the property. Thus, financial institutions must be compelled to use best standards when evaluating abilities of borrowers to repay and determining the value of the property. The main aim of these regulations is to ensure that financial institutions act in accordance with the law, introduce best practices and streamline the industry while enhancing the relationship between the financial institutions and the real estate sector.
At the same time, the regulator would be able to monitor the mortgage and banking sectors to avoid risk buildup and possible bubble burst with widespread repercussions. Consumer protection may involve limiting the debt limit, particularly during economic slowdown.
Supervising finance companies
Islamic and conventional finance companies are not properly supervised. For instance, these companies may just file reports to the regulator. In this regard, new regulations should improve supervisory roles and conduct thorough audits of filed reports and books of the companies to ensure that there are no discrepancies. Such changes would ensure a robust sector with best practices. Increased supervision and scrutiny would result in transparency based on clearly defined structures. Prudent management will ensure that these companies have the required financial resources to run their operations and avoid exposing customers to unnecessary risks.
Regulations for the insurance sector
The insurance sector is not well developed in the UAE. As such, it is evolving, remains highly dynamic while presenting regulatory challenges. The UAE can borrow best practices in the insurance industry from other countries and adapt them to the local condition.
Feasibility of the new regulations based on local legal/political environment
It is expected that a wide consultation and review of the current regulatory environment would be conducted with major stakeholders to determine the appropriateness of these new regulations. Besides, the regulator would provide at least two years to allow financial institutions to review and decided how they will implement the new regulations. These regulations are adjusted to the local environments of the UAE market.
Financial institutions are expected to comply with the new regulations without resistance. Any failure to follow these new regulations would be carefully assessed by the regulator, and the institution in breach would be given an opportunity to correct the violation. However, financial institutions that continue to violate regulation would be fined heavily or have their licenses withdrawn and canceled altogether. For instance, financial institutions would have to meet the minimum capital requirements, curb excessive lending, or control products that are more leveraged to avoid penalties.
Legal or political environment is favorable for the new regulations. The Royal Decree would only be issued once all regulations have been reviewed and supported by the cabinet. Financial institutions and managers have legal and regulatory responsibilities to ensure that their business activities are conducted within all laws and regulations of the UAE as provided by the regulator and other government agencies. The regulator may issue notice or circular informing financial institutions of the new changes in the law and provide sufficient time for executives to implement them.
Recommendations, Suggestions and Conclusion
Global financial institutions currently face massive threats from hackers. As such, the regulator should introduce tough measures to curb cyber security risks posed to banks. At the same time, individual financial institutions should also take initiatives to protect their systems from online risks.
At the same time, new laws should be introduced to curb money laundering and protect the banking sector from handling dirty money. Such new regulations should also extend to counter terrorism measures. The regulator should not allow any financial institutions in the UAE to act as a channel for illegal activities. Only sound regulations can deter such practices.
The regulator should introduce laws that favor the growth of modern means of money transfer such as mobile phones. At the same time, foreign currency exchange business should be developed through prudent regulations.
The ownership structure of 51/49 ownership is restricting foreign investments. Besides, the tendency of the government to favor locals against foreigners could limit foreign investment. It is therefore necessary for the government to review these regulations with the aim of improving foreign investment.
Ahmed, Bashir and Vivek Agrawalla. Banking Regulation: United Arab Emirates. London: Law Business Research Ltd, 2013. Print.
Central Bank of the UAE. Financial Stability Report 2013. 2013. Web.
International Monetary Fund. Islamic Finance: Opportunities, Challenges, and Policy Options. 2015. Web.
Trade Office. Financial Sector. 2014. Web.