Turkey’s banks entered the pandemic with some concerning underlying conditions and may need some significant financial ventilation if they are to come through it in good health. Foreign currency debt, depletion of foreign exchange reserves and political interference has added risk, with lenders likely to see increasing stress on their balance sheets in the months ahead. The picture darkens further the longer the health crisis continues.
COVID-19 has spread rapidly among Turkey’s 80m-strong population since it reported its first confirmed case on March 11 – reaching 86,306 cases and 2,017 associated deaths by April 20. The government has responded to the outbreak by closing borders, schools and universities, banning mass prayers and gatherings, issuing a stay-at-home order all those under the age of 20 and over the age of 65 and implementing a full lockdown on two consecutive weekends in April across 31 provinces, including Istanbul and Ankara.
To help lessen the dramatic impact this will have on businesses and citizens, Ankara has also introduced a TL100bn ($14.4bn) fiscal package which, among other measures, permits the postponement of tax payments, tax reductions and a draft law banning lay-offs for three months.
As in other countries, a major raft of the government’s response plan has focused on giving support to the banks – which leads to the question of how prepared lenders are to play a pivotal role in the country’s economic countermeasures. In Turkey’s case, the answer is far from reassuring.
After weathering the 2000-01 banking crisis, the Turkish banking sector underwent some significant regulatory tightening.
Key legislative changes include a 2009 prohibition on banks granting foreign exchange (FX) loans to households, with only large companies and/or those with significant FX reserves now eligible for them. Then, in 2012 the Central Bank of the Republic of Turkey (CBRT) introduced its Reserve Option Mechanism (ROM), which banks are obliged to contribute to, building a cushion for future crises.
A stronger banking system thus accompanied Turkey’s bounce back from the 2000-01 crash, with exponential economic growth fuelled by an equally large growth in credit. Indeed, from 2004-16 credit growth in Turkey was second only to China, worldwide, with a 45-percentage-point increase in the credit/GDP ratio over that period.
Turkey’s banks financed a lot of this via wholesale FX borrowing. This naturally created vulnerability to exchange rate fluctuations, a reality that the banks had to confront in a serious way in 2018, when the lira came under major pressure following the US-Turkey fall out over a cluster of issues, ranging from the Syrian conflict to Turkey’s detention of a US pastor and its purchase of Russian anti-aircraft missiles.
The stricter banking regulations paid off during that time: half of the ROM’s $60bn total was drawn down between July and October that year, and the considerable FX reserves of the banks was made available to cushion the impact of the falling lira. More stringent rules on lending also ensured a relatively low level of FX non-performing loans (NPLs), while banks were well hedged.
An unexpected shock
In 2020 the defences are not so robust. The currency, which had continued to depreciate before the advent of COVID-19, accelerated as the virus spread to Turkey. On April 6 the lira fell to its lowest level since August 2018, depreciating against the US dollar more in the year-to-date (12%) than in the whole of 2019 (11%).The CBRT also attempted an unsustainable defence of the currency by deploying its own FX reserves – and a number of currency swap deals – leaving these reserves at their lowest level since 2009, by March 20.
Depreciation has also raised the cost to banks of servicing their FX borrowing, both historic and recent (there was significant credit growth post-2018,too)while the banks’ FX positions – both in terms of their own reserves and those at the ROM – have not been rebuilt to the pre-2018 crisis levels. The sector faces around $6bn of principal FX bond and loan repayments in April and May this year, with another similar wave due in October and November. Banks do, however, have more than half of their deposits in FX, with this creating a further vulnerability to sudden withdrawals of the kind often observed in a crisis.
Meanwhile, external financing costs are also higher, partly given the negative global impact of the coronavirus epidemic on emerging markets in general, but also given wider concerns over the Turkish economy, which stands to see important sectors such as tourism, manufacturing and retail impacted badly – even while benefitting from a lower oil import bill.
In addition, for some time there has been growing international concern over politicisation of the financial sector, with pressure from the government on Turkey’s state banks to boost lending and on the CBRT to keep interest rates low (real rates are now around -2.6%), in order to fuel continued economic growth.
Thus, five-year Turkish Credit Default Swaps (CDS) are now priced higher than during the 2018 crisis,while spreads on Turkish bank US dollar bonds against US Treasuries are now around 1,000 basis points – a level not seen since 2018.
Holding the Line
The sector is thus facing the great challenge of COVID-19 while in shaky health, and with the CBRT also much less able to lend an FX hand. NPLs are almost certain to rise significantly as the pandemic continues, too, with likely political pressure on lenders to defer or even write off more individual and corporate debt, going forward. That alone will put balance sheets under pressure, in addition to the banks’ own need to service their FX borrowing.
On the plus side, the banks still have considerable potential FX reserves – Fitch estimates a total external debt servicing requirement for the banks in 2020 of $35bn-$40bn and available FX liquidity of around $81bn.Yet much clearly depends on the severity and length of the COVID-19 crisis, both externally and domestically. Behind their surgical masks, many in Turkey’s financial sector may therefore also be holding their breath, in the months to come.
Jonathan Gorvett is a journalist and analyst with many years experience researching and writing about the Gulf and the wider Near and Middle Eastern region. His interests include political and economic risk, development and the evolving place of GCC countries in the international diplomatic, political and economic landscape.
Reuters Apr 10,2020 “Two-day lockdown imposed in in much of Turkey” https://uk.reuters.com/article/uk-health-coronavirus-turkey-lockdown/two-day-lockdown-imposed-in-much-of-turkey-coronavirus-death-toll-tops-1000-idUKKCN21S1ZR
TRT World Mar 18, 2020 “Turkey launches $15.4bn aid package” https://www.trtworld.com/turkey/turkey-launches-15-4b-aid-package-to-fight-and-weather-impact-of-covid-19-34682; and Bloomberg 8 Apr 2020 Turkey to temporarily ban layoffs with virus cases near 40,000” https://www.bloomberg.com/news/articles/2020-04-08/turkey-to-temporarily-ban-layoffs-with-virus-cases-near-40-000
 Ahval News Apr 6, 2020 “Turkish lira drops to lowest since 2018 as virus spreads through Istanbul” https://ahvalnews.com/turkish-lira/turkish-lira-drops-lowest-2018-virus-spreads-through-istanbul
 BNE IntelliNews “Turkey Insight: Peering into the forex hole” https://www.intellinews.com/turkey-insight-peering-into-the-forex-hole-179583/
 Fadi Hakura, Chatham House Feb 7, 2020, “ A credit-fuelled economic recovery stores up trouble for Turkey” https://www.chathamhouse.org/expert/comment/credit-fuelled-economic-recovery-stores-trouble-turkey
 Fadi Hakura, Chatham House Feb 7, 2020 https://www.chathamhouse.org/expert/comment/credit-fuelled-economic-recovery-stores-trouble-turkey; and Fitch Ratings Mar 25,2020, “Coronavirus affects Turkey via funding conditions, bank metrics: https://www.fitchratings.com/research/banks/coronavirus-affects-turkey-via-funding-conditions-bank-metrics-25-03-2020
 Ahval Apr 4 2020, “Turkey’s financial stress intensifies” https://ahvalnews.com/turkey-economy/turkeys-financial-stress-intensifies-credit-markets-lira-defended
 Fitch Ratings Mar 25,2020, “Coronavirus affects Turkey via funding conditions, bank metrics”: https://www.fitchratings.com/research/banks/coronavirus-affects-turkey-via-funding-conditions-bank-metrics-25-03-2020