Can banks really afford the political risk of suing Dubai?

Can banks really afford the political risk of suing Dubai?

Una Galani says it wouldn't make sense for a bank that wants to grow its business with Dubai to pursue legal action against the sovereign, especially in a region where such relationships drive business.

September 18, 2012 5:44 by Reuters

Foreign lenders are threatening Dubai with a fresh debt headache. The UK’s Royal Bank of Scotland, South Africa’s Standard Bank and Germany’s Commerzbank have launched a lawsuit against Dubai Group, an entity owned by the emirate’s ruler Sheikh Mohammed. The move threatens to derail a two-year effort between 40-odd creditors to agree terms to restructure $10 billion of debt. But the banks playing hardball might be able to afford the political fallout.

Dubai Group has been left hung out to dry by the government, a contrast to the billions of dollars in financial support extended to Dubai World in 2009. Dubai Group’s diverse assets include minority stakes in banks around the world and German shopping centres, but are not strategically important to the emirate. Dubai may also be keen to reserve spare cash for a second restructuring of Dubai World, which may become necessary in 2015.

It wouldn’t make sense for a bank that wants to grow its business with Dubai to pursue legal action against the sovereign, especially in a region where such relationships drive business. Yet Dubai is no longer as active as other sovereigns like Qatar or Abu Dhabi. Of the three banks, understood to be collectively owed less than $500 million, RBS has the largest presence in the region. The part-nationalised UK bank has already sold its local retail operation and doesn’t appear to be in a hurry to extend its loan book to the emirate.

Dubai has limited leverage over the creditors that have decided they have little to lose. The current deal on the table offers to repay loans over 12 years. But the three banks want an attractive option to exit sooner. Either way, the move by a small group of lenders to initiate lengthy legal proceedings will put pressure on Dubai to find a compromise, or risk major delays for everyone.

It’s not clear if the rebel banks will see the London-based legal proceedings through to the end if Dubai Group refuses to budge. On the other hand, few observers originally thought the banks would dare to go this far. In any case, the banks will end up with no worse than the current terms. That puts the ball firmly in Dubai’s court.