The stability of the banking sector has been further strengthened by the ongoing reforms and boosted both mergers and acquisitions and foreign bank participation to the sector. The volume of the banking sectors’ credits to non-financial sector rose by more than 70 percent in real terms and the sectors’ profits increased by a considerable amount since 2002; capital adequacy and loan quality of the sector also improved. As of today, efforts towards increasing the consistency of the legal framework with the EU, completion of the restructuring process and then privatization of the public banks and development of modern risk management are on the agenda. Distinguished Participants, Today we not only have a stronger banking sector, which forms a basis for macroeconomic stability, but we also see remarkable progress in the Turkish economy in general. With the stabilization program that was launched in May 2001, great progress toward macroeconomic stability was made, especially in the disinflation process and recovery in growth. As the inflation rate is regarded as a signal of the quality of economic management, the achievement in the inflation front in the Turkish economy is among the most significant examples of progress toward better macroeconomic fundamentals. Single digit inflation was reached after a period of more than thirty years of high and chronic inflation. Additionally, as inflation targets were attained in 2002, 2003 and 2004, and thanks to a sound communication policy, the public in general now believes in the determination of the policy makers to fight against inflation.
Having suffered from the reckless and unstable macroeconomic management together with inefficient supervision, the system deteriorated severely and faced a serious moral hazard problem. Dear participants, A closer look at the Turkish financial system would be helpful to characterize its weaknesses and structural problems during that period. First of all, because of the high public sector borrowing requirement, fiscal dominance increased considerably in the financial markets and led the public sector to crowd out the private sector. Hence, the relationship between the banking sector and real sector could not develop as it should have done. Instead, the relationship between the banking sector and the public sector strengthened year after year. Secondly, the banking sector as a whole failed to exercise good risk management in its credit allocation. Since financing the public sector budget deficits with high real interest rates was an easy way to make profits, banks did not pay much attention to basic principles of risk management, such as maturity and currency mismatches. Some banks also created considerable amount of connected-loans in their balance sheets. On the public banks side, more specifically, which had a high share in the overall sector, banks were heavily used to support government policies and credits were allocated inefficiently, which resulted in big losses and weakened their capital structure.