For Turkey, the 1990s was a period marked by high inflation, volatile growth and financial crises. In this period, the CBRT policies mainly focused on restricting exchange rate fluctuations and ensuring stability in financial markets.
b. February 2001 Crisis and After
The failure to overcome structural problems and restore confidence in financial markets despite all the pre-emptive measures caused Turkey to experience the deepest financial crisis of its economic history in February 2001. The Turkish lira significantly depreciated, interest rates reached historic highs, payment systems as well as securities and money markets came to a halt due to banks’ failure to fulfill their liabilities, and the real sector saw many bankruptcies in this period. After this severe damage to financial stability, the financial system could only be made functional again with significant capital support from the government.
In order to put the economy back on track to sustainable growth, fiscal deficits were reduced and fiscal dominance was eased. Additionally, numerous regulations and structural reforms were introduced to achieve a robust structure in the banking system that would enable it to focus on its intermediation function, become resilient against internal and external shocks, and remain competitive on a global scale.
Meanwhile, the amendment made to the CBRT Law in May 2001 set price stability as the Bank’s primary objective and financial stability as a complementary objective.
After the crisis, structural reforms introduced in the banking sector were implemented decisively, and thus the Turkish economy stabilized in general. Consequently, the financial system strengthened in terms of structure, increased its profitability and significantly contributed to the strong growth performance of the economy.
c. Global Financial Crisis in 2008
The global financial crisis that broke out in 2008 was an important test for the resilience of both the Turkish banking sector and the overall economy. Due to its robust financial structure, the Turkish economy was minimally affected by the global crisis. In the aftermath of the crisis, Turkey received strong short-term capital inflows, leading to increased consumption due to easier access to credit, while the Turkish lira appreciated and the current account deficit widened.
These developments fueled concerns over financial stability and called for an alternative policy approach. Hence, the CBRT intensified its financial stability-oriented communication, thereby giving the first signals of a policy change.
Through the following changes, the CBRT adopted a flexible monetary policy oriented towards the primary objective of price stability that also safeguards financial stability.
Interest Rate Corridor: To constrain the existing macro financial risks, the CBRT redesigned its inflation targeting regime in a way that would enable different but complementary policy instruments to be used concurrently. In this renewed regime, first the interest rate corridor, referring to the spread between the overnight lending and borrowing rates, was widened, and an operational framework was designed to make it possible to adjust the volatility of short-term money market rates according to the circumstances. Consequently, the average yield of short term rates was reduced and their volatility was increased. In this way, short-term capital inflows were discouraged as much as possible.
Required Reserves: The CBRT also used required reserves as a macroprudential instrument to control the Turkish lira liquidity in the market and the credit supply. To this end, the remuneration of required reserves was stopped, the weighted average of reserve requirement ratios was raised, and the coverage of liability items considered in the calculation of required reserves was extended.
Moreover, reserve requirement ratios were rearranged according to different maturity brackets so that they would be higher for short-term liabilities. The aim of this arrangement was to strengthen the financial system by extending the maturity of banking sector liabilities.
Reserve Options Mechanism: The Reserve Options Mechanism was developed to support cost and liquidity channels in the banking system, and to provide banks with further flexibility in their liquidity management.
Accordingly, banks were allowed to:
- Hold a certain portion of their Turkish lira required reserves in foreign currency,
- Hold a certain portion of their Turkish lira and foreign currency required reserves in gold.
With these changes, adhering to its primary objective of price stability, the CBRT has shifted towards a flexible monetary policy that safeguards financial stability.