High levels of non-performing loans (NPLs) in many Middle East markets are acting as a deadweight on the region’s banks – tying up excess regulatory capital and denting credit ratings and returns. Why are NPLs levels in the region so high and why has the problem been so difficult to resolve?

Earlier in the year, I was invited by the publishers of CDR Essential Intelligence to share what I had learned on the frontline of NPL tracing and recovery in the Middle East. Drafting this chapter offered a great opportunity to reflect on how NPLs have become such a burning issue in the region, and how to put lending and debt recovery on a more sustainable footing.

So, what are NPLs and why are they so critical to financial stability? A loan stops performing when the repayments cease. The gradations stretch from a few missed installments but still some possibility of repayment, through to full default and write-off. 

Banks have to put money aside to cover these impaired loans. This ‘provisioning’ reduces the value of the assets on their balance sheet, with the knock-on impacts of higher regulatory capital demands and lower return on equity. High NPL and provisioning levels can also erode returns by reducing the amount of liquidity available to lend to and invest in viable growth businesses. 

Systemic instability 

If NPL rates rise significantly, banks could soon find themselves on a supervisory at-risk list. This can deter investment. If rates rise across the financial sector, central banks may be forced to intervene to save troubled institutions and prevent supplies of credit drying up. 

Oil price dependency 

NPLs are common in all markets and the Middle East is no exception. Defaults tend to rise when the twin jolts of high interest rates and falling income in an economic downturn make debts harder to pay off. 

What marks out the Middle East is its heightened susceptibility to fluctuating oil and gas prices. If prices plummet – as they did during the COVID-19 pandemic, for instance – the flow of money into and through Middle East economies dips and NPL levels begin to climb.

Loose lending

In some markets, NPL levels have been exacerbated by loose lending practices. Particular concerns center on the United Arab Emirates (UAE) – NPL rates reached 7.6% in 2019, before falling back to an improved, but still troubling 5.6% in Q3 2023. By way of comparison, the UK’s NPL rate is around 1%. 

Unlike the Gulf’s other economic giant, Saudi Arabia, where credit is governed by Sharia law and NPL rates are low (1.8%), the UAE permits a variety of non-Sharia interest charging facilities. From an NPL perspective, some of the UAE’s biggest problems stem from ‘named lending’. Rather than carrying out a proper assessment of the credit risks, money is lent on the basis of a personal guarantee from shareholders and/or directors of the business. The problem is that these guarantees may be worthless, especially if the business runs into trouble and the finances of the guarantors suffer as a result. 

Some borrowers or guarantors may have offered property or other collateral to back the loan. However, if calls are made on these assets, protracted enforcement proceedings allow plenty of time for transfer and/or concealment of ownership – dissipation – across extended networks of family and friends. 

Recovery rates are further hampered by lending to a wide range of expatriate business owners, who may have long since departed to their home countries.

Patchy oversight and enforcement 

Regulators in the UAE and elsewhere in the Middle East have sought to tighten up regulation in line with international best practice. However, application and enforcement of the rules remain patchy and inconsistent. Instances include the UAE’s categorization of loans at risk that runs from ‘watchlist’ through to ‘sub-standard’, ‘doubtful’ and ‘loss’. The problem is that the guidelines have been interpreted and implemented in wholly different ways from bank to bank, with the results leading to marked variations in the effectiveness of their provisioning and handling of NPLs.

Moreover, some new regulations have simply muddied the waters or led to unintended consequences. Instances include a new UAE ruling that requires banks to ensure that the value of a guarantee is in line with the borrower’s financial resources. That sounds sensible in principle. However, if the bank fails to set the guarantee at an appropriate level, they are barred from pursuing debt recovery in local courts. Wrangling over what is an appropriate guarantee has added to the legal minefield. 

International enforcement

What about pursuing debtors who have left the country? Encouragingly, a bi-lateral treaty between India and the UAE allows for reciprocal enforcement of judgements obtained by either country in the other. However, the UAE has not signed up to the United Nations Commission on International Trade Law (UNCRITAL), which allows for cross-border enforcement in signatory markets. Notably, Saudi Arabia is a UNCRITAL signatory.

Boosting your chances of recovery

So, is recovery a realistic possibility? Despite all the challenges, it is. From innovative cross-border legal strategies, to the use of forensic accounting to uncover concealed assets, we have seen first-hand how partnership between lawyers, investigators and third-party funders has taken the effectiveness of debt recovery to a new level. I will be looking at the emerging options and how to capitalize on these in a follow-up article.

Find out more

To find out more about the NPL challenges and how recovery is evolving, please see Cutting through the complexities of NPLs in the Middle East: Lessons from the frontline.

Let’s talk 

If you would like to discuss any of the issues raised in this article or chat about how we can support asset tracing and debt recovery, please feel free to get in touch.

Yaser DajaniYaser Dajani
Managing Director


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