The Turkish 2000-01 banking crisis
Turkey experienced a severe banking crisis during 2000 and 2001. This Special Report first covers the main characteristics of the crisis. Second, the main causes and triggers of the crisis are described. Finally, the consequences for both the domestic and international banking system are discussed. The crisis had a major impact on banking supervision and regulation, as both were extensively strengthened.
Author: Koen Brinke (intern)
The banking crisis
In November 2000, banks start to close their interbank credit lines to vulnerable Turkish banks, after concerns about the health of the banking sector have increased sharply. The concerns also prompt foreign investors to withdraw funds by selling off treasury bills and equities. Consequently, on 20 November 2000, Demirbank, a private mid-size bank, is not able to borrow anymore in the interbank market (Akyüz and Boratov, 2003). Therefore, it has to sell part of its government securities portfolio, causing a further fall in the value of government securities and an increase in secondary market interest rates, raising doubts about the sustainability of public debt and the crawling peg exchange rate regime that had been in place since December 1999 (Özatak & Sak, 2003). The situation further worsens and causes a hefty sell-off of securities in the debt market by banks to meet margin calls, accompanied by a massive capital outflow, turning the situation into a systemic banking crisis. On November 30, the Turkish central bank (CBRT) stops providing emergency lines of credit to banks, to keep its level of domestic assets constant. Consequently, the interbank rate jumps to 873%. As the interbank credit market dries up, an acute liquidity crisis occurs. On December 6th, Demirbank fails and is taken over by the Savings Deposit Insurance Fund (SDIF), a government body which is responsible for insuring savings deposits and strengthening and restructuring banks if necessary. The IMF assists Turkey with a financial package of USD 10.5bn, which helps to calm the markets and stops the decline in reserves. This allows the CBRT to successfully defend the peg of the Turkish lira to the US dollar, but it had already lost almost 25 percent of its foreign exchange reserves between 20 November and 6 December (see Figure 1).
The turmoil in November is followed by a political crisis in early 2001. On February 21, the prime minister and president have a dispute about fighting corruption in the banking sector (Özatay and Sak, 2002). Again, trust in the sustainability of the stability program disappears and a currency crisis occurs, as both foreign and domestic investors initiate a speculative attack against the Turkish lira (BRSA, 2010). The Istanbul Stock Exchange falls by 14% and interbank rates skyrocket, rising from 50% to 8,000%. Meanwhile, foreign exchange reserves again decline rapidly (see Figure 1). On February 22th, the government allows the lira to float freely. As a result, the Turkish lira loses about one-third of its value against the dollar.
Figure 1: Reserves and the exchange rate
After the abolition of the currency peg, the lira moves in a free float with occasional heavy interventions by the CBRT. The IMF provides more funds in 2001 to stabilize the exchange rate and to bring down interest rates by restoring confidence, bringing the total IMF financing since December 1999 to almost USD 30bn (Özatay and Sak, 2002). Nevertheless, the economy shrinks by 5.3% in 2001. GDP per capita even declines by 6.5% that year. Due to huge losses of state banks and banks taken over by the SDIF, public debt rises from 38% in 2000 to 74% of GDP in 2001. However, confidence returns relatively quickly. The economy starts to recover and GDP grows by 5.7% in 2002. Nevertheless, unemployment rises from 6.5% in 1999 to 10.4% in 2002.
Short economic history
Prior to the crisis, the Turkish economy was very unstable. Throughout the 1980s and 1990s, Turkey became heavily dependent on short-term capital inflows and experienced multiple boom-bust cycles. During the 1990s, economic growth fluctuated between -5.5% and 9.3%. Financial markets, interest rates and the exchange rate were also very volatile. While Turkey’s current account deficits were relatively small (around 1% of GDP during 1995-1997), it was mainly financed by short-term capital inflows. Inflation rates often exceeded 80%, caused by heavy reliance on monetary financing until 1997. Meanwhile, Turkey’s government ran large budget deficits, up to 7% of GDP in 1997. Interest rates on government debt exceeded the inflation rate, on average, by more than 30 percentage points (see Figure 2). Several economic sectors, such as the telecom sector, were dominated by state enterprises, and were generally operating at low levels of efficiency and representing a burden on the government budget (EC, 2009). The macroeconomic volatility and instability resulted in a very poor business climate.
1997-1999: Worsening conditions
The Asian and Russian crises in 1997 and 1998 negatively affected the confidence of foreign investors in Turkey (IHS, 2000). As a result, capital inflows into Turkey went down sharply and economic growth slowed down from 7.5% in 1997 to 2.5% in 1998. The slowdown in growth further undermined the confidence of foreign investors. In August 1999, a devastating earthquake hit the industrial heartland of Turkey, further deteriorating Turkey’s economic performance. The strong fall in capital inflows and the devastating earthquake pushed the economy into a deep recession. In 1999, the economy shrank by 3.6%. The budget deficit reached 12% of GDP and public debt rose to 40% of GDP.
Figure 2: Treasury bill rate
Source: EIU, Akyüz and Boratav
1999: Disinflation program
On 22 December 1999, just after the elections, the new government and the Central Bank of Turkey (CBRT) announced an exchange-rate based stabilization program to decrease the inflation rate to 10% by end-2001, supported by an IMF stand-by agreement worth USD 4bn. The program had the general goal of freeing Turkey from inflation and enhancing prospects for growth. The main element of the program was a pre-announced crawling peg exchange rate regime. Turkey requested the stand-by arrangement to raise international reserves available for balance of payments needs, provide a clear sign of confidence in the program, and catalyze support from public and private international investors. Furthermore, the program consisted of the privatization of large state-owned enterprises, including Turk Telekom, budgetary discipline and the regulation of the banking and financial system (Akyüz and Boratav, 2003). As a result, inflation started to fall in early 2000, but at a slow pace. Interest rates eased as a result of increasing capital inflows, a decline in risk premiums and the exchange rate anchor. Since they fell significantly faster than inflation, real interest rates turned negative (see Figure 2). However, the banking crisis broke out before inflation was brought under control. While the focus of the program was on macroeconomic imbalances, the government did not address the severe vulnerabilities in the banking sector.
Banking sector fragilities
In the years preceding the crisis, Turkey had a very fragile banking system. There were four important weaknesses. First, the banking sector had been deregulated and granted deposit insurance without effective supervision (Akyüz and Boratav, 2003). Second, the banking sector had become the main instrument of government financing, putting short-term borrowing from depositors and investors into government debt (EC, 2009). In 2000, more than half of the interest earning assets of private banks consisted of domestic government securities, making the bank’s earnings highly dependent on high-yielding treasury bills (Özatay and Sak, 2002). The quality of the government securities was directly related to expectations regarding public debt sustainability. Third, the Turkish banking system was highly reliant on foreign funding, making the banks vulnerable to sudden capital reversals. Especially private banks increasingly relied on borrowing abroad and resident foreign exchange deposits for investment in Turkish treasury bills, as almost two-thirds of the liabilities were denominated in foreign currencies (Akyüz and Boratav, 2003). This way, the banking sector was severely exposed to exchange rate risk. Fourth, the banking sector faced a large structural maturity mismatch. Private commercial banks were unable to borrow long-term in the domestic currency. Meanwhile, banks lent to the government and companies in relatively long terms.
Figure 3: Banking system losses
Source: Özatay and Sak
An important aspect of the Turkish banking sector was that the four state-owned banks held almost 30% of total assets in the banking sector in 1999. These were operating next to around 50 relatively small private banks. State banks suffered from large so called ‘duty losses’ (see Figure 3), which they had accumulated as they were forced to extend subsidized credit to the agricultural sector as well as craftsmen (BRSA, 2010). Also several private banks turned out to be insolvent. In 1998, the ratio of nonperforming loans (NPL) in the banking sector started to increase rapidly, reaching 11% in 1999 (Özatay and Sak, 2002). During the recession in 1999, thirteen small and medium-sized banks were taken under the full control of the SDIF (Akyüz and Boratav, 2003). However, this did not alleviate the banking system’s problems.
Throughout 2000, legislation on the privatization of public banks was repeatedly delayed by political wrangling (Özatay and Sak, 2002). Given the weakness of the banking system, this increased tensions in the markets. In October, criminal investigations into fraud at 10 private banks taken over by the SDIF were started. These developments strengthened the impression that there were large problems in the banking sector. As a result, banks closed their interbank credit lines to vulnerable banks in order to take no further risks, and foreign investors withdrew their funds, triggering the banking crisis.
The damage in the banking sector
The Turkish banking sector faced significant losses during the crisis. The sharp fall in prices of Turkish lira (TL) treasury bills in November 2000 negatively affected the banks’ balance sheets (Özatay and Sak, 2002). As meanwhile interbank rates increased sharply, this mainly affected banks under SDIF control and state banks with excessive interbank funding requirements (BRSA, 2010). The funding loss for private and foreign banks remained limited. In February 2001, particularly private banks made large losses following the devaluation of the Turkish lira, due to their un-hedged foreign currency position. The contraction in economic activity resulted in a sharp deterioration in loan quality, as the ratio of NPLs reached 19% in 2001.
These losses had large consequences. During 1999-2001, the SDIF had to rescue 18 banks in total, together holding 12% of total assets in the banking sector. The banking sector asset size decreased by 12.6% in real terms during the crisis, while the contraction in loans was even 29%. Also, the number of banks, branches and personnel decreased considerably.
Restructuring of the financial sector
In December 2000, just after the turmoil in late November, after meetings between the Turkish authorities and major foreign banks, foreign commercial banks committed to maintain exposure to Turkish banks and companies, in the form of interbank and trade related credit lines in existence at the time (Barkbu, 2011). The commitment was intended to complement the calming effect of the IMF assistance and to keep the external funding base for Turkish banks stable. However, the commitment ended in February 2001, when turmoil on the financial markets erupted again.
Immediately after the crisis, far-reaching reform and policy initiatives were taken. In May 2001, the Banking Regulation and Supervision Agency initiated a comprehensive restructuring program for the banking system (BRSA, 2010). The program had four main pillars:
- A restructuring of the state banks
- A prompt resolution of the SDIF banks
- A strengthening of the private banks
- A strengthening of the regulatory and supervisory framework.
To strengthen the capital structures of state banks, a total of USD 22bn was provided by the SDIF at the end of 2001. Regulations leading to so called ‘duty losses’ were abolished. Furthermore, state banks were reinforced through mergers and privatized. Banks under SDIF control were liquidated, merged with or transferred to another bank. In addition, USD 28bn in total was transferred to banks under SDIF control to strengthen their capital structures. The budget of the SDIF was financed by the Turkish government, which issued special bonds. The costs amounted to 31% of GDP in 2001. Consequently, public debt rose to 74% of GDP the same year.
The regulatory and supervisory framework was strengthened by various amendments in banking laws, in line with international best practices and particularly EU directives. To minimize financial risks, capital adequacy ratios for Turkish banks were raised to 12%, while international regulations required only 8% (EC, 2009). Lending in foreign currencies was only allowed for companies and individuals with revenues in foreign currency, minimizing the foreign exchange mismatch on bank balance sheets. Other regulations consisted of the inclusion of repo transactions on balance sheets. Futures, option contracts and other derivative products were included under the definition of credit, to limit overall exposure to counterparties.
Despite the elevated level of public debt, Turkey did not default on its sovereign debt. In June 2001, the government, faced with rollover problems, arranged a voluntary debt-swap operation (RI, 2012). Turkish lira (TL) government securities held by Turkish private banks were exchanged for USD-denominated bonds, to lengthen the maturities of government debt and help banks to cover their negative foreign exchange positions. In exchange of assuming the exchange rate risk of domestic banks, maturities were lengthened. While the average maturity of the old TL bonds stood at around 5 months, the new USD bonds had an average maturity of 36 months.
Not only public debt but also corporate debt was restructured, to help companies recover from the crisis and reduce the level of NPLs. Due to the large devaluations of the Turkish lira in February 2001, many companies were unable to service their external debt. To make it possible to continue their activities, a voluntary program for restructuring the manufacturing companies’ debt to the financial sector, the “Istanbul Approach”, was introduced in June 2002 (RI, 2012). A total sum of USD 6bn corporate loans was restructured, mainly by extending maturities.
Against the background of the economic crisis, the AKP, led by Erdogan, won the elections of November 2002. Various measures were taken to improve the business environment. A new Law on Foreign Direct Investment reduced the bureaucracy for foreign companies and resulted in a significant entry of foreign capital into Turkey. Other important reforms consisted of a large profit tax cut and a simplification of tax legislation. State enterprises were finally privatized. As a result, the AKP received a lot of goodwill in Turkey and abroad. The economic reforms under the AKP are regarded as factors that helped Turkey to achieve greater macroeconomic stability and high levels of growth in the following decade (Ugur, 2009). Between 2002 and 2007, the Turkish economy grew by 6.7% on average (EIU, 2012). The economy also recovered vigorously the global economic crisis in 2009. As a result of tight fiscal policy and high economic growth rates, public debt started to decline afterwards to 51% of GDP in 2005. Inflation first eased to single digits in 2004, down from over 80% during the 90s.
Prior to the crisis, the Turkish economy faced serious macroeconomic imbalances and a fragile banking sector. Concerns over the weak banking sector and slow reforms, together with a decline in capital inflows, triggered the banking crisis, followed by a currency crisis. Interest rates skyrocketed, several banks had to be rescued and the IMF assisted Turkey with almost USD 30bn in total. After three months of turmoil, exchange rate controls were abandoned. A successful debt-swap in June 2001 prevented a sovereign default. Partially thanks to far-reaching structural reforms the economy quickly recovered. Bank regulation and supervision were strongly improved. The reforms contributed to persistent banking sector stability during recent crisis years. Afterwards, the economy vigorously recovered from the crisis.
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Barkbu, B., Eichengreen, B. and Mody, A. (2011), International financial crises and the multilateral response: what the historical record shows. NBER Working Paper 17361
BRSA (2010), From Crisis to Financial Stability (Turkey Experience, Working Paper
EC (2009), Growth and economic crises in Turkey: leaving behind a turbulent past? Economic Papers 386
IHS (2000), Bank Privatisation Finally Agreed
Özatay, F. and Sak, G. (2002), Banking Sector Fragility and Turkey’s 2000-01 Financial Crisis, Brookings Trade Forum 2002: Currency Crises, Washington D.C.
RI (2012), Financial Restructuring. Rabobank International Turkey
Turkije Instituut (2013), De AKP en een nieuw millennium
Ugur, M. (2009), Turkish economic policy under AKP government: an assessment for 2002-2007