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December 22, 2011, Thursday

Turkey’s financial development potential

Financial development widens the range of financial services for savers and investors, consumers and producers, and allows them to better diversify their risks.

Greater and easier access to capital through efficient financial markets and intermediation, with lower information and transactions costs, is essential for economic growth. Financial development not only accelerates economic growth but also improves income equality, especially by providing small enterprises and the poor with greater access to credit. Blaming perverse incentives and excessive risk taking in advanced countries -- especially the US, whose subprime mortgage meltdown was fueled by badly regulated securitization -- in the global financial crisis should not mislead us to belittle the critical role of the financial sector in economic growth.

For an in-depth study of financial development around the world and in Turkey, we can turn to the World Economic Forum's 427-page Financial Development Report 2011 (FDR 2011), the fourth annual edition since its inaugural publication in 2008. FDR 2011, published on Dec. 12, defines financial development as “the factors, policies, and institutions that lead to effective financial intermediation and markets, as well as deep and broad access to capital and financial services.” It goes well beyond measuring financial development in terms of financial depth (the ratio of total financial assets-to-gross domestic product [GDP]). FDR 2011's Financial Development Index (FDI), reflecting current academic research on the drivers of financial development, allows statistical benchmarking of hundreds of indicators across 60 economies.

The seven pillars of the FDI, with a maximum score of 7, are: (1) institutional environment, covering financial sector liberalization, corporate governance, legal and regulatory issues, and contract enforcement; (2) business environment reflecting human and physical capital, taxes and costs of doing business; (3) financial stability, encompassing the risks of currency, systemic banking and sovereign debt crises; (4) banking financial services, measuring size, efficiency and financial disclosure; (5) non-banking financial services, capturing initial public offerings, mergers & acquisitions, insurance and securitization; (6) financial markets, including equity, bond, foreign exchange and derivatives markets; and (7) financial access, gauging commercial and retail access. Each of the seven pillars has many sub-pillars which contain the specific quantitative variables that constitute the FDI.

The 10 highest-ranked countries, based on their 2011 FDI overall scores, are Hong Kong, the US, the UK, Singapore, Australia, Canada, the Netherlands, Japan, Switzerland and Norway. According to the first table below, Turkey, which relies heavily and precariously on foreign capital to finance its economic growth, is yet to realize its full financial development potential. Its relatively low FDI overall score and global rank have not improved between 2008 and 2011. According to the second table below, Turkey's seven pillar scores are particularly low for non-banking financial services and financial markets. FDR 2011 singles out Turkey's scarce human capital and weak corporate governance as constraints on the institutional and business environment. It attributes Turkey's financial instability to the volatile currency system and the high risk of sovereign debt crisis. It identifies securitization, measured in terms of the ratio of securitization-to-GDP and the share of the total number of securitization deals, as the weakest area in Turkey's non-banking financial services.

The outcome of the Justice and Development Party (AK Party) government's campaign to promote İstanbul as an international financial center (IFC) is inextricably tied with Turkey's financial development. In an earlier column (“İstanbul's performance and potential as an int'l financial center,” Sept. 14), after reviewing the requirements for a city to emerge as an IFC, I concluded that the quest for İstanbul to become even a top regional, forget global, IFC will require time and hard work in the face of stiff global competition. Much of that time and hard work will be required to realize Turkey's financial development potential.

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