Some of the commercial loans in Turkey have been granted for some time within the framework of a recently announced method called “credit against expenditure”. What does “credit against expenditure” mean? What is the purpose of this method?
Let’s say that a company needs to purchase raw materials to use in manufacturing and needs financing from a bank to purchase the raw materials it needs. According to the new rule, the customer of the bank can obtain financing only by presenting to its bank the invoice issued by its supplier. The bank meets its customer’s financing needs by paying directly to its customer’s supplier. This is what the expression “credit against expenditure” means. Prior to the new rule, the bank would make the transfer directly to its customer. In this case, it was totally in the bank’s customer’s discretion to make payment to the supplier or not against the loan borrowed from the bank.
In accordance with the macro prudential measures announced by the Central Bank of the Republic of Turkey (CBRT) on 20 August 2022, a significant portion of the commercial loans granted in Turkey have become subject to the practice called “credit against expenditure”. It was applicable only for “participation banks” that a bank made the loan available by paying directly to its customer’s supplier. Now, the entire banking system has been on the way to become dependent on this method. However, this method is not applicable to loans granted to some segments in the economy. These segments are SMEs, tradesmen, net exporters, agricultural sector, financial institutions, and state-owned institutions.
The fact that the banking system provides loans to a large extent against expenditure means that the banking system is transformed into a structure based on participation banking. This is also a stage in Turkey’s transition to the Islamic finance model due to the fact that participation banks are the institutions which create funds and grant loans according to Islamic rules. Turkey experiences the reflection of a political ideology in the economy with a major and important transformation.
Turkey’s goal of transformation in the economy has been explained by the government constantly. It has been repeatedly stated that both a religion-based financial model is going to be implemented and participation banking is going to be expanded. Under these circumstances, I cannot understand on what grounds some economists in Turkey express objection when I state that Turkey has been moving to an Islamic finance model.
The Islamic finance model is not just about credit-against-expenditure method. Financial markets do not consist only of banking. Stocks, bonds, derivatives, non-bank financial institutions, etc. are also in the realm of finance. It is necessary to take a look at the loans provided against expenditure from two aspects: purely financial risk management principles and the principles of Islamic finance.
Credit against expenditure does not deserve objection within the framework of risk-reducing financial management principles. Making payment directly to a bank’s customer may cause hiccups. As a banking and finance principle, credit should be utilized in accordance with its purpose. By making payments directly to customers instead of customers’ suppliers, it may be possible for companies to utilize loans for purposes “other than trading.” The proprietor of a firm utilizing the loan can buy himself/herself a luxury car, for example, instead of paying the firm’s supplier for trading purposes. In this case, a bank is not capable of monitoring its risks concerning the loan granted. Islamic finance, on the other hand, is skeptical about the risk assessment from a different angle: what if the loan is utilized, for example, for a payment to a company involved in alcohol or tobacco business? In other words, looking at the issue in terms of risk management principles and looking at it from the perspective of Islamic finance principles is different. However, the implementation supported by both approaches is close to each other.
Credit-against-expenditure model is the equivalent of trade finance. In trade finance, the bank can measure its risk by monitoring that the loan it grants is utilized for trade. Unless, of course, by some unethical methods, the loan reaches the bank’s customer later on. If banks grant loans by not monitoring the trade, then they closely have to monitor the balance sheets of their customers. This is called “balance sheet financing” rather than “credit against expenditure”. Up until the announcement of recent regulations, Turkey had built its banking system on the balance sheet financing model.
In my professional life, I have seen many different banking systems in different geographies. For instance, balance sheet financing method does not find much practice in the banking system in Europe. That is, a loan the purpose of which is not clear cannot be utilized by sending just an instruction letter to the bank. The bank has to know the purpose of the loan, measure its risk and price the loan within the limits of the risks it measures. On the other hand, in the past, I happened to conduct loan operations based on loan agreements the text of which started with “basmala (in the name of God, the compassionate, the merciful).” Where? In Sudan, Saudi Arabia, Jordan, etc.
My explanations so far reveal that I support the use of credit-against-expenditure practice in terms of financial management principles that facilitate risk measurement and reduce risk. Yes. However, my objection regarding Islamic finance is not related to this specific practice. The Islamic finance model is not just about credit-against-expenditure method. There are some basic principles of Islamic finance. Interest (riba), excessive uncertainty (gharar), speculative (maysir) risk and return sharing, and investing in areas that Islam deems immoral (haram) are prohibited in the Islamic finance model.
I have asked many times in the past the following question my counterparts working in Islamic banks in various countries: you call the price of the loan you provide as a “profit share rate” instead of “interest rate.” If you finance the trade and the profit of that trade is shared, why do you have a profit share rate that moves in parallel with prevailing market interest rates? In general, I have got the following answer: we have to keep abreast of market changes, too. This answer has no justification for “keeping abreast of market changes.” As a matter of fact, Erdogan’s warning to participation banks in the past as far as the similarity between profit share rate and interest rate is concerned is significant.
If excessive uncertainty and speculative risks are prohibited in Islamic finance, a significant portion of derivatives and the stock market should also be prohibited. Countries which have Islamic finance systems also have stock markets. However, this is another topic for discussion.
I am against basing the political and economic order of any country on the rules of any religion. In this context, I am not against the credit-against-expenditure mechanism itself, but against the motivation behind this practice.
Turkey is increasingly under the influence of religion in education, law and now banking. It would not be realistic to expect the transformation in the economy to be limited to the new rules.
The developments in the commercial loan market in Turkey, especially after 20 August 2022, have slowed down the loan market significantly. Many companies do not have access to credit. However, the incumbent government had developed a credit-based growth model. Now, the cash flows of firms in many industries have been disrupted by the sudden cessation of loans. Growth should be expected to slow down to a significant extent under these circumstances.
The credit-based growth model was risky and unhealthy. In order to transform the banking system into an Islamic model, the interest has been reduced and the method of blocking the credit mechanism was preferred against soaring inflation. However, this method means a deterioration in cash flows for companies that have become increasingly dependent on credit in recent years.
The blockage of the credit mechanism after lowering the interest rate also means inconsistency in the government’s claims so far. According to the government, investment would increase when interest rates were lowered. However, vital risks began to emerge in some sectors and companies once the credit mechanism was suddenly stopped. In terms of market risks, it is necessary to closely monitor the coming months. Negative signals are coming from the market.
Along with the Islamic banking model, there are claims that banks, most of which are foreign, can exit Turkey. There may be foreign banks that are uncomfortable with the transition period and are not satisfied with operating in Turkey with lower business volumes. However, it is not easy for a bank organization to terminate its activities and leave a country. Hence, banks in the Western world have in-house Islamic finance departments to do business with countries the financial systems of which operate on the Islamic finance model. Many central banks and, for example, the Bank of England, the World Bank, various financial institutions have articles and research on how to work with the Islamic finance world. Their aim is to make money in these countries as well. In other words, as Turkey is transitioning to the Islamic finance model, we should not expect them to leave. If there are those who leave, there will be other economic reasons.
How societies live is a matter of choice. Turkish populace will make a choice of its lifestyle when the election time comes. The continuation of the current government after the election is going to mean that the economy is going to continue to be governed by an Islamic model that spreads its sphere of influence. Islamic rules are going to be deepening in the entire financial markets.
Economics is ideology and stays at the crux of politics. Turkey has experienced the reflections of the current ruling ideology on social life, law, education, freedom of speech in the past 20 years. Economy is one of the reflection points of ideology. It is necessary to evaluate the preferred lifestyle within the scope of the philosophy that is applicable in all aspects of life.
My analyses reveal that there are people in Turkey who would not object to an Islamic model at all, and that there are people who have objections just as much as I do. Which model will society be satisfied with? Are there alternative models against the existing ones and have they been presented to the society? What is the opposition’s proposal? How will the factions of the society that do not understand the model change be economically satisfied in the current negative economic course until the election?
We all have a side. We may have objections and even anger towards certain things within the framework of our views. However, analyses and evaluations must be fair and based on scientific observations.
Can an Islamic economic order exist in Turkey? It’s possible. What kind of economy will there be at the end of the transition period? For a long period of time and even consistently lower performance maybe! How can Turkey respond to the new order? Partly satisfied, partly uneasy. I am going to be one of those who is going to be uneasy. The feelings of all of us change in accordance with the distance between what we live and what we desire to live.
