On 26 September 2022, the UAE legislator issued Federal Decree-Law No. 23 of 2022, amending certain provisions of Federal Decree-Law No. 14 of 2018 concerning the Central Bank and the Regulation of Financial Activities and Establishments (the "Banking Law").
A key amendment introduced by Federal Decree-Law No. 23 of 2022 involved the replacement of Article 121, which now reads as follows:
"Article 121 - Protecting the Customers of Licensed Financial Institutions
- The Central Bank shall establish regulations for the protection of the customers of the Licensed Financial Institutions, as deemed adequate to the nature of the activities exercised thereby and the provided financial services and products.
- The Central Bank may establish a Unit of independent juristic personality, to receive and decide on the complaints of the customers of the Licensed Financial Institutions. A decision shall be issued by the Board of Directors for the establishment of such Unit and the determination of its functioning system, competencies and duties, as well as the regulations related to its human resources and financial affairs.
- The Central Bank and the Licensed Financial Institutions shall act together to raise the awareness of the society regarding the types of banking services, the financial products, and inherent risks, through all available means of communication and media, according to the controls specified by the Central Bank.
- The Licensed Financial Institutions shall not be allowed to charge any interest on the frozen interests -compound interests – regarding the facilities granted to the customers. This shall be subject to the controls and rules stipulated in the control regulations issued by the Central Bank."
This amendment reflects a significant shift in the UAE's approach, explicitly prohibiting Licensed Financial Institutions ("LFIs") under the jurisdiction of the UAE Central Bank from charging compound interest. This move underscores the emphasis on transparency in interest charges when extending credit facilities to customers, thereby enhancing consumer protection within the UAE banking sector.
Furthermore, by prohibiting the imposition of compound interest, the amendment protects customers from the compounding effects of interest on interest. This safeguard ensures that debt repayment terms remain equitable and manageable, helping to prevent borrowers from falling into cycle of debt.
Further complementing this amendment, the Ministry of Justice issued a directive on 27 February 2024, which was addressed to financial experts in the UAE. The directive mandates that financial experts must:
- i. apply simple interest and are prohibited from imposing compound interest.
- ii. avoid claiming interest on top of interest as compensation.
- iii. Allocate payments made by borrowers first to the principal amount rather than to interest.
The amendment of the Banking Law, reinforced by the Ministry of Justice's directive, establishes unambiguous legal standards for how interest and repayments are to be handled when a dispute arises and is referred to a financial expert. This clarity strengthens the protection of borrowers' rights during disputes, ensuring that financial institutions operate within fair and transparent practices.
The directive also emphasizes the protection of borrowers, particularly those who may be defaulting, by ensuring that any prior payments reduce the principal amount rather than merely covering interest. An intriguing question arises as to whether the principle of allocating payments to the principal amount before interest will also be adopted by the Central Bank and imposed on LFIs.
Additionally, the amendment of the Banking Law added new requirements for LFIs concerning obtaining 'adequate securities' when lending to both natural persons (individuals) and private individual enterprises (private sole proprietorships). The adequacy of the securities must be in accordance with the customer's income and financial position as well as the nature and value of the guarantee (if any), and the amount of the financial facility being requested. The Central Bank determines the specific requirements and standards for these guarantees. Essentially, this clause ensures that LFIs are securing appropriate collateral to mitigate the risk associated with extending credit.
The newly added text of Article 121 stipulates that:
"Article 121 bis - Guarantees of Credit Facilities
- The Licensed Financial Institutions shall obtain sufficient guarantees for all kinds of facilities provided to customers among physical persons as well as the private individual enterprises, according to the income of the customer, or the guarantee – if any – as well as the amount of the required facilities, as determined by the Central Bank.
- No claim, lawsuit or defence may be accepted before the Competent Judicial Authorities or the arbitration bodies, in case filed by any licensed financial institution concerning any credit facility provided to a physical person or a private individual enterprise, in case of not obtaining the guarantees mentioned in Clause (1) of this Article.
- The Central Bank may impose the adequate financial and administrative sanctions on the licensed financial facilities violating Clause (1) of this Article, according to Article (137) of this Decree-Law."
Failure of an LFI to obtain 'adequate securities' will lead to the inadmissibility of an LFI's application, lawsuit or defence when raised before the competent judicial authorities or arbitral tribunals in relation to the default or non-performance of the credit facility. This clause effectively enforces the obligation of LFIs to secure sufficient collateral before extending credit, by making their legal recourse contingent on compliance with this obligation. The UAE Central Bank is also authorised to impose administrative and financial penalties on non-compliant LFIs.
Additionally, the Chairman of the Judicial Council issued Circular No. 9 of 2022, which imposes restrictions on the enforcement of security accepted by financial institutions in relation to financial or credit facilities (loans). This circular elucidates the purpose of Article 121 bis, emphasizing the protection of recipients of banking facilities in the event of default. Specifically, enforcement actions are limited to the value of the securities initially provided to and accepted by the LFI deemed sufficient to secure the repayment of the facilities.
The circular aims to prevent the extension of enforcement measures to the borrower's other assets beyond the pledged securities, thereby mitigating the financial and social repercussions of such actions. It underscores the responsibility of LFIs to thoroughly assess the adequacy of guarantees before extending credit. Consequently, enforcement actions must adhere strictly to the value of the provided guarantees.
The circular cautions judges not to attach or enforce against on borrower funds beyond the pre-approved securities and restricts the issuance of travel bans or arrest warrants against borrowers in circumstances where the guarantees are not sufficient to cover the indebtedness owed to an LFI. Enforcement must be confined within the limits of the guarantees previously accepted by the LFI.
Following the issuance of Circular 9 of 2022, the Chairman of the Judicial Council issued Explanatory Circular No. 3 of 2023. This Explanatory Circular is linked to Circular No. 9 of 2022 and the supreme directives concerning the enforcement of security accepted by LFs for financial/credit facilities. In this circular, the Chairman directed judges' attention to several key points:
The enforcement restriction guidelines apply to all disputes related to banking facilities, regardless of when the facility agreement was entered into.
- i. The current regulation No. 29 of 2011 regarding bank loans and other services offered to individual customers, along with its amendments, serves as the main reference for Article 121 bis, which was added by virtue of Federal Decree-Law No. 23 of 2022.
- ii. Post-dated cheques covering installments up to a value not exceeding 120% of the loan amount or the debit balance can be considered as security for the payment of monthly installments. The total sum of these cheques can serve as security for the payment of the total loan amount with accrued interest/profits. In such instances, an action on post-dated cheques is admissible. However, enforcement of the judgment against the borrower for the amount of the security cheque(s) is limited to the cheque itself and does not extend to the borrower's other assets. Additionally, it does not include a jail sentence or travel ban if the borrower is unable to pay the loan amount.
- iii. A bare personal guarantee (without securities in rem which are real or movable securities) is not considered sufficient to obtain a credit facility. Such a guarantee must be accompanied by securities in rem, which are subject to the bank's assessment and discretion.
To conclude, the Banking Law and Circulars referenced above underscore the critical importance of LFIs securing sufficient collateral before extending credit facilities to individuals and private sole proprietorships. Failure to obtain such securities can lead to the inadmissibility of any claims by the Bank.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.