I am not arguing that the latest BRSA decisions were in the wrong direction. But the BRSA did not take a decision that will strengthen the effectiveness of the CBT decisions.

A number of articles and comments were released in the last three days following the latest decisions of the Banking Regulation and Supervision Agency (BRSA). The decisions were on consumer loans excluding vehicle and mortgage loans. It is maintained that with the BRSA decisions, interest on the mentioned loans will increase slightly which will limit the credit expansion (as desired) by affecting the rise in credit demand negatively. It is a subject matter of another discussion to what extent these claims are valid.

As you might have noted, the fundamental objective of the former Central Bank (CBT) decisions and the recent BRSA decisions is the same: They aim to slow down the credit expansion to some extent. But what sticks in my mind is different. Today, I want to address the BRSA decisions with respect to coordination with the CBT. Let me open it up.

Recall the main reason why the CBT decisions proved ineffective so far: In order for the CBT's policy rate for the current interest targeting regime to be effective, the CBT has to provide the short term (weekly) liquidity banks demanded. Otherwise, the market rate based on the supply and demand in the short term money market substantially diverges from the policy rate. If this turns out to be permanent, the policy rate loses its meaning and purpose. In other words, the CBT will have to abandon the inflation targeting regime. But since the CBT states that they stick to the regime, it is evident that the market rate must not be substantially different than the policy rate.

Under these circumstances, in order for the CBT decisions to serve the purpose, either the banks should cease increasingly demanding short term funds from the CBT or the BRSA should discourage the demand via decisions in the right direction. I have written several times why this cannot be attained spontaneously: to begin with, the maturity of deposits is quite short so that banks can offset the amount seized via short term borrowing from the CBT. Second, in order to prevent this, there must be a risk that the interest on borrowing from the CBT increases the next time. However, in that case the CBT either has to allow the market rate to diverge substantially from the policy rate or increase the policy rate directly. I have already expressed that the first option is quite dangerous. And the second one does not pose a significant risk against banks, for two reasons: the maturity of the deposits seized by the CBT is 50 days. In this period the bank can at most take two monetary board decisions. How much can the CBT increase the policy rate? What is more, such an act contradicts with the its policy aimed to reduce the short term capital inflows and the interest cuts the CBT has initiated at the beginning of the year under the projection that inflation rate moves in line with the targets. Then, the BRSA should step in. 

Short term borrowing need to be punished

The most important step the BRSA has to take in order for the CBT decision to be effective is to punish short term borrowing from the CBT. If this is done, banks will not be able to increase their demand for short term CBT funds to offset their loss from the rise in reserve requirements. Of course they will be able to continue short term borrowing from the CBT to fulfill daily transactions; but the volume of borrowing will not increase as substantially as it is today.

This step was not taken. As you might have noticed, I am not arguing that the latest BRSA decisions were in the wrong direction. I do not question the possible effects of the decisions, either. What I am trying to emphasize is that while steps are taken to establish the Committee on Financial Stability at the risk of challenging the future of independence of institutions in question, the BRSA, an institution involved in the committee, did not make a decision to strengthen the effectiveness of the former decisions of the CBT, another institution involved in the committee. Maybe they debated the issue and did not deem such a decision necessary. Then, this means that the dilemma facing the CBT decisions is not well understood even by the decision makers.

This commentary was published in Radikal daily on 23.06.2011