Turkish lira crisis – risk of contagion for European banks

Meanwhile, the Turkish lira is once again falling like a stone in relation to the U.S. dollar or the euro, not to mention in comparison with the real and solid currency called gold. To what degree do European institutions see themselves involved in Turkey at the current time – and how is the general situation assessed?

With the Turkish lira having lost around twenty percent of its value against the U.S. dollar since the beginning of the year, running out of foreign exchange reserves and tilting at windmills seem to have prompted the Turkish central bank CBRT to abandon its interventions aimed at supporting the domestic currency.

Major Spanish bank BBVA could also be in trouble
It is advisable to focus on the Turkish banking sector, which, as in comparable crises before it, threatens to bring a number of European banks into difficulties as well, among them first and foremost the major Spanish bank BBVA. This is exemplified by Garanti Bankasi.

Garanti Bankasi, including two other local institutions named Is Bankasi and Akbank, is majority-owned by the Spanish banking giant BBVA. Their bond rates are currently more than ten percentage points higher in relation to comparable U.S. government bonds.

According to their balance sheets, these institutions are still proving profitable and, according to official statements, are sufficiently capitalized. Despite all this, the very high interest rate differentials indicate that investors seem to see things a little differently, which is why there seems to be a lack of general confidence in Turkish banks.

Foreign Exchange Reserves Coming to an End – Interest Rate Differentials Widening
Until recently, the Central Bank of Turkey (CBRT) had been borrowing U.S. dollars from domestic commercial banks in order to sell these accumulated holdings to support the domestic currency in exchange for a purchase of Turkish Liras. As a result, foreign currency and foreign exchange reserves in Turkey are running out at an ever-increasing rate.

None of this has helped, because since the CBRT abandoned its efforts, the lira has depreciated again by more than 6.5 percent against the U.S. dollar. In addition, interest rate differentials now appear to be widening even more dramatically with reference to bank bonds outstanding under Turkish institutions as well as domestic corporate bonds relative to U.S. Treasury bonds of comparable maturities.

Foreign currency withdrawal fees to be introduced
Meanwhile, the run on foreign currencies among the Turkish population, citing Reuters news agency, has led Turkish banks to start introducing fees for a withdrawal of foreign currencies. State-owned Ziraat Bank now charges a 0.03 percent fee for account withdrawals of more than 3,000 U.S. dollars.

Garanti Bankasi, which was mentioned at the beginning of this article, now charges a fee of 0.015 percent for amounts of more than 20,000 U.S. dollars. Finally, Turkish state and commercial banks have been given the green light by the CBRT to take such measures because there has clearly been a shortage of foreign currency reserves among these institutions.

This dangerous situation is not only due to the fact that tourism in Turkey is at a standstill as a result of the ongoing pandemic, but also to the fact that Turkey’s cross-border trade has been reduced, in some cases significantly, over the course of the past few months. And so it is not surprising that Turkish companies are increasingly getting into trouble when it comes to servicing outstanding debts denominated in U.S. dollars or euros.

Contagion effects feared in Spain, Italy and France
If this situation persists or even worsens, contagion effects are likely to occur in Spain, Italy and France sooner or later. At the height of the lira crisis in 2018, even the ECB felt compelled to warn of precisely these contagion effects.

The last lira crisis in 2018 was used by some European institutions to scale back their activities in Turkey, in some cases significantly. Some commercial commercial banks were also forced to write down the value of assets held in Turkey. Despite all this, the level of involvement of European banks in the Turkish economy still proves to be quite high.

Among all foreign lenders, Spanish and French institutions are in the greatest danger, according to a warning by the Bank for International Settlements. Current estimates say that Spanish, French, Italian and British banks have loans outstanding in Turkey in a cumulative amount of almost 120 billion euros. BBVA alone is said to account for half of this amount, at 61 billion euros.

Meanwhile, the bad loan ratio in Turkey has climbed to 5.5 percent, according to official data, making it the highest since the global financial crisis. The fact that inflation had risen as high as 25 percent in the wake of the last lira crisis in 2018, and that the CBRT raised its key interest rate to as high as 24 percent at its peak, prompted President Erdogan to remove the then-chairman of the CBRT from office.

Since then, Turkey’s key interest rate has fallen to as low as 8.25 percent, while inflation is picking up again. The government in Ankara had already introduced various price controls in 2018 in response to developments at the time of the lira crisis. Numerous critics accuse Erdogan of having brought the CBRT under the control and thumb of politicians, as could be observed previously in Japan, among other countries.

European institutions reduce their stakes, BBVA expands lending….
Meanwhile, European institutions such as UniCredit are reducing their stakes in Turkish lenders or are considering such steps, as in the case of ING Groep or HSBC, in order to come out of this with a black eye. Only Spain’s BBVA, which has already written off a 75 percent stake in Garanti Bankasi, is holding on to its Turkey business and remains cautiously optimistic.

Garanti Bankasi’s U.S.-traded ADRs have lost more than 85 percent of their former value (from six USD to 0.91 USD) since 2011. Garanti Bankasi, despite this development, did not refrain from rapidly expanding and foreign currency-based lending to Turkey’s construction, real estate, tourism, and energy sectors.

Some of these sectors have not even recovered from the last lira crisis in 2018, while the Turkish tourism industry has been hit over the head with a kind of numbing sledgehammer by means of the coronavirus pandemic.

That doesn’t faze BBVA, which, on the contrary, expanded its lending in Turkey by another 21 percent in the first half of the year. Borrowers who feel they are no longer able to meet their financial obligations have also been granted deferrals of both interest payments and principal repayments.

DepthTrade Outlook

With the lira falling like a stone again against the U.S. dollar and the euro over the past few weeks, not to mention the performance of the lira relative to the only solid currency in this environment called gold, credit conditions in Turkey have deteriorated significantly, as expected.

As soon as the pronounced debt moratoria in the area of loan repayments and interest payments are lifted, one has to expect a strongly growing pressure in the Turkish banking system cauldron due to massively climbing defaults.

From the point of view of European banks such as BBVA, it can be assumed that this Spanish institution will once again have to be “rescued” by the Spanish state in order to pass on the resulting bill to European taxpayers. And so this bailout merry-go-round turns until one day it will stop turning.

Short positions on Lira are risky but could lead to high profit during this crisis. (We recommend EUR/TRY + low leverage)

Ben Schaack Send an email

Mr. Schaack is a financial analyst, specializing in the commodity, foreign exchange, and crypto markets - with more than 10 years of experience. Besides his business analytics studies, Mr. Schaack works as a journalist - covering finance, economy, and geopolitics. His special interests are focused on inflation hedging and exponential (compound interest) growth. He posts and discusses relevant news on his Twitter account.
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