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Why Do Turkish Banks Hold Gold at the Turkish Central Bank?

By Aslı Şahin
FX & Precious Metals Specialist

Turkey, the world’s fourth-largest consumer of gold, has had a long history with the precious metal, dating back to when the Kingdom of Lydia minted the first gold coins known in history over 2,500 years ago in present-day Western Turkey. Gold has a close connection with the Turkish life and culture, but it has also been used historically as a hedge against inflation and currency fluctuations, resulting in a vast amount of gold accumulated in form of jewellery, coins and bars.

Gold has a close connection with the Turkish life and culture, but it has also been used historically as a hedge against inflation and currency fluctuations.

Physical gold owned and held outside of the financial system by Turkish citizens is kept in households or private vaults, and is known as “under-the-mattress gold”. While the total amount held is unknown, the former Turkish deputy prime minister pointed out in 2017 that it is over 2,200 tonnes, while in 2015, the World Gold Council estimated it to be at least 3,500 tonnes. For many years, under-the-mattress gold was of little interest to banks.

Turkish Central Bank Gold Reserves

Source: CBTR, WGC

Although the gold market underwent liberalisation in 1993 and the import of gold has been permitted since 1995 with the establishment of the Gold Exchange, the majority of Turkish banks have kept their distance to gold. Instead, the Grand Bazaar in Istanbul has remained the centre for gold trading in the country. This changed in late 2011 with a new policy introduced by the Central Bank, which enabled banks to hold physical gold in their blocked accounts at the Central Bank as reserve requirement instead of Turkish lira.

A new policy introduced by the Central Bank in late 2011 enabled banks to hold physical gold in their blocked accounts at the Central Bank as reserve requirement instead of Turkish lira.

The new regulation initially allowed the banks to hold up to 10% of their Turkish lira reserve requirements as Good Delivery gold bars at the Turkish Central Bank’s account in the Bank of England. Since then, the limit has been increased to 30%, and the coefficient for each gold facility and ratio for different maturities have been adjusted. In September 2016, an additional 5% was allowed, which can be scrap gold. In early 2015, As part of efforts to encourage banks to keep gold, they were given the option to store gold at the Borsa Istanbul vaults, at almost the half the storage cost compared to BOE. In January 2017, the definition of reserve option mechanism was expanded to include 1-kilogram gold bars, in addition to large bars.

These initiatives and changes in regulation were part of the Central Bank’s efforts to make it attractive for individuals to bring their physical gold to banks and increase the Turkish lira’s liquidity in the banking system. This was a way of monetary easing for the Central Bank. On the other hand, from the perspective of the banks, holding gold instead of lira creates value because of the interest rate difference between gold and Turkish lira. The banks were able to use this excess Turkish lira for lending purposes instead of keeping it in the blocked accounts of the Central Bank.

The new policy has been welcomed by banks and by individuals looking to receive interest on their gold while not necessarily holding it as allocated physical gold. As a result, the policy has become the main stimulant boosting the Central Bank’s gold reserves in recent years. The Central Bank’s Annual Bulletin shows that its gold reserves topped 565.1 tonnes in 2017, which is 21.9% of its total reserves. The ratio of utilisation by the banks was 90.9% for Turkish lira requirements and 71.2% for gold deposit accounts. However, the Central Bank only started to purchase gold outright in May 2017, though it had already accumulated 116.1 tonnes by then.

As such, the rapid growth of its reserves in recent years has been a result of the new policy. Banks are able to hold physical gold at the Central Bank in different ways, and the options of holding it at the Bank of England or Borsa Istanbul gives them the flexibility to react to the market and manage their costs.

As such, the rapid growth of its reserves in recent years has been a result of the new policy. Banks are able to hold physical gold at the Central Bank in different ways, and the options of holding it at the Bank of England or Borsa Istanbul gives them the flexibility to react to the market and manage their costs.

Most of the gold banks are able to use for their reserve requirement needs comes from swaps or gold leases.

Although the main goal of the policy is to encourage people to bring their physical gold to banks, banks are not limited to customer gold deposits to fulfil the Central Bank reserve requirement. The gold can also be provided by borrowing gold or with a buy and sell gold swap, depending on the bank’s counterparty limits, liquidity or market conditions. For example, some banks buy physical gold on the local market when it is trading at a discount to fulfil their reserve requirement.

According to the Thomson Reuters GMFS Gold Survey 2017, only approximately 55 tonnes of scrap gold has been collected since the regulation was introduced, which is a small share of the total amount of under the pillow gold estimated to be held by private individuals in Turkey. The 362.7 tonnes of gold held by banks and financial institutions at the Central Bank shows that most of the gold banks are able to use for their reserve requirement needs comes from swaps or gold leases.

How do Turkish banks generate gold to hold at the Central Bank?
  • Gold deposit accounts

    For many banks, offering an attractive interest rate for time deposit accounts in gold to encourage clients to deposit their scrap gold has been one of the ways for banks to generate the physical gold they need for the reserve option mechanism. However, one of the major barriers for banks in collecting scrap gold is assaying and determining the purity and weight of the gold. This has been successfully managed by arranging certain days at bank branches where an expert from a refinery is present to examine the scrap gold that clients bring to deposit. After the purity and net gold weight is confirmed, the next step for the bank to credit the gold in grams into the client’s gold deposit account. The client can either open a time deposit account and receive an interest or keep it in a demand deposit account and sell the gold at the market rate when they choose to do so.

    It is important to note that what the bank doing is not safekeeping the scrap gold for the client or providing an allocated gold account. Instead, the bank credits the net grams in an unallocated account for the client. The refinery the bank has an agreement with will melt the scrap and produce Good Delivery kilobars or minibars and deliver it to the bank’s vault. The refinery does not have any ownership and is only paid a production fee. At this point, the client has their unallocated gold credited and the bank has the bars at its vault. At the reserve requirement term, which is calculated every other Friday, the bank may either transfer it to the Central Bank account at the Bank of England or Borsa Istanbul.

    Banks are able to pay an interest to the customers with time deposit gold accounts because the amount of gold they receive from the client and keep for their Turkish lira reserve requirement frees up liquidity that can be allocated as Turkish lira loans. Banks currently pay an interest ranging from 0.5% to 2.75%, depending on the gram amount and maturity of the time deposit account. A major input for the banks in determining the interest they pay is US dollar Libor rates and the market rates for gold lease, which indicates the opportunity cost of obtaining gold elsewhere.

    Additionally, if a bank is already holding 35% of its Turkish lira requirement in gold at the Central Bank (the maximum level allowed), the interest rate the bank will offer to new clients that bring scrap gold would not be as competitive compared to a bank that is holding only 15% of its Turkish lira requirement in gold at the Central Bank.

    In summary, considering the high Turkish lira interest rates, the difference between the interest paid for gold in a time deposit account and the Turkish lira interest rate is a valuable source of additional revenue for the bank (excluding costs, such as expert assaying fees and storage fees at the Bank of England or Borsa Istanbul).

  • Gold lease

    For some banks, depending on their capabilities, leasing gold can be a less costly way or an alternative to offering gold deposit accounts if the amount of scrap gold that can be collected from individuals fails to fulfil the bank’s reserve requirement needs. In this case, the bank would borrow gold and require its correspondent bank to allocate the bars and transfer the allocated London Good Delivery bars to the Central Bank account.

  • Buy and sell swap

    A buy and sell swap loco London could be an option for banks to consider. Similar to leasing gold, the bank asks its correspondent bank to allocate the ounces and to transfer the London Good Delivery bars to the Central Bank’s account.

At a glance: The Turkish gold market

Source: CBTR, WGC, Borsa Istanbul, Turkish Gold Miners Association.
What’s next?

In addition to regulations on the reserve option mechanism, other steps are being taken to develop Turkey’s gold market, such as the expansion of Borsa Istanbul’s vaulting capacity from 100 tonnes to 1,600 tonnes in January 2017, new regulations that entitle the Central Bank to be the primary buyer of the gold bars produced by Turkish refineries, gold-backed bonds and Sukuk issued by the Treasury with a maturity of 728 days and a six-month interest rate of 1.2%, which resulted in the accumulation of a 3.8 tonnes of physical gold from around 7,100 individuals, the development of a market-making facility for exchange members, and lastly the recent establishment of an electronic funds transfer (EFT) system to move gold stored by individuals in Borsa Istanbul to different banks. However, despite the initiatives taken, the amount of physical gold collected so far shows that most Turkish individuals are unwilling to give up their coins, jewellery and bars in return for an annual interest rate of up to 2.75%. The public remained very much in favour of keeping their physical gold within arm’s reach. With inflation at 15.4% in June 2018, the highest in 14 years, gold will certainly continue to strengthen its role as a hedge against volatility in Turkey and an asset for times of financial hardship.

As a Turkish myself, I always ask people why they prefer to own physical gold. It ultimately boils down to the same reasons, no matter where in the world they are from: is easy to invest in gold, and the precious metal is liquid, confidential, tangible, and outside the banking system. So what could be the next steps to encourage more under the pillow gold to enter the banking system?

  • Provide more transparency and understanding about what is unallocated, allocated and pool allocated gold, and ensure similar practices are maintained for these gold accounts among Turkish banks.
  • Enable blockchain and physical gold to work together in order to explore new possibilities for ownership, transfer and use in payments of physical gold which can potentially surpass the perceived benefits of holding gold under the pillow.
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