Turkey’s finance minister and son-in-law of President Tayyip Erdogan, Berat Albayrak, says he does “not expect any problems in the banking sector.” The comments, given in an interview with Reuters published yesterday, are in stark contrast to warnings from ratings agencies that the lira sell-off will weaken the lenders’ assets.

He added that the government will step in to support the banks, in the event of a problem.

In fact, the Turkish government probably has been supporting the banking system extensively during the past year. The locally-owned Halkbank, which has close ties to the Erdogan government, has become the most important source of new loans to Turkish businesses and consumers. Its loan book has converged on that of Garanti Bank, Turkey’s largest bank (and partly owned by Spain’s BBVA).

The collapse of the Turkish lira has increased the effective cost of debt service on Turkey’s US$300 billion of nonfinancial corporate debt; without new loans a great deal of the Turkish economy will shut down.

Halkbank vs Garanti loans

How is Halkbank financing itself? That is not entirely clear, but it is remarkable that Halkbank’s last major US dollar bond issue, a US$500 million 10-year floating rate note issued in October 2017, is trading exactly at par as of September 3, according to Bloomberg.

By contrast, Garanti’s 10-year dollar bond (a 2027 bullet denominated in euro) is trading at around US$44. The obvious conclusion to draw is that the Turkish state is supporting the paper of the politically-connected Halkbank. The support does not extend to the equity market, where Halkbank is trading at just 27% of book, having lost three-quarters of its value in US dollar terms since the beginning of the year.

Halkbank, it will be remembered, was alleged by US prosecutors to “launder billions of dollars-worth of Iranian oil proceeds, ultimately creating a slush fund for Iran to use however it wished – the very harm that US sanctions were put in place to avoid.” Its deputy manager Mehmet Hakan Attila, was convicted and sentenced to 32 months in prison for the scheme. The Turkish government offered to exchange the jailed US pastor for Attila, a deal that the Trump Administration rejected.

It appears that the Erdogan government has employed Halkbank as a quasi-state entity to flout US sanctions. These illegal activities probably helped to finance Turkey’s current account deficit during the past couple of years. If Turkey has been supporting Halkbank and other notionally private banks, as the numbers suggest, a severe shock to state finances is possible. Turkish reserves have fallen to US$73 billion from US$95 billion this year as the lira collapsed. Foreign holdings of TRY debt are collapsing.

According to official data, Turkish foreign debt declined after 2016. That is hard to square with Turkey’s enormous current account deficit, which implies a US$60-80 billion foreign financing requirement.

What we probably will find is that Turkey has borrowed through dodgy mechanisms managed through entities like Halkbank, the dissolution of which will accelerate the Turkish crisis.