Soft Budget Constraints, Government Ownership of Banks and Regulatory Failure: The Political Economy of the Turkish Banking System in the Post-Capital Account Liberalization Era

A weakly regulated banking sector is costly notably in the context of emerging -market economies characterized by transitional financial systems. Political and institutional forces play an important role in explaining the inability to implement proper banking sector regulations over significantly time periods. The Turkish experience in the aftermath of capital account liberalization leading to the liquidity crisis of 2000 and 2001 have been utilized as a case study for highlighting t he relevance of political and institutional variables in the process of bank regulation. In specific terms, the role that the banking system has played as an avenue for politically generated rent distribution has received primary emphasis. Three major dimensions of the Turkish banking sector in the 1990s have been underlined including the importance of the public banks' duty losses, politicization of new bank entry , and the negligible presence of foreign banks. These characteristics are explained by a) the direct involvement of the political authority in the regulatory process; b) the absence of incentives for banks under surveillance to restructure themselves; and c) low priority attached to bank regulation on the part of the regulatory authority in the pre sence of multiple and conflicting objectives. Finally, attention is drawn to the key role that the external anchors play in facilitating significant regulatory reform.