Turkish banks: a telling story
THE TURKISH financial system is based on banks, not on shallow capital markets. It is a credit-driven economy, and credit follows demand. The financial sector has always quickly adjusted to new circumstances, but the real sector involves many decision-makers. It is approximately a “large economy” with a huge number of price-takers, augmented by some big players. It is a Cournot-Walras economy. Convergence to a Pareto-efficient equilibrium in such an economy is not easy, though modelling is rather straightforward. My experience suggests that unless bank profits are squeezed, and liquidity dries up, the real sector responds and the consumer follows. So far so good: it is a stylized fact. However, what is currently happening has nothing to do with that. The “new abnormal” is indeed entirely new.
TURKISH BANKS: THE NORMAL COURSE
People tend to think of the Turkish banking system either as very strong or as very vulnerable, depending on historic episodes. For example, in the beginning of 2009 it was common currency to look at the post-Lehman world and conjecture that 2010 would be a difficult year for Turkish banks. After all, U.S. and European banks and other financial institutions suffered a great deal in 2009. So, why Turkish banks shouldn’t have? Indeed, loan demand had dropped sharply, and the possibility of credit rationing as an equilibrium phenomenon loomed large on the horizon. The ISE 100 was off the hinges right after Lehman, and had seen its lowest level on November 21, 2008. NPLs were trending up sharply, and it looked like provisions for new NPLs could easily wipe out up to half of 2009 estimated net profits, at the –then- current provisioning ratio of c. 80%. Foreign currency liquidity concerns rose amidst worries about the magnitude of c. USD92 billion gross private sector debt due in 2009, financial and real sector ensemble, including trade loans. The loan-to-deposit ratio fell as banks resorted to credit rationing. Furthermore, the syndicated loan market was expected to dry up in 2009. The outlook looked rather dim for a while, and the climax was reached by the end of March 2009. Thereupon, leading indicators to the effect that banks could indeed perform better than anticipated in the rest of the year began to pile up. After March, bank equity shares were obviously driving the stock market rally and expectations lined up with new realities quickly. Yes, a miracle –or almost so- was happening. Giant global banks were hit so hard that they were deprived of their equity capitals, but much smaller and allegedly more vulnerable Turkish banks made profits amidst the Great Financial Crisis.
THE GOOD OLD DAYS
In the aftermath of Lehman, emerging countries had continued to tap debt markets, but with great difficulty. The decline in the non-core liabilities of emerging economy banking systems was mainly demand-driven as industrial productions and GDPs came crushing down immediately in October 2008. There was no demand for credit because economies contracted. However, this decline was also due to the pervasive uncertainty clouding the world economy: risk premiums increased everywhere. In the second phase, developed economies resorted to quantitative easing and committed themselves to near-zero interest rates, which jump-started the flow of funds towards emerging markets. As a result, new credit booms occurred and non-core liabilities grew by leaps and bounds. In the case of Turkey, the new course meant two things. First, equity capital began to grow at a rate that is 15% higher than its pre-Lehman trend and kept this steady course for many years after 2009. The reason was twofold: the policy rate was cut from 16.5% all the way down to 6.5%, which implied considerable capital gains for Turkish banks. Then the rising NPLs were not allowed to wipe out net profits since the BRSA (Banking Regulation and Supervision Agency) had cut the reserve requirement rate to 1% or TL loans and to 2% for FX-denominated loans for an initial period of three months
–which was extended. At the going rate the banks were covering for 80% of non-performing loans. That made a huge difference. Second, banks foreign funding increased from c. 5% of total liabilities to c. 22% within the first Post-Lehman five years. Access to debt markets was quasi-automatic, and both corporate and banking sector debt increased rapidly. Emerging market corporate debt became popular. The London money market became was awash with corporate credit. Cheap and easy money caused a domestic-demand driven growth path for at least two consecutive years.
Hence, in the aftermath of the Lehman bankruptcy there was much to worry about. However, the CBRT (Central Bank of the Republic of Turkey) began easing rapidly, and that move proved essential. The equity capital of the sector grew at an accelerating rate after October 2008. The growth in equity was due to retained earnings as the sector had distributed 47% of net profits as cash dividends in 2007. It increasingly refrained from so doing as cash dividends fell to 27% in 2008 and to 16% in 2009. So 30% of the change came from there. 26% of the change in equity was due to valuation effects, i.e. the securities portfolio booked as AFS (available for sale) gains value as interest rates fell and the gains go under equity unless such securities are sold whereas 25% rise came from current period’s net profit and 18% from capital increases.
BEGINNING OF THE STORY: 2009
The above trend growth of the equity base proved sustainable, and from then on equity continued to grow at a respectably high rate for about five years. Return on equity was high at c. 20%, and capital adequacy was more than sufficient. The problem arose during the last two episodes of rapid currency depreciation, and exacerbated as profitability also fell. Add to this rating issues and rising costs of funding from overseas, and you may end up predicting that a though year is ahead. Or, is it?
TURKISH BANKS: THE ABNORMAL COURSE
No, the situation is entirely different. Turkish banks’ profits skyrocketed in the last few months. According to BRSA banking sector’s total profit was TL 63.245 million in March 2022. That figure was TL 16.383 million in March 2021 and TL 15.347 million in March 2020. Net interest income after provisions was TL 103 million in March 2021 but it was only TL 35.092 million in March 2021. Net profit increase for public banks is the highest. It isn’t interest income from lending in particular; rather it is interest income from securities. It isn’t zero-coupon bonds though. It is mainly floating rate notes and CPI-linkers that generate the huge profit. Inflation rose by leaps and bounds and securities linked to inflation generated large profits. This will go on and on throughout the year because even the CBRT admits that average inflation will stay above 40% this year. Note that CPI-linkers’ profit s booked with a two months’ delay – booked according to inflation two months earlier. So the 70% CPI of last month isn’t in the cards yet, and neither is the 61% CPI of the previous month. Also note that the CBRT is funding banks at 14%, a very low rate. The currency-protected TL deposits’ currency risk isn’t on banks either. This will be a year of an incredible profit boom for banks, one that isn’t comparable even to the golden years of 2009 and 2010. At that time there was a global crisis and both the BRSA and the CBRT made the right choices. This year’s boom is a direct result of rampant inflation and wrong monetary policy mix. It is a transfer in fact. So, we cut the policy rate of interest and not only the exchange rate jumped, but also interest income boomed.
OUTLOOK
What is the outlook, without unduly stretching political imagination? The prospects are dimly lighted in our opinion. And stress is bound to gradually build up. “The Logic of Political Survival” is the title of an interesting book by four distinguished authors, among them Bruce Bruno de Mesquita of NYU and Hoover Institution. Political survival dictates many mandates, some going against the inner beliefs of many observers and even politicians. However, it can be a useful instinct when the privately held beliefs would lead many leaders astray. Should they let themselves be conquered by canons of time-honoured international power politics they could stand firmer on the political soil. We seem to witness more of conformity to power politics, and that is at least understandable, since it is rational behaviour. On the other hand, not all conflicts can be readily resolved through a rational prism. As elections approach, what will happen after that becomes more and more intriguing.