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A new recommendation to tackle the crisis
Both domestic and foreign credit channels came near to a halt. If the credit channels do not start working again, Turkish economy will contract significantly. I have discussed many times in this column what can be done to prevent this. The first recommendation was enabling the credit channel to function through the credit guarantee fund.
On Friday, I received a letter criticizing that recommendation and ensuring particularly the feasibility of the foreign currency credit side of the recommendation. I will not give the name as he/she requested so. I will just say that he is a friend with who I entered very useful discussions and developed monetary policy recommendations at the Central Bank after the 2001 crisis. Unfortunately, he is currently not working at the Central Bank in a period where we need him the most.
From my article on October 20, titled "What must be done?" "... With a third party providing guarantee, the risk the bank extending the credit will face decreases... The fundamental principle here is that both the borrower and the lender take risks. Therefore, the party providing the guarantee does not do so for the whole credit amount (for example, for 80 percent of the total at most). Upon the guarantee provided, the party receives some collateral. Therefore, the risk is shared among those three parties.
... It will be useful to elaborate on the probability to build such fund using public funds. For instance, let us assume that a 10 billion dollar fund is built. Let us think like a conservative; under leverage rate of six, this fund can receive collaterals amounting 60 billion dollars. S the total credit stock of Turkey is considered, this amount appears to be quite generous."
Then, in the studies at TEPAV we calculated that 0.3 to 0.8 percent of the national income will be enough to finance this fund by the public sector. Thus, it was a feasible policy recommendation.
The article continues like this: "The 'mother' of questions is waiting there for an answer: Can we design a mechanism that will ensure the functioning of the foreign credit channels even slightly?" I tried to answer the question in my article on October 30, 2008 titled 'What shall be done? (2)":
"... We will eliminate the awkwardness in the balance sheet of the CB (refers to the foreign currency deposits in the balance sheet). We will build a fund or something like that. The CB will transfer both the deposit debt and the foreign reserves kept in exchange of the debt to this fund... The fund can be designed as a bank or credit guarantee fund, or a mixture of the two. If it is to work as a bank, it can directly extent credits to companies in need of foreign exchange. If it works as a guarantee fund, it can provide guarantee for the credits foreign banks extend to Turkish companies. Therefore, it can provide guarantee for amount of credits high above its deposits. This is the main advantage over the first alternative. However, if the foreign banks will not start extending credits even if provided with collateral, the second alternative does not work. If so, the fund works like a bank."
The new recommendation incorporates the Central Bank into the issue in a different way. The difference seems to function in particular with respect to the operation of foreign currency credits. The new recommendation proposes the following system to provide guarantee for foreign exchange credits (I am writing it the way I understood without giving technical details):
Treasury: Transfers funds to the Credit Guarantee Fund (CGF) in foreign currency (makes capital investment). A part of the fund to be received from the IMF can be used for this purpose.
Company with foreign exchange earnings: Applies to the bank to receive credit in foreign currency (assume he asks to receive 100 dollars).
Bank: Evaluates the credit application. If the bank considers that the company is eligible, it applies to the CGF and asks for guarantee for a part of the credit. Assume that the amount is 70 percent of the credit amount (70 dollars).
CGF: Evaluates the application of the bank and the company subject to the application and makes a decision as soon as possible. If the decision is affirmative, the CGF provides guarantee for the 70 percent of the total credit in exchange for a commission from the company, and then informs the bank of the decision.
Bank: The KGF informs the CB about the guarantee and the bank requests from the CB rediscount credit of 70 dollars in exchange for the guarantee.
Central Bank: Extends rediscount credit of 70 dollars to the bank, for example under Libor + 0.5 interest rate.
The source of the credit might primarily be a part of the IMF fund to be received. Second, half of the foreign exchange borrowing limits of the banks as provided by the Central Bank can be allocated with this purpose.
Bank: Adds 30 dollars to the 70 dollars received from the Central Bank and extends the credit to the company. Central Bank and bank agrees transparently on the upper limit of the cost of the credit to the company (credit interest rate).
If the credit becomes non-performing: The GCF pays the 70 guarantee to the bank. This bank adds 30 dollars to this amount and pays the 100 dollars rediscount credit loan to the Central Bank.
If the credit does not become non-performing: The company pays the bank 100 dollars credit amount as well as interest amount. The bank gives 100 dollars to the Central Bank and repays the rediscount credit loan of 100 dollars as well as the interest amount.
This system seems to work. So, what are the risks and the distribution of risks? What does this mechanism mean in fact? Answers together with the TL credit mechanism will be given tomorrow.
This commentary was published in Radikal daily on 22.02.2009