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Dubai: The UAE inter-bank rate (EIBOR) has risen sharply - in contrast to the Fed rate - reflecting tighter funding constraints in the market. In the context of rising funding costs, analysts expect banks to pass on funding costs to their customers through higher lending rates.
"We attribute this to the banks increasing loans in the first half of the year to the point of reaching a funding block. The cost of funding is set to rise with inter-bank and time deposits. Banks will have to manage their balance sheets more efficiently and pass higher funding costs onto lenders to avoid margin erosion," said Munir Shahin and Karthik Sank-aran, analysts with Merrill Lynch, said in a report on Sunday.
Bankers agree that lending rates in the country are yet to adjust to the prevailing cost of funds and will soon trace EIBOR. Some banks have already adjusted the rates of loans to some classes of customers.
"Lower income groups are charged higher rates as a risk premium. Rates are likely to go up across the board," said the retail banking head of a local bank.
"We expect banks to gradually pass on the higher costs aided by the strong demand. We estimate that 75 per cent to 85 per cent of loans are variable rate largely linked to EIBOR - so most of the cost should be automatically passed on to borrowers," they said.
Bankers say that part of the problem is due to the demand for funds being far in excess of its supply.
Banks are expected to start demanding wider spreads and/or a better credit from new borrowers and do not expect a serious fall in demand for loans.
The cost of borrowing would have to be raised substantially to make a dent in loan demand given current levels of investment spending and deep negative real rates.
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