The Impact of Turkish Monetary Policy on North Cyprus Banking Sector

Turkish Lira is the legal tender in the Turkish Republic of Northern Cyprus. This makes the Turkish Republic of Northern Cyprus be in the Turkish lira zone. The monetary policy decisions of Turkey’s central bank, to a great extent, determines the monetary policy in the Turkish Republic of Northern Cyprus. Even though the Turkish Republic of Northern Cyprus has its own central bank, the impact on the policy change is very minimal and so the monetary policy in the Turkish Republic of Northern Cyprus has to be in parallel with Turkey's central bank. This thesis aims to investigate the impact of the monetary policy changes and the instability in Turkey on the banking sector of the Turkish Republic of Northern Cyprus. This panel data study will cover the period of 2004-2019. The findings show that interest rates have a significant and positive impact on return on equity and return on the asset on banks, implying that an increase in interest rates improves the financial performance of financial intermediaries in the Turkish Republic of Northern Cyprus. An increase in total loans to total deposits has also been found to have a positive and significant impact on return on equity and return on assets. Inflation, on the other hand, has a negative impact on the return on equity. Changes in exchange rates are estimated to have no significant effect on the bank's return on equity and return on asset in the Turkish Republic of Northern Cyprus. However, this is not the case for nonperforming loans where this study finds that fluctuations in exchange rates worsen the asset quality of the banking sector. As expected, instability in Turkey proxied by the instability index also has a deteriorating significant impact on the non-performing loans. An increase in total deposits and the ratio of total loans to total deposits both have a significant and positive impact on total loans. This study also finds that an increase in interest rates leads to a decrease in total loans. Finally, gross national product growth which has been used as a control variable in the model has been found to have a positive association with the size of banks in the Turkish Republic of Northern Cyprus. Exchange rates, total loans to total deposits, and total deposits were also found to have a positive impact on the size of the sector. However, interest rates indicate a negative impact on the total asset size of the banking sector in the Turkish Republic of Northern Cyprus. The findings of this study highlight the need for policymakers to keep a close eye on Turkey's monetary policy due to its high involvement in the Turkish Republic of Northern Cyprus banking activities. In addition, policymakers should also try to develop measures for mitigating the negative impact of inflation and instability that originates from Turkey.