Competition, Efficiency, and the Impact of Monetary Policy Changes in the Turkish Banking Sector

Since its founding era (1923-1945), Turkish banking sector has undergone several developmental stages during which the Turkish economy and its banking sector have experienced high inflation, financial instability, and inefficiency. After the political and currency crises of 2000-2001, the Turkish government and Central Bank of Turkey (CBT) with the help of the International Monetary Fund (IMF) imposed several restructuring programmes to strengthen the private banks, progress with privatisations and establish supervisory entities. Consequently, Turkey's banking sector began to recover during the period 2002 until 2008. However, after 2008, financial imbalances were beginning to be reflected again in the Turkish banking sector and its economy. A review of the Turkish banking literature clearly demonstrates which essential finance and banking areas have been under-evaluated. For instance, the links among risk-taking activities, the transmission of monetary policy through different channels, and competition are all significantly unexplored. Hence, this thesis assesses the three main areas in the Turkish banking sector by studying the impact of Non-Performing Loans (NPLs) on Turkish bank efficiency, examining the transmission of monetary policy through Bank Lending Channel (BLC) in Turkish banks whilst considering the impact of bank characteristics, and investigating the relationship between competition, stability, and efficiency in Turkish banks.

Initially, this thesis investigates bank efficiency whilst considering the impact of NPLs. To compute technical, allocative, and cost efficiency, the current thesis uses a modified Data Envelopment Analysis (DEA) approach with NPLs identified as an undesirable output. The obtained results suggest that there is a negative relationship between NPLs and all three kinds of efficiency. To consider more closely what balance sheet items and employee characteristics tell us about efficiency, this thesis investigates efficiency determinants by applying a quantile regression technique. In addition to investigating the balance sheet items, this thesis considers

two unique efficiency determinants, namely employees' gender and education. The results reflect the positive impact of capitalisation and Net Interest Margin (NIM) on all kinds of efficiency. In contrast, the relationship between Net Non-Interest Margin (NNIM) and efficiency in Turkish banks has been found to be negative. This negative sign emphasises the fact that Turkish banks do not reflect an efficient approach in managing their non-interest sources of income. Furthermore, the findings show that a higher percentage of female employees can have a positive impact on the efficiency, innovation, flexibility, and management culture of the banks. Moreover, the results gained from evaluating education, confirm the positive impact of having more educated employees.

This thesis further examines the monetary transmission mechanism through BLC with consideration of NPLs by applying the Bayesian estimation. In addition to capitalisation, liquidity, and size, this thesis introduces technical and allocative efficiency as an additional characteristic. The results show the existence of BLC in Turkish banks from 2002 until 2017. The results also highlight that the efficiency scores in the Turkish banks can determine the bank's sensitivity to any monetary policy shock. The results also confirm the impact of other characteristics (size, liquidity, and capitalisation) on a bank's approach toward interest rate changes. Larger and more liquid banks with higher capitalisation are more stable.

Finally, this thesis evaluates the impact of competition on financial stability and efficiency by deploying the Boone indicator to measure bank competition, the Z-score to measure for financial stability, and a DEA approach to compute technical efficiency. Three main hypotheses are tested: 'bad management'1, 'bad luck2', and 'moral hazard'3. This thesis tests

1 This hypotheis is discussed by Berger and De Young (1997). It explains that higher costs will be incurred by banks with lower levels of efficiency due to the fact that in these banks credit is inadequately monitored, and operating expenses are not managed efficiently.

2 Berger and De Young (1997) discuss more on exogenous events rather than managers' skills or their risk-taking appetite to explain NPLs ratio in a bank.

3 Moral hazard hypothesis explains that weaker banks are more vulnerable to risk-taking attitude and danger than stronger banks.

the relationship between the 'bad management' hypothesis and efficiency in Turkish banks. The Boone indicator for forty-two Turkish banks was found to be negative. Only two banks represent a positive Boone indicator, Diler Yatirim Bankasi A.S and Istanbul Takas ve Saklama Bankasi A.S. The positive Boone score for these two banks shows that they are competing for the amount of equity. The results support a positive relationship between competition and stability, which supports the competition-stability theory. The results also reflect the similar relationship between competition and efficiency. Hence, enhancing competition reduces NPLs and has a positive effect on financial stability.

In conclusion, the findings of this thesis and its evaluations emphasise the importance of bank efficiency and managing the NPLs ratio. Strengthening and improving a bank's balance sheet quality and controlling the NPLs ratio should be one of the CBT's main actions. This thesis not only confirms the importance of bank efficiency in the process of money generation, profit making, and capitalisation but also in the fields of competition and stability. Hence, boosting efficiency scores should be one of the main missions for Turkish regulators and policy makers. In addition, optimising interest and non-interest income sources also would improve the possibility for banks to utilise their financial and non-financial sources. Moreover, having gender diversity in the workplace and hiring more educated people would improve the management culture of Turkish banks as it would usher in novel ideas and different perspectives. It would also increase flexibility and create more innovations. Experiencing volatile economic indicators like inflation rate fluctuation and unstable economic conditions should be enough to bring the sense of necessity needed to impose an efficient reform plan to address these fundamental issues.