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Western EuropeMarch 3 2023

Turkey’s controversial monetary policy continues

The central bank of Turkey’s macroprudential adjustments has made the operating environment for the country’s banks increasingly complex. James King reports.
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Turkey’s controversial monetary policy continuesImage: Getty Images

Turkey’s central bank (CBRT) has doubled down on its unorthodox monetary policy stance in recent weeks, following further easing of interest rates and the introduction of new macroprudential measures. In its Monetary Policy and Liraisation Strategy for 2023, the apex institution said it would increase the weight of Turkish lira assets and liabilities in the domestic banking system by using its policy interventions in a “strengthened manner”, which includes, among other things, further changes to the securities maintenance ratio applied to domestic lenders.

By the middle of 2023, the CBRT aims to increase the ratio of lira deposits in the banking system to above 60%, from 53% at the end of December 2022. This objective comes as the central bank looks to prop up the local currency amid surging inflation, which official data puts at 58%, and as the main policy rate continues to fall. Over the past two years, official interest rates have plunged at the behest of the country’s president, with the stated aim of lifting production, investment and employment. 

On February 23, the CBRT cut its main one-week repo rate further, to 8.5% from 9%, in response to a series of earthquakes that struck the south of the country in the same month. But this unorthodox approach has delivered significant problems, as well as distortions, across the wider economy. In November 2022, ratings agency Fitch affirmed its “B” rating for the sovereign with a negative outlook.

“A big component of the downside risks captured by this negative outlook actually emanates from the unconventional set of policies pursued by the Turkish authorities. Not only have we seen, in the second part of 2022, additional monetary easing by the central bank in spite of rising inflation, but also what we saw is the increasing use of regulatory measures in order to achieve some policy aims,” says Erich Arispe Morales, senior director in Fitch Ratings’ sovereigns group. 

As the CBRT has turned to these macroprudential adjustments, the operating environment for the country’s banks has become increasingly complex. The latest regulatory change affecting the sector is the central bank doubling the securities maintenance ratio for commercial banks’ foreign exchange deposits from 5% to 10% on February 24. This requires that lenders hold Turkish lira-denominated bonds, equal to the central bank’s requirements, for these foreign currency deposits until they achieve a Turkish lira deposit ratio of 60% or more.

This follows a series of macroprudential regulatory changes by the apex bank in 2022, covering a broad range of bank exposures and activities. As a result of this capricious and fast-moving policy environment, Fitch Ratings adjusted its ESG Management and Strategy scores for Turkish banks from three to four, to indicate the “moderately negative” impact of this intervention on banks’ credit ratings. 

Hindrance and constraints 

“[This change] reflects our view that this increased regulatory intervention in the banking sector actually hinders the operational execution of management strategy. It constrains management’s ability to determine strategy and price risk, and it creates an additional burden for [banks],” says Lindsey Liddell, head of Turkish bank ratings at Fitch. 

To compound this set of challenges, the CBRT has been setting and then altering key regulatory objectives for the banking sector. This includes banks’ total share of lira deposits, which was initially set at 50% in 2022, before it was increased to 60%. 

“A key focus for the authorities is now the absolute percentage of lira deposits relative to a bank’s total deposit base. So that has now become a new master regulation, if you like, trying to govern banks’ behaviour, in order to increase the level of lira deposits. This threshold was initially set at 50% but it has now increased to 60%, so the goalposts keep getting moved,” says Ms Liddell. 

Assuming at some point Turkey has a ‘normal’ monetary policy, the banks will be in trouble

Atilla Yesilada

Although the CBRT has introduced a number of supportive policy measures to increase the flow of credit to the economy, particularly in the wake of the recent earthquakes, criticisms of its current policy stances are reaching new highs. A general election is scheduled for May 2023, pitting the incumbent administration against an opposition that has pledged to restore an orthodox approach to the management of the economy. But any transition to a more normalised policy environment is unlikely to be easy. 

“The [CBRT’s] liraisation strategy is just seat-of-the-pants policy-making to fend off immediate currency devaluations. It really has no basis in the received wisdom of economics. You don’t do liraisation, or de-dollarisation, in an economy that is suffering from accelerating inflation,” says Atilla Yesilada, GlobalSource Partners’ Turkey country analyst. 

“Assuming at some point Turkey has a ‘normal’ monetary policy, the banks will be in trouble. They are all short-matched, meaning that the costs of their deposits will increase much faster than their loans. So, they could incur huge losses.”

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Read more about:  Regulations , Western Europe , Turkey