Capital Adequacy Proved Inadequate

 After international regulations on banking system could not prevent the collapse of giant banks, they came to be debated again. Regulations regarding capital adequacy and their effects also receive their share of criticism.

  Banking sector serves such an important function as including savings into the financial system and allocating these savings into appropriate fields. Banks are always exposed to risks due to the transactions they carry out. Since banks occupy a significant position in the economic system and problems in their systems affect the entire economy, they are subjected to some limitations by regulating bodies. 

Today, capital movements have already passed beyond national borders. Gates to the financial markets have been removed to a great extent. It has become utterly difficult to trace money through various financial transactions. For this reason, it is impossible to isolate the crises particularly of developed countries. The crisis that began in large economies is gradually spreading to other countries just as a ripple in water does. All these factors have led international institutions to subject the structures in banking system –like in many other fields- to certain standards. Regulations that were adopted within this context aim for an orderly and systematic progress of the banking system. Then how successful did these regulations appear to be? Especially the recent negative developments indicate that all these regulations are not sufficient, so to speak. Because the world has almost got used to news of successive bank collapses. Besides, the banks that went bankrupt were no trifling matter. It is no doubt that banks are one of the pillars of national economy. Governments of the countries where banks are in deep troubles have begun to take almost extraordinary measures in order to come through this period. Governments have injected large amounts of capital to enable banks to take this tight bend. Governments are trying to do their best for the functioning of economic system in their countries. At this point, we must return to the beginning and ask: How successful were the international regulations that are meant to manage banking system? It seems that economy circles will discuss for a long time how effective these regulations were individually or as a whole. We are going to analyze here the issue of capital adequacy and the effects of related regulations. 

Capital Adequacy and Basel Standards

Capital adequacy is among the requirements introduced by international institutions that are related to banking system. Capital adequacy ratio is defined as the percentage of a bank's capital to its risk-weighted assets. This ratio determines how much of a reasonable amount of loss a bank can absorb when risks emerge. That is to say, capital adequacy ratio is seen as an indicator of a bank’s financial strength. There is a standard metric for this ratio set by the Basel Committee. According to the standards declared by the Basel Committee in 1988, capital adequacy ratio (CAR) of international banks should be a minimum of 8 percent. Credit risk was taken into consideration in calculating capital adequacy ratio in this practice. With the 1996 Amendment, in addition to credit risk also market risk was taken into consideration in determining CAR. As investment instruments and risk types have gradually become more sophisticated in time, these standards fell short. As a result, Basel II standards were formed in 2004.

Basel II uses three pillars: minimum capital requirements (addressing risk), supervisory review and market discipline – to promote greater stability in the financial system.Within the new standards CAR remained as 8% again, while the notion of risk was dealt with from a broader perspective. Risk rating assumed a greater importance, too. While Basel II was implemented in Europe, it was put over to years ahead in many countries including U.S. Criticisms were voiced claiming that many small banks in U.S. can not meet these requirements and that a lot of banks will suffer falls in their capital due to Basel II practices. The crisis that began in August 2007 and effects of which were felt in many fields has caused a lot of banks to collapse. Large banks have been faced with liquidity problems since they took high risks and the complicated instruments they had invested in lost most of their value. Additionally, assets that did not affect the balance sheet structure and CAR since they were off-balance-sheet items before stood out now against large-scale losses. All calculations pertaining to CAR, excess liquidity and profitability became complicated.

Consequently, many banks like Merrill Lynch, Bear Stearns, Wachovia, Washington Mutual, Dexia and Fortis began to experience capital squeeze and tried to overcome this problem through government support or acquisition by other banks. Lehman Brothers went bankrupt. Goldman Sachs and Morgan Stanley changed their status by transforming from investment bank to commercial bank. 

How Do Turkish Banks Face the Crisis?

When Turkish banking system is analyzed, it is seen that the system has weathered serious crises and took useful lessons from them. In fact, only 7 years ago Turkish banking system has experienced the worst crisis ever in its history. Much has changed in that period and its aftermath; it is even that Turkish banking system was reshaped and restructured, in a sense. Many banks were seized after the 2001 crisis; BDDK (Banking Regulation and Supervision Agency-BRSA) and TMSF (Savings Deposit Insurance Fund-SDIF) were formed and equipped with extraordinary powers. Control over banks was increased. Various measures were taken to render Turkish banking system compatible with international standards. While Turkey has adjusted to Basel I standards, it has delayed the implementation of Basel II. CAR in Turkey was raised to 12% while it was 8% before. It is frequently asked nowadays: How will Turkish banking system face this crisis which has caused great shocks all over the world? The general view on this issue is that financial structures of Turkish banks are very strong now as a result of the process Turkish banking system passed through in 2001. Just as the famous saying “once bitten twice shy” suggests, Turkish banks take extreme caution in the current fluctuation. 

According to the figures from the October 2008 report of BDDK, non-performing loans were YTL 1,369 million in December 2007 and YTL 2,181 million in August 2008. There occurred a 7.6% increase in non-performing loans in August comparing to the previous month. The increase is 59% when compared to December 2007, however. Total assets of Turkish banking sector amounted to YTL 647.8 billion in August 2008 falling by 0.8% comparing to July 2008. Banks’ syndication loans grew by 2.4% as compared to the previous year and reached US$ 13.3 billion, while securitization loans grew by 4% totaling US$ 13 billion. Net term profit of the banking sector fell by 1% in August 2008 compared to the preceding month. When we look at the banking sector CAR as of August 2008, we see that it is 17.71% currently, being well above the designated standards. This ratio is 16.29% for deposit banks, 14.31% for participation banks and 62.44% for development and investment banks. If the classification is done according to capital ownership, it is seen that CAR is 16.61% at domestic private banks, 22.32% at public banks and 15.64% at foreign banks.

It must be also added that the investment instruments held by banks in foreign countries which have caused large-scale losses are not present in Turkish banking sector. However, the crisis abroad affects Turkish banks anyway. Although the financial structures of banks are healthy, they should not throw prudence to the winds.