United Arab Emirates (UAE) is a federation that is comprised of 7 distinct emirates namely Abu Dhabi, Sharjah, Dubai, Ajman, Fujairah, Umm Al-Quwain, and Ras Al-Khaimah. Each of these emirates is governed under certain rules and regulations formulated by a hereditary emir who is the sheik of Abu Dhabi. Among the seven emirates, the capital emirate is Abu Dhabi. Due to being the capital of the federation, it is the center for cultural endeavors and commercial activities in the state. The economy of the UAE is immensely developed and it is a prominently developed state in the Middle East. The significance of its development is demonstrated by the fact that the income per capita of UAE is 7th highest in the world. UAE is considered to be an attractive country for foreign investors because of its diversification in the economic sphere which includes trade, tourism, manufacturing, real estate, and banking. This paper is focused on the financial institutions of UAE and the history of the Central Bank of the United Arab Emirates. The role of the central bank is also addressed in this paper. In addition, the challenges which confront the Central Bank of the United Arab Emirates and the banking sector of UAE are also highlighted in the ending sections of this paper.
Central Bank of the United Arab Emirates
The Central Bank of the United Arab Emirates was established in 1980 and it replaced the old Currency Board of UAE which was established in 1973. The Central Bank of the UAE is the central institution of the state and it has the authority of managing the issuance and circulation of currency in the UAE. It is responsible for the assurance of the currency stability of the UAE. The Central Bank of UAE manages the credit policy of the state, and it also provides financial and monetary support to the government of UAE. It also manages, develops, and observes the banking system which is present in UAE. The reserves of currency and gold are also managed by the Central Bank of UAE. The Central Bank of the UAE also plays a supportive role to banks that are close to bankruptcy under financial crisis. This state institution also represents UAE at international institutions such as the Arab Monetary Fund, the International Monetary Fund, and the World Bank (Abu Dhabi, 2013). These are the main responsibilities that are associated with the Central Bank of UAE; however, for the topic of this paper, the management of the banking sector of UAE, which is regulated by the Central Bank of UAE, will be discussed in the following sections. These sections will cover banking regulations, monetary policy for banks, and the adoption of BASEL, which was implemented by the Central Bank of UAE.
Commercial Banking Sector UAE
The commercial banking sector in the UAE consists of 51 financial institutions of which 28 banks are owned by foreign institutions and the remaining 23 are local banks. In these banks, millions of customers are served for their financial requirements through conventional banking. However, Islamic banking is also becoming common due to the fact that Islam is the national religion of UAE and consumers are interested in the products of Islamic banking. These banks offer deposit and credit services denominated in both local and foreign currencies. The most common currencies which are used in the UAE’s banking sectors are Arab Emirate Dirham (AED) which is the national currency of UAE and others include the United States Dollars (US$), Euro, GBP, and more. In UAE, every bank offers the facility of Automated Teller Machines (ATM) to all customers which facilitate financial transactions. The commercial banking sector of UAE is regulated under the authority of the Central Bank of the United Arab Emirates. The most fundamental responsibilities of the Central Bank of UAE related to commercial banking are the formulation of credit, banking, and monetary policies. In addition, the Central Bank of UAE also ensures the implementation of the formulated policies (HSBC, 2012).
The Role of Central Bank for the Commercial Banking Sector and UAE
As mentioned above, the commercial banking sector of the UAE is regulated and governed by the Central Bank of the UAE. It signifies the role and importance of the Central Bank of UAE in the domain of commercial banking. The Central Bank of the UAE intends to achieve its economic goals based on which the banking sector is regulated. These goals are the regulatory force that manipulates rules and regulations for the banking sector. The regulatory force is comprised of the following aims;
The Central Bank of the UAE attempts to support the currency and in doing so, the Central Bank targets to maintain stability in its value. This stability of the currency value is managed with the intent to internally and externally strengthen the currency. It also foresees the freeing of currency to be converted into foreign currency. The credit policies are formulated by the Central Bank of UAE in concordance with the objectives of the development of the national economy. The Central Bank of the UAE is empowered to act as a bank for other banks that are operating in UAE. The Central Bank of UAE aims to fulfill these objectives by organizing and promoting banking in UAE. It also administers the effectiveness of the banking system by formulating laws and regulations for all banks in the UAE (Central Bank of the U.A.E., 2013).
Monetary Instruments for Banking Sector
In order to achieve the monetary goals, the Central Bank of the UAE offers several policies to the commercial banking sector of UAE by which liquidity of banks is managed. The monetary instruments to support the monetary policy include the minimum reserve requirement ratio. It is related to the reserves of banks which are needed to be maintained at the Central Bank. These reserves are maintained without any interest earned on them. By regulating the level of these reserves the monetary policy is managed by the Central Bank and the monetary goals are achieved. Another instrument is the Dollar to Dirham and Dirham to Dollar swap. It is an approach to introduce dirham denominated liquidity when banks require greater access to the local currency. The next instrument signifies the capacity of the Central Bank i.e. advances and overdraft facilities for banks. The Central Bank provides loans to advance money to banks for 7 days without any collateral. It also offers an overdraft facility which allows banks to utilize their reserves which are maintained at the Central Bank without any charges for 7 days (Central Bank of the U.A.E., 2013). These are a few instruments by which the Central Bank of the UAE supports its monetary policy and attains its monetary objectives. Based on these instruments and facilities, the banking sector of UAE also strengthens which is another reason for the foreign interest in UAE.
The banking regulations formulated by the Central Bank of UAE are in the form of an official gazette which contains all regulations and descriptions of authorities of the Central Bank in the form of laws. It states every activity of the Central Bank in which other organizations or financial institutions are involved in the form of dealing. This dealing must concord to the commercial principles which are associated with banking. All deals which the Central Bank comes across with any other party have to be considered as commercial (The Council of Ministers UAE, 1980). The Central Bank must issue, buy or sell its deposit certificates in Dirham in accordance with the limits that are explicated by the board of directors. This operation occurs in the situation when the Central Bank deals with active banks operating in UAE. It is the policy of the Central Bank that it must offer banks loans and advances only on current accounts without any collateral for seven days (The Council of Ministers UAE, 1980). It is part of the regulations of the Central Bank that it may set credit ceiling for every bank that is operating in the premises of UAE and these credit ceilings would be on the basis of credit operations which are carried out by banks with the Central Bank of the UAE. Another important regulation for the relationship of banks with the Central Bank of UAE is that the Central Bank must not renew or accept any maturing bill which has been discounted by the governing body i.e. the board of directors of the Central Bank (The Council of Ministers UAE, 1980). These are some of the key regulations which are known to be formulated for strengthening the relationship of banks and the Central Bank and also to improve the functioning of the overall banking in UAE (The Council of Ministers UAE, 1980).
In the year 2006, the Central Bank of the UAE announced the implementation of BASEL II for the entire banking system operating in the UAE. This implementation was preceded by a one-day seminar in which all banks were informed of the intention of the Central Bank. BASEL II is a whole set of regulations that was proposed by the BASEL Committee on Bank Supervision, which is responsible for the regulation of the banking sector internationally. This set of regulations is primarily associated with the operations of banks. BASEL II majorly deals with the capital of financial institutions unlike BASEL I which was focused on the credit risks of banks (Al-Tamimi, 2008). The implementation of BASEL II in the UAE banking sector by the Central Bank was preceded by various suggestions. These suggestions for the implementation of the regulations of BASEL II include those related to control and supervision of operational risk; banks operating in the UAE may adopt their own operational risk plan which they feel to be most appropriate. For market risk, banks should adopt the amendment of 1996 in the regulations of BASEL I. This adoption must be in concordance with the regulations of BASEL II (Al-Suwaidi, 2006). One of the most significant reasons to adopt BASEL II was the foreign influence that the UAE has in its commercial domain and the standardization of the banking system in accordance with the international standards. These are the reasons for the adoption of BASEL II by the Central Bank of the UAE.
Regulations for Employees’ Protection
As being the regulatory authority for the entire system of banking which is operating in the premises of UAE, the Central Bank of UAE is also responsible for employee protection in the industry. The employment relationships in UAE are governed by the Labor Law which was legitimized in 1980. These regulations are related to employment and protection of employees which are formulated by the Central Bank of UAE and are completely in accordance with the labor law of UAE. These regulations cover banks’ policies related to wages, contracts, working hours, rights of terminations, vocational leaves, facilities, and medical benefits. These regulations are indirectly taken from the international labor laws (HSBC, 2012). However, there are some policies that the Central Bank of UAE has proposed on its own such as the Mecca pilgrimage or any other religious leave to be awarded to all employees in a legal pathway.
UAE holds a great significance in the global economy which has gained immense interest from foreign institutions and investors over the last few years. For this reason, the standardization of the business framework is necessarily entailed in accordance with international standards. Similarly in the banking sector, the Central Bank of UAE aims to manage and develop the economy of UAE to make it competitive at the global level. However, the fulfillment of this is not easy and it faces severe challenges keeping in view the volatile global conditions, which must be addressed. These challenges are in every domain, from regulating banks to managing reserve levels for banks. However, up till now the banking sector of UAE has proved to be resilient against all such challenges including the global economic crises and intense competition in the global financial markets. The Central Bank of UAE has proven to be able to take control of all chaotic or crisis situations (Wam, 2013). However, challenges that are faced by the global economy have the potential to threaten the stable stance of the UAE’s banking system. The Central Bank of UAE has played a remarkable role in maintaining the economic worth of the UAE economy in the international market. The challenge for the Central Bank relates to the development and implementation of regulations that are applicable to both local and foreign banks (Central Bank of the U.A.E., 2013).
The commercial banking sector of UAE is one of the most prestigious business domains in the world. This sector is governed by regulations of the Central Bank of UAE which significantly exerts a great influence on dealings and policies of all banks operating in the premises of UAE. The authoritative role of the Central Bank of the UAE is highly significant for the government of the UAE. Policies covering managing reserves, facilitating advances to UAE banks, ensuring employees’ rights, and adoption of BASEL II by the UAE banking system are regulated and implemented by the Central Bank of UAE. The Central Bank of UAE has proven to be a successful participant at various global forums to promote the UAE for attracting new capital from international businesses and financial institutions. The banking system is one of the important factors which contributed positively to the phenomenal progress of the UAE in the global economy.
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