Several international banks failed to close their lira positions with Turkish counterparts on Tuesday, an outcome of policies that are keeping a lid on local-currency liquidity offshore, according to people familiar with the matter.
Foreign lenders were unable to meet lira obligations as the cost of borrowing in the currency jumped as high as 1,050% for offshore investors, the people said, asking not to be identified discussing sensitive information.
The banks’ failure is reminiscent of previous dislocations in the offshore lira market, where regulators have engineered a lasting liquidity crunch to prevent a disorderly depreciation in the currency. That resulted in several settlement failures similar to Tuesday’s, and, as a consequence Turkish regulators temporarily banned local lenders from trading with Citigroup Inc., UBS Group AG and BNP Paribas.
A person familiar with policy makers’ thinking said regulators were unlikely to impose fines over Tuesday’s settlement failures. Turkey’s banking regulator declined to comment.
The latest supply squeeze followed heavy interventions in the currency market last week. Dollar sales executed by state banks to prop up the lira began to settle after a public holiday, draining the supply of local currency and pushing the overnight borrowing rate in the offshore market to its highest level in 17 months.
To deter short sellers, foreign investors have essentially been barred from borrowing from local banks and don’t have access to Turkish central bank funding. As a result, those without liras on hand have to borrow the currency in the offshore market — where supply is limited — driving up the rate.
Behind the strains are concerns about the level of Turkey’s reserves and an aggressive monetary easing cycle that’s fueled an outflow of foreign capital. Facing pressure on the currency to weaken, authorities have been leaning on state banks to bolster the lira with dollar sales, rather than raising interest rates or curbing the supply of credit.
The central bank’s gross currency reserves have dropped by more than a third this year to $49.2 billion as of July 17. Including gold, they stand at $89.5 billion. Of this, more than $54 billion is borrowed from local lenders through short-term swaps, according to the latest available data through the end of June.
As in previous episodes of funding stress, investors struggling to get hold of liras started dumping their stock and bond holdings, according to two traders familiar with the matter.
The Borsa Istanbul 100 Index fell 3.5% on Tuesday, while the yield on Turkey’s benchmark two-year bond rose above 12%, its highest level since April.
Signs of normalcy returned to financial markets on Wednesday, with the overnight rate plunging back down to 6.8%, just below the central bank’s own benchmark. Still, the cost of borrowing money for two nights was around 100%.
The lira breached the psychologically important level of 7 per dollar on Wednesday, slipping as much 2%, despite efforts by state lenders to stop the slide. It’s weakened more than 15% against the U.S. currency this year.
(Updates with additional information in paragraph after Lira Crunch subheadline)
–With assistance from Asli Kandemir.