Economic Success and the Banking Industry

Interest rates, another form of fiscal policy, affect the economy by determining the rate of investments. Any increase in the interest rates causes a decrease in the level of investments due to the fact that it means that a higher amount has to be paid for every unit of currency borrowed. This is not a negative effect however because rising interest rates usually mean that the economy is growing and that there is a need to increase interest rates to control or decrease the money supply available to counter inflation (Baumol, 2006). The effect of the interest rate in the economy and on money supply can be explained in simple supply and demand terms. When the economy is growing, there is a need for more capital to fund investments and capital expansion. This increase in demand also causes a corresponding increase in the rates because people are now willing to borrow money at higher interest rates as opposed to when the economy is in a slump (Baumol, 2006). The concern of the Federal Reserve in this matter, which will be discussed in the later section, is that this could lead to an oversupply of money causing sharp inflation within the economy. The banking sector forms a major part of the any financial system. Most of the transactions and activities of money and capital markets are carried out by banks. Most of the State banks were established to finance a particular industry such as agriculture, but private banks generally have close connections to all the large industrial groups and holdings. As applied to the model, the Turkish banking sector went through major consolidation during 1999-2003 in the aftermath of a failed disinflation program (December 1999–February 2001), a devastating financial crisis and a renewed IMF program that brought about the recovery. In early 2004, relative macroeconomic stability appeared to have been achieved, and having gone through the worst, the sector appeared set for the next phase of consolidation and growth. A large number of experts and financial institutions are giving positive signals in this regard and have illustrated various reasons for ongoing improvement in Turkish Banking Sector. Another economic marker that must be examined is the impact that Non-performing loans has on the banking industry. Since the Asian Financial Crisis of 1997, it has been observed that there has been an increase in the level of Non-performing Loans (NPLs). Non-performing loans is a term applied to loans that are in arrears and provide no profit for banking institutions. There has been a noted increase in the NPL to Total Loan Portfolio (TLP) ratio from 14. 6 percent as of June 2000 to 17 percent as of June 2001. This signifies a 2. 4% increase in the NPL to TLP ratio in the time span of one year. The ratio of NPLs is also a standard by which the quality of the assets of a bank is measured. The quality of the assets, which a bank possesses, is also in turn determined by its profitability which can be partly measured by the ratio of non-performing loans with the total loan portfolio. Many commercial banks have large volumes of loans, yet this can be a misleading statistic. It is important to keep track of the percentage of these loans that are performing, meaning they provide the commercial bank with steady returns, and loans that are non-performing. Non-performing loans therefore is an important benchmark by which the profitability of banks is gauged.