In recent years state-owned Turkish banks became instruments in the pursuit of macroeconomic goals, especially after the government’s sovereign Turkey Wealth Fund (TWF) took over their management.
The Turkish government now plans to utilise public banks in its response to the COVID-19 outbreak. However, the damaged credibility of the Turkish banking sector, elevated international borrowing costs, increased dollarisation, and the high level of public guarantees on existing loans make this a risky move.
The government is refraining from taking drastic measures to protect public health or create social welfare safety nets, instead favouring an approach that aims to keep economic activity ticking along.
At the same time, it is trying to tackle the economic aspects of the crisis without harming government balances. Its measures include postponing tax payments, introducing a partial-working allowance through the extra-budgetary Unemployment Insurance Fund that subsidises workers whose hours have been cut, and extending cheap loans through public banks.
While the scope of other measures remains limited due to stringent prerequisites and bureaucratic hurdles, the loans offered by public banks may play an essential role in helping both households and cash-strapped enterprises without creating a direct burden on the Treasury. However, measures such as postponing credit card payments and extending loans with grace periods may put a significant portion of the rescue cost on the shoulders of public banks.
In 2018 and 2019, with Turkey’s economy reeling from a severe currency crisis, the government relied primarily on public banks to boost economic activity and defend the Turkish lira, even though they should by law operate on the principle of profitability, just like private banks. The transfer of their shares formerly held by the Treasury to the TWF started this new era for public banks.
The TWF took over the management of public banks in 2016, just after the failed coup attempt. The TWF’s operations, including management of large funds in currency and capital markets, are far from transparent. The shady operations of the TWF and the possible role of state-owned banks in these operations raise questions over the use of these banks’ funds.
Public banks mainly drove the growth in loans over the last two years. While the loans of public banks increased 22.7 percent and 19.4 percent in 2018 and 2019 respectively, loan growth rates of private banks were only 3.9 percent and 4.1 percent.
Consequently, public banks’ share in the total loan volume, which was 30 percent by 2016, increased to 37 percent by 2019. This implies a profound divergence between the approach of public and private banks in loan assignment and credit risk management, which raises systemic concerns.
For personal loans, real estate was generally used as collateral in this credit boom. As a result of the ongoing economic crisis, the construction sector shrank by 8.3 percent year on year in real terms, and the value and liquidity of real estate decreased significantly, a development which may increase the stress on public banks.
The collateral on corporate loans, on the other hand, has been largely provided by the Credit Guarantee Fund (KGF), especially since 2017. In 2017, the loan volume created by the KGF rose from 6.7 billion liras ($1 billion) to 208.1 billion liras ($31 billion) compared to the previous year, and the guaranteed volume increased from 5.1 billion liras ($760 million) to 187.5 billion liras ($28 billion).
In this period, KGF-borne guarantee volume, which previously fluctuated in the range of 0.1-0.2 percent of GDP, rose to 6 percent. The size of loans guaranteed in 2019 was 188 billion liras ($28.1 billion), which corresponds to one-tenth of the corporate loan stock.
In September 2018, banks were obliged to restructure KGF-backed loans before writing them off, and banks had to evergreen these loans. While this helped banks to improve their profitability on paper, it also raised concerns regarding the reliability of banking balance sheets. Combined with the macroeconomic instability, especially after the introduction of the new presidential system, this led to a downgrade in Turkish banks’ credit ratings.
The banking sector afterward faced difficulties in rolling over its foreign debts. Net capital inflows excluding real estate investments turned negative in 2018 and 2019. In the last two years, banks faced elevated financing costs and became net loan payers.
As they strove to adapt to this new situation vis-à-vis loans, the government positioned public banks at the front line to defend the lira. In March 2019, the banks were forced to refrain from providing liquidity to foreign fund managers, which saw the cost of borrowing liras in international markets soar past 1000 percent. The state-owned banks spent a large portion of their foreign currency reserves in supporting the lira to stop it falling below key psychological thresholds. This further reduced the credibility of Turkish banks in international markets by casting doubt on their corporate governance.
In September 2019, The Banking Authority of Turkey (BRSA) allowed banks to write off bad loans amounting to 46 billion liras ($6.67 billion). As of February, the ratio of non-performing commercial loans, which constitute approximately 80 percent of total loans, reached 6.1 percent. However, the actual amount of non-performing loans could be considerably higher than this figure. A senior executive at Turkey’s largest bank, İşbank, predicts that bad loans will rise to 7.5 percent.
The BRSA was founded in 2000 as an administratively and financially autonomous body to improve the quality of regulation and supervision of the banking sector with the ultimate goal of preventing financial crises. However, there has been a significant setback in the political independence of the banking regulatory framework, especially in the last two years.
The banking executives who expressed their concerns regarding the size of non-performing loans at a technical meeting with the International Monetary Fund were immediately fired per the request of BRSA. Once an agency designed to be free from political interference, the BRSA sued a critical anchorman over one of his tweets on the financial rescue package shortly after President Recep Tayyip Erdoğan sued him.
Another adverse development in the banking sector is the high degree of dollarisation. As a result of macroeconomic instability and the depreciation of the lira, the share of foreign exchange deposits, which was 34 percent in 2014, increased to 49 percent in 2020. The degree of dollarisation would also be a challenge for banks in supporting the government package with cheap lira loans, which would increase their balance sheet currency risk.
Many households and enterprises may face difficulties making instalments to repay loans if they cannot earn enough to cover their basic expenses after the six month grace period.
Depending on the undisclosed credit volume, a jump in public banks’ non-performing loans may trigger a systemic shock with the potential to affect the entire financial system. In such a scenario, the burden on the Treasury would be much higher than if a credit/grant scheme subsidised by the central government budget with predetermined appropriation limits was introduced.
Although the indicators for Turkish banks do not seem critically risky, the lack of transparency surrounding their balance sheets and the imprudent regulatory framework undermine their credibility.
The government has failed to unveil a strategy to offset the burden of COVID-19 measures placed on public banks against elevated roll-over costs and net capital outflows. With credit default swap rates at as much as 650 basis points, the Treasury would also not be able to fully cover enormous costs caused by KGF guarantees and the losses of public banks in the case of a systemic shock.