How Monstrous Consumer Credit Growth Is Impacting Banks and Turkish Bonds 1

Turkey’s economy has bounced back from a contraction in Q3 2016 to grow at 5% in Q1 2017. It is expected to have grown even quicker in the second quarter. A rise in credit has been primarily responsible for the bounce-back.

According to Al-Monitor, Turkish banks’ profits reached 25 billion liras ($7 billion) in the first half of 2017. This was equal to their entire aggregate profits in 2016.

As we have seen in the previous article of this series, the rise in bank profits was fuelled by government policies and encouragement to lend. One of the measures adopted for it was providing treasury-backed loans via the Credit Guarantee Fund (CGF).

Defending banks

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The CGF has issued loans amounting to 207 billion liras ($59 billion) to 313,000 customers according to Huseyin Aydin, the president of the Turkish Banks Union. The legal limit of the CGF is 250 billion lira.

According to an article written by Mustafa Sonmez and published by Al-Monitor, Aydin has expressed that “We used the legal limits to the full. We put all the money we had into loans, to the last penny,” referring to the effort by banks to support government policies.

On the criticism by President Recep Tayyip Erdoğan regarding banks’ profits, he said, “Judging by the profits at the Istanbul stock exchange, in the industry or other companies, the profits of the banking system are at a reasonable level.”

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Impact on bonds

The lending spree that the banks have been on has certainly supported the real sector. However, schemes like the CGF which are guaranteed by the government, and loan growth in particular, has put the banks at risk.

The graph above shows the rise in non-performing loans. The government has pledged to absorb 7% of possible defaults on the new loans made under the CGF, thus negatively impacting credit quality. Though banks have continued lending, they’re not sure about the use it is being put to.

Further, it has put pressure on government finances, which is reflecting in government bonds.

The graph above shows that since early June, yield on the 10-year government bond has risen by 50 basis points.

Given that the CGF is nearing its legal limit and some tax incentives are close to ending, further pressure can be expected on Turkish bonds if the legal limits of the facility are not increased or the government does not announce more measures.

A somber view on the economic future of the country in general and on credit quality of loans and overall bank profitability could put upward pressure on yields.

The CGF could also have an impact on equities apart from Turkish bonds. Let’s assess this in the next article.

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