Funding Quality and the Pricing of Retail Rates: Evidence from the Turkish Banking Sector

This paper documents how a system-wide deterioration in funding quality, which we argue to be underpinned by macroeconomic conditions, can have a substantial effect on the pricing of deposit and loan rates. The study is motivated by a puzzling observation from the Turkish banking system. During 2015-2016, retail rates of Turkish banks displayed a persistent upward trend while the policy and money market rates remained unchanged. We conjecture that the underlying reason was the continued deterioration in the structural liquidity positions of Turkish banks, reflected as rising loan-to-deposit ratios (LDR). Our results show that in the presence of increasing pressures from worsening funding quality, banks with high LDRs tried to attract more deposits while trying to slow loan growth rates. To this end, these banks offered higher rates to deposits, particularly to more stable deposit types. Similarly, evidence suggests that banks with worse funding quality raised the rates more on the loans side. As expected, banks increased the rates for the clients/segments where they had more market power. On the other side, despite the increasing pressures on interest rate margins, high LDR banks do not seem to have opted for risky loans.