Banking System Restructuring in the Context of Macroeconomic Stabilisation

A weak banking system was a root cause of the crisis that ended the December 1999 stabilisation programme and led to a new series of IMF packages. The quasi-currency board rules supporting the exchange rate-based disinflation attempt exacerbated problems of currency and maturity mismatch in the banking system, leaving it highly vulnerable to the shifts in international investor sentiment that occurred after mid-2000. The success of the new programme and sustained recovery are unlikely without significant reform of the banking system, difficult though that may be in a crisis. Central Bank inflation targeting cannot work well if a risk-exposed, fragile banking system constrains interest rate policy adjustments in either direction. Conversely, a healthy banking system requires macro stability, as high inflation and a large public debt currently distort banking incentives. Achieving durably low inflation would moreover allow Turkish agents to issue more debt denominated in their own currency and at longer maturities, greatly enhancing stability of the financial system. Disinflation and banking reform thus go hand in hand, an important strength of the current programme...