UAE banks must scrutinise clients

Better oversight by financial institutes would prevent the brazen ways some businesses misuse funds

Enterprises go bust, unscrupulous management or large shareholders perpetrate frauds, and managements embezzle … all the time. This goes on around the world, even in jurisdictions where a high level of disclosure required, corporate governance mandated, whistle-blower policies exist, corporate taxes (therefore filings) levied, credit bureaux are pervasive, and so on and so forth.

Disclosure norms are even more stringent for listed firms. All things considered, there are enough and more tools for stakeholders to ascertain the financial health of companies, albeit to varying extents.

The Middle East is singular for a variety of reasons. First, the majority of firms are privately owned and not listed. Second, the largest stakeholders in these entities, very often, are banks. A significant proportion of such entities are over-leveraged.

Third, a reputational if not financial stakeholder — the statutory auditor — is largely unsupervised and the industry practically unregulated. Lastly, public disclosure of financial statements is not mandatory.

Everything considered, there is no oversight over, or insight into, any privately owned entity. Only one type of institution has the privilege of some insight — and that is the bank.

Businesses in the Middle East are either government-related (or owned) entities, listed companies or privately-owned firms. Government auditors closely scrutinise the first type. The second is required by law to disclose financials, management structure, periodic financial reporting, and theoretically, subject to oversight from any stakeholder.

Oddly enough, we see little activism or public criticism (until too late) in connection with the performance of listed firms.

That leaves the last variety (private or family-owned firms) gloriously naked in its inadequacy, leaving the three main stakeholders — lenders, creditors and employees — utterly exposed to the whims and fancies of owners.

Of these three stakeholders, creditors and employees have no locus standi whatsoever. The former can demand financial statements if they have the leverage, but employees have no way of knowing the financial health of their employer — exposing them to severe risk in case of difficulties faced by the firm.

Employees only

find out something is amiss, when salary payments are delayed. It is often too late by then, leaving employees in doubt if they will ever receive their end-of-service benefits if they choose to leave. Can employees tip off the authorities if they suspect financial misdemeanour?

Even if they could, to which regulator would they have to complain, for example, about falsified accounts? Lamentably, they could not, as whistle-blowing is not protected under UAE law.

Although the reporting of criminal activity is obligatory under the law, if a whistleblower provides confidential information to the police, for instance, he will not only be in breach of his employment contract, but perhaps even the law.

Whistle-blowing could be considered a criminal offence for a number of reasons, under Article 379 of the UAE Penal Code. Ironically, the employer may view such disclosures as a breach of the Civil Code under Article 905.

This apart, there looms the issue of what constitutes criminal activity — falsifying financial statements, not adequately funding end-of-service obligations, providing wrong information to lenders, indulging in circular transactions to demonstrate high sales, etc. Could these constitute criminal activity?

Creditors are on equally thin ice, as the feeble enforceability of their commercial contracts puts them in a vulnerable spot in any event. So this counts them out as well as ineffectual in their ability to protect their own rights. This brings us back to banks.

Lenders are the only stakeholders that are capable (other than regulators) of bringing about some semblance of corporate governance, best practices and reasonable oversight, over family-owned enterprises. (Non-borrowers, needless to say, stay comfortably out of this orbit as well!). That it is in the collective interest of banks to do so is a statement of the obvious. It therefore boggles the mind as to why this has simply not happened. Other than in the case of a syndicated facility — a rarity in the local market — banks create no common ground for lending.

In other words, they plainly just do not come together in lending to a common borrower, even if they recognise the need to do so. This recognition is a foregone conclusion and is irrefutable.

Then why the aversion to collective action? One would have thought that in the absence of appropriate regulation, banks would have stepped into the breach and applied some standards, or shackles, or requirements on their common borrowers.

The explanation of this peculiar state of affairs lies in the belief that banks have — that the activities of lending and retrieving monies are essential components of a zero sum game. The belief that for every winner there has to be a loser.

The woeful truth is that banks take a transactional view of this aspect, whereas it calls for a long-term strategic perspective. Over the long run, cooperation can only lead to winning and losing being evened out across the board. Regrettably, this view is not ascribed to.

What does one make of all this? While the absence of adequate regulation and the overwhelming presence of self-interest should spur lenders to place a high level of oversight on borrowers, it is not incumbent on them. Although it is a tremendously powerful and feasible workaround, and a pressing need of the hour.

Simply put, it is not their job. Secondly, what about those firms that do not borrow from banks. Who will protect the stakeholders of these entities?

The whole issue of disclosure, transparency and corporate governance from the point of view of protecting all stakeholders is a burning one for government to address. This constitutes a vital element of “ease of doing business”.

But it must be argued that it must extend to the protection and fair treatment of stakeholders in the event of its cessation as well.

Lenders are the only stakeholders that are capable (other than regulators) of bringing about some semblance of corporate governance, best practices and reasonable oversight, over family-owned enterprises. That it is in the collective interest of banks to do so is a statement of the obvious. It therefore boggles the mind as to why this has simply not happened.

■ Vikram Venkataraman is Managing Director of Vianta Advisors.