The new monetary policy implemented by the CBT can hardly be successful without the support of the BRSA.

Can an independent authority (The Central Bank of Turkey - CBT) take a decision that will not give results unless supported by another independent authority (The Banking Regulation and Supervision Agency - BRSA) and expect the latter to act in compliance? In that case, who will ensure the coordination?  Even if the coordination is established, how will it be made binding? Can the authority which the mentioned institutions are independent from (The Treasury-The Minister of Finance) secure that compliance is binding? If it can, does independence not vanish? The ongoing debates about the new policies of the CBT do not focus on these questions. However these are of critical importance since the new monetary policy implemented by the CBT can hardly be successful without the support of the BRSA. Let me stress the reasons once again:

Though went out of the scope of the usual inflation targeting, the CBT did not declare that the regime was abandoned. In contrast, the Monetary Policy Council (MPC) announces interest rate decisions following each meeting in reference to the difference between the inflation expectations and the inflation target. Interest rate decisions are discussed on the television, newspapers and in financial circles before and after all MPC meetings.

The core principle of the inflation targeting regime, both for the usual or the unusual one, is that the short term interest rate resulting from the interbank operations in the short term money market and the weekly policy rate (repurchase rate) announced by the MPC (or the CBT) should be close in value. So that the policy rate can affect the longer term interest on deposits and loan as well as the benchmark interest on Treasury bills via the market-determined short term interest rate. If it cannot or if the mentioned interest rates diverge from the policy rate, the monetary policy decisions will prove inefficient.

The interest rate announced by the MPC (the CBT) cannot affect the short term market rate via "arm power". If the borrowing requirement is high and if this requirement tends to push the short term market interest rate above the rate announced by the MPC, the CBT lends to banks. In contrast, if short term liquidity is abundant so that banks face difficulty in selling these funds to other banks, that is, if short term interest rate tends to decrease below the MPC rate, the CBT borrows from banks.

Turkish financial system has been facing liquidity constraints for a long time. If the CBT does not lend short term (weekly) liquidity to banks, short term interest rate will exceed the MPC rate causing a divergence. In that case, in order for the MPC rate to have a meaning, the CBT has to respond to banks' needs and provide liquidity.

As the CBT increases the reserve requirements, banks will have to keep an increasingly higher proportion of deposits with 60-day maturity in average. If they do not want to lose their share in the loan market, they can increase weekly borrowing from the CBT to compensate for the deposits it seized with an aim to reduce the credit supply.

Data for July 7 suggest that banks are still playing this "game of compensation". The CBT still has to give back the liquidity withdrawn. Thus, credit supply does not slow down in spite of the substantial increase in reserve requirements (this is what the figures for the end of the June reveal).

Under these circumstances, it is evident that, in order for the increase in reserve requirements to be effective, the BRSA must set a ceiling for weekly borrowings from the CBT. The BRSA's latest decision to increase capital reserve requirements, the continuance of efforts to this end and/or the rise in the global risk appetite might affect the credit supply. But we should be cautious: These decisions and developments could have been effective even if the CBT have not introduced the decisions on reserve requirements. If the only aim is to make sure that the CBT decisions gain a purpose (with the aim to protect the prestige of the CBT, for instance), a decision similar to that I mentioned in point seven will be needed. This, however, takes us back to the first question above. I will continue.

This commentary was published in Radikal daily on 12.07.2011