Various theoretical and empirical studies have been put to determine the existence and direction of the casual relationship between financial development and economic growth. There are four possible results concerning this causal relationship: financial development follows economic growth, financial development is a determining factor of economic growth, there is bidirectional causality and there is no causal relationship.
This paper aims to explain the relationship between financial development and economic growth in Turkey through taking into account the effects of the Banking Sector Restructuring Program in 2001. After implementation of structural reforms in financial sector and obtaining political stability, Turkey enjoyed high growth rate with a single-digit inflation rate in the last decade. The strengthened financial system became primary factor for the improvement in Turkey’s economic situation. In Turkey, financial development after 2001 contributed to the economic growth through re-establishing trust, improving country’s reputation, increasing private investments, gaining know-how and professionalism, and improving the access of financial services in all regions of the country. In this context, this study contributes to the literature by explaining the relationship between financial development and economic growth in Turkey through showing the transformation in Turkish financial sector and its effects on Turkish economy.
The paper is organized as follows: firstly, Turkish banking sector before 2000-2001 financial crisis is investigated through mentioning the weaknesses in the sector, secondly, banking sector reform is summarized, thirdly, financial sector development after banking sector reform is briefly explained and basic data about the sector is presented, fourthly, the relationship between financial development and economic growth is examined, and finally, some recommendations are given based on the findings in Turkish experience.
Banking Sector before 2000-2001 Financial Crisis
In the early 1980s, Turkey left ‘import substituting industrialization’ policy and switched to ‘export-led growth strategy’ in order to restore Turkish economy (Yucel, 2009). After this transformation, financial liberalization program in Turkey was applied. Before 1980s, financial sector “was repressed and highly regulated”, and there were interest rate ceilings on deposits and credits (Ardic and Damar, 2007, p.6).
Following financial liberalization after 1980s, the number of banks increased rapidly in Turkey (BRSA, 2010). During that period, entrance to the financial sector was easy because granting licenses was simple whereas cancelling licenses was difficult (BRSA, 2010). The following table shows the increase in banks number in Turkey before financial crisis in 2000-2001.
Figure 1: New Bank Entries into the Sector and Total Number of Banks
Source: BRSA, 2010, p.10.
In 1999, the number of banks became 81, and the sector reached to 8,104 branches and 184 thousand personnel (BRSA, 2010). During that period, the share of first five banks within total assets remained under 50%, the share of first ten banks within total assets remained under 70% and the share of global capital within sector reached 7.1% at most (BRSA, 2010). Also, the contribution of growing banking sector to the economy increased. The following table gives basic information about banking sector during 1990-2000.
Table 1: Main Operational Indicators of the Sector
Source: BRSA, 2010, p.9.
Although banking sector grew a lot following financial liberalization, “the criteria of profitability and efficiency were not implemented implicitly” (BRSA, 2010, p.10). In terms of scale, Turkish banking sector remained small in comparison to similar economies (BRSA, 2010). Banks supported public finance rather than private sector; they had problems about “weak deposit to credit transformation, low concentration with new entries into the sector, also weak risk management culture” (BRSA, 2010, p.9).
During 1990-2000, banking sector grew but did not make a stable progress. Although nominal growth of total assets, loans, and deposits was high, real growth of these indicators fluctuated when high inflation was taken into account. Real growth was 8.1% for total assets, 3.6% for credit volume, and 6.9% for own funds (BRSA, 2010). Also, financial sector preferred to rely on public securities and by this way, receded from its main function of intermediation. Most of the banking sector’s resources were transferred to public sector (BRSA, 2010). Banks started to borrow funds from abroad and lend them to government in order to gain higher interest returns (Ardic and Damar, 2007). For this reason, the share of credits remained very low in comparison to similar economies. The ratio of credits within total assets was 47% and the credit/deposit ratio was 84% in 1990 whereas these ratios decreased to 33% and 51% respectively in 2000 (BRSA, 2010). The ratio of interest income from credits within total interest incomes was 69.2% in 1990 whereas this ratio decreased to 38% in 2000 (BRSA, 2010). Therefore, “public had crowded out private investments … [f]inally, due to the interests rising with high fund demand from public sector, the financial intermediation efficiency of the banking sector deteriorated” (BRSA, 2010, p.12).
Figure 2: Share of Credits and Securities Portfolio within Total Assets
Source: BRSA, 2010, p.12
Additionally, before 2000, the sector was exposed to high risks. The sector operated with low capital. The share of own funds was 10.1% in 1990 whereas it decreased to 7.3% in 2010 (BRSA, 2010). Also, the risks associated with the sector increased because the banking sector became really sensitive to liquidity, interest and exchange rate risks (BRSA, 2010). To illustrate, capital adequacy ratio of the sector decreased to 8.2% and the ratio of non-performing loans to total loans increased to 11.1% in 1999 (BRSA, 2010).
In conclusion, the fragility and structural problems in banking sector constituted a ground for the financial crises in November 2000 and February 2001 which were the most severe crises in Turkish history (BRSA, 2010). As Ozatay and Sak (2003) states, financial fragility of the banking sector accompanied with other triggering factors led to the crisis.
Banking Sector Reform
After financial crisis, foreign resource utilization became necessary in order to maintain macroeconomic stability and for this reason, economic policy prospects were submitted to the IMF immediately (BRSA, 2010). Within the framework of the 18th stand-by arrangement made with IMF, financial system improvement and the continuation of structural reforms were accepted as main priorities of the country (BRSA, 2010). Besides macro structural reforms including fiscal discipline and monetary policy, Turkey also put The Banking Sector Restructuring Program into implementation on May 15, 2001 in order to strengthen its financial system (BRSA, 2010).
In accordance with restructuring program, the Banking Regulation and Supervision Agency which has an autonomous administrative authority was established (BRSA, 2010). New regulations were accepted in order to provide more transparent and effective operation of banks. Public banks were restructured financially and operationally, private banking system was rehabilitated, surveillance and supervision over banks was strengthened through legal and corporate regulations, and banks in trouble were taken over by SDIF (Saving Deposit Insurance Fund) (BRSA, 2010).
For restructuring of public banks, the following means were taken into account: duty loss receivables ($17.5 billion) were cleared, the regulations causing duty losses were abolished, capital support was given, their short term liabilities (TL 8,5 billion) were abolished, and financial support was given to improve their cash inflow and liquidity positions (BRSA, 2010). Moreover, in order to enable them competitive in modern banking system, public banks were converted to corporation and their personnel number was reduced about 50% (BRSA, 2010).
For resolution of banks transferred to SDIF, the following means were taken into account: the banks which were not able to fulfill their liabilities either lost their operation licenses or were transferred to SDIF, a total of 11 banks were transferred to SDIF after financial crises, when the bank shares were taken over by SDIF, the financial structures of banks were rehabilitated through “capital increase, reserve transfer, liquidity support, making available advances, making deposits and cancelling the penalty liabilities”, and when the bank shares were not taken over by SDIF, then resolution were made through transfer of insured deposits and assets to third parties (BRSA, 2010, p.42).
For achieving a sound private banking structure, the following means were taken into account (BRSA, 2010): long-termed savings were encouraged, tax incentives were given to increase merger and turnover of banks, the process of transfer and merger transactions were simplified, capital structure of banks were strengthened, the quality of supervision was improved through double audit mechanism, debt restructuring system was founded to help real sector companies maintain their activities during financial crises, and asset management companies were established to liquidate more loans.
For recovering the regulatory framework, the following changes were made (BRSA, 2010): autonomy of Central Bank was improved, SDIF became independent institution, Turkish Accounting Standards Board was founded, foreign direct investment was encouraged through protecting foreign investor rights via newly adopted FDI law, sanctions were strengthened, and private finance houses were founded to increase the efficiency of the system. Also, the table below summarizes the regulations adopted during restructuring process in order to strengthen financial system.
Table 2: Strengthening the Regulatory Framework and Impacts Thereof
Source: BRSA, 2010, p.61.
Financial Sector Development in Turkey after Banking Sector Reform
After 2002, capital structures of banks have improved. To illustrate, private banks increased their capital with their own resources about TL 2.269 million in 2001, TL 1.020 million in 2002, and TL 714 million in 2003 (BRSA, 2010). Also, banks have adopted corporate governance principles and by this way, have improved accountability and transparency to their shareholders (BRSA, 2010).
Additionally, during that period, financial sector experienced a regulated growth. With the effect of financial crisis, the number of banks decreased from 81 to 51 in 1999-2005 period but the share of global capital increased. The share of first five banks within total assets increased above 55%, the share of first ten banks within total assets increased to 84% and the share of global capital within sector reached 6.3% at most (BRSA, 2010). The number of branches, personnel, ATM and post machines started to increase regularly in order to reach more customers. Also, the number of bank cards and credit cards increased continuously and reached 48,2 million and 30 million respectively in 2005 (BRSA, 2010). The contribution of growing banking sector to the economy increased. The following table gives basic information about banking sector during 2002-2005.
Table 3: Main Operational Indicators of the Sector
Source: BRSA, 2010, p.77.
On the other hand, financial sector has attained stable and high progress after banking sector reform. This stable and “high growth experienced in banking sector increased financial deepening and banking sector could support the economic growth in a stronger manner” (BRSA, 2010, p.77). During 2002-2005 periods, total assets annually increased by 24% on average. Also, loans increased rapidly because banks started to focus on their main function that is financial intermediation rather than financing public sector. For this reason, within total assets, the share of loans increased while the share of securities portfolio decreased relatively. Loans annually increased 45% on average during 2002-2005. Although loans grew rapidly, this growth was healthy. As it is seen in the following table, there was a decrease in the ratio of non-performing loan to gross loans. In 2002, this ratio was 17.6% but over time it decreased to 4.8%.
Table 4: Banking Sector Financial Soundness Indicators
Source: BRSA, 2010, p.79.
Financial sector also started to pay attention to private customers besides corporate customers and for this reason, sector became stronger (BRSA, 2010). The above table shows the improvement in intermediation function of banking sector. As it is seen, the ratio of consumer loans to total loans was 4.5% and the ratio of loans to deposits was 35.5% in 2002 and these ratios increased to 18.8% and 62.2% respectively in 2005. Also, the financial sector’s contribution to the economy increased through loans. The ratio of loan to GDP increased to 23.1% in 2005 (BRSA, 2010).
On the other hand, after reform, financial system was still dominated by banks but at the same time, non-bank financial institutions started to grow rapidly (IMF, 2007). Although non-bank financial institutions constituted only about 13% of the system, the number of insurance companies and pension companies, leasing and factoring firms started to increase (IMF, 2007).
The Relationship between Financial Development and Economic Growth
After 2002, Turkey experienced steady and high growth with low inflation rate. During 1991-2001, the economic growth was 2.87% and inflation was 74.67% in average whereas during 2002-2008 periods, the economic growth increased to 6.35% and inflation decreased to 17.24% in average (Global Development Network Growth Database). Also, the fluctuations of these indicators decreased a lot. The following table shows the changes in GDP growth, GDP per capita growth and inflation.
Table 5: Economic Situation Indicators
Source: Prepared by using data from Global Development Network Growth Database at http://dri.fas.nyu.edu/object/dri.resources.growthdatabase
As it is seen, Turkey experienced a steady growth after the crisis. Even in 2008 global financial crisis, Turkey continued to grow. Also, in the first quarter of 2011, “Turkey’s economic growth accelerated to 11 percent” while China’s economic growth was 9.7 percent (Bryant and Gokoluk, 2011, para.1-2). This growth rate “was faster than in any other member of the Group of 20 developed economies” (Bryant and Gokoluk, 2011, para.2).
The improvement in Turkey’s economic situation mainly resulted from restructuring of financial sector, macro structural reforms to support market economy, budget discipline and transparency in public administration, and monetary policy reforms based on price stability (BRSA, 2010). However, the strengthened financial architecture “became primary factor in protecting economic stability and rendering more resilient economy which is resilient against external fluctuations” (BRSA, 2010, p.82). “[S]tructural reforms, to minimize fragilities in the banking sector which played an important role in crisis dynamics in the transition period following 2000-2001, became the engine of economic growth and accelerated crisis resolution” (BRSA, 2010, p.82).
In Turkey, 2000-2001 crises were experienced primarily due to banking sector weaknesses (Ozatay and Sak, 2003). Although Turkey experienced high level of financial deepening in 1990s, this liberalization followed by a tough economic crisis (Ardic and Damar, 2007). For this reason, the credibility of financial sector became essential for economic growth in the following years. Financial development post-crisis period became the most important factor in order to re-establish trust both nationally and internationally and to improve economic expectations. The economic growth could not be succeeded without improvement in Turkish financial sector because the restructuring financial sector was necessary to establish trust on sustainability of the stability program. Financial sector gained trust through improved transparency and accountability. This situation also contributed to improve real sector confidence. For improving accountability and transparency of the sector, audit mechanism was strengthened and the Banking Regulation and Supervision Agency started to publish detailed data about the sector in a daily, weekly, and monthly basis (BRSA, 2010).
Additionally, financial development after 2001 contributed to improve credit rating of the country. Post-crisis regulations strengthened the reputation of financial system and established more sound market structure. For this reason, credit rating of Turkey increased after 2001 (Undersecretariat of Turkish Treasury, 2011). The following table shows the development of Turkey’s credit rating according to different credit rating agencies.
Table 6: Turkey’s Long Term TL Credit Rating
Source: Prepared by using information from Undersecretariat of Turkish Treasury, 2008, p.26; Undersecretariat of Turkish Treasury, 2011, p.26.
The improvement of Turkey’s credit rating mainly resulted from financial deepening. To illustrate, in 2010, Turkey’s local-currency sovereign credit rating increased to BB+ and according to the statement of S&P, this increase resulted from “the success of Turkey’s regulatory institutions in preserving the solidity of the financial sector, despite external adversity” (Lesova, 2010, para.1). Also, as of September 2011, Turkey’s local-currency sovereign credit rating increased to BBB- and according to the statement of S&P, this increase resulted from “continuing improvements in Turkey’s financial sector and the deepening of local markets” (Standard & Poor’s ups Turkey’s credit rating to investment grade, 2011, para.2). This situation decreased the cost of borrowing in Turkey.
Additionally, credibility of financial system decreased Turkey’s ‘risk premia’ and reduced capital costs and domestic interest rates (OECD, 2010). As a result of this, broader range of borrowers and fund users enjoyed declined real interest rates and lenghtened maturity of funds (OECD, 2010). According to OECD Economic Surveys of Turkey (2010), “[t]his supports not only the post-crisis recovery, but also offers a basis for stronger and broader-based long-term growth” (p.16).
At the same time, credibility of financial system increased inflows from foreign investors. The improvement of Turkey’s credit rating positively affected the foreign capital inflows to country. “In Turkey, the entrance of foreign banks into the sector contributed to economy through foreign capital and investment financing” (Demirkan, Inkaya, and Aydemir, 2011, p.8). The following figure shows the increase in the share of foreign banks in Turkey.
Figure 3: The Share of Foreign Banks within Total Banks
Source: Prepared by using data from www.tbb.org.tr
As it is seen in the figure, the share of foreign banks within total banks increased a lot after 2001. “After the crisis, Turkey experienced a great amount of foreign bank entry” (Aysan and Ceyhan, 2008, p.3). The most important factor of the foreign bank entry was “the high growth potential of the Turkish banking sector” (Aysan and Ceyhan, 2008, p.3).
On the other hand, the productivity and efficiency in the financial sector have increased as a result of competitive environment (BRSA, 2010). “While the sector was 52% efficient in 1990, the efficieny increased to 98% in 2006 for the sector in general” (Aysan and Ceyhan, 2008, p.18). Also, the productivity of the sector increased due to technological improvement resulted from the structural changes in the banking sector (Aysan and Ceyhan, 2008). “[T]he liberal financial intermediary system gained significant know-how and professionalism” (Nazlioglu, Yalama, and Aslan, 2009, p.108). The banks have adopted new management principles, ideas, processes, and procedures (BRSA, 2010). They have provided competitive advantage through product differentiation and they gained market discipline (BRSA, 2010). This situation also affected other sectors in the country and eventually facilitated economic growth.
After banking sector reform, financial intermediation of the banking sector has improved which in turn promoted economic growth. Banks have started to create income from their main activities. Most of the bank resources have been transferred to private sector instead of channeling these resources to government (BRSA, 2010). For this reason, the share of loans within total assets has increased while the share of securities portfolio within total assets has decreased (BRSA, 2010). Moreover, as financial markets have deepened, both deposit and credit interest rates have decreased (BRSA, 2010). By this way, private investments have been encouraged and increased. The following table shows the growth of private investments by sectors in Turkey after 2001.
Table 7: Gross Fixed Investments by Sectors
Source: Prepared by using data from www.dpt.gov.tr
Additionally, the following figure shows the growth of both private and public sector investments after 2001.
Figure 4: Gross Fixed Investments of Private Sector and Public Sector
Source: Prepared by using data from www.dpt.gov.tr
As it is seen in the figure, solidity and efficiency of financial institutions have contributed to the growth of both private and public investments. The contribution of financial development on private investments and total investments can also be seen in empirical studies. For instance, according to the study of Nazlioglu, Yalama, and Aslan (2009), in Turkey, “the private investment and total investment respond positively to an increase in two financial development indicators (total credit and credit to the private sector)” (p.114).
Additionally, financial system and real sector are closely connected to each other. Therefore, after the improvements in financial system, Turkish real sector also has been recovered rapidly (BRSA, 2010). For this reason, financial intermediary function has a critical importance in obtaining macroeconomic growth. Also, in Turkey, financial stability increased the access of financial services in the country (BRSA, 2010). The following table shows the loan/deposit ratios in all geographical regions of Turkey. As it is seen, loan/deposit ratios increased in all regions during 2002-2005. Also, as it is seen, coefficient of variation decreased during that period. For this reason, geographical regional differences decreased and more regions got a chance to access financial services that eventually contributed to the economic growth of the county.
Table 8: Geographic Differentiation by Loan/Deposit Ratio
Source: BRSA, 2010, p.80.
In Turkey, improvement in financial sector after 2001 contributed to the economic growth through re-establishing trust, improving country’s reputation, increasing private investments, gaining know-how and professionalism, and improving the access of financial services in all regions of the country. The positive impact of Turkish financial development on economic growth is also emphasized in some international reports. For instance, IMF Country Report of Turkey (2007) suggests that “further financial deepening will contribute to the diversity and efficiency of the financial system, and ultimately enhance macroeconomic and financial stability” (IMF, 2007, p.28). For this reason, in this report, it is suggested that “financial system and especially nonbank financial institutions should continue to develop rapidly” in order to boost economic growth” (IMF, 2007, p.1). Also, OECD Economic Surveys of Turkey (2010) states that “[t]he robustness of Turkey’s banking sector was a great advantage during the crisis and helped to support the recovery. Sustaining the robustness of the banking sector is key to stable growth … The efficient functioning of the financial system will be instrumental for future growth by lowering capital costs for all borrowers in the economy, notably the small firms” (OECD, 2010, p.7).
On the other hand, some empirical studies in Turkish literature establish the importance of financial development for economic growth in the country. For instance, Halicioglu (2007) investigated the period of 1968-2005 and conducted the bounds testing approach and Granger causality analysis. In this study, he found the unidirectional causality from financial development to economic growth (Halicioglu, 2007). Also, Altintas and Ayricay (2010) investigated the period of 1987-2007, used the bounds testing approach, and found that %1 increase in financial depth resulted in 0.67% increase in economic growth. Moreover, Yucel (2009) investigated the data from 1997-2007 and found that policies aimed at financial development and trade openness had positive effects on economic growth. Furthermore, Demir, Ozturk and Albeni (2007) investigated 1995-2005 period, used Johansen cointegration test with Granger causality test, and found that credits given to private sector and market capitalization were Granger-cause of reel GDP (Agir, 2010). There are also other studies – such as Darrat (1999); Aslan and Kucukaksoy (2006); Yay and Oktayer (2009); Acaravci, Ozturk and Acaravci (2007) – in which the direction of causality was also found to be running from financial development to economic growth in Turkey (Agir, 2010). These studies also constitute a proof for our thesis that financial development led to economic growth in Turkey. On the other hand, there are a few papers – such as Aslan and Korap (2006); Ozturk (2008); and Ege, Nazlioglu and Bayraktaroglu (2008) – that found contradictory results due to different financial development proxies and different methodologies (Agir, 2010).
In the early 1980s, Turkish financial system switched from a repressed system to a liberal system. Although financial liberalization reforms in Turkey were introduced in 1980s, the studies about financial development and economic growth started to be carried out during late 1990s. For this reason, in Turkish literature, there are not enough studies which focused on this topic. Also, in Turkey, financial deepening after the Banking Sector Restructuring Program has different from financial deepening before 2000-2001 periods. For this reason, the relationship between financial liberalization and economic growth should be investigated through taking into account the effects of the Banking Sector Restructuring Program. In this context, this study contributes to the literature by showing the transformation in Turkish financial sector and its effects on Turkish economy.
In conclusion, financial liberalization is important for the economic growth of countries. However, if financial sector is fragile and if it harbors deficiencies, then financial crisis become inevitable. Turkish experience constitutes an example for the importance of well-functioning financial system for the whole economy. This experience underlines that stability and soundness of financial sector is very important to facilitate economic growth at the same time to prevent and manage crisis. The new regulations about Turkish financial sector after 2000-2001 financial crisis created strong financial structure and brought financial stability to the country. For this reason, the effects of 2008 global financial crisis became very limited on Turkish economy because Turkey “showed considerable resilience thanks to important reforms implemented after the 2001 crisis” (OECD, 2010, p.1). Financial liberalization along with necessary regulations improved the trust and confidence both within country and foreign environment. Financial stability was supported by political stability and this situation brought stable growth to the country.
As it is seen in Turkish experience, it is vital to solve problems and fragilities of the financial sector. Strengthening solidity and efficiency of financial institutions is essential. In this respect, as it is stated in the study of Prasad, Rogoff, Wei, and Kose (2003), countries should focus on improving institutional quality through “robust legal and supervisory frameworks, low levels of corruption, high degree of transparency and good corporate governance” in order to get benefits of financial liberalization (p.6).
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