In an environment where no one trusts another, credit channels are naturally obstructed. However, we have to make the credit channels work as soon as possible to slow down the economic contraction and ensure recovery.
We need a mechanism that will decrease risk perception of banks (that will diminish the inconfidence in the corporate sector) so that the banks will not act reluctant in extending credits. A third party to intermediate between the bank and the company gives an opportunity to fulfill this aim.

Guarantee system
My suggestion as I frequently touched upon since October 20, 2008 had the potential to ensure the functioning of TL credit channel. The fund to be established by means of the resources to be allocated from the budget (up to 0.8 percent of the national income) would provide guarantee for a certain amount of the credits banks extend. Let us call this the credit guarantee fund (CGF).

Things were harder when foreign exchange credits are considered. Corporate sector has received foreign exchange credits from banks abroad and a high proportion is due in 2009. If they cannot receive new credits to pay the due ones, they will have to repay their foreign loan out of their own resources or by receiving foreign exchange credits from domestic banks. This will either mean the shrinkage of companies (fall in production) or a rise in the exchange rate.

Solving this problem, seemed to be relatively harder than eliminating the obstruction in the TL credit channels, even the foreign exchange resources were deposited to the CGF as there were no foreign banks to care for or act upon any guarantee. They were all dealing with their own problems.

The new recommendation I touched upon yesterday solves this problem. Because in this mechanism, there is no need to say the foreign bank 'I will provide you a guarantee but you will renew the credit'. The mechanism involves the Central Bank (CB). The CGF provides the guarantee not to the foreign bank but to the CB. A significant part of the credit amount (for instance 70 percent) is given by temporarily lowering the CB reserves. And this feature ensures the functioning of the mechanism.

The mechanism previously recommended for TL credits works in any case. However, it functions more efficiently if the CB credits steps in, in a similar way as done in foreign exchange credits. Or, a combination of the two can be done: The CGF provides guarantee for a low amount of each 100 dollars of credits so that the risk the commercial banks undertake increases.

What does the system imply and what are the risks? Let us elaborate on this.
Central Bank: Does not undertake a risk. Since the commercial bank adds a certain amount to the fund received from the CB and then extends the credit to the company, CB reserves fall down at first. As the credits become due, the CB collects the receivables and the reserves rise to the original level. In case an agreement is signed with the IMF, a part of the IMF fund can be transferred to the central bank and the problem concerning the temporary fall in reserves can be eliminated. Furthermore, the CB will earn interest revenue over the funds given to the commercial bank.

On the other hand, if the credit given to the company becomes non-performing, the CB does not undertake any risk as it in any case collects the receivables from the involved commercial bank. Therefore, the only challenge for the CB would be to explain the whole world why it was involved in this system. However, since this kind of measures is introduced in each country, this will not be a major problem.
Commercial Bank: Gains advantage as it will return to its original function (extending credits). However, the interest profit equals to the difference between the credit interest rate for the company as jointly decide with the CB and the interest rate for the CB borrowing. Therefore, interest earnings are limited from the above. The risk of the bank arises from the amount of the credit not covered by the CGF guarantee. In our previous example, this amount was 30 dollars per each 100 dollars of credit.
CGF and the Treasury: These two must be addressed together as the Treasury invests capital in the CGF. Therefore, if the company fails to repay the credit, the Treasury undertakes the risk. In our specific example, 70 dollars out of every 100 dollars of credit extended by the commercial bank is at the risk of the Treasury. Under normal conditions, the ratio of non-performing credits to the total credits extended by the commercial banks is 3 to 4 percent. In this context, let us assume that the ratio for the credits to be extended under this system will be 10 to 15 percent. Since the CGF will receive a commission from the companies in exchange for the guarantee, the rate of commission can be set to meet the loss originating from the non-performing loans, completely or partially.
But, what will be the source of the funds to be allocated by the Treasury? If an IMF agreement is signed, for instance 3 billion dollars out of the IMF fund can be allocated for this system and invested in the CGF. Since the CGF will not directly extend credits but will use the resources to as capital, it can provide guarantee for, let us say 18 billion dollars of credits with a leverage rate of six.
Company: The system does not impose additional risks on the company. The company is faced with same risks of receiving normal credits. And the benefit of the system for the company is obvious: It has access to foreign exchange credit.
Tax-payers: If desired, the fund can be abolished as the crisis ends and things normalize, for instance in 2011. So, the profit of the fund is transferred to the Treasury. If there is a loss, it is imposed on the shoulders of all tax-payers. However, as the economy will shrink to a higher extent in the absence of such fund, in particular a certain part of the society (for instance, masses will lose their jobs) will be harmed more deeply. The evaluation regarding which outcome is more desirable will be made by the government and ultimately by the voters.

This commentary was published in Radikal daily on 23.02.2009