Implication of Globalization on the Banking System of Turkey - Essay Example

Implication of Globalization on the banking System of Turkey Financial globalization pertains to the opening up of the local financial and banking system to foreign capital and foreign financial institutions. The onset of globalization demands that domestic financial institutions adopt higher accounting standards, stronger legal enforcement systems and stricter disclosure requirements. Financial globalization promoted financial development. When foreign financial institutions enter a country, domestic financial institutions have to become more efficient in order to survive. (Claessens and Jansen 2000) Foreign financial institutions bring in the best practices. Financial liberalization helps improve domestic prudential supervision because local supervisors learn new risk management practices (Mishkin 2003). Financial globalization increases liquidity and lowers the cost of capital, which stimulates investment and economic growth. Financial liberalization consists of two components. The first component is the internal financial liberalization which results in the lifting of regulations that restrict domestic financial institutions from lending their funds at market rates. The second component is the external financial liberalization which occurs when domestic financial markets are opened to flows of foreign capital and foreign financial institutions. After a period of financial liberalization, the central bank supervisors already lack the technical expertise to monitor the banks' new lending programs. Without this capacity for prudential monitoring, the local bank regulators cannot stop the banks from doing excessive risk-taking activities. Banks expand their lending activities and go on a lending mood. In countries with well-developed banking sectors, financial liberalization has resulted in lending booms and banking crises in the 1980s in Japan and in 1990s in the United States. The financial globalization process allows domestic banks to borrow abroad. The banks pay high interest rates to get foreign capital so they can double their lending, while foreign deposits that fund the bank's lending activities are deemed protected by a government guarantee. During financial globalization, the financial systems are heavily prone to transmission across borders, markets, and events in case of severe shocks. These effects mirror exposures to common shocks, or potential spillovers arising from the crisis. The first response is to guarantee oversight of internationalized financial institutions. The second is to put in set up cross-border crisis management and arrangements that can manage a severe shock and minimize spillovers. Both responses need the cooperation of multinational institutions. The bank supervisors must check so that the payment systems are robust to withstand a cross-border banking failure, that banking authorities are able to foster trusting relationships to project a rapid flow of sensitive information, and that bank crisis management arrangements are defined. Countries with systemic cross-border banks like Turkey must be well-prepared for potential problems of bank insolvency and must have the technical and financial capability to coordinate a potential bail-out scenario with foreign authorities taking into consideration the negative externalities of a bank failure. Turkey had an uncompetitive banking and financial market until the 1980s. It implemented controlled interest rates, promoted competition through directed credit and imposed high reserve requirements. The Turkish banking system also adopted barriers to both entry and mobility. The main barrier to restrictions on financial intermediation, and restricted mobility seems to be the size of the large banks which had a negative effect on competition. Most Turkish Banks have implemented an uncompetitive pricing system. (Denizer, 1997) Turkey since 1980 had seen a trend towards the provision of credit through public banks. Public banks account for approximately 30 percent of the total sectoral assets. The banking reform in Turkey had the aim of attaining a competitive and efficient financial system. Deregulation and entry of foreign banks into the system were implemented. Futhermore, the specific reforms eliminated interest rate restrictions on deposits and loans, and intoduced new financial products and institutions. The initial result of this policy was the increase of interest rates which led to the collapse of six banks. Some large banks exhibited collusive practices. (Denizer, 1997) In Turkey, there was an expansion of bank branches from 1963-1980. Banks had competed for deposit collections and this led to extensive bank branching networks. However, the rising inflation rates led to negative real deposit interest rates. However, despite the negative interest rates, deposits still increased. This led to an increase in deposit collection by the banks. This led the banks to open more branches. The banks then invested these deposits into assets which generated positive and profitable returns. The main weakness of the liberalization was the excessive bank branching and the growth of bank sizes which did not reflect the accurate cost of capital. Prices were distorted during that time. (Denizer, 1997) From 1980-91, the number of savings accounts which had been opened in local banks had increased from 26 million to 36.7 million. There was also a significant increase in the number of accounts which were opened with the large banks. Firm concentration ratio of number of accounts jumped from55 percent in 1980 to 62 percent in 1991. The percentage of the savings deposits had declined in the leading banks but the number of savings accounts placed had increased as these large banks attracted small depositors. The big depositors had exploited other opportunities for a higher return to their investments. (Denizer, 1997) The Central Bank of Turkey removed directed credit programs and eliminated preferential rates to attain efficient allocation of resources. Reserve requirements were lowered but liquidity ratios remained high. (Denizer, 1997) By late 1980s, the Turkish banking system had a highly concentrated market tructure and an overbranched and inefficient system. The top 5 banks managed approximately 70 percent of total deposits, 64 percent of assets and owned 60 percent of all branches. As a result of easing of entry restrictionst, Turkish banks increased to 66 from 43 between 1980 and 1990. There were some mergers also. There were also 31 new banks, 19 were foreign and 11 local, respectively. The new banks focused on trade finance and corporate banking. The banks, in general did not go into retail banking. Major banking operations were limited to the three large cities. The new banks just looked for profitable niches in wholesale corporate banking. Akkurt et. al., (1992) maintained that the entry of new banks, most specially the foreign ones led to major improvements of human capital and information technology of the sector. The reform has improved the performance of the Turkish banking system but there are still areas for improvement. Regulatory barriers had been relaxed leading to improved mobility in retail banking. The breaking up of public banks can lead to the establishment of 20 new banks which can reduce concentration and widen retail banking. Reform had lessened concentration in the industry but the major players still set the pricing among themselves. Turkey lacks a varied credit industry. Most banks prefer corporate rather than retail banking. The breaking up of the large public banks before privatization will help address this weakness and hopefully develop better governance and an increasing level of competitiveness. There is also a persistent gap in banks which offer housing finance and mortgages to individual borrowers (Denizer, 1997). Finally, despite the prevailing efficiency of the Turkish banking regulatory framework and the excellent supervisory capabilities of the local authorities, the Central Bank of Turkey needs to seek a holistic balance between competition, systems stability and overall banking efficiency. (Denizer, 1997) These are some of the areas that need to be addressed to strengthen the Turkish banking sector. The first one is the development of the type of bank collateral. Bank collateral assists various financial intermediaries lessen the problems of adverse selection and moral hazard. Collateral also lessens moral hazard by prohibiting borrowers from taking on too much risk. The second area is the general weakness of the legal system to safeguard restrictive contracts. A working legal system can reduce moral hazard incentives for borrowers who take on excessive risk. Furthermore, if the business and political interests intervene, the judges will be unable to enforce restrictive contracts for the weak. Hence, the equity and fairness of the legal system is crucial. The common law is expected to protect property rights and to enforce private and public contracts. The third area is the management and distribution of government-directed credit. The political leaders of governments usually keep credit to themselves and to their favored business and political allies. Government directed credit has a huge volume and value. The government can mandate the fund circulation by directing government financial institutions to give different loans at preferential rates and by allowing individuals and companies to access preferential credit regardless of the type of collateral. The government is not concerned if the loans are going to financially viable enterprises since the government banks are not keen on making profits. Hence, the result of government-directed credit leads to inefficient investments and slower growth. (Mishkin, 2007) The fourth area for improvement is strengthening the weak level of the banking regulatory system. A prudent measure of government regulation can ensure that more information is made available in financial markets. Many developing countries adopt weak accounting standards and disclosure requirements posing serious difficulties for lenders. Once the asymmetric information problems persist, the country experiences a credit crunch. Hence, there is a need to establish legal and regulatory institutions which allow the flow of information. (Mishkin, 2007) CONCLUSION Financial globalization has made marked improvements and encouraging changes in the Turkish banking system as well as in the banking system of other countries around the world. Financial liberalization fosters the growth of institutions so that financial markets can carry out the essential function of getting capital to its most productive uses which then paves the way for growth and reduction of poverty. However, financial globalization can also have negative impacts if government policymakers do not manage the entire process superbly. References Akkurt,A ., Hakioglu,D ., KarayalcinA, ., Koc.,O zcet,C ., Senel,A ., Usta, N., Varol,0 . "Developments in the Turkish Banking Sector: 1980-1990,"in Aydogan,K ., andH . Ersel.,( eds), Issues in Banking Structure and Competition in a Changing World.Conference Proceedings, Central Bank of the Republic of Turkey, Ankara, 1992. Denizer, Cevdet, 1997, Effects of Financial Liberalization and New Bank Entry on Market Structure and Competitiveness in Turkey, World Bank Policy Research Paper. Mishkin, Frederic, 2007, Is Financial Globalization Beneficial, Journal of Money, Credit & Banking, Vol, 39. Issue 2-3. Page number 9. Read More