Turkish banks’ foreign liabilities are on the increase, and that bodes ill for the country’s economy.
Most of the recent increase in Turkey’s external debt has been driven by bank borrowing, Fitch Ratings said 3 September 2014. The rapid rise in banks’ foreign liabilities, particularly at the short end, leaves them more vulnerable to an extreme stress involving an abrupt and prolonged market shutdown. The increase in external debt was one of the factors leading to the downgrade of Turkey’s three largest domestic privately owned banks to ‘BBB-‘, the same level as the sovereign, in June.
Turkish banks’ foreign borrowings increased almost threefold, to US$ 164 billion, between end-2008 and end-1H14, rising to 38% of the country’s total external debt from 20%. Sovereign external debt rose more moderately and other sectors’ foreign borrowings were largely unchanged. Banks therefore accounted for 71% of the increase in Turkey’s foreign debt during the period. Furthermore, banks accounted for virtually all the increase in foreign-currency external debt, as the growth of sovereign external liabilities mainly arose from greater foreign holdings of lira-denominated government bonds.
The short-term component of banks’ external foreign-currency liabilities also increased significantly, more than quadrupling over the same period, while long-term foreign-currency debt doubled. The substantial short-term component within banks’ debt raises refinancing risks.
Banks’ foreign assets have shrunk and foreign-currency liquidity now mainly comprises placements with the Turkish central bank. Nevertheless, the drawdown of foreign-currency reserves placed against local-currency liabilities (the reserve option mechanism, ROM), together with liquid foreign assets and a small portfolio of unencumbered government bonds, should give banks around US$ 71 billion of reasonably reliable foreign-currency liquidity to cope with a short-lived stress. Other assets and FX derivatives may generate moderate additional foreign currency. This represents a reasonable liquidity position relative to our estimate of the sector’s one-year external debt service requirement, in the extreme scenario of a complete market shutdown, of US$ 80 billion-85 billion.
Nevertheless, a sudden and prolonged foreign market closure would put significant pressure on banks’ foreign-currency liquidity, particularly as there are potential constraints on the central bank’s ability to make available additional foreign currency beyond that placed under the ROM. The central bank would be likely to face several other claims on its limited reserves in a stress scenario, including servicing of corporate and sovereign external debt, outflows of portfolio investments and financing of the current account deficit. Therefore a sudden market closure, or further rapid growth of banks’ external debt, raising vulnerabilities, could put pressure on banks’ ratings.
Other aspects of banks’ credit profiles would probably also weaken if Turkey’s external liquidity tightens significantly. Capital ratios would be likely to fall, asset quality deteriorate and profit margins shrink for all banks, not just the ones that have borrowed extensively from abroad. This may also increase pressure on bank ratings.
A detailed Fitch analysis of Turkish banks’ external debt and foreign-currency liquidity, is provided in Turkish Banks’ External Debt and FC Liquidity: Dependence on Market Access and Central Bank Policy Has Increased, published by the rating agency on www.fitchratings.com. A panel discussion on Turkey’s external finances will take place at a ‘Turkey: More Challenges Ahead event, hosted by Fitch Istanbul on 11 September 2014, the agency said.