Banks in Spain and France are among the most exposed to the Turkish public sector, including to government debt, data shows, as the lira continues to fall amid concerns about Turkey's economy and the direction of its monetary policy.
The lira fell sharply May 23 and remained weak May 24 despite the central bank's decision to raise its key liquidity window lending rate, at which it lends to commercial banks, to 16.5% from 13.5%. The rate increase had been widely anticipated, despite political resistance to it in Turkey, and was subsequently described as insufficient to support the currency.
The lira touched 4.86 to the U.S. dollar May 23. It was trading at 4.75 to the dollar at midday GMT May 24, compared to its closing price May 23, 2017, of 3.57 lira — a 24% fall.
The spread on the five-year credit default swap on senior Turkish sovereign debt, which acts as an insurance against widening yields on the bonds and moves in the opposite direction to the yield, was 273.65 basis points late May 23, up 105 basis points.
Bonds issued by the Turkish government, meanwhile, have also taken a battering in global markets, with yields climbing to 15.22% on May 23.
Data from the Bank for International Settlements for the fourth quarter of 2017 shows that banks in Spain had $20.82 billion of exposures to the public sector, including government bonds, trailed by lenders in France with $7.14 billion, and German and U.K. lenders both with $2.53 billion and $2.53 billion apiece.
The May 23 rate increase came amid criticism of President Recep Tayyip Erdogan for interfering in Turkey's monetary policy and for insisting that the central bank hold rates despite inflation pressures. On May 11, Erdogan referred to interest rate increases as "the mother of all evil" and flying in the face of economic convention to suggest that higher interest rates cause, rather than limit, inflation.
Rating agencies warned that comments impede on the independence of the central bank, which is enshrined into law, with possible implications for the country's risk rating.
"We have been negative on Turkey for a long time due to bad macroeconomic policies, which come all the way from the top, that is, from Erdogan ... He is directly to blame for the current problems," Jan Dehn, the head of research at Ashmore, an emerging markets fund in London, said. "Funding is now being withdrawn, which will make it difficult for Turkey’s banks to roll domestic credit. Default rates will rise and bank [losses] will rise. This will further tighten domestic conditions and slow growth."
Individual savers have already begun shielding their accounts, a banker with a leading retail group in Turkey, who requested anonymity, told S&P Global Market Intelligence prior to the May 23 hike. "A lot of switching from lira deposits to US dollars happened in the past few months due to lira interest not being deemed as adequate."
Analysts and investors are forecasting contagion may spread to Turkey's banks, which are likely to be squeezed by spiking bad loans and high-risk premiums on foreign funds as a consequence of the lira's decline.
Lenders in Turkey expect a wave of nonperforming loans from their business customers to hit if the currency's value does not come down below 4.5 lira to the dollar, the banker said.
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