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1. A
GLOBAL / COUNTRY STUDY AND REPORT
ON
FINANCIAL MARKET OVERVIEW OF UAE
Submitted to
Gujarat Technological University
UNDER THE GUIDANCE OF
PROF. DEEPAK SANGHAVI
Submitted by :
Enrollment
Name of Student
No.
117070592010 Patel Viral R.
117070592013 Satoniya Ramji J
117070592024 RasadiyaVasant.H
117070592042 Kadivar Ravi I.(Leader)
117070592056 BagadiyaTarun R.
117070592058 DharajiyaMukesh G.
C.U.SHAH COLLEGE OF ENGG.&TECH.
(DEPARTMENT OF MBA)
WADHVAN CITY

2. INTRODUCTION OF UAE
Dubai
Dubai, the second largest of the seven emirates, is ruled by the Al Maktoum family. It
occupies an area of approximately 3,900 kilometres, which includes a small enclave
called Hatta, situated close to Oman, amongst the Hajar Mountains. Dubai, the capital
city, is located along the creek, a natural harbour, which traditionally provided the basis
of the trading industry. Pearling and fishing were the main sources of income for the
people of Dubai. Under the wise leadership of its rulers, Dubai's focus on trade and
industry transformed it into the leading trading port along the southern Gulf. His
Highness Sheikh Maktoum bin Rashid Al Maktoum is the current ruler of Dubai.
Sharjah
Sharjah, which shares its southern border with Dubai, is ruled by the Al Qasimi family.
It is approximately 2,600 square kilometres and is the only emirate to have coastlines on
both the Arabian Gulf and the Gulf of Oman. In the nineteenth century the town of
Sharjah was the leading port in the lower Gulf. Produce from the interior of Oman, India
and Persia arrived there. Sharjah's salt mines meant that salt constituted an important
part of its export business, along with pearls. In the 1930s when the pearling industry
declined and trade decreased due to the creek silting up, Imperial Airways' flying boats
set up a staging post for flights en route to India, which benefited the residents of
Sharjah. Today, under the leadership of Sheikh Sultan bin Mohammed Al Qasimi,
Sharjah is the cultural and educational centre of the UAE and takes pride in preserving
the country's cultural heritage as well as promoting Arab culture and traditions.
Ajman
Ajman is the smallest emirate, comprising only 260 square kilometres. It is ruled by the
Al Nuami family. Surrounded mostly by the emirate of Sharjah, Ajman also possesses
the small enclaves of Manama and Musfut in the Hajar Mountains. Along the creek
dhow building was the specialised trade. Fishing and date-trees provided the local
population with their primary means of sustenance. Ajman benefited greatly from the
union of the emirates, a fact that is reflected today in their stately buildings and
infrastructure. Sheikh Humaid bin Rashid Al Nuami has been the ruler since 1981.

3. Qaiwain
Umm Al Qaiwain is ruled by the Al Mualla family. It is the second smallest emirate,
with a total area of around 770 square kilometres. Positioned between the emirates of
Sharjah and Ajman to the south and Ras Al Khaimah to the north, Umm Al Qaiwain has
the smallest population. Fishing is the local population's primary means of income. Date
farming also plays a significant role in the economy. After the union of the emirates in
1971 Umm Al Qaiwain developed into a modern state, and continues to progress under
its present ruler, Sheikh Rashid bin Ahmed Al Mualla.
Ras Al Khaimah
Ras Al Khaimah, the most northerly emirate, is ruled by another branch of the Al Qasimi
family. It covers an area of 1,700 square kilometres. Thanks to the run-off water from the
Hajar Mountains, Ras Al Khaimah has a unique abundance of flora, so it is no surprise
that agriculture is important to the local economy. The emirate also benefits from its
stone quarries, and fishing, which is plentiful in the rich waters of the Gulf. The city of
Ras Al Khaimah, situated on an inlet, has a rich history. It was renowned for its
prosperous port and for its exquisite pearls, which were famous as being the whitest and
roundest available anywhere. Ras Al Khaimah's current ruler is Sheikh Saqr bin
Mohammed Al Qasimi.
Fujairah
The only emirate without a coastline on the Arabian Gulf is Fujairah, which is ruled by
the Al Sharqi family. Situated along the coast of the Gulf of Oman, Fujairah covers
about 1,300 square kilometres. Unlike other emirates, where the desert forms a large part
of the terrain, mountains and plains are its predominant features. Fujairah's economy is
based on fishing and agriculture. Like Ras Al Khaimah, the land in Fujairah is irrigated
by rainwater from the Hajar Mountains, making it ideal for farming. Sheikh Hamad bin
Mohammed Al Sharqi is the present ruler.

4. HISTORY OF FINANCIAL MARKET IN UAE
The UAE’s relatively open borders and economy have won praise from advocates
of expandedfreedoms in the Middle East while producing financial excesses, social
ills such as human trafficking, as well as opportunity for both illicit and legitimate
Iranian businesses to operate there. Moreover, the social and economic freedoms
have not translated into significant political opening; the UAE government remains
under the control of a small circle of leaders, even as it allows informal citizen
participation and traditional consensus-building.
Members of the elite (the ruling families of the seven emirates and clans allied
with them) also routinely obtain favored treatment in court cases and lucrative
business opportunities. However, economic wealthcoupled with some government
moves against political activists—have enabled the UAE to avoid widescale
popular unrest that have erupted elsewhere in the Middle East since early 2011.
Political reform has been limited, both before and since the Arab uprisings began
in the region. Lacking popular pressure for elections, the UAE long refrained from
following other Gulf states’ institution of electoral processes. It altered that
position in December 2006 when it instituted a selection process for half the
membership of its consultative body, the Federal National Council (FNC). Possibly
to try to ward off the unrest sweeping the region, the government significantly
expanded the electorate for the September 24, 2011, FNC election process.
However, turnout was only about 25%, suggesting that the clamor for democracy
in UAE remains limited or that the citizenry perceived the election as unlikely to
produce change.
Government has not announced a major expansion of the FNC’s powers, which
many intellectuals and activists seek. On foreign policy issues, the UAE—along
with fellow Gulf state Qatar—has become increasingly and uncharacteristically
assertive in recent years. This assertiveness is probably a product of the UAE’s
ample financial resources and its drive to promote regional stability. The UAE has
joined the United States and U.S. allies in backing and then implementing most
international sanctions against Iran, causing friction with its powerful northern
neighbor.

5. In 2011, it sent police to help the beleaguered government of fellow Gulf
Cooperation Council (GCC) state Bahrain, supported operations against Muammar
Qadhafi of Libya, joined a successful GCC diplomatic effort to broker a political
solution to the unrest in Yemen, backed the Arab League suspension of Syria, and
appointed an Ambassador to NATO. It gives large amounts of international
humanitarian and development aid, for example for relief efforts in Somalia. The
UAE’s growing assertiveness on foreign policy marks its emergence from the
2008-2010 global financial crisis and recession. That downturn hit Dubai emirate
particularly hard and called into question its strategy of rapid, investment-fueled
development, especially of luxury projects.
For the Obama Administration and many in Congress, there were early concerns
about the UAE oversight and management of a complex and technically advanced
initiative such as a nuclear power program. This was underscored by
dissatisfaction among some Members of Congress with a U.S.-UAE civilian
nuclear cooperation agreement. The agreement was signed on May 21, 2009,
submitted to Congress that day, and entered into force on December 17, 2009.
However, concerns about potential leakage of U.S. and other advanced
technologies through the UAE to Iran, in particular, have been largely alleviated by
the UAE’s development of strict controls, capable management, and cooperation
with international oversight of its nuclear program.
GOVERNMENT PROCUREMENT
The UAE is not a signatory to the WTO Agreement on Government
Procurement. The UAE grants a 10 percent price preference for local firms in
government procurement. The UAE requires companies to register with the
government before they can participate in government procurements, but to be
eligible for registration, a company must have at least 51 percent UAE
ownership.
This requirement does not apply to major projects or defense contracts where there
is no local company able to provide the goods or services required. The UAE’s
offset program requires defense contractors which are awarded contracts valued at
more than $10 million to establish a commercially viable joint venture with local
business partners that is projected to yield profits equivalent to 60 percent of the
contract value within a specified period (usually 7 years).

6. To date, more than 40 such joint venture projects have been launched, including,
inter alia, a hospital, an imaging and geological information facility, a leasing
company, a cooling system manufacturing company, an aquiculture enterprise, a
foreign language training center in Abu Dhabi, and a firefighting equipment
production facility. Two of the largest offset ventures are an international gas
pipeline project (Dolphin) and the Oasis International Leasing Company, a British
Aerospace offsets venture.
There are also reports, as well as anecdotal evidence, indicating that defense
contractors can sometimes satisfy their offset obligations through an up-front,
lump-sum payment directly to the UAE Offsets Group
SERVICES BARRIERS
Insurance
Foreign insurance companies may operate only as branches in the UAE. In 1989,
the UAE government banned additional foreign insurance companies from opening
due to the perception that the market was saturated. In 2004, the Ministry of
Economy and Planning announced that it would open the UAE insurance sector to
new foreign insurance companies. In 2006, the President of the UAE issued
Federal Law No. 16 of 2006, amending some provisions of Federal Law No. 9 of
1984 on insurance companies and agents.
An insurance company established in the UAE must be a public joint stock
company. At least 75 percent of the capital in such companies must be owned by
UAE nationals, while the remaining 25 percent may be owned by a foreigner. In
the Emirate of Abu Dhabi, the offering of insurance coverage for construction
projects and companies under the Abu Dhabi National Oil Company (ADNOC) is
restricted to Abu Dhabi-based insurance companies.

7. Banking
The UAE Central Bank does not grant new licenses to foreign banks. However, the
Central Bank has granted licenses to some GCC banks. In 2008, the Central Bank
allowed several foreign banks already operating in the UAE to set up new
branches. According to Central Bank statistics, there were no new foreign bank
branches in 2009, but local banks opened 43 new branches, six new electronic
banking services units, and nine new pay offices.
In 2006, the UAE made important changes to the Commercial Agencies Law
(Agencies Law), which previously had required that all commercial agents be
either UAE nationals or companies wholly owned by UAE nationals, and had
restricted the number of agents a foreign principal could appoint as well as the
terms of the agency relationship.
The 2006 amendments:
(1) limited an agency contract to a fixed time period;
(2) required mutual consent to renew an agency agreement;
(3) allowed either party to file fordamages;
(4) eliminated the Ministry of Economy’s Trade Agencies Committee,
(5) which handled agency disputes; and
(6) allowed the import of ―liberalized goods‖ without the agent's approval.
Nonetheless, foreign companies still find it difficult to dismiss a non-performing
local agent without protracted litigation in the local courts, and experience has
shown that the authorities’ application of the new law has not always eased the
way for the termination of agents as expected. It also remains difficult, if not
impossible, to sell in UAE markets without a local agent.

8. FINANCIAL ECONOMY
In the 40 years since oil was first discovered and exported, the UAE has
beentransformed from a region of small sheikhdoms subsisting on pearling,
fishing, herding, and agriculture to a modern state with a high per capita income
and substantial trade surplus. The largest and wealthiest emirate is Abu Dhabi,
which is the principal petroleum producer and financier of the federation. Dubai,
the second largest emirate, thrives on wealth derived from a services-based
economy (tourism, construction, telecommunications, media, real estate, and
financial services). Together, the two emirates provide more than 80 percent of the
UAE’s income, while the northern emirates remain relatively undeveloped. Key
economic policy decisions are made at the emirate level with little coordination
among the seven emirates.
The UAE economy remains heavily dependent on oil and natural gas; the revenue
from oil exports in particular enables the government to finance infrastructure for
the non-oil economy. Economists forecast that in 2007–8 the economy is expected
to grow at an average annual rate of approximately 7 percent. Investment in
manufacturing and energy-intensive sectors such as petrochemicals and metals will
drive the non-oil sector, aided by exports made more competitive by the weakness
of the U.S. dollar.
The services sector, primarily tourism, is expected to continue to gain strength who
succeeded his father as president of the UAE in November 2004, is expected to
continue the relatively liberal economic policies of his predecessor: privatization of
some government assets; provision of incentives for foreign and domestic private
investment; avoidance of a national income or sales tax; and curtailment of both
money laundering and the use of the banking system to foster terrorist activities.
In April 2007, vice president and prime minister Sheikh Mohammed ibn Rashid Al
Maktumdelivered a major policy speech in which he outlined a comprehensive
three-year UAE Government Strategy, the core of which is sustainable economic
development. He placed heavy emphasis on upgrading the UAE’s education
system and making emiratisation a national priority.
Gross Domestic Product (GDP)

9. In 2004 the UAE’s GDP was US$105.2 billion. Economists calculate the 2005 real
GDP growth rate at 8.2 percent, with GDP exceeding US$132 billion. Per capita
GDP for 2005 was high compared with other Arab countries—almost US$29,000.
For theperiod 2006–7, real GDP growth is expected to remain strong, driven not
only by high oil earnings but also by sustained expansion in the non-oil sectors.
Real GDP is forecast to grow 8.9percent in 2006, with GDP exceeding US$162
billion, and to grow 7 percent in 2007.
Government Budget
The UAE federal budget accounts for approximately 25 percent of total federation
fiscal transactions; the remainder consists of the fiscal operations of the
individualemirates, and the combined expenditures constitute the consolidated
accounts. Oil revenue accounts for more than 60 percent of all income, and
consequently the volatility of the oil market has created significant fluctuations in
government income. Economists calculate that based on rising global oil prices
offset by significant public-sector pay increases and higher capital expenditures,
the 2004 budget ran a relatively small deficit of US$233 million (0.2 percent of
gross domestic product (GDP), as compared with deficits in 2002 and 2003 that
were 11 percent and 4.5 percent of GDP, respectively).
According to the UAE government, in 2005 a 20-yearperiod of fiscal deficits came
to a close when the government budget had a surplus of approximately US$10.4
billion (almost 8 percent of GDP), as revenues increased by 70 percent,and
expenditures, fueled by large increases in public-sector wages, rose by 27 percent.
In 2006, as a result of rising oil prices and increased production, the budget is
expected to generate an estimated US$20 billion surplus (approximately 12.4
percent of GDP). The surplus is expected to decline to 8.4 percent and 7.4 percent
of GDP in 2007 and 2008, respectively, as a result of expenditure growth
outpacing revenue growth.

10. However, economists caution that UAEfiscal data inaccurately reflect the actual
strength of the government’s finances, for two reasons. First, a significant portion
of Abu Dhabi’s oil earnings are not reported as current revenue, but rather are paid
directly into reserve accounts. Second, the data do not reflect the substantial
income generated by the emirates from overseas investments (estimated in 2006 to
be more than US$600 billion), most of which are held by Abu Dhabi. Both of these
revenue streams fund part of the federal deficit; were they to be factored into the
budget equation, the government budget would actually show no deficit in 2004
and a higher surplus in ensuing years.
Banking and Finance
The UAE Central Bank was established in 1980 to direct monetary,credit, and
banking policy. It maintains the UAE government’s reserves of gold and foreign
currencies, acts as the bank for banks operating in the UAE, and serves as the
state’s financial agent at international financial institutions. In response to pressure
from the World Trade Organization to open the banking sector to more foreign
competition, in late 2004 the UAE Central Bank stated that it would consider
allowing new foreign banks to establish themselves in the UAE for the first time in
20 years. As of late 2006, however, no new licenses had been issued.
Relative to its population and gross domestic product, the UAE has an unusually
highnumber of banks—21 local, 25 foreign, 2 specialized, and approximately 50
representative offices of other foreign banks. The top six commercial banks control
70 percent of total bankingassets and reported very strong profit growth from 2002
through 2005.
Although the sharp drop in prices on the UAE stock markets negatively affected
bank profits, in 2006 the sector remained profitable overall, primarily as a result of
the growth of conventional retail and commercial banking (personal loans, credit
cards, and residential mortgages).
The Dubai International Financial Center (DIFC) opened officially in September
2004. The DIFC is a self-regulating financial free zone, operated independently of

11. the UAE Central Bank and including more than a dozen international financial
institutions. In September 2005, it established the Dubai International Financial
Exchange, which provides markets for equities, bonds, funds, sharia-compliant
products, and derivatives and is fully open to foreign investment.
The Dubai Financial Market (DFM) and the Abu Dhabi Securities Market opened
in March 2000and have been linked electronically since 2004. Both stock markets
surged in value and liquidity from 2002 until November 2005, when a steep
decline began that did not reverse until early 2007.The sharp downturn in stock
prices in 2006 was Gulf-wide and is attributed to the overvaluation of stocks and
heavy bank borrowing to finance initial public offerings.
Islamic banking has assumed a more prominent role in the UAE in recent years,
and most conventional banks are opening or expanding Islamic banking
departments; sharia-compliantconsumer and investment products also are being
introduced. Government agencies and majority state-owned companies are using
Islamic bonds—sukuk—to finance development and acquisitions.
Terrorism is financed using the banking system in two primary ways—through
moneylaundering and through financial transactions in the hawalasystem, which is
a traditional alternative remittance system that operates outside the control of the
conventional banking sector. After 9/11 a link was drawn between branches of
Citibank in the UAE and the UnitedStates and financing of the terrorist attacks.
In response, the UAE Central Bank has frozen theassets of organizations
suspected of having ties to al Qaeda or to the former Taliban regime in
Afghanistan and educates financial institutions on countering money laundering
and terrorist financing Legislation was enacted in 2002
Tightening reporting requirements for financial transactions and increasing
penalties for money laundering. Hawalaoperators, thought to be the conduit for
much of the funding earmarked for terrorist activities, are now licensed in the UAE
and required to report suspicious transactions to the UAE government. As of early
2007, the UAE Central Bank had registered 201 hawaladealers.
MACROECONOMIC AND FINANCIAL SECTOR DEVELOPMENTS

12. At the time of the 2001 FSAP, the U.A.E. financial sector and its
regulationand supervision were developing unevenly. The financial sector was
dominated by strongand well-supervised banks, which posed minimal near-term
systemic risk. The insurance andsecurities industries were found vulnerable, less
developed, and in need of strengthenedsupervision. The legal and judicial
infrastructure for the financial system was also in need ofreform.
The results of the detailed assessments of banking supervision (BCP),
transparencyof monetary and financial policies, and payments systems were also
mixed. There was a high degree of observance of the BCP, although several
important changes in the banking law were recommended by the FSAP team.
Transparency practices in conducting monetary policy and banking supervision
were well observed, while some practices were found in need of improvement. The
payment systems, although simple and far from state-of-the-art, were found to be
well managed and systemic risks well contained.
Since the 2001 FSAP, the authorities have made progress in
implementingfinancial sector reforms. In the banking sector, the Central Bank of
the United ArabEmirates (CBU) is in the third year of its risk-based supervisory
program, which involvessupervisors examining a bank’s credit, operational, and
market risks, and how the bankimplements policies to address them.
The CBU has engaged, since late 2004, in intensepreparations for the
implementation of Basel II. In the area of AML/CFT, several key lawshave been
approved including Federal Law No. 4 of 2002 on anti-money laundering,
FederalLaw No. 1 of 2004, which addresses combating the financing of terrorism,
and Federal LawNo. 8 of 2004, which addresses AML/CFT in the DIFC.
Also the authorities have establishedand staffed the Emirates Securities and
Commodities Authority (ESCA), which has become fully operational in overseeing
the securities markets. They have also established the legal and regulatory
framework governing the DIFC and the institutions and markets it supervises.
Finally, the payment system has been fully automated and computerized and an
RTGS system for large value payments has been functioning smoothly since 2002.
Macroeconomic Developments

13. An outward-oriented development strategy and prudent financial policies
haveresulted in impressive economic growth over the past few years and led to
a large accumulation of external financial assets. This success had been
underpinned by AbuDhabi’s skillful management of the country’s oil wealth and
Dubai’s strong push foreconomic diversification. Oil export revenues have pushed
the current account surplus toabout US$36 billion in 2006, equivalent to 22 percent
of GDP, the fiscal surplus to almost29 percent of GDP and gross official reserves
to US$28 billion (Table 1).2 The dirham was
Financial Sector Developments
The monetary aggregates and credit to the private sector continued to grow
ata double-digit pace in 2006. Given the pegged exchangerate, domestic interest
ratesclosely tracked the increase inU.S. dollar rates, but werenegative in real terms
given theacceleration in inflation. Partlyas result, growth of credit to theprivate
sector was 37 percentfor the year as a whole, downfrom 44.5 percent in
2005.Money growth showed asimilar pattern, decelerating to23.2 percent in 2006
from 33.8 percent in 2005
After an extended run-up, stock markets in the U.A.E., as in the rest of the
GCC generally, suffered a sharp correction starting in late 2005. While
markets andcorporate earnings initially rose in line with oil prices, from 2005
onwards, price gainsseemed to be spurred by unrealistic expectations of continued
earnings growth and easycredit conditions. Volatility was exacerbated by
investors’ liquidation of existing positions tofund speculative subscriptions to
initial public offerings (IPOs).
In 2002, the Emirate of Dubai announced the creation of the Dubai
International Financial Centre (DIFC) as a regional financial hub. In June
2004, theestablished the DIFC as a Federal Financial Free Zone, a 110-acre
complex withinDubai, as well as the Dubai Financial Services Authority (DFSA),
responsible for regulationand supervision of entities licensed to carry out banking,
securities market and reinsuranceactivity in the DIFC.
Although their exact size is not published, the external assets of the Abu
DhabiInvestment Authority (ADIA), are believed to be substantially larger
than CBU holdings. ADIA is owned by the Government of Abu Dhabi, and is

14. charged with managingthe emirate’s financial assets. While ADIA’s investments
are mainly outside the country, it isthe largest shareholder in National Bank of Abu
Dhabi (73 percent) and Abu DhabiCommercial Bank (65 percent), the two largest
banks, and also has shares in two smallerbanks.
FINANCIAL SYSTEM
Banking System
The U.A.E. banking sector is well developed and gaining in sophistication.
Thesector is the second largest among GCC countries after Saudi Arabia’s, with
assets equivalent to 130 percent of GDP in 2005. The banking sector is not highly
concentrated, with the five largest banks accounting for about 44 percent of system
assets. Although there are 25 foreign banks compared with 21 local banks, the
share of foreign banks in total banking assets declined from 25 percent in 2001 to
22 percent in 2006.
The number of banks has been quite stable for a number of years, because of a ban
on new foreign entrants and the government’s desire to avoid mergers. This policy
appears to be changing with the announcement in April 2007 of the planned
merger of two Dubai banks, which when completed would result in the largest
bank in the U.A.E. (and among the largest in the GCC).
Welcome steps are being taken to lift the moratorium (since 1981) on the
licensing of new foreign banks, but further steps in this direction would be
appropriate.The CBU authorized three new GCC banks (from Qatar, Kuwait, and
Saudi Arabia) in 2006,with the understanding that U.A.E. banks will be given
reciprocal treatment. Foreign banksare present as branches and each can have a
maximum of eight branches in the country.Moreover, they are subject to a 20
percent tax on profits, which is not applied to domestic
The bank ownership structure reflects the prevalent role of the state and
ofgovernment related entities, complemented by an active private sector. State
ownedinstitutions are run on a purely commercial basis and listed on local stock
markets, and theyaccount for 63 percent of total bank assets. Among the five

15. largest domestic banks, only onehas no government or ruling family ownership.
Large family-owned conglomerates are alsoshareholders of banks.
The Islamic banking sector is developing rapidly alongside the
conventionalsystem. Islamic banks have increased their share of total bank assets,
from 8.8 percent atend-2002 to 12.6 percent at end-2006 (14.2 percent of deposits).
Dubai hosts the oldestIslamic bank, while two conventional banks became Islamic
banks in 2004. There are alsoseveral Islamic finance companies, and a number of
commercial banks have opened Islamicwindows.
As their activities are rapidly growing, Islamic banks are exposed to risks similarto
those of conventional banks. However, Islamic banks do not benefit from the
availabilityof hedging instruments, money market instruments, and funding
facilities at longermaturities. Islamic banks also tend to be smaller and less
diversified than conventional banks.
The impact of the sharp correction in the equity market on the banking sector
has been limited. The strength of retail banking and credit growth, as well as
diversification(including outside the U.A.E. for some of the largest banks), have
mitigated the impact onbank profits of the sharp decline in equity markets and the
drying up of IPO operations, onwhich the banks had made substantial fees and
margin interest income in 2005.
The sheer size of real estate development, notably in Dubai, raises concerns
about the exposure of the financial sector but the exposure including to
constructionand mortgage loans is estimated conservatively at 15 percent of
loans, and is concentrated in some institutions and geographical areas.
The loan portfolio of financecompanies is also growing rapidly. In terms of
residential property, several analysts haveindicated that a large number of
residential units is to come to the market during 2007–2008,and have expressed
some concerns regarding speculative activity in the market.
Anecdotalevidence suggests that excess demand for commercial property and
retail space will continueover the medium term. It is notable that a significant
number of projects are undertaken bylarge property developers owned by the state
or ruling families.

16. Some financial institutions appear to be vulnerable to risks emerging in the
small but rapidly developing mortgage market. The U.A.E. property market is
significantly less bank dependent than other regions, and bank mortgages are only
6.6 percent of bank loans (Table 3), since both locals and expatriates purchase
property largely with other assets.7 Mortgage loans were initially developed by
Islamic finance companies, and are provided at floating rates.
Most lenders operate with loan-to-value ratios(LTVs) of 70 to 80 percent, but with
increased competition and the need to sell some units, a relaxation of lending
standards has also been observed, with LTVs approaching 90 or 100 percent in
some segments.8 Demand for credit is also being fueled by high population growth
and low interest rates both in real terms and compared to rental yieldscontributing
in turn to speculative behavior and increasing asset prices.
Beyond traditional mortgages, household real estate exposure is deemed to be
higher than the single stock ofmortgage loans, as the final use of personal loans for
business purposes is not well apprehended in the data.
Staff recommends enhancing the prudential regulation and monitoring of
banks’ exposure to the real estate sector. Although the CBU has undertaken to
revise its classification of the exposure of banks to the real estate sector, significant
uncertainties remain on the extent of real estate exposure.10 More appropriate
prudential oversight ofbanks’ exposure to real estate is also under consideration by
the CBU. The current CBU regulation limits a bank’s real estate exposure to 20
percent of its customer deposits.
However, this is not adequately linked to the expansion of the market and the
evolvingfunding structure of commercial banks. Staff recommends continued
improvements in the sectoral classification of loans, enhanced oversight of
nonbank financial institutions involved in real estate financing, and the
introduction of more adequate prudential regulations, such as maximum LTV and
debt-to-income ratios.
Over the past three years, U.A.E. banks have been steadily increasing their
borrowing from abroad (Figure 1). In addition to bank loans, several U.A.E.
banks havebegun to issue Euro Medium-Term Notes (EMTNs).

17. Since the domestic banks’ favorable ratings have allowed them to borrow at
relatively low rates, EMTNs have generally been issued with five-year tenor and at
an interest rate in the range of 30 to 50 basis points over LIBOR.
Although potentially increasing their exposure to exchange rate risk, these
instruments have allowed banks to better match the duration of their liabilities and
assets, thereby reducing their sensitivity to interest rate risk. The banking sector
remains profitable. After exceptional gains in brokerage, fee, and trading income
in 2005, and with some institutions experiencing a slowdown in profit growth,
returns on asset and equity declined somewhat in 2006,
while still remaining at comfortable levels. Continued growth in retail banking
activities have contributed to alleviate the effects of the slowdown in noninterest
income while margins have narrowed in some market segments. However,
personnel expenses are on the rise because of the increased cost of living and the
need to attract highly qualified professionals.
Payment Systems
Under the Banking Law, the CBU operates and oversees the payment
system.promote banking and supervise over the effectiveness of the banking
system according to theprovisions of this Law.‖states that the Board ofDirectors of
the CBU shall ―establish clearing houses….‖ These two provisions, permit the
CBU to run a fully centralized accounting system, through which all interbank
payments are settled.
Licensed commercial bank are required to maintain three separate accounts
with the CBU. A dirham current account is used for settling the bank’s financial
transactions, while two additional accounts, one in dirham and another in U.S.
dollars, are used to hold the bank’s reserves at the CBU. Recently, banks and
moneychangers have alsobeen allowed to open euro and U.S. dollar current
accounts, benefiting from the new Fund Transfer System’s ability to handle
settlements in multiple currencies and to utilize cash deposits and withdrawals for
local trade settlements.
FTS is a Real-Time Gross Settlement (RTGS)system based on a secure intranet
network. It allows member banks to view their statementsin real time. All U.A.E
banks have been part of the new system since 2002. The laborintensive Check
Clearing System (CCS) is scheduled for a comprehensive upgradeduring 2007.

18. The authorities are aiming to introduce a new Image CCS that will allow for the
settlement of checking transactions within 2 to 4 hours, improving significantly on
the current paper-based system that clears in T+1. A SWITCH system continues to
be used to settle ATM transactions. A project is currently under way to create a
GCC-wide SWITCH network that would facilitate transactions between member
countries.
THE DUBAI INTERNATIONAL FINANCIAL CENTER (DIFC)
The level of banking activity in the DIFC is small compared with the
domesticmarket. As of January 2007, seven banks were authorized to accept
deposits or providecredit in the DIFC, and three of them were operational. In
addition, 20 firms regulated asbanks in other jurisdictions are authorized to provide
investment banking services.
As ofDecember 2006, DIFC banks held total assets of around $518 million, a tiny
fraction of theUS$200 billion in total U.A.E. banking assets. U.A.E. banks
establishing a presence theDIFC are required to obtain approval from the Central
Bank
DIFX has succeeded in attracting a sizeable number of listings and competes
effectively with other exchanges in the U.A.E. As of January 2007, the total
market capitalization of DIFX was about US$21 billion, 45 percent of which
originated from bondinstruments (including sukuk). Seven equity securities are
listed on the exchange (3 of which are ordinary shares) with a market capitalization
of about US$6.7 billion.
The Dubai International Financial Center
The Dubai International Financial Centre (DIFC) was established in 2004 as the
firstFederal Financial Free Zone in the U.A.E. Activities permitted within the
center include banking services, capital markets, asset management, reinsurance,
Islamic finance, ancillary services, and business processing operations. Under the
Free Zone legislation, financial institutions licensed to operate in a free zone may
conduct.
Business with residents and nonresidents but when conducting ―financial
bankingactivities,‖ they are prohibited from transacting in the U.A.E. Dirham and
from taking deposits (regardless of currency of denomination). DIFC is constituted
of three independent authorities under the Office of the President of the DIFC:

19. Dubai International Financial Centre Authority (DIFCA) is primarilyresponsible
for setting the center’s overall development strategy. It also acts as the registrar of
securities and companies. Its subsidiary, DIFC Investments is home to the Dubai
International Financial Exchange (DIFX) and Hawkamah, an institute dedicated to
the promotion of corporate governance in the region.
Dubai Financial Services Authority (DFSA) is the financial services regulatory
body of the DIFC. As an independent regulator, its activities include:
(i) rule-making and policy development;
(ii) (ii) licensing and registration;
(iii) supervision of DIFC participants; and
(iv) enforcement of legislation.
Dubai Judicial Authority (DJA) is an independent judicial system that deals
with civil and commercial matters arising from or within the DIFC. The legal
system, including property and contract law in the DIFC is based on common law.
The mission statement of the DIFC is to be ―a catalyst for regional economic
growth, development and diversification.‖ In pursuit of this goal, the founders have
attracted aninternational team of highly qualified professionals and established
rules and regulations based on industry best-practices. Moreover, the facilities have
been equipped with world-class infrastructure and state-of-the-art technology.
The establishment of DIFC has been well received at regional and international
levels. As of end-January 2007 it had attracted more than 330 companies that have
benefited from 0 percent taxation and no restrictions on the level of foreign
ownership. Close to half of the institutions registered by DIFC are financial and
ancillary service companies.
Twenty-three securities have been listed on DIFX, which has been growing
steadily and specializing in Islamic finance. Stress tests of the aggregate banking
system and of individual banks wereconducted based on data provided by the
authorities.
The focus was on credit risk, with particular attention to developments in the real
estate market. Interest and liquidity risk was also quantified. Foreign exchange risk
was also reviewed, although this risk has been limited by the commitment of the
authorities to the exchange-rate peg. Stress tests were conducted based on data for

20. end-September 2006 on the 46 U.A.E. commercial banks, and were based on the
current loan classification system for nonperforming loans.
19 Staff noted that the set of data available would need to be enhanced to
conduct a comprehensive assessment of risks in the banking system by including:
(i) household and corporate balance sheet data;
(ii) data on large exposures in the banking system; and
(iii) a moreprecise breakdown of personal loans and estimate of real estate
exposure.
Stress tests suggest that the banking system would be generally resilient to an
across the board and significant deterioration of asset quality. A situation of a
doublingof the current level of substandard, doubtful and loss loans would be
withstood relativelywell by banking sector capital, with overall capital adequacy
declining from 16.3 percent to11.5 percent Large banks and foreign banks would
be the most affected. Areplication of one of the tests performed in the initial FSAP
was also conducted to test howmany banks under extreme conditions would
exhaust their Tier 1 capital. Because of thehigher leverage of the banking system
and of some banks in particular, 11 of the21 locally incorporated banks instead of 6
in the initial FSAP stress tests would exhausttheir Tier 1 capital.
Overall, the banking system would be resilient to a deterioration of
creditquality caused by external shocks. Fluctuations in world oil prices have a
bearing on thebanking sector predominantly through banks’ liquidity, while their
effects on asset qualityare difficult to estimate because banks have little direct
credit exposure to the oil and gassector.
Nonetheless, a deterioration of loan quality which might result from external
factors(e.g., significant uncertainties created by turmoil in a neighboring country or
indirect effectsof strong international sanctions), affecting significantly the
financing of trade and relatedservices (transportation) in the U.A.E. was simulated.
The banking system would weather theshock relatively well (capital adequacy
would decline to 13.2 percent). Four locallyincorporated banks would see their
capital drop below the minimum required 10 percent.