Turkey’s economy has long been subject to boom-bust cycles linked to capital flows. And while the Turkish banking system continues to perform well, it faces some structural vulnerabilities that can pose financial stability risks. In common with peer countries, Turkey has been developing and implementing a macroprudential policy (MPP) framework, which has had some success in mitigating financial stability concerns. Looking ahead, Turkey’s macro-prudential and micro-prudential tool kit should be expanded and used in a more targeted and active manner to ensure financial stability, with a focus on debt-to-income limits on households, steps to constrain unhedged foreign exchange borrowing, and more active use of steps to limit growth in very fast-growing credit segments.
Turkey’s economy has long been subject to boom-bust cycles linked to capital flows. Reflecting in part low domestic savings, Turkey remains heavily dependent on foreign capital flows, contributing to large real sector volatility. Turkey’s gross external financing needs are large, representing roughly a quarter of GDP on an annual basis. The dependence on foreign capital means that when capital inflows slow, economic activity slows sharply, leading at times to hard landings. This in turn can pose risks for financial stability, and underscores the importance of ensuring a sound macroprudential framework.
The Turkish banking system continues to perform well, although vulnerabilities remain.
Relative to banks in peer countries, banks’ profitability remains high; leverage and the level of non-performing loans are low; and capital buffers are strong. Banks have been comfortably rolling over external borrowing notwithstanding the volatile external backdrop, and the banking system short FX position has recently declined. However, the increased dependence of banks on short-term foreign borrowing (over 60 percent of overall bank external funding) represents a rollover risk. In addition, the banking sector loan-to-deposit ratio has surpassed 100 percent from 70 percent a few years ago, and consumer indebtedness relative to disposable income, while lower than in many other developed countries, has risen to 50 percent in the recent credit boom. Corporates are exposed to direct foreign exchange risk with its short FX position totaling $126 billion (although only $9 billion is short-term).
MPP Framework and Turkey’s MPP Measures
A well-articulated MPP framework is crucial to achieve more effective crisis prevention. The 2007/8 crisis underscored the need for countries to develop a strong policy framework to address macro-financial systemic risks including enhanced prudential regulation, intensified supervision and introduction of new MPP instruments. The MPP framework should enable the authorities to identify the main sources of systemic risk, develop a well-focused policy agenda to mitigate these risks, and provide clarity as to which authorities are responsible and accountable for crisis prevention. The MPP should also ensure a high degree of accountability and willingness to act as well as mutually supportive policies among the relevant agencies while preserving the operational autonomy of established policy fields (see IMF (2011), Lim et al (2011) and Nier et al ( 2011)). Aside from the MPP, the first line of defense for maintaining systemic financial stability should be robust micro-prudential supervision and regulation.
Turkey has made active use of MPP measures, notably since the Lehman crisis, to safeguard the domestic financial sector. In October 2008, banks dividend payouts were sharply curtailed to bolster bank retained earnings and capital. In January 2009, the BRSA loosened FX liquidity requirements while restructured loans were reclassified from ‘overdue’ to ’performing’ under certain conditions. Banks were also prohibited, starting in June 2009, from lending in FX (or FX-indexed loans) to consumers while from March 2010 onwards banks temporally lowered their new general provisioning rate for cash loans.
In 2010, a credit boom took off in Turkey, for which the authorities then resorted to additional MPP instruments, albeit with a delay. Initially, the steps were taken primarily by the CBRT, which relied—starting in late 2010—on successive increases in reserve requirements (RRs) to temper loan growth. However, this measure proved largely ineffective as the CBRT offset the higher RR by injecting additional liquidity via open-market operations. The authorities also used moral suasion to target a uniform 25 percent increase on banks’ annual loan growth for 2011, adjusted for exchange rate movements, which apparently became binding for some banks by mid 2011. More importantly, starting in June 2011, the BRSA—motivated by macroprudential concerns—increased risk weights for new general purpose (consumer) loans and raised general provisioning requirements for banks with high levels of consumer loans or non-performing consumer loans. These June 2011 measures, together with the implicit nominal credit growth target and the worsening external market conditions, contributed to the sharp slow-down in credit growth in the second half of 2011.
In October 2011, the CBRT introduced a new RR framework whereby banks have been progressively allowed to meet TL RR by posting FX and gold. The share of TL RR that can be met by using FX been steadily raised, and banks are now able to use up to 60 percent of TL required reserves with FX and 30 percent with gold. In addition, the CBRT is now applying a varying “Reserve Option Coefficient (ROC)” that requires a higher equivalent amount of FX or gold to meet a given portion of TL RR. Given the large opportunity cost difference between banks’ TL and FX funding, banks’ participation has been over 90 percent of the maximum allowable amount. The CBRT aims to use this fine-tuning ROC tool for capital flows and financial stability purposes. In principle, this tool will absorb FX inflows, while increasing banks’ FX liquidity buffers and the CBRT’s gross reserves.
Turkey made progress on the organizational aspects of its MPP framework. The Financial Stability Committee (FSC) was created in June 2011 to improve coordinating of all the agencies involved in safeguarding financial stability while maintaining operational autonomy of the participating agencies. The 2011 IMF Financial Stability Assessment Program (FSAP) Update also recommended an increased emphasis on communication, an enhanced interagency coordination, as well as a leading role of the CBRT on the macroprudential committee to harness the central bank’s expertise in risk assessment.
Expanding the Tool Kit
Looking forward, the authorities could consider implementing in a pre-emptive and targeted manner a wider set of MPP instruments to ensure financial stability. In particular, macro-prudential and micro-prudential policy measures could be considered to maintain systemic financial stability by preempting surges in credit, discouraging banks from funding their loan activities via increased short-term FX borrowing, and limiting unhedged FX borrowing by the corporate sector. A more countercyclical and targeted macro-prudential policy approach would also complement fiscal and monetary policy, which, respectively, have been underutilized and overburdened. The sequencing and calibration of any new measures will need care, so as to avoid unintended deleveraging. While it is not advocated that all the below measures be swiftly implemented, the authorities could consider the application of such macro-prudential and micro-prudential policies should the above-mentioned broad areas of risks and financial stability become a policy concern. In particular, safeguarding systemic financial stability also requires robust micro-prudential regulation and supervision.
Measures could be considered in the following areas:
Conserve existing capital buffers. The BRSA has fully implemented Basel II as of June 2012, which also includes Basel II.5 provisions (CRD III). Based on results of the Basel Quantitative Impact Studies (QIS), banks seem well positioned for the introduction of Basel III by 2015, and thus, an accelerated time table could be considered. Turkish banks have maintained a comfortable capital adequacy ratio of 16.3 percent (which dropped by only 0.2 percentage points from implementation of Basel II) and tier 1 capital at 14.1 percent (both above peer countries). It would be important to phase-in Basel III (capital, liquidity and leverage rules) according to the agreed schedule, or even on an accelerated basis given that results of quantitative impact studies (QIS) have been promising so far, especially compared with peer countries. For instance, banking sector leverage remained strong with around 8 percent (Basel III definition). Turkey’s minimum capital target of 12 percent as well as tight dividend payout rules are useful micro-prudential measures in an environment of strong credit growth, given that capital buffers can erode quickly when banks expand their balance sheets towards higher risk-weighted loans.
Prevent household overleveraging. Household debt, although lower than in many peer countries, has increased to around 50 percent of disposable income during the recent boom phase. Setting a consumer debt-to-income limit (DTI) across the banking system could help maintain household balances’ resilience. Banks already apply such DTI requirements for their internal risk management and credit scoring.
Contain short-term FX borrowing by banks. Turkish banks, partly due to improved external sentiment and limited local funding (loan-to-deposit ratio at 103 percent), make extensive use of this source of funding. Introducing a minimum FX liquidity ratio at the 3-month and longer horizons while phasing in Basel III liquidity ratios could help address banks’ structural maturity and currency mismatch. As in the existing liquidity regulation framework in Turkey, the Basel III liquidity rules could be differentiated by currencies. Finally, the application of FX RR increases at shorter maturities could also be considered to slow down banks’ short-term external borrowing.
Limit nonfinancial corporate FX exposure. FX corporate loans comprise 26 percent of banks’ total loan portfolio and 40 percent of corporate loans. The BRSA draft regulation on credit risk management should be finalized to improve banks’ risk management and help supervisory examination of banks’ FX lending practices. But there is scant information on corporate FX hedging, and filling this data gap would be important. It would be also possible to tighten the conditions by which non-FX earning corporates could borrow FX in Turkey. Also, higher risk weights and provisioning on unhedged FX lending to corporates could be introduced if growth in this lending segment would become excessive. Data availability would be an important prior condition for such a measure.
The views expressed in this article are those of the author and should not be attributed to the IMF, its Executive Board, or its management. Any errors and omissions are the sole responsibility of the author.
International Monetary Fund (2011) “Macroprudential Policy: An Organizing Framework”.
———, (2012a), Turkey 2012 Article IV Consultation,” IMF Country Report 12/338.
———, (2012b), Turkey: Selected Issues Paper,” IMF Country Report 12/339.
Lim, C., F. Columba, A. Costa, P. Kongsamut, A. Otani, M. Saiyid, T. Wezel, and X. Wu
(2011) “Macroprudential Policy: What Instruments and How to Use Them? Lessons from Country Experiences,” IMF Working Paper 11/238.
Nier et al (2011), “Institutional Models for Macroprudential Policy, IMF Staff Discussion Note 11/18.
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