Turkey's monetary policy pivot gives hope to banks

The pressure is easing for Turkish banks amid a steep rise in interest rates and more relaxed regulation following the reelection of President Recep Tayyip Erdoğan.

The benchmark interest rate has nearly tripled in two months, with August's 750-basis-point hike to 25% far larger than economists anticipated. Independent economist Arda Tunca said this was good news for lenders and was an indication the central bank wanted to bring rates closer to private savings and personal lending rates, which were on average 27.8% and 48.1%, respectively, as of July 14, according to official data.

"The central bank's message was that it intends to catch up with the market and then it will revert to its main function, which is providing price stability," said Tunca.

Banks' earnings in foreign currency terms have suffered due to Turkey's unorthodox economic policies, which included slashing interest rates. This led annual inflation to surpass 85% and the lira to tumble to all-time lows versus the dollar. Yet Erdoğan has seemingly changed tack since May's narrow election victory, appointing market-friendly figures to key roles to return Turkey to more mainstream economic policies that should restore some equilibrium to the financial sector.

Early steps

Several central bank reforms since the election removed some pressure on the country's lenders. One move saw the requirement for banks' lira-denominated deposits decline from 60% to 57%, which eased competition for deposits, Yapi ve Kredi Bankasi AŞ CEO Gokhan Erun said during the bank's latest earnings call.

Lenders' margins had been squeezed as they competed to meet the original target, and those that did not were compelled to increase their holdings of government securities as a percentage of their loan book by 700 basis points, according to Enver Erkan, chief economist at investment firm Dinamik Yatirim.

The central bank has also scaled back a lira deposit initiative that protected savers against currency fluctuations. The purpose was to convince customers to convert foreign currency holdings into lira to help ease pressure on the ailing currency. In return, they would be guaranteed to be compensated for any decline in its value. Foreign currency and FX-protected lira accounts represent about 68% of bank deposits, said Tunca.

Another post-election reform reduced the ratio of government securities that banks must hold to 5% of their loan books from 10% previously, said Erkan.

"Regulations regarding the purchase of bonds had put a lot of strain on the banking sector," Erkan said. "Bankers are demanding a simplification of the rules."

Margin pressure

Performance was mixed across Turkish banks during the second quarter. Among the country's five largest lenders, Akbank TAS, Türkiye Is Bankasi AS and Turkiye Garanti Bankasi AS booked higher net income on both a quarterly and annual basis, while Yapi ve Kredi and Türkiye Vakiflar Bankasi Türk Anonim Ortakligi reported lower profits.

Yet lending margins have been squeezed, with Garanti, Akbank, Yapi ve Kredi and QNB Finansbank A.S. reporting steep year-on-year declines in net interest income. The quartet's average net interest margins similarly tumbled over the same period by 395 basis points to 3.48%, Market Intelligence data shows.

This slump was mainly due to declining income from consumer price index-linked government bonds, which had been a key source of profits, and narrower loan-to-deposit spreads, said Sevgi Onur, vice president and banking analyst at Seker Invest.

Banco Bilbao Vizcaya Argentaria SA-owned Garanti Bank's margins on lira-denominated lending fell to just 0.81% in the second quarter from 6.65% in the prior-year period as deposit costs rose and loan yields fell. The bank said it was able to offset the pressure on customer spread from strong fee and trading income.

Challenges ahead

While many early policy moves have been promising, other perils await. The central bank will likely introduce disincentives to restrict consumer spending, such as reducing the number of installments for new loans and increasing Turkey's special consumption tax, said Erkan. This tax applies to companies that manufacture, construct or import goods, according to a note by law firm Erdem & Erdem.

The central bank has also cut banks' maximum monthly lira-denominated commercial loan growth to 2.5% from 3%. Similarly, the vehicle loan growth limit was reduced to 2% from 3%.

Furthermore, given the volatile recent history of the central bank, which has had five governors in the last four years, the question remains about whether it will have the freedom to pursue the required policies, according to Tunca.

"The level to which interest rates will rise should be a technical question but instead it's a political one, and so banks will be cautious because of this uncertainty," said Tunca.

Even so, banks may be able to take solace from Turkey's new medium-term economic plan. Erdoğan made his most definitive commitment yet to the policy reversal during the Sept. 6 announcement, saying that "with the help of tight monetary policy, we will bring inflation down to single digits," the Financial Times reported.

The sentiment certainly brings the country's leadership more in step with its banks.

"We hope that Turkey finds the solution in reestablishing a market-based economy," BBVA CEO Onur Genç said on a July 28 earnings call.