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Flashnote
Global Research
Macroeconomics
Turkey
Turkey
A detailed look at the CBRT’s macro-prudential policy
framework
 Since December 2012, the Central Bank of Turkey has been
lowering interest rates and raising required reserve ratios
(RRR)
 This combination was used actively in 2011. But the bank
has expanded its macro-prudential policy toolkit since then
 As a result, small RRR hikes similar to those the CBRT
delivered in the December-February period are unlikely to
slow credit growth in a meaningful way. They may be more
effective in preventing excessive lira appreciation
Déjà vu?
The Central Bank of Turkey (CBRT) has been easing policy since September 2012, but it
was the bank’s last rate decision of 2012 that gave markets a feeling of déjà vu. On 18
December, the CBRT cut the policy rate by 25bp and raised required reserve ratios (RRR)
for the banking sector, after leaving them unchanged for 14 months. In January and
February 2013, the CBRT pushed down the overnight rate corridor, by 25bp in each
meeting, and hiked RRR further.
6 March 2013
Melis Metiner
Economist, Turkey
HSBC Yatırım Menkul Değerler A.Ş.
+90 212 376 4618
melismetiner@hsbc.com.tr
View HSBC Global Research at:
http://www.research.hsbc.com
Issuer of report: HSBC Yatirim Menkul
Degerler A.S.
Disclaimer &
Disclosures
This report must be read
with the disclosures and
the analyst certifications in
the Disclosure appendix,
and with the Disclaimer,
which forms part of it
Typically, the central bank has used this policy mix to achieve two objectives. Rate cuts
are aimed at reducing the carry for the Turkish lira, discouraging short-term portfolio
flows, and preventing excessive lira appreciation. Reserve requirement hikes are used to
cool down credit growth.
This combination of lower rates and higher reserve requirements was first introduced in
late 2010, but the CBRT continued to implement it throughout 2011 even though growth
was nearing overheating territory, inflation was significantly above target, and the current
account deficit was widening at an alarming pace. Sharp reserve requirement hikes did
help slow credit growth to a certain extent that year, but macro-prudential tightening by
the banking regulator also played a role.
This time around, two new policy tools, the reserve option mechanism (ROM) and reserve
option coefficients (ROC), complicate the picture. In this note, we provide detail on what
these acronyms mean and argue that small RRR hikes similar to what the CBRT delivered
in the December-February period are unlikely to slow down credit growth in a meaningful
way. They may be effective liquidity management tools however, and help prevent
excessive lira appreciation.
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Macroeconomics
Turkey
6 March 2013
Expanding the reserve requirement framework
Required reserve ratios (RRR) are precautionary reserves that must be kept by commercial banks.
Currently, Turkish banks must keep 11.0% of their lira liabilities and 11.5% of their FX-denominated
liabilities as required reserves at the central bank. Ever since October 2010, reserve requirements do not
earn any interest.
Starting in September 2011, the CBRT gradually phased in two new policy tools that work in conjunction
with the RRR framework. First, the central bank allowed commercial banks to hold some of their lira
reserve requirements in hard currencies or in gold. This is called the reserve option mechanism, or ROM.
The cost of funding for raising hard currencies or gold to keep in a non-interest bearing account is lower
than that of raising liras, so the introduction of ROM was aimed at reducing the opportunity cost
associated with holding reserve requirements. Currently, banks can keep up to 60% of their lira liabilities
in FX and up to 30% in gold. The remaining 10% must be kept in Turkish liras. RRR for FX-liabilities
must be held in hard currencies only (Table 1).
Table 1. Evolution of the reserve option mechanism (ROM)
Announcement date
Effective on
For TRY reserve requirements
For FX reserve requirements
12-Sep-11
05-Oct-11
27-Oct-11
01-Nov-11
27-Mar-12
29-May-12
21-Jun-12
30-Sep-11
14-Oct-11
11-Nov-11
11-Nov-11
13-Apr-12
22-Jun-12
06-Jul-12
20-Jul-12
03-Aug-12
31-Aug-12
14-Sep-12
10% can be kept in FX
20% can be kept in FX
40% can be kept in FX
10% can be kept in gold
20% can be kept in gold
45% can be kept in FX
50% can be kept in FX
25% can be kept in gold
55% can be kept in FX
60% can be kept in FX
30% can be kept in gold
10% can be kept in gold
19-Jul-12
16-Aug-12
0% can be kept in gold
Source: CBRT
Then, starting in May 2012, the central bank of Turkey imposed a haircut of sorts on banks who wanted
to take advantage of the reserve option mechanism. By setting reserve option coefficients (ROC) for
reserve holding tranches, the CBRT started to ask banks to hold more FX or gold for each lira of reserves
not held in liras.
How exactly does ROC work? Assume that a bank needs to keep TRY100 in reserve requirements.
Further, assume that this bank would like to keep 60% of its lira reserve requirements in hard currency,
taking advantage of the reserve option mechanism for holding FX to its fullest extent. If there were no
reserve option coefficents, this bank would set aside the dollar equivalent of TRY60 as reserve
requirement, parking it at the central bank. Assuming a USDTRY exchange rate of 1.80, this would
remove USD33 of liquidity from the banking sector.
Following the introduction of reserve option coefficients, the same bank now has to park TRY99 at the
central bank. At the same exchange rate, this corresponds to USD55.
.
Reserve requirement that must be parked at the CBRT=TRY100* [(40%*1.4)+(5%*1.8)+(5%*2.1)+(5%*2.3)+(5%*2.4) ]
=TRY99.0 or USD55.0
2
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Macroeconomics
Turkey
6 March 2013
Put in the simplest terms, higher reserve option coefficients drain more FX liquidity from the banking
sector, for as long as the sector chooses to hold some FX (or gold) in lieu of liras. Charts 1 and 2 show the
ROC for each FX- or gold-holding tranche. The weighted ROC for holding FX or gold now stands at
1.65. This means that for each unit of lira reserve requirement not kept in liras, banks now have to forego
1.65 times the euro, dollar or gold bullion equivalent, and keep it at the CBRT.
Many advantages…
What is the advantage of this new framework? According to the CBRT, the reserve option mechanism
(ROM) accomplishes four goals: 1) reducing lira volatility, 2) reducing the need for lira sterilisation by
the CBRT, 3) reducing the need for short-term currency swaps, and 4) providing an incentive for the
banking sector to build reserves, even if the central bank’s own net reserve position is unchanged. 1
The most important function of ROM is that it acts as an automatic stabiliser against capital inflows. If
global liquidity is plentiful and risk appetite is strong, portfolio inflows into Turkey are likely to
accelerate. In such a scenario, the central bank would increase reserve option coefficients (ie. draining
more FX from the banking sector for each lira RRR not kept in liras). Reducing the amount of FX
liquidity available to the banking sector would ease the appreciation pressure on the lira, offsetting the
impact of strong inflows. In the opposite scenario where risk appetite is weak and Turkey experiences
capital outflows, the CBRT could reduce reserve option coefficients, increasing the available amount of
FX liquidity. This would support the lira and offset depreciation pressure. Bank officials have described
the ROM framework as a “pressure release valve for the currency.” This description is apt. Chart 3 shows
that lira volatility has been on a downwards trend ever since June 2012. Reserve option coefficients were
raised for the first time at the end of May.
ROM also reduces the need for lira sterilisation by the central bank. In a scenario where strong inflows
are causing lira appreciation, a more orthodox policy response would be for the CBRT to purchase FX in
open market operations and to sterilise the excess lira liquidity that this would create. The CBRT is
hesitant to resort to this tool for two reasons. First is the difficulty associated with conducting effective
Chart 1. Reserve option coefficients (ROC) for holding FX in
lieu of liras
Chart 2. Reserve option coefficients (ROC) for holding gold
in lieu of liras
3.0
2.5
2.1
2.0
2.3
2.4
1.8
1.4
1.5
1.0
0.5
Reserve option coefficient
Reserve option coefficient
3.0
2.4
2.5
1.9
2.0
1.4
1.5
1.0
0.5
0.0
0.0
0
Source: CBRT
5
10 15 20 25 30 35 40 45 50 55 60
% of lira reserve requirement
0
5
10
15
20
% of lira reserve requirement
25
30
Source: CBRT
______________________________________
1 "Rezerv Opsiyonu Mekanizması,'' by Koray Alper, Hakan Kara and Mehmet Yörükoğlu. 22 October 2012. Available in Turkish at: www.tcmb.gov.tr
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Macroeconomics
Turkey
6 March 2013
Chart 3. Lira volatility has come down in the second half of 2012
%
20
18
16
14
12
10
8
6
4
2
0
Jan-10
Chart 4. Outstanding stock of currency swap transactions
for the banking sector has been reduced
TRY bn
120
100
80
60
40
20
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Jan-13
0
Jan-10
USDTRY 3m implied volatility
Source: Bloomberg
Jul-10
Jan-11
Jul-11
Jan-12
Jul-12
Stock of outstanding cross currency swaps
Source: BRSA
sterilisations. Because lira liquidity is distributed unevenly in the Turkish banking sector, sterilising large
amounts of dollar purchases could squeeze the lira liquidity of certain banks that are more dependent on
the CBRT’s funding. Another reason has to do with the stigma associated with FX interventions. The
CBRT believes that dollar purchase (or sale) auctions are sometimes misinterpreted and lead to questions
regarding the nature of the exchange rate regime. More specifically, interventions aimed at reducing the
volatility in the exchange rate may sometimes be interpreted as interventions targeting a specific
exchange rate level. ROM, on the other hand, gets around this issue by reducing amount of lira liquidity
that would have to be sterilised by the central bank.
Third, ROM reduces the need for the banking sector to enter into short-term currency swap
agreements. Prior to the introduction of this framework, banks would fund their lira reserve requirements
by entering currency swaps with parties abroad. Allowing the banks to keep RRR in hard currency
reduces the need for cross currency swaps. The CBRT believes that less frequent use of currency swaps is
healthier as it reduces short-term foreign borrowing of the banking sector. Chart 4 shows that the
outstanding stock of cross currency swaps has also been trending downwards ever since June. Chart 5 on
the next page illustrates the same point, in a different way: the off-balance sheet long FX position of the
banking sector has been reduced by roughly USD11bn since early June, pointing to a smaller on-balance
sheet short FX position.
Finally, this new policy tool boosts the FX reserves of the banking sector. Hard currency reserve
requirements are kept at the central bank, and as a result, figure into the CBRT’s gross reserves, but they
leave the central bank’s net FX position unchanged (Chart 6). For the banking sector though, keeping a
portion of lira reserve requirements in FX, could provide a hard-currency buffer against unexpected
capital outflows.
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Macroeconomics
Turkey
6 March 2013
Chart 5. The banking sector’s off-balance sheet long FX
position has been reduced, pointing to a smaller on-balance
sheet short FX position
USD bn
35
30
25
20
15
10
5
0
-5
2008
USD bn
110
2010
2011
2012
Off-balance sheet net FX position (LHS)
USD bn
140
100
120
90
100
80
80
70
60
60
2009
Chart 6. The CBRT’s gross reserves have risen sharply as
reserve requirements are kept at the bank in hard currencies.
The central bank’s net FX position is little changed, however
40
20
2008
2010
FX and gold reserves
CBRT's gross FX reserves (RHS)
Source: BRSA, CBRT
2009
2011
2012
2013
Net FX position
Source: CBRT
…and one major drawback
Recent communication by the central bank has put a lot of emphasis on the fact that annual loan growth is
now running at above 20%, much faster than the CBRT’s 15% guidance. Despite this, the CBRT has cut
the overnight lending rate four times in five MPC meetings, bringing it to 8.50% as of February, from
11.50% in August last year. Over the past three months, the CBRT has also been hiking reserve
requirements, albeit much less aggressively than in 2011. In December, FX-RRR was hiked 40bp. In
January, FX-RRR was hiked 50bp, and TRY-RRR 20bp. Finally, in the February MPC meeting, FX-RRR
was pushed up by 40bp, and TRY-RRR, by 20bp.
What is the cumulative impact of this policy mix? Are reserve requirement hikes offsetting the easing that
has come via rate cuts, and will we see a sharp slowing in credit growth similar to what happened in late
2011? We think this is unlikely. The fact that banks hold the majority of their reserve requirements either in
FX or in gold renders lira reserve requirement hikes less effective. Currently, banks hold 53% of their
reserve requirements in foreign currencies (out of a possible 60%) and 25% in gold (out of a possible 30%).
The remaining 22% is held in Turkish liras. So when the CBRT raises (or cuts) required reserve ratios for
lira liabilities, the impact for the banking sector is rather muted. For instance, in the most recent MPC
meeting, the CBRT hiked lira RRR by 20bp. Assuming that banks’ usage of reserve options remains
unchanged, this is expected to remove 320 million of lira liquidity, 660 million of dollar liquidity and
USD290 million of gold from the banking system. What is the opportunity cost of having to hold this
amount in a no-interest account? A back-of-the-envelope calculation assuming lira yields for interest earning
assets at 11% , FX-yields at 3.4%, and gold yields at zero works out to a mere TRY76m (or USD42m).
Another way to get a sense of the actual magnitude of a 20bp hike in lira RRR is to calculate the effective
RRR for lira and FX liabilities. Total lira liabilities for the banking sector is around TRY700bn. If the
reserve option mechanism were not in play, banks would be required to hold TRY77bn of reserve
requirements at the central bank (assuming lira RRR of 11%, Charts 7 and 8). Currently however, banks
hold only TRY14.0bn of lira reserves, with the remainder held in FX or gold. This corresponds to an
effective TRY-RRR of 2.0% (=14/700).
5
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Macroeconomics
Turkey
6 March 2013
Chart 7. Weighted average* required reserve ratios (RRR) for
TRY- and FX- liabilities
Chart 8. Because the majority of lira RRR is held in foreign
currencies, the effective TRY-RRR is low. So the impact of
small TRY-RRR hikes is limited
%
14
%
25
11.0
12
9.0
10
8
6
5.0
10.6 10.2
10.610.2
11.0 11.5
20
15
6.0
23.2
11.5
11.0
10
4
5
2
2.0
0
0
end-2009
end-2010
end-2011
TRY RRR
end-2012
current
FX RRR
* A weighted average is given because reserve requirements in Turkey vary by the
maturity of liability. Shorter maturities are subject to higher reserve requirements
Source: CBRT
Actual
Effective
TRY RRR
Actual
Effective
FX RRR
Source: CBRT, HSBC
Let’s look at the FX side. Total foreign-currency denominated liabilities for the banking sector is around
USD235bn. With a weighted average FX-RRR of 11.5%, banks will soon be holding USD27bn as FX
reserve requirements at the central bank.2 In addition to this however, 53% of lira RRR is also held in FX,
and 25% is held in gold (Chart 9). To simplify, we treat gold as a hard currency, and calculate that banks
are holding a total of USD54.6bn of reserve requirements, against both lira- and FX- liabilities, in hard
currencies. This corresponds to an effective FX-RRR of 23.2% (=54.6/235).
Looking at charts 7 and 8 together shows that the magnitude of the macro-prudential tightening delivered
over the past three months is not similar to what happened in 2011. In 2011, the CBRT was primarily
concerned with curbing lira-denominated consumer loan growth, so TRY-RRR was hiked sharply while
FX-RRR was reduced throughout the year. Currently, however, the CBRT’s macro-prudential tightening
is coming through the FX-channel. Banks keep the majority of their reserves in hard currencies, which
drains FX liquidity from the system. On top of this, the CBRT is hiking FX-RRR more aggressively than
TRY-RRR, even though FX-credit growth is rising at roughly half the pace of TRY-credit growth (Chart
10). The 130bp of cumulative FX-RRR hikes since December have drained USD2.54bn of liquidity from
the banking system, whereas the 40bp of TRY-RRR hikes have drained only TRY0.62bn (USD0.34bn).
______________________________________
2 In the February MPC meeting, lira RRR was raised to 11% and FX RRR to 11.5%. These new ratios will become effective on 15 March 2013.
6
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Macroeconomics
Turkey
6 March 2013
This time is different
Putting all this together, we come to two conclusions. First, if RRR hikes are not combined with dramatic
reductions in reserve options (i.e. CBRT forcing banks to hold a larger portion of their lira reserve
requirements in liras), they are unlikely to slow down credit growth in a meaningful way. This is why we
believed that a policy mix combining rate cuts, RRR hikes, and reserve option cuts was a possible
outcome for the February MPC meeting. But as the central bank shifted down the rate corridor by 25bp
and hiked lira- and FX- reserve requirements by 20bp and 40bp respectively, it made no change to the
current ROM settings. This brings us to our second conclusion. Because the majority of lira reserve
requirements are held in FX and because the CBRT is hiking FX-RRR more sharply than TRY-RRR, the
current iteration of the “rate cut, RRR hike” policy mix is squeezing FX liquidity more than lira liquidity.
As a result, it is likely to be more effective in curbing excessive lira appreciation and less effective in
slowing loan growth.
Chart 9. How do banks hold their lira reserve requirements?
in liras
22%
in gold
25%
in FX
53%
Chart 10. FX loan growth is rising at a 10% annual pace,
versus 20% for lira loans. Yet the CBRT is hiking FX-RRR
more aggressively
% Yr
60
50
40
30
20
10
0
-10
-20
2008
2009
2010
TRY-loans
Source: CBRT
2011
2012
2013
FX-loans
* FX-loan growth has been adjusted for currency movements
Source: BRSA, HSBC
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Macroeconomics
Turkey
6 March 2013
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Disclosure appendix
Analyst Certification
The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the
opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their
personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific
recommendation(s) or views contained in this research report: Melis Metiner
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