We can expect to hear new policy decisions.

I am looking for an answer to the question I put on Monday: Will the measures introduced by the Central Bank of Turkey (CBT) and the Bank Regulation and Supervision Agency (BRSA) enable a slowdown in the hike in credit demand? In fact statements by the Central Bank when declaring the decisions and New Year's greeting speech by Minister Ali Babacan sort of give an answer to this question. The common feature of the statements is that new decisions are soon to come.

There is a wide academic literature on the 'credit channel' which analyzes the impacts of the monetary policy on the economy through credits extended to the corporate sector and consumers. The research on this subject has two branches. First focuses on the effect of the changes in monetary policy on the eligibility of borrowers and lenders. The second branch is known as the 'bank-credit channel' and concentrates on the amount of funds lenders can extend as a loan rather than the eligibility of lenders or borrowers. 

To reduce credit volume
There is no need for any further detail. It is obvious that the latest decisions are targeted to play a role rather on the bank-credit channel. To put it in short, the target is to reduce the reserve amount banks have to deposit at the Central Bank in exchange for the deposits they collected. This way, banks will be able extend lower amount of credits relying on short term funds.

The primary goal therefore is to reduce the amount of loans extended relying on short term funds. It will obviously be pleasing if the rise in credit volume is limited even slightly. It appears that banks' maintaining the rise in credit volume relying on long term funds does not seem to bother anyone unless this puts an upwards pressure on inflation rate.

There are two important factors for the monetary policy affect the credit supply at the desired degree: Banks can find new types of borrowing that are not subjected to required reserve ratio and extend new loans with funds accessed via these new channels. So banks should not have such an opportunity for the rise in required reserve ratio to be effective in limiting credit supply at the desired degree. Second, if the corporate sector has access to new sources of credit other than banks, it is not possible to limit the hike credit supply at the desired degree. Please note that I insistently say 'at the desired degree'. Such measures will obviously have a certain effect in any case: For instance, small and medium size enterprises might not gave access to foreign borrowing. But if the main goal is to limit rapid credit expansion relying on short term funds, the channels reducing the effectiveness of the measures should also be 'blocked'. 

Capital controls
Distinguishing feature of the year 2010 for the economy is that high current account deficits are almost completely financed with short term foreign borrowing. When you go deep in detail, you come across with new distinguishing features: First, foreign funds in form of deposits have elevated significantly. Second, short term loans of the banking sector have never increased as substantially as in 2010.

The moral of the story is that if it is targeted to restrict banks to expand credit volume relying on short term funds, other channels, the swap channel for instance, should also be taken into account. And once again the issue eventually locks at capital controls which are not even mentioned as an option.

Note: My commentaries will be published only on Tuesdays and Thursdays until a new arrangement.

This commentary was published on Radikal daily on 06.01.2011