When the latest growth figures were released earlier this week revealing that the economy had contracted a staggering 13.8 percent and that all economic sectors, with the exception of the banking sector, had shrunk, many began pointing their figures at the banking sector's overly cautious lending policies and their increased lending to the Treasury as one of the culprits behind the staggering contraction.

This is unacceptable in the sense that it is conducted at the expense of real business activities. … This extreme ‘short-termism' is neither sustainable nor ethical,” wrote İbrahim Öztürk, an associate professor at Marmara University, in Wednesday's Today's Zaman. Economist Bülent Şenver agreed. He told Today's Zaman, that banks' overly cautious risk aversion was one of the principle reasons for the significant contraction in the economy. “One of the reasons that led to banks not feeling the contraction in the economy was their investment in government securities,” he added.He was critical of banks, noting that their increase in profit in the first quarter of the year was 30 percent, unprecedented elsewhere in the world.The implication is that banks' lending strategies, while highly profitable, are serving only to strangle the private sector.But, not everyone agrees that banks deserve so much heat -- some say that the banking sector's very profitability is what keeps the economy from melting down completely. “Turkey's economic contraction is caused by forces largely outside of Turkey,” Dr. Murat Yülek, a former World Bank economist and now chairman of PGlobal Global Advisory Services, told Today's Zaman. He implied that the strength of the banking sector was largely behind the resilience in the Turkish economy that was preventing the largest conglomerates from going bust.“Turkey's crisis is largely psychological,” Yülek said, noting that the domestic contraction was being brought about largely by contraction of export markets and plunging consumer confidence. Despite the rate of contraction, he said, Turkey is nowhere near as badly affected as the US. “The US is very bad because the balance sheets […] are all really bad. In Turkey, we are not seeing companies like Koç Holding going bust.” Indeed, emerging market economies -- Turkey included -- have long been more dependent on external factors such as foreign direct investment (FDI) than more developed economies. And the financial sector plays a key role in determining these outside flows. Commenting on the predicament of emerging markets and their vulnerability to external developments, Joseph Stiglitz, professor of economics at Columbia University, recently wrote that in the developing world, “a decline in exports, reduced remittances, lower foreign direct investment and precipitous falls in capital flows have led to economic weakening.” A strong banking sector is often the lynchpin in attracting investment -- especially in the context of fierce competition for FDI and portfolio investment. A crumbling banking sector is one of the greatest determinants of an economic crisis.More than one reason for banking profitsSpeaking with Today's Zaman, Ercan Erguzel, head of the economic and strategic research department of Deniz Bank, said there were a number of reasons for banks strong profitability and that investing in government bonds was just one of the reasons.Besides an increase in bonds in banks' portfolios, there is the addition of the widening spreads between credits and lending as well as the duration mismatch between assets and liabilities -- the average term on assets is one year, and on liabilities, it is just a couple of months. “In an environment of increasing interest rates, its inevitable that you will be making profits out of this,” he said.And with respect to bonds, although he expected this trend to continue through the second quarter, he didn't feel that it would last forever: “Since the Central Bank of Turkey is ending its easing cycle, interest rates have stabilized and benchmark bond rates have stabilized. It's difficult to make such profitability.” He said that as interest rates begin going up in the future and bond rates fall, the mismatch on the banks lending will, in all probability begin reversing the profitability on balance sheets.He was also quick to point out that a bank's first priority was not to pump liquidity out into the non-financial sector but rather to maintain profitability. “In an environment of increasing non-performing loans, we have to be more cautious.” Countries that have experienced surging non-performing loans on banks' balance sheets have helped precipitate larger crises -- especially when external debt could no longer be serviced.Turkey and Canada are the only two countries in the G-20 who have not had to lend to their banking sectors or bail them out as a result of the ongoing global financial crisis. Those countries whose banking systems have not been careful in both their lending and borrowing policies have damaged the whole economy's sovereign ratings, fueling a vicious cycle and spooking investors further. The Royal Bank of Scotland (RBS) said yesterday Turkey was not on the bank's list of troubled economies in Eastern Europe.Bloomberg quoted RBS Emerging Markets top analyst Timothy Ash as writing to clients warning them to stay away from some countries, saying that “current account deficits, excessive foreign borrowing and hence large external financing requirements as relative to foreign-exchange reserve positions” were a cause for serious concern, especially as related to sovereign debt risk.Turkish banks conservative lending and borrowing policies as well as their strict adherence to above-market levels of capital adequacy ratios are widely believed to be among the principal reasons that Turkish banks have escaped the same damage experienced elsewhere.And the countries narrowing current account deficit, brought about at least in part by tightening credit and constricted domestic demand, has further lessened the burden faced by emerging markets.Non-performing loans in Turkey have increased from 3 percent in January to about 5 percent at present. Erguzel predicted the rate will rise to between 6 and 7 percent in the coming months.Capital adequacy rates in Turkey are now at about 18.5 percent. According to BASEL II international banking standards, banks are required to maintain a capital adequacy ratio of 8 percent.Banking Regulation and Supervision Authority (BDDK) President Tevfik Bilgin has recently said that banks' non-performing loans would have to jump to about 25 percent before the capital adequacy ratios of Turkish banks would drop to the lower limit demanded by the BASEL II guidelines.  03 July 2009, FridayDAVID NEYLAN  İSTANBUL