Summary of my conference paper
By 2010, Turkish interest rates had fallen to the lowest levels in the country's history. Adem Yekeler and I asked what that meant for how banks make money, and what they would have to do next.
In February 2002 the Turkish central bank's overnight borrowing rate stood at 57%. By April 2006 it had fallen to 13.25%. After the global financial crisis the central bank cut again, from 16.75% in October 2008 by a total of 1,025 basis points, to 6.5% in November 2009, the lowest level in the country's history.
Banks held 88.4% of the assets of Turkey's financial sector in 2009, so what low rates did to banks mattered for the whole economy. The paper, written in Turkish with my co-author Adem Yekeler, looked at how bank balance sheets had changed from 2002 to 2010 and what a long period of low rates would mean next.
We used public data from the central bank, the banking regulator and the Banks Association of Turkey. Inflation and the overnight rate moved closely together, with a correlation of 0.93, and causality tests showed that inflation drove rates rather than the other way round. We estimated Turkish government bond yield curves from 2006 with the Svensson method to see how the whole curve moved through the crisis.
We then treated a bank's balance sheet as an optimisation problem: maximise profit, subject to funding, regulation and market structure. That leaves a bank three main levers: the maturity of what it lends, the margin it charges, and its fee income and costs.
Turkish banks moved from funding the government to lending to the economy. The share of loans in balance sheets rose and the share of securities fell, and corporate lending, not consumer lending, was the real alternative to holding bonds. Housing loans, general-purpose loans and credit cards grew fast.
Funding stayed short, with deposits concentrated in maturities of up to three months, so funding costs followed market rates closely. Assets repriced more slowly than deposits, so when rates fell in 2009 the net interest margin rose to 5%. Return on assets averaged 2% in Turkey, against 0.9% in the US and 0.5% in the EU.
There was still room to grow. In 2009 Turkish loans were 43% of GDP and deposits 54%, against EU-27 averages of 154% and 134%.
Falling rates had flattered bank profits. Once the cuts stopped, margins would narrow and the maturity lever would weaken. Profit would then depend on fee income, cost control, sound risk management with risk-based pricing, technology and scale. We expected pressure for consolidation, and warned that managers under profit pressure might be tempted to take on more risk.
We also expected the relative weight of banks' Treasury functions to fall in a world of low rates, low margins and low volatility. That is one call I am glad I did not take personally.
Interest rate movements during the global financial crisis and the impact on the banking sector