Banking Reform class
Research Option Mechanism adopted by Turkey after 2008 financial crisis could
help to decrease the volatility of Turkish lira?
Dr. Dora Piroska Sevinj Ahmadova
Before financial crisis, Turkish central bank was indicated by its power
of stabilizing economy using price stability and low inflation tools. During
2008-2009 financial crisis, central banks could observe that traditional money
policies were not enough for stabilizing Turkish lira and economy adequately.
After deepening the crisis in the year of 2008, real economic situation had
collapsed and it made way think about applying unconventional ways of money
policy. The solution of Turkish central bank was to apply Reserve Option
Mechanism (ROM) in order to stabilize currency.
After the global economic crisis, the priorities of developing countries
and developed countries have changed in order to be focused on monetary policy.
In this process, developing countries such as Turkey, were observing the impact
of capital inflows and expansion of monetary policy of developed countries. That
was the reason why developing countries were trying to strengthen their
monetary policy with non-traditional policy tools.
Central Bank of the Republic of Turkey (CBRT) announced its “exit
strategy” from traditional policies since the mid of 2010, when crisis started.
With this new strategies, Turkey aimed to stabilise not only the price, but
also financial stability and to decrease volatility of local currency.
In addition to the interest rate policy, which enables the interest rate
corridor to be made asymmetrical when necessary and to respond to the
ever-changing economic and financial conditions with active liquidity
management, the reserve requirement policy has been implemented as a
complementary policy tool with the aim of financial stability.
The most important innovation has been the Reserve Option Mechanism
(ROM), which has brought a new and different dimension to the reserve
requirement policy, while the required reserves have been shifted to a
multi-rate structure with rate differentiation on a maturity basis.
While it is a well-known rule and widespread practice for a central bank
to make its reserves from its own currency, the CBRT’s ability to hold required
reserves liabilities in gold and foreign currency is noteworthy as the
accumulation of international reserves that it has attracted.
This paper aims to investigate the reasons why ROM could stabilize the
volatility of Turkish lira after 2008 financial crisis. I argue that during
2010, there was a change in Required Reserves Establishment which considered to
keep up %10 of their liabilities in Euros or USD and precious metals. It made way to increased liquidity of Turkish
lira against foreign currencies during the periods of inflow to country, and
increased capacity of payable liabilities during the periods of outflow. The system
made possible to limit: the credit spread during FDI, the sensitivity of
lending to capital flows, volatility. As a result, it increases the stability
of whole economic system.
The methodology by which the analysis was conducted is literature review.
Paper will start with introduction, followed by quick overview of literature.
Body part will include supportive facts about argument and criticism. Conclusion
part will observe results of the investigation and further researches.
ROM was introduced in 2011 and after that the first book that was
dedicated to it was Alper, K. , Kara, H. Ve Yorukoglu, M. (2012) “Reserve
Option Mechanism”. In their book, authors describe the essence of ROM mechanism
and the reasons that have driven the force to imply it. After that CBRT started
to publish annual reports of this mechanism with empirical results of the
development and stability of economy. In this reviews, it is apparent that
thanks to this mechanism, Turkey got rid of the crisis and currency volatility
was reduced. The publications of Oduncu, A., Akçelik, Y. ve Ermi?oglu, E. on
“Reserve Options Mechanism and FX Volatility” written in 2013 give the reasons
why this mechanism helped to pass crisis away.
ROM decreased the volatility of Turkish lira after 2008 crisis?
The law change in 2011
made it possible to keep some part of liabilities in foreign currencies and
precious metals. According to 2011 Required Reserves Communique, in all banks,
up to %10 of Turkish lira liabilities can be kept in US dollars or Euros. Additionally,
in order to keep the market and banking system flexible, all precious metal
liabilities should be kept in precious metals and up to %10 percent of foreign
currency liabilities were allowed to be kept in precious metals under Central
Bank “standard gold” deposits. This policy is called Required Liabilities
Policy, which is aimed to meet the liquidity requirements of banks, the lending
and borrowing capacity and to increase the security. Simultaneously, this
policy helps to maintain the price and financial stability1. The money in the market
affects the banks credibility. During the inflows to the country, foreign
investors are exchanging their investments to Turkish lira in order to be able
to invest and it increases the banks foreign exchange capacity. Also, if the
required liabilities are low, credit growth is accelerating. During the
outflows and increased liabilities, the cost of giving credit is increased
leading to decreased growth of the credits.
This policy makes it possible to prevent the immediate economic decline
by sterilizing the investments.
This new mechanism called
Reserve Option Mechanism (ROM) aimed directly 2 issues: one of them was to
limit the adverse effects of Turkish lira volatility against foreign currencies
and second was to bring new horizon to the reserve requirements which was
deducted to keep economy stabile. Thanks to ROM, banks could keep allowed
portion of liabilities in foreign currencies and gold. The percentage which is
measured to allow these liabilities is called Reserve Option Ratio (ROR). The
coefficients of Foreign Exchange and gold reserves are called Reserve Option
Reserve Option Mechanism
is captured in order to meet the Turkish Banking sector requirements
permanently in lower cost, to reduce the risk of the exchange rates spread and
fluctuation, to be independent of time for foreign exchange reserves by
supporting them effectively and reduce negative effects of high volatility of
capital movements in macroeconomic terms3.
Source: Alper, K. , Kara,
H. Ve Yorukoglu, M. (2012) “Reserve Option Mechanism”
Graph 1 show the working
mechanism of ROM. Let’s imagine that before the mechanism banks had chance
which was indicated by point A. During the FDI, as it is easy and cheap to
access foreign money liquidity, banks will benefit from ROM more by using some
parts of foreign investment for required liabilities. It will lead to move
point A to the right. In this case, the increase pressure on Turkish lira will
decrease, by drawing down the exchange rates for foreign currencies and
stabilizing the fluctuation of the lira. During the outflows, the exchange
rates for the foreign currencies will go up. Banks will need currency
liquidity; in which they will meet it by reducing the reserve option. In this
case, most of the liabilities will be provided by Turkish liras which will boom
the demand for lira and put a limit on devaluation.
Another benefit of
Reserve Option Mechanism is that; it provides short term Turkish lira swap
transaction to banking sector. In this way, banks can meet their Turkish lira
needs more rapidly by currency exchanges. Followed by ROM benefit of limiting
the growth of the foreign currency loans, the currency volatility decreases and
short-term capital flows reduce.
Reserve Mechanism must be
used by banks in order to be able to take place as an automatic balancer on the
market and reach its intended targets. It seems that the banks are using this
mechanism in a high-order and stable manner. 12 of the banks which benefit of this
mechanism uses %55-60 of its ability, while remaining 21 banks are using %25-30
Reserve Option Mechanism
also influences the CBRT’s foreign exchange reserves. However, gross foreign
exchange reserves are increasing as there is no change in the net foreign
exchange reserves since the foreign reserves, which are held as required
reserves, are not purchased by the CBRT, but they belong to the banks. As of
the end of 2011, the amount kept as foreign currency for Turkish Lira required
reserves increased from USD 10.3 billion to USD 27.2 billion as of December 21,
thus, the gross reserves of the CBRT reached approximately US $ 120.8 billion5.
criticism of ROM
Although the interest
rate corridor and reserve requirement policy developed by the CBRT as a
solution tool against the new economic situation, especially after the global
financial crisis seems to have succeeded in practice up to this time, there are
some deficiencies in these tools. With the policy of required reserves,
financial and price stability are tried to be provided through lending and
exchange rate channels. The rise of credits and foreign exchange at this stage
led to interest rate being pushed to the second plan, while it was the most
important instrument of traditional inflation targeting policy. The interest
rate instrument used in the inflation targeting policy in Turkey was accepted
by both public and financial circles, while changing tendency focused on lending
and foreign exchange have led to the wasted implementation of policies that
were accepted until this time. In this terms, the CBRT has had to make an extra
effort for the new vehicles to be accepted by the public again.
The adjustment of
interest rates within the framework of the CBRT’s interest rate policy increased
the uncertainty over interest rates and made it more flexible. Moreover, the
fact that interest rates are determined by the banks within the boundaries of
the corridor rather than by the decision of the Monetary Policy Committee,
suggests that the CBRT has lost interest on interest rates. The use of interest
rate uncertainty as a tool is contradictory to the requirement of transparency,
which is one of the important preconditions of the inflation targeting policy.
For this reason, it has become imperative for the CBRT to share all its future
operations with the public in a timely manner, thus avoiding possible
The CBRT has mixed these
new instruments in order to ensure a more reasonable growth of loans against
the problem of rising current account deficit. However, loans are divided into
investment and consumption credits. Despite the fact that consumption credits
are a source of consumption and current deficit, which is understood to be
consumed, as from the name of investment credits, investment credits have
opposite characteristics. Investment credits are long-term and large-volume
credit types used for the supply of capital goods necessary for production. The
end result of these loans is that the economy is returning as production and
value addition. However, with this new policy amendment, the CBRT has adopted a
policy of slowing the growth rate of all loans without discriminating
investment and consumption credits. This situation will further reduce the rate
of growth of the country to fall below the potential and other macroeconomic
problems (such as employment). Therefore, the CBRT’s policy on credits should
be revised to try to slow the lending part of the loans, as well as try to
increase investment loans.
The solution of financial
problems in the European Union countries, which is the one of the biggest
export partners of Turkey after the global financial crisis, requires a long
process. As a result, the decrease in export revenues caused a decrease in the
amount of foreign exchange that came to the country. In addition to this
decline, the cost of borrowing foreign currencies increased, increasing the
restrictions on foreign capital, which can cause businesses with a high amount
of borrowing capacity in foreign currency to have difficulty in paying their
Due to globalization, neither
of the countries in the world cannot isolate themselves from economical, social
and cultural developments. Turkish national economy has taken its share of this
crisis, despite the fact that the country was based on a solid macroeconomic
basis since its establishment. It is apparent that this new policy mix, which
is applied in order to minimize the effects of the crisis, has succeeded in
examining the present results even in a very short and countable historical
period. Particularly, the main result is that ROM implementation has reduced Turkish
Lira volatility since the beginning. This practice has also created an effect
in the foreign exchange reserve management of the CBRT. In this way, the
negative effects of financial volatility on financial stability has been
reduced. It can be stated that the CBRT is generally successful in determining
the problem and implementing the policy mix, although it is necessary to pass a
longer period in order to evaluate the effectiveness of the non-traditional
policy instruments during the crisis.
The fact that the
secondary effects are still ongoing and that no one knows how long, it is clear
that this policy mix will continue for some time. It should not be forgotten
that the success of the policy mix will increase the efficiency of the CBRT in
the liquidity management of the banking sector. In this process, the policy of
inflation targeting has been somewhat back warded, making way to greater
inflation rates. In the following stages, the CRBT should focus on the
inflation stabilizing economy by turning into chance next probable crisis.
Basically, this policy
Limits the credit growth which can be led
from rapid capital inflows,
In particular, limits the amount of credit
that can be given in foreign currency from the supply side,
Both expands and collapse, in order to
reduce its sensitivity to capital flows,
Reduces the exchange rate volatility,
Increases the gross foreign exchange
reserves of the CBRT,
Increase of the gross reserve in favor of
the private sector will contribute to increasing the durability and efficiency
of the entire financial system, leading to more efficient use.
Glocker,C. and Towbin, P.(2012) “Reserve
Requirements for Price and Financial Stability: When AreThey Effective?”,
International Journal of Central Banking,
Alper, K. , Kara, H. Ve Yorukoglu, M.
(2012) “Reserve Option Mechanism”, CRBT Economic notes, 2012-28
Oduncu, A., Akçelik, Y. ve Ermi?oglu, E.
(2013) “Reserve Options Mechanism and FX Volatility”
(2012b) “Financial Stability Report”, Ankara
(2012c) “Year of 2013 Money and interest rate policy”, Ankara.
and Towbin, P.(2012) “Reserve Requirements for Price and Financial Stability:
They Effective?”, International Journal of Central
K. , Kara, H. Ve Yorukoglu, M. (2012) “Reserve Option Mechanism”, CRBT Economic
notes, 2012-28: p.22
A., Akçelik, Y. ve Ermi?oglu, E. (2013) “Reserve Options Mechanism and FX
Volatility”, Working Paper No.13/03, CRBT, Ankara. p.67
(2012b) “Financial Stability Report”, Ankara.p.14
(2012c) “Year of 2013 Money and interest rate policy”, Ankara.p.12