Durmuş Yilmaz: Financial Stability Report - II
Speech by Mr Durmuş Yilmaz, Governor of the Central Bank of the Republic of Turkey, at the
presentation of the "Financial Stability Report - II", Ankara, 13 June 2006.
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Distinguished Guests, Dear Members of the Press,
Last August, we shared with you the first Financial Stability Report, which we consider to be
supportive of price stability, our primary objective, and involves a compilation of our studies on the
evaluations of financial stability. I am happy to present the second report to you today. I would also like
to remind you that this report will be on the Bank's web page as of today.
Today, I would firstly like to focus on the definition and significance of financial stability and central
banks' approaches to the issue. Then I will touch on the duties and powers of the Bank regarding
financial stability. Lastly, I would like to emphasize the main points in the Financial Stability Report.
Distinguished Guests,
Providing a clear definition of financial stability is as difficult as achieving and maintaining it. In a
broader sense, financial stability can be defined as the condition of an economy's mechanisms for
pricing, allocating resources and managing financial risks functioning well enough to contribute to the
performance of the economy.1 The European Central Bank defines financial stability as a condition
whereby the financial system is able to withstand shocks without impairing the transformation of
savings to investment opportunities. Moreover, some definitions are also derived from the concept of
instability.
In recent years, globalization of financial markets, increased richness in financial instruments, financial
deepening and structural changes have caused the system to become much more complicated, thus
enhancing the significance of financial stability. Any fluctuation that may occur in foreign markets may
rapidly spread to other countries. As a matter of fact, recent developments in international financial
markets were also reflected on Turkey. I can say with great pleasure that the strengthened financial
structure of Turkey has minimized the unfavorable effects of recent fluctuations. This case, once
again, has proven the significance of a sound financial system with risk sensitive policies, which is
reinforced by effective monitoring and supervision. It is a widely known and accepted fact that the
primary objective of central banks is to achieve price stability. Monetary policy is conducted via
operations carried out in financial markets and its success depends on the flawless operation of
financial institutions and markets. Therefore, financial stability is a sine qua non for effective monetary
policy. Besides, the responsibility of central banks for the operation and supervision of payment
systems oblige them to monitor financial stability.
The fact that financial instability may pose serious risks to macroeconomic targets such as sustainable
growth and price stability enhances the significance of financial stability for central banks. Therefore,
central banks and governments increasingly pay more attention to the monitoring of structural and
macroeconomic developments that may pose risks to financial stability as well as to the effectiveness
and robustness of institutions operating in financial markets.2
Under the CBRT Law, financial stability has been stated as a supportive objective. In this framework,
the Bank is empowered to monitor the financial markets, to regulate the volume and circulation of
Turkish lira, to establish payment, securities transfer and settlement systems and to set forth any
regulations regarding these systems; and to set up the procedures and conditions regarding the
liabilities of financial institutions for reserve requirements. The Central Bank takes the necessary
measures in order to achieve stability in the financial system in the face of developments, shares its
evaluations on financial stability with the public in line with the principle of transparency and issues
warnings concerning the fragilities and risks in the financial system.
Distinguished Guests,
As I have just emphasized, the function of monitoring financial stability takes place within the
framework of the goals of central banks to achieve price stability and develop sound payment systems
and it is of a different nature to the supervision of other institutions operating in financial markets.
Indeed, monitoring the robustness of the financial system requires the evaluation of various factors
that threaten the financial system as a whole and create systemic risks. For this reason, the
perspective of the Bank is a macro and risk-focused one, similar to the perspective used in the
financial stability reports published by other central banks.
The definition of objectives and functions of central banks are different from those of supervisory
authorities. Though central banks increasingly tend not to deal directly with the monitoring and
supervision of banks in recent times, they continue to monitor developments in the banking sector as
well as the basic systemic risks.
Today, 38 central banks around the world publish the Financial Stability Report. In a total of twenty
countries, fourteen European and six non-European countries, supervisory authority is separate from
the central bank.
Especially in systems where the power to monitor is granted to autonomous institutions other than the
central bank, the function of monitoring and supervising the financial system focuses on the issue of
financial soundness and effectiveness of individual institutions. However, the monitoring of the
financial system as a whole in terms of financial stability is carried out by central banks.
In countries such as England, Australia, Norway, Finland and Sweden, where the supervisory authority
is not the central bank, central banks, including that of Turkey, focus on the objective of price stability
and carry out operations consistent with monetary policies by monitoring the developments in financial
markets. Besides, they establish a strong and reliable payment system and take the necessary
measures in order to prevent the problems faced by any financial institution from affecting the financial
system as a whole. Central banks also function as the "lender of last resort".
Evaluations made by supervisory authorities gain importance as regards the sound monitoring of
financial stability by central banks and, effective corporate cooperation with these authorities becomes
more critical. I am pleased to say that the cooperation between the Central Bank and Banking
Regulation and Supervision Agency, the Undersecretariat of Treasury and the Capital Markets Board
as supervisory authorities, is increasingly progressing.
The Financial Stability Report, the first of which was published last August, analyzes macroeconomic
developments with respect to their effects on sectors, presents analysis and evaluations about the
banks and evaluates current and future risk factors.
Distinguished Guests,
We are undergoing a period where the banking sector has increased intermediary activities, which is
the primary function of banks, and where mutual interaction between the sectors in the financial
system gains more importance because of the risks that require close monitoring. Therefore, in this
part of my speech, I would like to discuss the developments in the banking sector within the framework
of macroeconomic perspective and the risks involved.
Despite the fact that giant steps have been taken regarding public finance thanks to current tight fiscal
policy, maintaining fiscal discipline and achieving the primary surplus target are still of great
importance as regards financial stability.
In the rapidly growing Turkish economy, the ratio of current account deficit to gross national product
became 6.4 percent in 2005. The rapid increase in the share of long-term capital inflows and direct
investments in the financing of the current account deficit, which is expanding due to high growth
rates, is deemed favorable for the sustainability of the deficit.
As it is known, in parallel to changing interest rate policies of Bank of Japan, the Federal Reserve and
the European Central Bank in recent periods, uncertainty about interest rates has increased globally,
leading to capital outflows from emerging markets. Nevertheless, reinforced macroeconomic
fundamentals, tight monetary and fiscal polices, the shock-absorbing function of the floating exchange
rate regime, the reduced ratio of short-term foreign credits to international reserves and disciplined
implementation of the current economic program minimize the adverse effects of outflows on the
Turkish economy.
The rapid rise in the consumption tendency despite the relatively low increase in disposable income
increases the indebtedness of households. Therefore, close monitoring of likely risks for the household
that may arise from the increasing demand for housing loans, which is still low compared to other
countries, is of great importance. Indeed, as seen in (other) country experiences, asset prices can rise
rapidly in periods of expansion to be followed by slumps in housing prices, which would
simultaneously push down the value of the collateral for the financial sector and decrease household
wealth. Therefore, these are important risk factors that should seriously be taken into account.
Dear Guests,
I would like to draw your attention to credit cards regarding the household indebtedness issue. As it is
known, in general, the credit card is a payment instrument that enables its owner to purchase goods
and services at member businesses without using cash. Moreover, if credit card users wish to
withdraw cash or to delay their credit card payments for a determined period, the relevant amounts
spent turn into credit and thus the credit card becomes a credit instrument. Institutions issuing credit
cards incur POS (Point of Sale) machine investment and membership to national and international
payment systems expenditures, and they are exposed to liquidity risk due to unforeseen cash
withdrawals.
Consequently, banks tend to determine higher credit card interest rates than those of consumer
credits due to their higher risk exposures, namely the higher credit risk because of weak collateral
structure and liquidity risk because of unforeseen cash withdrawals. A survey of country practices also
reveals that credit card interest rates are determined higher than interest rates set for consumer
credits. Therefore, it is in the interest of credit card users to meet their short-term credit needs via
consumer credits rather than their credit cards.
Moreover, the interest rates applicable to credit card transactions differ significantly from bank to bank.
The tendency of customers towards credit cards of banks with lower interest rates will enhance
competition in the banking sector and the interest rates applicable to credit cards will be pushed down.
The highest interest rates applicable to credit cards by banks are announced on the Bank's web site.
Distinguished Press Members,
The reduced credit costs in an environment of falling inflation has enhanced credit opportunities of
firms in the corporate sector and has played an important role in the growth of investments
expenditures. Nevertheless, we consider the open foreign exchange position of firms that utilize
foreign exchange credits, despite their lack of foreign currency revenues, as a significant risk factor.
Therefore, the effective use of risk aversion techniques, taking into consideration the İzmir Derivatives
Exchange facilities, is of vital importance.
Furthermore, considering the likely implications of Basel II, especially on the financial system, both the
banking sector and firms should carry out the necessary studies relating to capital accord and
accomplish the necessary initiatives and arrangements for the improvement of their corporate
management structures.
Distinguished Guests,
In 2005, the most outstanding development pertaining to the banking sector, which constitutes 87
percent of the entire financial system, was the gradual acceleration of foreign capital inflows.
According to the final figures for share transfers, the share of non-residents in total assets of the
banking sector in 2005 was 12.4 percent. Including the portion of shares of non-residents in some
banks, which have been agreed upon, although the legal permit process thereto has not been
completed yet, the share of non-residents in total assets has reached over 16 percent. Comparing the
ratio of assets of the banking sector to the GNP in Turkey to those of developed countries, it is seen
that Turkey ranks considerably lower on the list. As long as the favorable developments continue, the
banking sector should grow in parallel or, even more. However, it is obvious that in a sector so
capitalintense, achieving growth will not solely be domestically. I believe that foreign capital inflows to the
banking sector should be handled within this framework.
In 2005, while the balance sheet of the banking sector grew in size, the share of TL-denominated
assets and liabilities increased. As the crowding-out effect of the public sector diminished, the share of
credits in assets continued to increase. This indicates that the banking sector has come close to its
fundamental function. Despite the fact that the rapid upsurge in credit volume has increased the credit
risk, the decline in the NPL ratio and the high provisioning policy adopted by the sector during the
same period are considered as favorable developments. Meanwhile, the monitoring of credit risk,
which may increase due to the policies on credit allocation that are likely to be eased in the growth
period of the economy, is of great importance.
In 2005, while the maturities of assets of the banking sector were extended, the liabilities still had
short-term maturities. This shows that the vulnerability against the interest rate risk and the maturity
mismatch of the sector increased. In order to facilitate banks' interest rate risk management, it is
deemed necessary to make regulations that will also allow floating rate consumer credits along with
the currently available fixed rate credits.
In 2005, the ratio of liquid assets to total assets decreased as a result of the continuation of the
upward trend in credits. Nevertheless, despite the short-term structure of deposits, especially the
renewable nature of the major portion of term savings deposits, low condensation and the fact that the
assets, which can be accepted by the Central Bank as collateral, comprise a significant part of the
assets of the sector are considered risk-reducing factors with respect to liquidity management.
Distinguished Guests,
In a falling inflation environment, increasing fundamental banking activities along with banks'
narrowing profit margins, and the rise in net wages and commission revenues, which is a more stable
source of income, make a positive contribution to the diversity of assets and income of the sector.
Hence, they have a favorable effect on profitability performance, which has an important role in
financial stability.
The capital adequacy ratio of the banking sector is realized well above the legal limit of 8 percent. The
capital adequacy ratio is high due to the facts that the government securities portfolio of the sector is
high and the mentioned portfolio is evaluated in the zero percent risk weight category. The high capital
adequacy ratio improves the resistance of the financial structure of the banking sector against shocks.
The Financial Strength Index, which provides information about the soundness of the banking sector
and which has been enhanced by the sub-index of interest rate risk compared to the previous Report,
reached its highest level at the end of 2005. Despite the declines in profitability, capital adequacy and
interest rate risk indices, the recovery in the asset quality and liquidity indices were effective on this
development. The Financial Strength Index is observed to maintain almost the same level in the first
quarter of 2006 as well.
In order to measure the resistance of the banking sector against shocks, the development of credit
and market risks were analyzed via stress tests and scenario analyses. It was found that a sufficient
amount of capital was maintained for the assumed risks and the sector's resistance against probable
shocks was strong. Thus, in May 2006, significant market movements were experienced, which can
also be perceived as tests of the resistance of the sector. It was observed that due to their strong
capital structures, our banks were less affected by these activities compared to the past.
Distinguished Members of the Press,
Now, I would like to give you some information about the Financial Sector Assessment Program that
our country has recently participated in, which is of vital importance as regards the evaluation of the
components of financial stability.
The Financial Sector Assessment Program was established in May 1999 with cooperation between
the International Monetary Fund and the World Bank in order to strengthen the financial structures of
countries in consideration of the risks and problems posed by the financial sector. The Program is
carried out with the support of numerous national central banks and supervisory authorities.
The major objectives of the Financial Sector Assessment Program are to encourage the
predetermination of the fragilities of the financial system, to formulate necessary policies, to provide an
environment for effective communication with national authorities and to create a joint platform in order
to ensure the effectiveness of policy proposals and the technical assistance provided by both the
International Monetary Fund and the World Bank. In addition to these functions, the Financial Sector
Assessment Program aims to set the vital priorities of the financial sector and encourage the
enhancement of the sector in this respect.
The number of countries, which have already participated in and are planning to participate in the
Financial Sector Assessment Program in the near future, is 184. A report including the assessment of
the financial system will be issued at the end of the program. It is planned to finalize the studies on the
Financial Sector Assessment Program, which were started at the beginning of 2006 with the
coordination of the Undersecretariat of the Treasury in order to contribute to the ongoing reform
process of the Turkish financial sector, by the end of the year.
The Financial Sector Assessment Program process in Turkey is expected to contribute to the
development of the financial sector in terms of institutional infrastructure. Furthermore, the resistance
of the sector will be analyzed on an international platform via stress tests to be applied to banks within
the framework of the Program.
Distinguished Guests,
Proper and effective implementation of macroeconomic policies, in other words, the achievement of
macroeconomic stability, is the sine qua non of financial stability. It is very important for the banking
sector, which should be able to cope with the Basel II process in the near future, that the improvement
of the infrastructure of the financial system continues and that efficient control and supervision is
carried out. As firms will contribute to stable growth with the funds that they obtain from banks, the
compatibility of the corporate sector with the Basel II process is of great importance as well.
In this framework, determined implementation of current economic policies, increased confidence in
financial markets, the establishment of risk culture and the adjustment of economic actors' risk
perceptions according to dynamic conditions will strengthen the stability in financial markets.
Esteemed Guests,
Before concluding my speech, I would like to thank you for your participation. I hope our assessments
and analyses will help the participants of the financial market to undergo a better decision-making
process.