S&P: Turkish banks’ external loans subject them to danger

S&P does not expect any liquidity issues with Turkish banks
S&P: Turkish banks’ external loans subject them to danger
Turkish banks

Which banking systems in emerging markets are most vulnerable to external financing pressures and why? Standard & Poor’s asked and answered in a report today.

The agency says major central banks are tightening monetary policy faster than initially expected, which is likely to make global liquidity scarcer and more expensive.

Some banking systems in emerging markets are exposed to this phenomenon either directly through their large net external debt, or indirectly through exposure to companies or governments.

Of the five banking systems discussed in the report in Egypt, Indonesia, Qatar, Tunisia, and Turkey, Turkey and Tunisia appear to be the most vulnerable.

Risks facing the banking system in Turkey


Turkish banks remain highly vulnerable to negative market sentiment and risk aversion due to their declining but still high external debt, amounting to about $143 billion as of March 31, 2021.

As a result of monetary policy normalization by major central banks, global liquidity will decline, increasing refinancing risk for Turkish banks. These risks are compounded by very high local inflation, unpredictable monetary policy, and the potential negative impact of the Russia-Ukraine conflict on commodities imports, the tourism sector, and investor sentiment.

Under S&P’s base-case scenario, it does not expect a major disruption to Turkish banks’ access to syndicated or other major bilateral funding lines in 2022–representing about 51% of their total short-term external debt on March 31, 2022, assuming that local authorities can stabilize the Turkish lira to some extent. Indeed, banks were able to roll over most of their syndicated loans with foreign counterparties in April-June 2022, with rollover rates fluctuating between 88% and 101%–admittedly at a higher price. Nevertheless, S&P expects a lower appetite for senior and subordinated bank bonds.

The other risk S&P foresees for Turkish banks is the increase in deposit dollarization and ultimately deposit withdrawal if residents start to lose confidence in the system.

On May 27, 2022, 58% of deposits were denominated in foreign currencies, up from 44% in 2017. Since the severe currency devaluation in December 2021, local authorities have implemented several measures to push banks and depositors to convert their foreign exchange deposits into Turkish lira, including a foreign exchange-protected deposit scheme with an objective of converting 20% of deposits by Sept. 2, 2022.

Banks that will not comply with this limit will be subject to penalties. Although those measures have helped to reduce dollarization from a peak of 69% in mid-December 2021, the deposits benefitting from this scheme covered about 13.7% of deposits on May 31, 2022, so the benefit might turn out to be only temporary.

Turkish banks have still some cards up their sleeves but playing them might be more complicated than what the numbers suggest. The agency estimates broad liquid assets in foreign currency at around $154.8 billion on March 31, 2022 (including mandatory reserves of about $49.9 billion). This should suffice to cover upcoming funding maturities over the next 12 months, which amounted to about $85.7 billion on March 31, 2022.

Therefore, on paper, the position appears well matched. However, $75.9 billion of Turkish banks’ foreign assets were placed with the Central Bank of the Republic of Turkey (CBRT) on March 31, 2022. As such, under a hypothetical extreme scenario, the CBRT could restrict access to these assets given its already weak foreign exchange reserves, and push banks to default. Clearly, a significant increase in foreign exchange demands by depositors would add pressure on the local currency and, in turn, on already low CBRT’s foreign exchange reserves, increasing the risk of capital controls. In 2022, the CBRT enacted a new law requiring exporters and companies operating in the service sectors to convert 40% of their foreign exchange revenues into local currency to contain reserve erosion.