The UAE Central Bank recently announced a 0.25 per cent hike in its key policy rate (Certificate of Deposit rate). This hike comes after the US Federal Reserve announced an increase in its short term interest rates by the same percentage, a measure taken for the first time in nearly a decade. Central banks in other Middle Eastern economies like Saudi Arabia, Kuwait and Bahrain also followed suit, raising their key interest rates. Further, with the US Fed rate hike, the US Dollar is expected to strengthen, thus making remittances even more attractive for expats living in the UAE.

So what does this rate hike mean for UAE residents? Are loan interest and profit rates expected to go up soon? Are rates on bank term deposits likely to go up too? Would it become more difficult to get a loan in the future?

How does the Certificate of Deposit rate affect bank interest rates?

Certificates of Deposit (CD) are issued by the UAE Central Bank with an aim to absorb excess liquidity in the market. These instruments of monetary control are issued exclusively to banks in the UAE. Banks that buy such Certificates of Deposit earn an interest rate which is decided by the Central Bank. This interest rate forms the basis, and is the prime indicator of how interest rates are determined across the banking market in the country.

Certificates of Deposit are marketable instruments and banks can enter into repurchase agreements with the Central Bank or within themselves, thus affecting the supply of finance in the economy.

Looking for a loan for yourself? You can browse through over 90 personal loans, 76 car loans and 70 home loans in the UAE.

According to the latest statistics provided by the UAE Central Bank, the total Certificates of Deposit in the UAE stood at AED 94.7 billion as of October 2015. Before the 2008 financial crisis, the total pool of Certificates of Deposit in the UAE was much lower, around AED 40 billion. This was because the lending market in the country was growing rapidly and banks had bigger risk appetites. They were aggressively lending to both individuals and businesses with the aim to earn higher returns, and therefore held a smaller share of Certificates of Deposit.

With the UAE Central Bank increasing its key policy rate, it would essentially affect banks which directly deal with Certificates of Deposits. However, banks would transmit this hike to borrowers resulting in bank finance becoming more expensive, as the cost of borrowing is expected to go up with such a move.

While many experts are anticipating only a marginal to small increase in interest rates in the UAE, the actual impact on interest rates will depend on the discretion of banks and whether they opt to absorb the impact without transmitting it to borrowers. Whatever the outcome, it isn’t a bad idea to prepare yourself for an increase of any magnitude.

How will a potential rate hike negatively impact your personal finances?

Higher interest cost for mortgage borrowers?

Mortgage borrowers are likely to be the most affected if there’s even the smallest rate hike. This is because the long loan tenures and high loan amounts would magnify the effect of the rise in interest rates. While potential borrowers could be offered higher rates to start with, existing borrowers who have a variable rate on their mortgage, would end up paying higher installments.

Higher rates on personal, auto and SME loans?

Interest/profit rates could go up for other loans as well. The applicant category most affected would be unlisted companies’ employees and SMEs who are anyway offered loans at higher rates across the banking market.

Possible positive effects of the rate hike

Picking short-term deposits over long-term ones

If you’re interested in saving money in bank deposits, a potential rise in interest/profit rates means that its a smart idea to choose short-term deposits over long-term deposits. So your money is not locked away in a deposit that earns you a lower return, vis-a-vis the ones that could offer a higher rate in the near future.

Choose from over 154 term deposits available in the UAE.

Reap the rewards of a healthy credit history

Irrespective of whether or when loan rates go up, banks will always be competing with each other for credible borrowers. With credit reporting gaining momentum in the UAE, a healthy credit report will determine your ability to borrow in the future, and can help you get the best rate on various types of loans.

[Related: The growing role of Al Etihad Credit Bureau in UAE]