UAE Supreme Court reaffirms ban on compound interest

The case involved two credit facilities granted to the borrower: a commercial loan for AED 634,000 (approx. US$172,600) with an interest rate of 11.25% and a personal loan for AED 66,000 with an interest rate of 10.5%, totalling AED 700,000.The borrower defaulted on the two loans and the bank, which has not been identified, claimed AED 1.919 million plus 11.25% annual interest.

A court-appointed expert calculated two alternative sums for the total outstanding debt. Firstly, he calculated the outstanding balanced owed by the borrower up to the last payment date. Total withdrawals were AED 700,000, of which AED 50,214 was deposited, leaving a total principal balance of AED 649,786. The accrued interest up to the last payment date was AED 40,967.28, which meant that the total outstanding balance was AED 690,753.28.

The expert’s second calculation included compound interest. In his calculation of the outstanding balance up to the end date of the statement submitted for the two loans, the expert concluded that the total withdrawals, total deposits and the total principal balance remained the same as the first calculation, but the total accrued interest was AED 860,147.88 with additional late payment interest of AED 43,170. Consequently, the total outstanding balance was AED 1,553,103.88.

The appellate court adopted the second option, which was then appealed to the Supreme Court, who upheld the appeal as the second amount exceeded the principal amount of the loans themselves.

The Supreme Court pointed to Article 121 of the Federal Decree-Law No. 23 of 2022, an amendment to Federal Decree-Law No. 14 of 2018, which prohibits licensed financial institutions from charging interest on accumulated interest, leading to the Supreme Court ruling against the decision of the appellate court.

Matthew Escritt, a finance expert with Pinsent Masons in Dubai, said: “The decision means lenders will need to show increased transparency around loan terms”.

“This could result in enhanced protection for borrowers against excessive interest charges, particularly in circumstances where financial distress had resulted in payment default.”

Seya Rahnema, a finance lawyer at Pinsent Masons, added: “For financial institutions, the judgement necessitates a review of their credit and interest accrual policies, and specifically their consumer credit policies, which are more likely to capitalise unpaid interest and add such amounts to the outstanding loan amount.”.

As commercial loans on market standard terms accrue interest separately, they are less likely to be impacted by the ruling, but financial institutions must still ensure that interest calculation methodologies are transparent and do not charge compound interest.