Nothing in this article is to be construed as legal advice. This is an economic analysis of what I see as being possible rational decisions.
What are security cheques?
Let me first explain: a post-dated cheque has traditionally been used in the UAE as a last ditch guarantee in the event that a bank or other party cannot be paid by the person signing the cheque, often in the case of a loan or service rendered or goods supplied, ahead of an expectation of receiving payment in the future at some point. This is because a criminal case could be filed against that person in the event that the cheque is presented and then returned if there are insufficient funds in the account related to it. The ultimate penalty for this in the past was jail, providing a lot of leverage to the party trying to recoup their funds. There are various laws surrounding how a bounced cheque is handled by the legal system but the spirit of the law seems clear to me and that is to stop people from behaving in a fraudulent manner. However, various parties, including banks, company suppliers and vendors as well as individuals such as landlords have used the letter of the law to apply anti-fraud rules to economically distressed companies and persons.
Why do I say this? Well, think of it this way: If the intent of the law was to, for example, jail people who cannot pay back a loan then there would be a law that specifically states that. However, in the absence of a security cheque that bounces, a person who fails to pay back a debt does not necessarily face the same fate as a person who has bounced a cheque and certainly the path to the final legal judgement is much more balanced. This reasoning clearly points to the fact that the law was not meant to punish those in financial distress. It is the spirit of the law that has been twisted and put to use for purposes not intended. I am not a mind reader, but the logic certainly points to these conclusions.
Dubai’s new law on security cheques
In mid-November, a legal decision in Dubai that resulted in the offence of a bounced cheque being downgraded to a misdemeanour and that non-fraudulent bounced cheques with a value of Dh200,000 or below would be dealt with a fine of up to Dh10,000. This bold step heralds the end of security cheques.
The cynical might point out that this is a Dubai law and that there are six other Emirates. They might also point out that the cap of Dh200,000 excludes many stakeholders. I am an optimist and I think that thinking through the details and the natural ripple effects of this decision will have large effects on the economy.
The consequences of the new law
Let’s begin with the Dubai versus the other Emirates issue. First of all, in practice the Abu Dhabi courts are effectively already handling non-fraudulent cases of bounced cheques in a similar manner. Second, while it is not clear to me what happens when a bounced check enters the court system of another emirate, one thing does seem clear: if the other emirates don’t match Dubai’s move then banking business will move to Dubai, and if banking business moves to Dubai then all business will move to Dubai. After all, business owners will want to set up in a legal environment that does not punish business failure with possible jail time.
But what about the Dh200,000 cap? Won’t that mean that ,eg SMEs or individual people, in practice cannot borrow over Dh200,000 because, traditionally, most banks will ask for a cheque for each loan you take? What about SMEs who often need to borrow much more than that? Remember, it is only an incompetent bank that will give large open loans. A competent bank would only lend SMEs for a specific purpose, for example to buy a piece of equipment or discount certain receivables (what clients owe).
The meaning of the new Dubai law is clear: The spirit of the bounced cheque law is to punish fraudsters, not those in financial distress. The burden of credit risk has moved from the courts firmly back to where it belongs, with the banks. Some banks will resist and try to find ways to neutralise the effect of the decision. The smart banks however will see this as an opportunity to grab market share. I have repeatedly pointed out two things about our banking system: 1. It is not efficient as reflected in the relatively low level of service level competition given 23 operating banks and a population of around 8 million, and 2. Core financial results are worsening. For banks to survive the current economic challenges they must increase the deployment of their current balance sheets, ie more lending and less cash. They can only do this by grabbing local market share or exporting their lending.
The decision on bounced cheques is a clear disruption to the status quo. Smart, nimble banks will be able to grab local market share from slower, close minded banks.