What does Turkey’s latest bout of currency volatility mean for the country’s banking sector?
As usual, that was one of the first questions asked by markets after president Recep Tayyip Erdogan dispensed with yet another central bank governor on March 18.
Quite why Naci Agbal was sacked after only three months in post remains unclear. Most initially connected it with the central bank’s decision two days earlier to hike rates by a larger-than-expected 200 basis points, given Erdogan’s apparently unshakeable conviction that higher interest rates are the cause of all economic ills, including inflation.
But then rumours began to spread that Agbal had been pushing for an inquiry into how $140 billion of Turkey’s foreign-exchange reserves came to be dissipated in a futile attempt to defend the lira without raising rates during the inglorious two-year reign of presidential son-in-law Berat Albayrak as economy supremo.
Which explanation is correct will likely remain an open question, given the Turkish government’s approach to transparency, for which Erdogan shows about as much enthusiasm as interest rates.
Crystal clear
What is crystal clear is that Erdogan’s brief experiment with economic rationality – which began when Albayrak was finally replaced in November by experienced political operator Lütfi Elvan, and Agbal was installed at the central bank – is over.
Speaking on Wednesday, Erdogan struck a relentlessly positive note, dismissing market volatility as unreflective of Turkey’s economic fundamentals.
His only substantive response to the lira losing nearly 10% of its value against the dollar and a 450bp spike in the yield on the Turkish 10-year was to call on citizens to cash in holdings of foreign currency and gold, and invest the proceeds in local assets.
There are reasons to be cautious – and possibly more so than in previous crises
Inevitably, whenever the lira goes into a tailspin, attention turns to the Turkish banking sector and its heavy dependence on short-term external funding, more than $80 billion of which comes up for refinancing this year.
Time and again, market watchers have fretted that western banks might not roll over the syndicated loans of their Turkish counterparts. Yet despite a succession of upheavals during the past six years – attempted coup, currency crisis, Covid – there has been no sign of this happening.
Rollover rates did dip below 80% after the currency crisis of 2018, but that was largely due to a decline in appetite for foreign currency lending among Turkish banks and a rise in deposit dollarization. More than 90% of syndicated loans were successfully rolled over last spring after the start of the pandemic.
Is there any reason to think that this time might be different?
Bigger picture
Starting with the bigger picture, in many ways the sector remains as strong as ever. Three of the four largest banks are owned by the state, which has both the means and – as it has demonstrated twice during the past three years – the willingness to recapitalize them as required.
Meanwhile, the leading private sector players – Turkish and foreign-owned – are well-capitalized, well-managed and profitable, with healthy liquidity and apparently robust balance sheets. System-wide non-performing loans (NPLs) stood at 4.1% of the total at end-December.
Nevertheless, there are reasons to be cautious – and possibly more so than in previous crises.
That NPL number, for instance, is expected to rise sharply once Covid emergency measures are rescinded. Around 10% of bank loans are currently covered by payment moratoria, according to S&P, while loans are now classified as non-performing only once they are 180 days overdue.
That in itself would not be a disaster. Banks everywhere are facing similar challenges, and Turkey’s were as proactive in provisioning last year as any. Forbearance and moratoria can, and likely will, be extended until the pandemic passes and growth resumes.
Uniquely vulnerable
What makes Turkish banks uniquely vulnerable is that they still bear the scars of previous crises and bad economic management.
The true extent of asset-quality deterioration in the sector is obscured not just by Covid measures but also by the fact that banks had been allowed to restructure large chunks of corporate debt during the previous two years without accounting for it.
Add to that the fact that a third of Turkish banks’ loan books are still denominated in foreign currency, and that many of the most enthusiastic foreign currency borrowers before the 2018 lira collapse were in sectors without currency inflows, such as construction and energy, and the picture looks less rosy.
Then there is the question of runaway credit growth. Erdogan has two favoured methods of boosting the Turkish economy. One is infrastructure projects. The other – which may partly explain his aversion to high interest rates – is loose credit.
Under Albayrak’s reign, banks were pushed to ramp up lending to all segments to counter the effects first of the 2018 crisis and then of the pandemic.
Last year, overall lending in Turkey increased by 35%, flattering NPL ratios, boosting capital requirements and raising concerns about the long-term viability of loans extended during a time of crisis.
State banks were the main conduit for this credit bonanza, but measures were also implemented to try to force private-sector lenders to follow suit. Some of these were abandoned under the new economic team, and credit growth cooled at the start of this year after interest-rate increases.
Whether this measured approach will be continued remains to be seen – but the sweeping changes made to Turkey’s economic management in March do not bode well. In addition to Agbal, the respected heads of the sovereign wealth fund and of Ziraat Bank, the largest state-owned bank, were also ousted.
If Erdogan has indeed embarked on another of his experiments in economic and monetary unorthodoxy, Turkey – and its banks – are in for a rough ride.
The prospect of rising interest rates in the US is already prompting investors to rethink their exposure to emerging markets. Turkey’s balance-of-payments situation is always precarious and further declines in the lira would inevitably raise the spectre of capital controls.
After the latest volte-face, it will take a lot to convince outsiders that Erdogan and his government have any long-term commitment to market stability and economic rationality.
