Turkey s Experience with Macroprudential Policy

Turkey s Experience with Macroprudential Policy Hakan Kara* Central Bank of Turkey Macroprudential Policy: Effectiveness and Implementation Challenges CBRT-IMF-BIS Joint Conference October 26-27, 2015 İstanbul * The views expressed are those of the presenter and not necessarily those of the Central Bank of Turkey

35 Turkey s GDP continued to grow steadily in the post-gfc period, notwithstanding significant global and geopolitical shocks. GDP (Seasonally adjusted, constant prices, billion TL) 33 31 29 EU Debt crisis Taper Tantrum Geopolitical shocks 27 25 GFC 23 21 19 17 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: TURKSTAT. Last Observation: 2015 Q2 2

Outline 1. Background for Turkish prudential framework 2. Implementation of macroprudential policies 3. The outcome 3

Background and Initial Conditions 4

Establishing an institutional framework for financial stability TWO MAIN INFLECTION POINTS 2001 crisis: redesigning microprudential framework 2011: explicit macro-approach to financial stability 5

2001 crisis: Once bitten, twice shy Restructuring and recapitalization of the banking system Strengthened bank regulation and supervision Foundation of the banking regulation and supervision agency (BRSA) Implementation of tight regulation and supervision 6

1960 1966 1972 1978 1984 1990 1996 2002 2008 2014 The pace of financial deepening since 2003 highlighted the need for macroprudential policies. 140 120 100 Private Credit/GDP Ratios (%) Upper income (OECD countries) Turkey Emerging Markets 80 60 40 20 0 Source: World Bank 7

10.2004 04.2005 10.2005 04.2006 10.2006 04.2007 10.2007 04.2008 10.2008 04.2009 10.2009 04.2010 10.2010 04.2011 Extending maturities were also instrumental in credit boom through higher affordability, limiting the impact of monetary policy. 50 45 40 35 30 25 20 15 10 5 Average maturity of personal loans (months) 0 8

1108 0209 0509 0809 1109 0210 0510 0309 0609 0909 1209 0310 0610 0910 The need for a macro approach have further intensified after the QE, with rapid credit growth and marked currency appreciation. Total Loan Growth Rates (13 Weeks Moving Average, Annualized, FX Adjusted, Percent) 125 Real Exchange Rate (2003=100) 60 45 120 30 115 15 110 0-15 -30 Beginning of QE by Fed 105 100 QE Source: CBRT

2007:09 2007:11 2008:01 2008:03 2008:05 2008:07 2008:09 2008:11 2009:01 2009:03 2009:05 2009:07 2009:09 2009:11 2010:01 2010:03 2010:05 2010:07 2010:09 2010:11 2011:01 Sharp widening in the current account deficit, financed with short-term inflows called for an immediate policy action. Current Account Balance (Seasonally Adjusted, Quarterly Average, Billion USD ) 0-1 -2-3 -4-5 -6-7 80 70 60 50 40 30 20 10 0-10 Main Sources of External Financing* (12-months Cumulative, Billion USD) Portfolio and Short-Term* FDI and Long-Term** Current Account Deficit -8 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2008 2009 2010 2011-20 Source: TURKSTAT, CBRT. *Short-term capital movements are sum of banking and real sectors' short term net credit and deposits in banks. Long-term capital movements are sum of banking and real sectors long term net credit and bonds issued by banks and the Treasury. Source: CBRT.

Capital outflows are closely associated with output losses across EMs. Source: Claessens and Ghosh (2013) 11

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015* Historically, sharp capital flow reversals (sudden stops) in Turkey are associated with large output losses. 10 8 6 4 2 0-2 -4 Net Capital Flows / GDP GDP Growth Rate -6-8 -10 Crisis Year Cumulative Output Loss 1994 14,3% 2001 12,3% 2008-2009 15,1%. * As of Q2, annualized. Source: CBRT. 12

MaP under Institutional Constraints Rapid credit growth and widening current account deficit have required an urgent response by the end of 2010. No institution had the mandate and/or explicit objective at the time to deliver the necessary response. The CBRT stepped in by Incorporating financial stability into the IT framework Redesigning the toolkit to respond to macro financial risks Reserve requirements and interest rates were used jointly for both monetary policy and MaP purposes. 13

Monetary Policy Framework: Financial stability augmented IT Price Stability Price Stability Financial Stability Policy Rate Policy Rate Interest Rate Corridor Reserve Req. Policy 14

Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11 Jun- Jun- Jun- Jul-10 Jul-10 Aug Aug Sep- Sep- Oct- Oct- Nov Nov Nov Dec- Dec- Jan- Jan- Feb- Feb- Mar Mar Apr- Apr- May May May Jun- Jun- 12 Initial phase of MaP implementation (September 2010-Mid 2011): Interest rate policy used jointly with Reserve Requirement Ratios 14 10 8 6 4 2 Overnight Interest Rate Lending Corridor Rate Overnight Rate (%,5-day MA) One-Week Repo Rate (%) 12 10 8 6 4 2 140 14 0 12 10 8 6 4 2 Reserve Requirement ratio (RRR) Effective RRR 12 10 8 6 4 2 0 0 15

01.10 03.10 05.10 07.10 09.10 11.10 01.11 03.11 05.11 07.11 09.11 11.11 01.12 03.12 05.12 07.12 09.12 11.12 RRR hikes and the new policy strategy have somewhat contained further acceleration in credit growth. Total Loan Growth Rate (Year on Year Change, Percent) 40 35 RRR Hikes Financial Stability Committee and BRSA measures 30 25 20 15 10 Source: CBRT. Total credit is inclusive of all types of banks (deposit banks, participation banks, and development/investment banks) and credit cards. 16

Yet, the new approach posed challenges for policy communication. Complex transmission mechanism of new tools Inherently vague nature of financial stability: difficulty of linking each tool to objectives (unlike IT) Even so, this episode has increased the awareness for the need to adopt a more explicit institutional MaP framework. Paved the way for the foundation of a financial stability committee. 17

Second Phase of MaP Implementation: Financial Stability Committee 18

Financial Stability Committee (FSC) was a significant step for the establishment of a formal institutional framework for MaP. Organization Structure CENTRAL BANK OF THE REPUBLIC OF TURKEY CAPITAL MARKETS BOARD UNDERSECRETARIAT OF TREASURY FINANCIAL STABILITY COMMITTEE CHAIR: DEPUTY PRIME MINISTER BANKING REGULATION AND SUPERVISION AGENCY SAVINGS DEPOSIT INSURANCE FUND Founded in June 2011. Enhances information sharing, coordination, and cooperation. Main duties are to assess the systemic risks, identify necessary measures, and make relevant policy recommendations. No decision power or tools; the power rests with the authorities represented in the Committee. Each institution has its own mandate and responsibility. 19

Broad Objectives of Macroprudential Policy Increase sustained growth prospects Contain credit growth and household overborrowing Improve the quality of financing Bolster safety nets against external financial shocks Dampen the financial amplification channels Interaction between capital flows, credit, and exchange rate 20

Intermediate Target 1: contain credit growth and change the composition of credit to reduce the share of household borrowing. MAIN TOOLS: Financial Institutions Based Risk weights Loan-loss provisions Borrower Based LTV ceilings Maturity limits Limits on # of installments 21

Why focus on credit growth and household borrowing? Credit booms are the most robust and significant predictors of financial crises. Borio and Lowe (2002), Reinhart and Rogoff (2009), Jorda et al (2011), Gourinchas and Obstfeld (2012), Schularick and Taylor (2012) A rise in the household debt to GDP ratio predicts lower output growth over the medium-run. Mian, Sufi and Verner (2015) 22

Dec-06 Jun-07 Dec-07 Jun-08 Dec-08 Jun-09 Dec-09 Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12 Jun-13 Dec-13 Jun-14 Dec-14 Jun-15 Household borrowing displays a strong relationship with the current account deficit. Consumer Loans and the Current Account (Change YoY, % of GDP for Consumer Loans, % of GDP for Current Account Deficit) 10 5,0 9 4,5 8 4,0 7 6 5 4 3,5 3,0 2,5 2,0 1,5 3 1,0 2 CAD/GDP ΔConsumer Loans Stock/GDP(RHS) 0,5 1 0,0 Source: TURKSTAT, CBRT. 23

The macroprudential measures to smooth credit cycle and to contain household debt were implemented in two major steps. First Round (2011) Higher risk weights and provisions for consumer loans. Limits to credit card payments LTV cap for housing loans Second Round (2013-2014) Caps, limits, and higher risk weights on credit cards Maturity restrictions (36 months) for uncollateralized consumer loans LTV cap for vehicle loans 24

0110 0410 0710 1010 0111 0411 0711 1011 0112 0412 0712 1012 0113 0413 0713 1013 0114 0414 0714 1014 0115 0415 0715 Macroprudential policies have succeeded in containing loan growth. 50 45 I Loan Growth Rates (Annual percentage change) 50 45 40 35 30 Two Rounds of Macroprudential Policies II 40 35 30 25 Commercial 25 20 20 15 15 10 Consumer 10 5 5 0 0 Source: CBRT. Last Observation: September 11, 2015. Inclusive of loans extended by all types of banks (deposit banks, Participation banks, and development/investment banks). FX adjusted. 25

06.06 12.06 06.07 12.07 06.08 12.08 06.09 12.09 06.10 12.10 06.11 12.11 06.12 12.12 06.13 12.13 06.14 12.14 06.15 The share of consumer loans in total loans have declined considerably since 2011. 27 26 Consumer Loans / Total Loans I 25 II 24 23 22 MaP to curb consumer loans 21 20 26

12.10 12.11 12.12 03.13 06.13 09.13 12.13 03.14 06.14 09.14 12.14 03.15 06.15 08.15 The MaPs have been instrumental in reversing the upward trend in the household indebtedness ratio in recent years. Household Assets and Liabilities (Billion TL, Percent) 1000 Total Assets Total Liabilities Liabilities/Assets (RHA) 60 750 55 500 50 250 45 0 40-250 35-500 30 Source: CBRT Financial Stability Report May 2015 Last Observation: August 2015 27

Intermediate Target 2: increase the quality of financing (liabilities) MAIN TOOLS: reserve requirement policy Strategy: adjust RRR and remuneration rates to favor Core liabilities over non-core liabilities Long-term over short-term TL over FX 28

12.2011 03.2012 06.2012 09.2012 12.2012 03.2013 06.2013 09.2013 12.2013 03.2014 06.2014 09.2014 12.2014 03.2015 06.2015 12.2011 03.2012 06.2012 09.2012 12.2012 03.2013 06.2013 09.2013 12.2013 03.2014 06.2014 09.2014 12.2014 03.2015 06.2015 12.2011 03.2012 06.2012 09.2012 12.2012 03.2013 06.2013 09.2013 12.2013 03.2014 06.2014 09.2014 12.2014 03.2015 06.2015 12.2011 03.2012 06.2012 09.2012 12.2012 03.2013 06.2013 09.2013 12.2013 03.2014 06.2014 09.2014 12.2014 03.2015 06.2015 20,0 19,0 18,0 17,0 16,0 15,0 14,0 13,0 12,0 11,0 10,0 Reserve Requirements were used in several dimensions to improve the quality of external finance and bank liabilities. TL vs FX (short term) TL short FX short 20,0 19,0 18,0 17,0 16,0 15,0 14,0 13,0 12,0 11,0 10,0 Core vs Non-core (FX) Core FX Non-Core FX 12,0 11,0 10,0 9,0 8,0 Short vs Long (core) Core TL short Core TL long 20 18 16 14 Short vs Long (Non-core) Non-Core short Non-Core long 7,0 12 6,0 10 5,0 8 4,0 6 29

01.14 02.14 03.14 04.14 05.14 06.14 07.14 08.14 09.14 10.14 11.14 12.14 01.15 02.15 03.15 04.15 05.15 06.15 07.15 08.15 09.15 RR measures have been effective in extending the maturity of the noncore liabilities Maturity Breakdown of Non-Core FX Liabilities (Percent) 60 RR Measures to encourage maturity extension 50 Up to 1-Year 40 Longer than 3-Years 30 20 10 1 to 3-Years 0 Source: CBRT Last Observation: October 9, 2015. 30

01/10 04/10 07/10 10/10 01/11 04/11 07/11 10/11 01/12 04/12 07/12 10/12 01/13 04/13 07/13 10/13 01/14 04/14 07/14 10/14 01/15 04/15 07/15 as well as stabilizing credit to deposit ratios. 130 Credit/Deposit Ratio (Percent) 130 120 120 110 110 100 90 RR Measures to Support Core Liabilities 100 90 80 80 70 70 Source: BRSA Last Observation: September 11, 2015. 31

Intermediate Target 3: Bolster safety nets against external shocks MAIN TOOL: CBRT FX Reserves Strategy: Create direct FX liquidity provision facilities for banks to build resilience against external finance shocks. Reserve option mechanism FX deposit facility 32

01.12 05.12 09.12 01.13 05.13 09.13 01.14 05.14 09.14 01.15 05.15 09.15** FX liquidity readily available to the financial system is now considerably above the short term debt stock of the banks. Short-term Debt Stock* and FX Liquidity Facilities to Banks (Billion USD ) 100 90 80 70 60 50 40 30 ROM FX and Gold Reserves+Short-Term FX Borrowing Facility Short Term FX External Debt of the Banking System (RHA) 100 95 90 85 80 75 70 65 20 60 *According to remaining maturity. ** Data as of September 2015 is flow and subject to change. Source: CBRT Last Observation: September 30, 2015. 33

Intermediate Target 4: dampen the financial amplification mechanisms triggered by cross border flows MAIN TOOLS: Wide Interest Rate Corridor Flexible interest rate policy against sudden shifts in capital flows Reserve Option Mechanism Build reserves with low sterilization costs during inflows. Reduce sensitivity of credit and exchange rates to capital inflows. 34

CBRT has expanded the policy toolkit to weaken the amplification mechanisms triggered by global liquidity cycles. Flexible Interest Rate Corridor Global Liquidity Capital Inflows Reserve Option Mechanism External Borrowing Currency Appreciation Rapid Credit Growth Balance sheet and collateral effects, further credit growth 35

2004Q3 2005Q1 2005Q3 2006Q1 2006Q3 2007Q1 2007Q3 2008Q1 2008Q3 2009Q1 2009Q3 2010Q1 2010Q3 2011Q1 2011Q3 2012Q1 2012Q3 2013Q1 2013Q3 2014Q1 2014Q3 2015Q1 2015Q3 2016Q1 The interaction between capital flows, exchange rate and bank loans have been dampened considerably since the implementation of MaPs. 2 1,5 1 0,5 0-0,5-1 -1,5-2 Capital flows, exchange rate, and credit cycles (HP filtered, standardized) Loans (t) REER (t+3) Inflows (t+3) The New Policy Mix Source: CBRT. 36

Macro Outcomes of MaP Implementations 37

0108 0708 0109 0709 0110 0710 0111 0711 0112 0712 0113 0713 0114 0714 0115 0715 Current account balance has shown a persistent and sizeable improvement in recent years, despite the volatility in capital flows. 100 90 80 70 60 50 40 30 20 10 0-10 Current Account Deficit and Net Capital Inflows Net Capital Inflows (12 Month Cumulative, Billion USD) CAD (excluding gold, right axis) MaP CBRT starts using ROM actively 100 90 80 70 60 50 40 30 20 10 Source: CBRT. 38

0107 0407 0707 1007 0108 0408 0708 1008 0109 0409 0709 1009 0110 0410 0710 1010 0111 0411 0711 1011 0112 0412 0712 1012 0113 0413 0713 1013 0114 0414 0714 1014 0115 0415 0715 The share of long-term and FDI inflows have increased since 2011. Net Capital Inflows (12-Months Cumulative, Billion USD) 100 Portfolio and Short Term** FDI and Long Term* 80 60 New Policy Mix 40 20 0-20 Source: CBRT. *Long term capital movements are sum of banking and real sectors long term net credit and bonds issued by banks and the Treasury. Short term capital movements are sum of banking and real sectors' short term net credit and deposits in banks. Last Observation: August 2015. 39

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 GDP growth stayed relatively stable since 2011, despite the heigthened volatility in capital flows. 15 10 5 0-5 -10-15 -20 Annual Change in Net Capital Flows/GDP (percent) GDP (real, annual growth, percent, right axis) 20 15 10 5 0-5 -10-15 -20 Source: CBRT. 40

2008 2009 2010 2011 2012 2013 2014 The contribution of global factors to Turkey s monetary and financial conditions have declined after the implementation of MaP policies. 100 90 80 % Share of Global Factors* in Explaining Turkey s Financial Conditions 70 60 MaP measures 50 40 30 20 *Global Factors are VIX index, global growth, US treasury 10-year yield and 10-2 year spread. Source: Kara, Özlü and Ünalmış (2015) 41

01/10 05/10 09/10 01/11 05/11 09/11 01/12 05/12 09/12 01/13 05/13 09/13 01/14 05/14 09/14 01/15 05/15 09/15 Inflation expectations improved during the initial stages; yet deteriorated since the taper tantrum due to persistent depreciation in TL. 10,0 Medium-term (2-year ahead) Inflation Expectations (Percent) 9,0 8,0 7,0 Adoption of the New Policy Framework Taper tantrum and political uncertainty 6,0 5,0 Target 4,0 3,0 2,0 1,0 0,0 Source: CBRT. Last Observation: September 2015. 42

Final Remarks Macroprudential policies in Turkey have engineered a soft landing and improved sustained growth prospects. Sensitivity of economic activity to capital flow volatility have declined considerably. Overall, the Turkish experience suggests that well targeted countercyclical MaP can improve the policy tradeoffs. Building buffers in good times, using them in bad times Yet, neither monetary policy nor macroprudential policy can substitute for deeper structural reforms. 43