A sudden tumble of interbank lending rates to multi-year lows in the UAE is narrowing the gap between UAE rates and those in major related markets, and the trend may have further to run, bankers say.

They cite several reasons, including the global move toward lower rates and loose liquidity in the UAE market. Either way, it appears to be good news for the UAE Central Bank, which has repeatedly urged banks to lower their quotes in recent years.

After moving sideways from last August to the start of July, the three-month Emirates interbank offered rate was fixed at 1.375 per cent on Monday. That was a tad higher than Saturday's 1.369 per cent, which was the lowest level since May 2004, but down from 1.526 per cent at the start of July.

The three-month U.S. dollar London interbank offered rate , at 0.447 per cent on Friday, has also been on a downward path since late June. Because the UAE dirham is pegged to the dollar, there is pressure for the rates to move in tandem.

But Libor has dropped only about 2 basis points this month, much more slowly than Eibor. And UAE interbank rates have been going in the opposite direction than those in neighbouring Saudi Arabia; the equivalent three-month Saudi rate, at 0.948 per cent on Monday, has been on the rise since last September. It is up about 17 bps so far this year and close to its highest level since April 2009. The Saudi riyal is also pegged to the dollar.

DOWNTREND

Global conditions are one factor behind the downtrend in the UAE. With countries such as Germany and France selling short-term debt at negative interest rates, and traders speculating the European Central Bank may begin full-fledged quantitative easing, it has become harder to justify high Eibor quotes.

More importantly, liquidity conditions in the UAE banking system are very loose and there appears to be no immediate prospect of a rise in funding demand large enough to change this.

"The market is very liquid at the moment and there is quite a big differential between Eibor and, say Libor and even Saibor, so the gap has some room to narrow in good liquidity conditions," said Liz Martins, a senior regional economist at HSBC.

An Abu Dhabi-based treasury official at a commercial bank said: "For the last two months, there has hardly been any interbank activity because the banks have plenty of liquidity.

"This has affected the rates and I expect the trend to continue for some time, depending on what happens globally, with a gradual decline in rates going forward."

Deposit growth in the UAE banking system has been outpacing lending growth for this year as a whole. Although deposits fell 1.2 per cent month-on-month to Dh1.13 trillion ($ 307.7 billion) in May, the second month in a row of falls according to the latest central bank data, it is not clear that a downtrend has started.

A range of evidence, including a rise in foreign investment in Dubai's real estate market, suggests the emirate continues to attract inflows of money. Any further turmoil in Western markets may prompt local people to bring money back to the UAE, where banks are mostly better capitalised than they are in the West.

Meanwhile, lending growth in the UAE remains slow, partly because of sluggish demand from the real estate sector, which still faces excess supply left over from the 2008-2010 property crash. Total loans in the UAE grew a mere 2.5 per cent from a year earlier in May.

Lending growth is the main difference between the UAE and the booming Saudi banking system. Bank lending growth to the Saudi private sector hit 13 per cent on an annual basis in May.

"This move in Saibor reflects the high economic activity in Saudi - with all these projects attracting business, Saudi is becoming like a big workshop," said Abdulwahid al-Matar, head of trading at Saudi Hollandi Bank.

"We are going to see more demand from banks for client deposits to cover their ratios."