The objective of the CBT to limit the credit expansion was relevant. But why did the BRSA not take the decision needed so as for the CBT decision to work?

News spread that Merkel and Sarkozy failed to reach an agreement in their latest meeting, too. It is told that Merkel reflected the opinion that "Steps must be taken to get prepared for Greece’s default” while Sarkozy said that the European Union was a family and that the family should not abandon Greece.

One story I read explains the underlying reason for the difference in stances of the two leaders as follows: French banks are holding a higher proportion of Spanish, Irish, Italian and Portuguese assets compared to German banks. Therefore, in case of a possible default, French banks will be affected at a larger degree and be in higher need of capital support.

This is an understandable explanation, though only with a myopic approach. Anyway, what matters for the purposes of this commentary is that the motivation for economic policies decided (or not decided in the case with Europe) would not always be “rational”. In such cases, “unawareness” steps in. Sometimes lack of information leads the situation and in some other cases a “necessary” decision cannot be made due to political reasons. It will not be assertive to say that the latter generally has a larger influence on economic policy decisions. Under some conditions, a certain decision must be accompanied by some others to be effective. If the decisions relate to different authorities and if there is no coordination mechanism among these, only a part of the necessary measure package might be taken in the case of which desired outcomes cannot be reached.

This was the exact situation in Turkey between November 2010 and July 2011 (August 2011?). In November 2010, the Central Bank of Turkey (CBT) increased reserve requirements in order to slow down rapid credit expansion. The CBT this way increased the amount of reserves banks had to keep at the CBT in exchange for the deposits they collected with the aim to decrease the credit supply. The objective the CBT set was quite correct since rapid credit expansion was risky, as experience of financial crises suggested, and in the case with Turkey, the expansion was enabled by strong short term foreign exchange (FX) inflows (foreign capital inflows) which could be reversed suddenly.

Why have I evoked this old subject? The reason for this is hidden in presentations the CBT delivered recently. Those presentations involve a graph that shows the changes in credit volume in the mentioned period. Two sub-periods are distinguished. First is the period when the CBT started to increase reserve requirements. Second is the period when the Bank Regulation and Supervision Agency (BRSA) stepped in, following general elections. Credit supply did not decrease as desired but increased rapidly until the second-sub period.  The pace of increase in credit supply tended to decrease only after the BRSA stepped in.

The question is the one that I have been asking insistently since then: why did the CBT took a decision which could not have worked unless the BRSA stepped in? Or let me to reframe it as follows given that it was the right step to limit the credit expansion: Why did the BRSA not take the decision needed so as for the CBT decision to work? Due to unawareness? Lack of information? Political viability? Which one?

This commentary was published in Radikal daily on 08.10.2011