Erdogan targets Turkish banks over economic crisis (Al-Monitor, August 11,2017)

Turkish President Recep Tayyip Erdogan this week launched a fresh barrage of criticism and warnings at banks, charging that they are making unfairly large profits during a time of economic strain. Addressing the Chamber of Commerce and Industry in the northern city of Trabzon Aug. 8, Erdogan said, “Banks are not behaving themselves. We keep saying that interest rates must come down, but banks are using the citizens’ deposits almost as a means of fleecing them.”

Pointing to a significant increase in bank profits, Erdogan said, “Last year, after all the distress we went through, banks had a profit growth of 40%, which means there is a problem here. … Moreover, banks have almost doubled their profits this year. This is a disaster.” In a thinly veiled call to discipline the sector, Erdogan said, “I believe our central bank and public banks will take firms steps on this issue and pull this thing down.”

Banking, interest rates and the profitability of banks have long been major targets for criticism in political Islam. Yet, Erdogan’s Justice and Development Party (AKP), in power since 2002, owes much to Turkey’s increased integration in Western capitalism, through which it ensured economic growth and boosted its popular support. The AKP government, however, has failed to fully come to terms with the inevitable cost of this process — the reality of interest rates — and has instead continued to grumble about banks and an “interest rate lobby” to its conservative base, often demonizing the sector. Erdogan’s latest outburst is just another episode of the same old story.

In the past two years, the AKP regime actively encouraged banks to turn on the lending taps as it scrambled to pull the economy from the brink of crisis. As a result, the business volume of banks expanded and their profits shot up. Now, Ankara is trying to obscure its role in this outcome by mounting a fresh attack on banks and interest rates.

That the Turkish economy relies heavily on external funds to grow is a well-known fact. Banks are the intermediary in the provision of those funds. Drawing on the liquidity expansion spawned by the global financial crisis, Turkish banks have been borrowing from abroad and then using the money to lend to consumers and companies at home. In some years, the process has been relatively easy, in others more difficult. In any case, Turkish banks abide by the law and split hairs when issuing loans, with the big economic crisis of 2001 serving as a grim shadow. Since that crisis — fueled in part by poor scrutiny of the banking sector — Turkish banks have been under tight control, imposed mostly by the Banking Regulation and Supervision Agency.

Until mid-2016, the banks had to make do with low profits, with return on equity falling below 10%. As a result, the loan supply shrank. Turkey’s political jitters and geopolitical strains worsened the crunch, as major international credit rating agencies cut the country’s grades. All this resulted in an economic slowdown.

The year 2015 was especially hard for the banks, leading authorities to cut the requirement for reserves they must hold. The move increased the cash available for use and thus paved the way for bigger profits. In other words, the 40% increase in bank profits that Erdogan is now slamming became possible thanks to Ankara’s support in the wake of a bad year and the state’s decision to prop up the banks.

This year’s profit boom has been courtesy of the government as well. To fend off the threat of a full-blown crisis, Ankara enacted measures encouraging lending to the real sector, including treasury-guaranteed loans issued via the Credit Guarantee Fund (KGF). As a result, loans grew by more than 40%. When bank profits reached 25 billion Turkish lira ($7 billion) in the first half of this year, equal to their total profit in 2016, this was again the result of government support.

While Erdogan fumed at the bankers association, Huseyin Aydin, president of the Turkish Banks Union and head of the country’s largest public bank, was saying this: “In a period of high uncertainty and risks, confidence [in the economy] has been boosted, thanks also to [government measures]. On the issue of growth, we managed to do in six months what the European Union could not do for 10 years, recovering in three quarters only. We used the legal limits to the full. We put all the money we had into loans, to the last penny.”

According to Aydin, loans totaling 207 billion Turkish lira have been issued to 313,000 customers via the KGF, meaning that the mechanism has become a big opportunity for banks to sell loans and thus profit. What about the numbers that Erdogan was denouncing? “Judging by the profits at the Istanbul stock exchange, in the industry or other companies, the profits of the banking system are at a reasonable level,” Aydin said.

Lending incentives have for once brought banks high profits while temporarily easing the crunch on the markets. Yet the whole thing is nothing more than an exercise in buying time. The KGF’s loan volume is close to its legal limit of 250 billion Turkish lira, and many are already asking how long its support can continue.

In an Aug. 10 column in the financial daily Dunya, banking executive Tugrul Belli highlights the price for buying time. He wrote, “Regardless of whether the Credit Guarantee Fund limit is used up or not, one thing is for certain – a further expansion of the current measures appears quite impossible without a further increase in macroeconomic risks. The said measures include fiscal policy as well.”

Though everything may seem on track on the surface, Turkey’s public finances are under strain. The treasury’s domestic borrowings stood at 16 billion lira in July, well above the planned 15.1 billion lira. As a result, its debt rollover ratio surpassed 140%, just as it did in June. The impact of pressure on domestic borrowing is seen in the yields on sovereign bonds as well. The yield on the benchmark bond has reached 11.7%, its highest level since 2009. In September, the treasury will also have to buy foreign exchange or offer eurobonds to gather the money to repay external debts.

Belli draws attention also to the “twin deficit” danger. He estimates that the budget deficit this year will be somewhere below 2.5% of gross domestic product. He added, “The current account deficit, meanwhile, could climb to 5% from 3.8% in 2016, depending on how the growth rate performs. This would inevitably raise the risk of twin deficit for the economy.”

In sum, the risks for the Turkish economy are growing silently. Is there anything to suggest that the economy can be steered back to stability? Any signs to that effect are very limited. The Turkish economy is accumulating stress.