Macroeconomic problems are a concern for BRSA as much as they are for CBRT.

Title of Sefer Levent's Saturday commentary in Radikal was 'Laughs in London, conflict in Istanbul'. The commentary begins with the following sentence: "Central Bank of the Republic of Turkey (CBRT) President Durmuş Yılmaz and Banking Regulation and Supervision Agency (BRSA) President Tevfik Bilgin are in conflict for the second time on required reserve ratio."

The reason for the conflict is the decision the CBRT took on early October and continued last Friday. The mentioned decision is on required reserve ratio. Banks should hold a certain proportion of the collected lira deposits at the CBRT; therefore such proportion cannot be solved to customers in form of loans. The exact proportion to be kept depends on the required reserve ratio set by the CBRT. Higher the ratio is, lower the loan banks could extent will be.

Ratio was cut during the crisis

Required reserve ratio was cut during the crisis due to the liquidity shortage in the market and banks' reluctance to carry out interbank operations. CBRT hiked the ratio at early October and announced that a further rise will take place before the end of October. This was realized last Friday and the ratio was pushed back to the pre-crisis level. At the beginning of October when the initial decision was made, BRSA reacted indicating that they were not informed of the timing of such action. The commentary by Mr. Levent suggests that the BRSA has sustained the reaction. We witness rapid credit growth and the CBRT is worried about the potential risks such expansion might lead to. Let me try to explain the view of the CBRT, being a person that has gone through a similar process as an executive at the Bank.

We went through the same thing in 2004-2005 period: the CBRT was concerned with the problems created/to be created by rapid credit expansion. The issue was not approached solely in terms of inflation. The Bank was unease also about the contribution of such expansion to growing current account deficit and disturbing banks' balance sheets in the future (such as the hike in non-performing loans). 

Imports are growing
For instance, consumer loans in particular push up directly importation of consumption goods. This both heats up the economy and boosts current account deficit. But if you read this picture solely with respect to the profitability of banks; consumer loans ensure diversification of their credit portfolios, reduce risks and affect profitability positively. But this is an 'instantaneous' or 'myopic' point of view. Academic research on banking crises reveals that more than half of earlier banking crises followed from rapid credit expansion.

One way to cool down the credit expansion is to increase interest rates. Another option would be to push up required reserve ratio. However if inflation rate is doing fine, choosing the former would be redundant with the sole purpose of limiting rapid credit expansion. And at this stage should the BRSA step in.

Since the CBRT has cut the required reserve ratios in the face of the global crisis; i.e. in the face of extraordinary conditions, the ratio was pushed back upwards. But indeed it is the BRSA that should take the lead role against such rapid credit expansion. This cooperation is necessary for both financial stability and to prevent superfluous hikes in interest rate.

An 'aphorism' from the 2004-2005 period: Macroeconomic problems are a concern for BRSA as much as they are for the CBRT. Fulfilling its responsibilities solely through a personnel focusing on microeconomic regulations and supervisions does not meet the expectations from the BRSA. They should mobilize good macroeconomists, also.

This commentary was published in Radikal daily on 14.11.2010