A new bankruptcy law, issued in the UAE on 24 October, could encourage banks to increase lending to SMEs because it sets out a framework for insolvency proceedings and debt restructuring, says Fitch Ratings.
“We estimate that SME lending represents around 5% of total UAE bank loans, much of which is unsecured. The UAE’s existing insolvency law does not provide for the rehabilitation of distressed companies through creditor agreements.
“There are many recent examples of ‘skip’ cases, where SME owners have fled the UAE when they could not repay their bank loans because, as under domestic personal criminal law, expatriate borrowers can be jailed if they bounce a cheque or fall behind on their financial obligations,” Fitch analysts said.
Fitch said it had not reviewed the new law, but based on media reports and legal commentary, it thinks it will provide alternatives to liquidation and offer broader options for debt restructuring, which should benefit creditors.
The new bankruptcy law should help improve prospects for creditor rights and provide a more supportive environment for SMEs as they will be allowed to continue to operate while restructuring plans are being agreed. Media reports indicate that the new law should take effect in the coming months.
The introduction of formal bankruptcy laws might, in time, also help to stamp out the common practice among UAE banks of rolling over and restructuring impaired loans. The level of restructured loans does not affect the Issuer Default Ratings assigned to UAE banks because all of these are support-driven, but this forms part of Fitch’s assessment of asset quality, a key factor in Fitch’s analysis of a bank’s Viability Rating. The bulk of restructured exposures are corporate loans, but according to press reports, UAE banks have restructured Dh7bn ($2bn) of loans, representing 0.8% of total private-sector lending at end-August, to 1,700 SMEs since operating conditions became tougher from H1 2015.
A high level of restructured loans is not healthy for a banking system, and any steps taken to curb this practice would enhance transparency and make it easier to assess the true quality of lending in the UAE.
“In our view, the impaired loans/total loans ratio for UAE banks would rise from a reported 5.5% to around 10% if loans overdue for 90 days or more, but not considered impaired, and restructured loans were included in the reported impaired loans ratios.”
Restructured loans to Dubai World and Dubai Holdings, which are sizeable, are well known examples of loans reclassified to performing from impaired, which resulted in significant reductions in the reported impaired loans ratios of many UAE banks.
According to media reports, under the new law, a regulatory body, the Committee for Financial Restructuring, will be established, with members appointed by the Federal National Council. The Committee will oversee all bankruptcy proceedings and enforce rulings imposed by the courts. For example, it will be able to impose negotiated restructurings as long as a majority of creditors agree with restructuring terms.
The Committee will maintain all records of bankruptcy proceedings but, in Fitch’s view, court procedures can be more transparent. It may be that some transparency will be lost through the delegation of functions to the Committee. Investors and creditors benefit from transparency and it is still unclear to what extent this will be provided by application of the new law. The Committee’s operating style will become clear over time, but lack of transparency is a feature of UAE business negotiations generally.
Once passed, the law will apply to all companies established under the UAE’s commercial companies’ law. Companies established in the UAE’s free zones are not included because these areas have their own insolvency and bankruptcy laws. Private individuals unable to repay their debts will not be affected, and personal insolvency laws are being developed.