The prolonged weakness of the Turkish lira (TRY) combined with high inflation will likely increase problem loans for Turkey’s banks, Moody’s Investors Service said in a note on April 16.

“The lira’s decline will lead to higher loan-loss charges that reduce banks’ profitability and capital ratios, which would raise the risk the availability of foreign funding would decline,” Moody’s said. “Because 33% of Turkey’s bank loans at year-end 2017 were denominated in foreign currencies, primarily US dollars and euros, if the lira’s exchange rate versus the dollar remains at or above last [April 11’s all-time low of TRY4.15 [a historically lower point of 4.1944 occurred on April 11 but at around 20:30 local time on April 16 the rate was 4.1081], problem loans will increase. A sustained depreciation of the lira will reduce the repayment ability of corporate borrowers that have no foreign currency revenue and are unhedged.”

The TRY has weakened towards 12% on a year-on-year basis and has fallen by around 7% in the past month.

Moody’s, which on April 16, issued a separate report saying the chronic weakness of the TRY was credit negative for Turkey’s sovereign debt rating and posed difficulties for its economy, also closely examined the loan difficulties expected from sticky double-digit inflation, which was 10.2% in March versus the central bank’s 5% target (plus or minus 2 percentage points) and the 8% forecast for end-2018.

The rating agency said: “We expect the lira’s depreciation to increase inflation, eroding corporate profitability and consumers’ purchasing power and ultimately increasing problem loans. Among major banks, Turkiye Vakiflar Bankasi TAO (Ba3/Ba2 stable, b12 ) and Yapi ve Kredi Bankasi A.S. (Ba3/Ba2 negative, ba3) are more vulnerable given that their problem loan ratios at the end of 2017 exceeded the peer group average of 2.8%: Turkiye Vakiflar’s problem loan ratio was 4.0%, while Yapi’s was 4.1%.”

The TRY’s depreciation will also cut capital ratios as foreign-currency denominated risk-weighted assets increase while lira-denominated regulatory capital remains unchanged, Moody’s said. “A deterioration of bank capital also will reduce banks’ ability to lend, curtailing economic growth. We consider Turkiye Is Bankasi A.S. (Ba3/Ba2 negative, ba3) and Yapi to be more vulnerable, since their ratios of tangible common equity to risk-weighted assets were weaker at year-end 2017 than the peer group average of 10.5%; Turkiye Is Bankasi’s was 8.7%, while Yapi’s was 9.2%.”

Investor concerns about the solvency of Turkish banks will likely reduce access to foreign-currency funding, a key vulnerability of Turkish banks because of their large foreign-currency refinancing needs, 49% of which were short-term as of the end of 2017, the rating agency said, concluding: “The risk of a sudden fall in foreign funding has increased, but remains low for the time being. Turkish banks’ access to international capital markets is currently unconstrained, benefitting from abundant global liquidity.”