EMRE DELİVELİ >Braveheart ROCs Central Banking

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Duringa speech on Friday, Central Bank Governor Erdem Başçı underlined that it wouldtake a (brave) heart to implement the Bank’s latest tool, Reserve OptionCoefficients (ROCs).

Commercialbanks have been allowed to keep some of the lira reserves they are required to maintainat the Central Bank in foreign currency (FX) for a while. At the end ofMay, the Central Bank increased the upper limit of this option to 45 from40 percent of total required reserves. It also noted that this last 5 percentwould have to be multiplied by a coefficient of 1.4. So 100 liras of reservescould be replaced with 140 liras worth of euros or dollars.

Sincethen, the Bank has not only increased the upper limit gradually to 60 percent,it has also introduced different ROCs at different tranches. While itcut its lending rate by 1.5 percent at the latest rate-setting meeting onTuesday, the Central Bank also increased allROCs by 0.2, which now vary between 1.3 in the first tranche of 0-40percent to 2.2 in the final tranche of 55-60 percent and have emerged, alongwith the interest rate corridor, as the primary policy tool.

Youmight wonder why banks would want to keep more money as reserves that don’t payout any interest- the simple answer is that it is cheaper to borrow FX thanlira. In fact, you can find the threshold FX interest rate for each tranche bydividing the cost of Central Bank funding by the ROC. Since that rate iscurrently 6.1 percent, banks would want to utilize the option in full for thefirst tranche as long as they can borrow in FX at lower than 4.7 (6.1/1.3)percent.

Ofcourse, this is only a very rough calculation, which assumes banks can get asmuch foreign funding as they want. But the more interesting question is why theCentral Bank would want to implement such a scheme. For one thing, it wouldtake some pressure off the lira if the country is exposedto strong capital inflows resulting from the globaleasing by the major central banks.

Infact, ROCs can work both ways. When this hot money stops or reverses, bankscould tap their FX reserves at the Central Bank. In this sense, the Bank seesits new tool as an automatic stabilizer. While it could indeed decrease FXvolatility, I am not sure if this novel system could withstand a major crisis. Besides,I wonder if it is making Turkey more vulnerable by encouraging foreignborrowing.

Başçınoted that that having FX parked at the Central Bank makes it easier for banksto borrow from abroad, and they have indeed resumed getting foreign loans.That’s when I started getting confused. I thought the Bank did not want dollarizationand currencymismatches in the first place. The ratio of short-term debt to reserves,one of the Bank’s reserve strength indicators, is already above one.

Myconfusion grew when he emphasized that only central banks not paying intereston reserves could implement ROCs, and that required guts, or a brave heart. Icould not figure out the relationship, so I consulted a Turkey economist aswell as a couple of central bankers. They could not, either.

TheCentral Bank’s new tool indeed ROCs. I hope adding another layer to thealready-complex set of policies does not make us also roll.


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