Foreign exchange rate exposure, market risk and foreign currency derivatives: An investigation of turkish deposit banks

From 1990 to 2001, emerging-market economies, such as Turkey, have experienced major financial crises. Among the main causes of these crises are banks holding serious, net open positions, banks having poor risk-management approaches for currency, and central banks' poor exchange-rate policy choices. However, new policies implemented in the wake of these crises have brought about the formation of a culture of financial risk management in these countries. These countries have also shifted their exchange rate regimes from fixed to floating. In this context, this study first examines whether the Turkish banking sector, restructured in the early 2000s, is still today sensitive to exchange-rate risk. Next, the study explores which value-at-risk model should be used to most accurately measure foreign exchange-rate risk. Third, the study investigates whether the Turkish banks' usage of foreign exchange-rate derivatives helps them to reduce or instead increases their exposure to foreign exchange-rate risk. Results clearly show that Turkish deposit banks are still exposed to foreign exchange-rate risk. In order to measure foreign exchange-rate risk more accurately, for the Turkish Lira-Euro exchange, they should use a FIGARCH-based, value-at-risk model under a Student's-t distribution, and for the Turkish Lira-US Dollar exchange, they should use a GARCH-based, value-at-risk model under a Student's-t distribution. As for derivative usage, findings clearly show that Turkish banks use foreign-currency derivatives effectively; derivative usage helps these banks to significantly reduce their currency risk. However, results also indicate that the 2007–2008 mortgage crisis has adversely affected the performance of the Turkish deposit banks regarding currency-risk management since, after the mortgage crisis, on the one hand, banks' sensitivity to exchange-rate risk has increased, while, on the other hand, banks have become less successful at reducing their currency risk through the use of foreign exchange-rate derivatives.