How a Banking Feud Sparked Turkey's Liquidity Crisis: Along With IMF, Nation Asks Lenders to Keep The Credit Lines Open
By Hugh Pope, 12/12/2000, The Wall Street Journal, Page A23

ISTANBUL, Turkey -- With international bankers worried that Turkey's 11-month-old program of disinflation and economic reform could unravel, Turkish and International Monetary Fund officials are busy securing commitments to keep the country's lines of credit open.

Yesterday, 30 Europe-based banks met in Germany and pledged to keep credit lines open; Turkish and IMF officials will seek similar commitments tomorrow in a meeting with U.S. bankers in New York convened by Citibank.

A $7.5 billion package of emergency IMF funding announced on Dec. 6 has brought a fragile stability to Turkish markets. The IMF says Turkey doesn't now need extra bridge loans from other international institutions. But interest rates are still high, partly because foreign banks have cut their exposure to the country.

Before normal lending resumes, international bankers will want to understand how what began as minor bloodletting between Turkish banks could spin out of control into a full-scale financial crisis. The crisis is part of a saga that started in 1999. After 30 years of high inflation, erratic growth and increasing corruption, Turkey announced it wanted to go straight -- yet again. The country of 65 million people, with a $200 billion economy that overtook Russia's gross national product in 1998, applied for its 17th standby agreement with the IMF.

Turkey had a long-term plan, the most stable-looking government in a decade, and had been on a self-imposed austerity program since mid-1998. So the IMF gave $4 billion to back a new three-year program, matched by another $4 billion from the World Bank. The aim: to bring inflation, which averaged more than 80% in each of the previous eight years, down to single figures by 2003.

The program was implemented this past January, and all went well at first. Interest rates on government paper plummeted to 45% from highs of more than 140% in 1999. Turks could make financial plans at last, thanks to exchange rates that were guaranteed to devalue the Turkish lira slowly until mid-2001. The government started fixing up social security and agricultural subsidies. By this summer, Turkey had raised more money through privatization and the sale of mobile-phone licenses than it had in the previous 15 years.

But after 11 months, privatization had slowed. Lower interest rates had fed a consumer-lending boom that sucked in imports, putting pressure on Turkey's foreign-currency reserves. The lower rates also constrained the easy profits once made by midsize banks that survived mostly by lending money to the government. As criminal cases began to uncover decades of corrupt bank management, some Turks began to move money abroad.

It was at this critical juncture that a "blood feud," as the big-selling newspaper Hurriyet called it, broke out in the banking sector. One of the midsize banks, Demirbank, had been taking business from Turkey's big established banks. It had also bet big on the anti-inflation program's success in bringing interest rates down still further. At one point it held 10% of Turkey's domestic debt.

But it was funding its operations from Turkey's short-term money markets, which are supplied by the same big-money banks it had alienated. When delays hit a big Demirbank foreign-loan syndication, the bank suddenly found its lines of credit cut. Demirbank was forced to dump its treasury bills at a loss to meet margin calls and other obligations.

Normally, the central bank would have stepped in to ease Demirbank over its liquidity crisis. But a key condition of IMF support for the anti-inflation program was a cap on the total foreign and local currency in circulation in Turkey. So, when the Demirbank crisis triggered a small rush to buy dollars from the central bank, it drained Turkish liras out of circulation just when it was most needed to ease lending between banks.

Investors in emerging markets were already nervous about trouble brewing in Argentina. On Nov. 22, they stampeded out of Turkey. Few wanted to hold Turkish positions over the long U.S. Thanksgiving holiday weekend. As yields on Turkish domestic assets jumped from 35% to 45%, many investors started selling Turkish treasury bills to cut their losses. They sought safety in dollars, sucking the central bank's currency reserves down further. Deutsche Bank alone sold $700 million worth of Turkish treasury bills in a day, mostly on behalf of clients. Briefly breaking with the IMF plan, the Turkish central bank supplied local currency to the banks. But it was too late. Turkish markets stalled and plunged into a panicky tailspin.

Within two weeks, $7 billion of Turkey's $24 billion of precrisis foreign-currency reserves had fled the system. Fears spread that Turkey would be forced to devalue its currency, which would wreck the Turkish program, shake global confidence in emerging markets and undermine the stability of the ruling order of Turkey, a rare secular democracy in the Muslim world.

But Turkey hung tough and took over Demirbank. This helped it earn the admiration of the IMF and the promise of $7.5 billion in emergency funds. As the outcome became clear, investors poured back in more than $1.5 billion -- including at least $300 million through Deutsche Bank, which hosted yesterday's meeting with international banks in Frankfurt.

Speculators with liquid assets have won big. Some estimate that as many as one-third of the customers of the international banks at yesterday's meeting in Frankfurt were actually high-net-worth Turks. International hedge funds also bet hundreds of millions of dollars, Turkish brokers said. They could achieve 10% gains in dollar terms in two weeks simply by playing the market for short-term deposits during the crisis. Indeed, a dollar-based gain on Turkish treasury bills of 29% to the end of June could still be locked in yesterday, according to Istanbul's Bender Securities. Far greater returns were theoretically possible at the Istanbul Stock Exchange, where prices fell 50% during the 30 days to Dec. 5, and then rocketed back up 40% in two days.

Meanwhile, Turkey lost.

The big banks that ganged up on Demirbank lost much of the international credibility -- and cheaper borrowing rates -- that they had worked hard to acquire over the past year. Consumer lending that had helped the economy return to growth after a massive August 1999 earthquake has ground to a halt. Growth is now expected to be flat in the first quarter of 2001. And heavily burdened Turkish taxpayers will again foot the bill for delays in reaching budgetary and economic stability in the country.

The legitimacy of the reform process itself has also been thrown into question. Although Turkey has vowed that the aim of its IMF-backed program is to privatize the economy and financial system, Demirbank became the 11th Turkish bank to be taken under state control in the past two years. More seem likely to follow.


  1. What was Demirbank's exposure to changes in the shape of the yield curve?  How could it have hedged this exposure?
  2. "Turkish markets stalled and plunged into a panicky tailspin."  Does this mean that those that did not panic could have made money?  Explain.  What are the implications for the market to stabilize itself?
  3. "Speculators with liquid assets have won big."  Were there no liquid assets anywhere in the international economy?  Why weren't the prices for Turkish assets bid up by these investors?
  4. How would a synthetic option position to protect against Turkish lira fluctuations have fared in such an environment?