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“Masallah, you are doing very very well”
State Minister Mehmet Şimşek addressed to corporate sector, banking sector, households and in general all of us "masallah, you are doing very very well". I wonder what is that we miss but honorable State Minister see.
Turkish Statistical Institute (TURKSTAT) recently announced February Industrial Production Index. Industrial sector is continuing to melt down by two-digit rates. As you may remember, the said index fell down by 21.3 percent in January. Unemployment rate is still going up. Employment Institution (İŞKUR) recently announced that the number of people receiving allowance from unemployment insurance fund will increase by 67 thousand from January to March. These figures indicate that the contraction in real sector will at full speed continue in the first quarter of the year. On the other hand, profits of the banking sector rose by 23 percent in nominal terms in January as compared to the same month last year. In the meanwhile, State Minister Mr. Şimşek added insult to injury by a statement making us say "are you kidding me?" Mr. Şimşek said "You are doing very very well." According to Honorable Minister, both the banking sector and households were doing very well. And the situation of the corporate sector was not bad at all. So, under these circumstances, is the coast clear? Is the Honorable Minister right? No, let us see why.
Observing the asymmetry between the real and the financial sector, the first question to ask is this: Why does the profit rate of the banking sector rises? It is quite simple; there are two reasons: First, for a certain period of time, the banking sector is cutting down the volume of loans to the corporate sector and investing the funds they hold to Treasury bills and government bonds. During the last five months, government debt security (GDS) portfolio of the banking sector increased by 20.3 billion TL while loan portfolio decreased by 9.6 billion TL. GDS interest rate fell down by percent during the same period. So, what happened? As the demand of the banking sector for GDS went up rapidly, GDS prices increased and GDS interest rate decreased. So, what happened? The value of existing GDS stock of the banking sector increased. So, what happened? Banks received additional profit out of their GDS portfolios. The rise in the profitability of banks stem from their GDS portfolios the volume of which increased due to withdrawal of corporate sector loans and the corresponding decrease in interest rates. The rise in profitability is a result of reluctance to extend loans to the corporate sector due to rising risks. It is not good news at all. This is the first point.
Second, in this context, interest rate cuts by the Central Bank of Republic of Turkey (CBRT) helped banks to record higher rate of profits out of their GBS portfolios. Let us emphasize it: Rate cuts by the CBRT were beneficial for only banks in recording profits. The benefit of the rate cuts for the corporate sector was quite limited. Why was that so? The reason is quite simple: Banks hesitate to extend loans to the corporate sector. Why is this so? This is so because the domestic and foreign sales of the corporate sector have been decreasing rapidly. So, what? Interest rate cuts by the CBRT only help the banking sector in folding their profits. And this is not good news at all. This is the second point.
The conclusion drawn from the answer to the first question is: Banks lending to the state rather than the corporate sector increase their profit rate. And the second question: So, under such a condition, is it necessary to say "the banking sector is doing well" as Mr. Şimşek did? No, it is not. If the companies operating in real sector are not doing well, the banking sector of that country cannot be doing well. That is it. Why? The reason is quite simple: If almost 30 percent of bank assets are composed of GBS portfolio, 50 percent of assets must still be composed of loans extended to companies. These companies had received those loans assuming that they will sell 100 units of items; but today, they cannot sell 100 items. Or, they cannot receive the amount to be received for the sold 100 items due to price cuts. What must be expected under these circumstances? The rise in profits of the public sector will compensate for the non-performing loan portfolio the volume of which will, in any case, increase.
So, what? It is not right to say "Banking sector is doing well." If the corporate sector of a country is in stress, the banking sector is going to be in stress. It happens tomorrow if not today.
So, where is the exit? There are three prerequisites to find the exit: First, the reality must be completely embraced and be communicated to the public. It is wrong to say "you are doing very well" if you do not have a solid ground. Second, it is necessary to take measures to strengthen bank capitals right away. Third, corporate and banking sectors must be presented an exit strategy. Local elections in Turkey ended two weeks ago. And none of the three prerequisites has been fulfilled yet.
This commentary was published in Referans daily on 09.04.2009