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    Thoughts foreign exchange credit gives rise to

    Fatih Özatay, PhD18 June 2009 - Okunma Sayısı: 1021

     

    Over the period from the beginning of June important economic decisions have been announced. I believe that the mentioned decisions are favourable in general. However, this judgement does not mean the decisions pose no risks nor have no deficiencies. In this context, I would like to address the decisions concerning foreign exchange credit.

    The decision allows firms that cannot receive foreign exchange credits from banks as they have no foreign currency earnings use foreign exchange credits provided that the amount and the maturity period are over a certain level. Though it seems to increase the exchange for the corporate sector, the decision does not elevate the current risk since such companies were already able to receive FX credits from foreign banks as well as branch offices abroad of national banks.

    But, pay attention: It is only the 'current exchange risk' that does not rise. And that risk is already at a considerably high level: That firms that have no foreign currency earnings use foreign exchange credits were able to receive FX credits from foreign banks as well as branch offices abroad of national banks and even receive foreign exchange indexed credits from domestic banks as per the previous practice made those firms exposed to exchange risk.

    This is a highly important issue. When announcing this decision on Monday with a press release, it was underlined that to receive foreign exchange credit, those with no foreign currency earnings must borrow at least $5 million and it is expressed that in that case, in the framework of market economy banks will make risk assessments more cautiously.

    However, certain things must be kept in mind: First, the global crisis originated from the country where the rules of the market economy apply at the highest extent possible; and from the financial sector. We all know what has happened. Second thing to note is the biggest recent contribution of the theoretic literature: This literature highlights persistently how balance sheet weaknesses of both the banking and the corporate sectors companies have the potential to become a big pain in the neck of the economy.

    Among these balance sheet weaknesses, the most prominent is the exchange risk arising from the big difference between the foreign exchange payables and foreign exchange receivables of these institutions. Even things go on track in your country, the institutions with balance sheet weaknesses become troubled in case of an exchange rate rise due to changes in external conditions. In turn, these institutions drag the economy down as well. Moreover, if such weaknesses become revealed foreign exchange demand in the national economy booms even external conditions are a bed of roses.

    So, how can we avoid this risk? Let us first touch upon the rationale behind the decision. First, it is argued that "Even if we prohibit firms with no foreign currency earnings to obtain foreign exchange credits via domestic channels, they someway pass by the prohibition; for example they obtain foreign exchange credits from foreign banks." There is an economic rationale: cost of such credits is lower as the foreign exchange risk is disregarded. Second, such prohibitions hinder the development of domestic financial system. On the other hand, deepening of the financial system is beneficial considering economic growth. Third, foreign exchange loans received from branches abroad of domestic banks are recorded as foreign debt of Turkey thus scaling up the country risk. If the credits could have been received from domestic banks, the amount would not have been recorded as foreign debt.
    It is impossible to not agree with these rationales.

    What will we do then? We will take departure from the determination that such risks encountered by the corporate sector eventually become to be encountered by the banking sector. In other words, we will not feel relieved because the exchange risk faced by the banking sector is eliminated thanks to the measures implemented after the 2001 crisis. In the banking sector stress tests we will also consider the relations of banks with companies facing risks. If the stress level is going up, we will ask banks to keep higher amount of required reserves even for the domestic currency denominated credits extended to risky companies. Of course we hope it will not be necessary to take this type of bitter measures. However, the Banking Regulation and Supervision Agency would better be cautious.

     

    This commentary was published in Radikal daily on 18.06.2009

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