FINANCIAL INNOVATIONS IN DEVELOPING COUNTRIES:

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FINANCIAL INNOVATIONS IN DEVELOPING COUNTRIES:THE CASE OF TURKEYA THESIS SUBMITTED TOTHE GRADUATE SCHOOL OF SOCIAL SCIENCESOFMIDDLE EAST TECHNICAL UNIVERSITYBYARMAĞAN ÖNDER HERGÜNERIN PARTIAL FULFILLMENT OF THE REQUIREMENTSFORTHE DEGREE OF MASTER OF SCIENCEINTHE DEPARTMENT OF ECONOMICSAUGUST 2015

Approval of the Graduate School of Social SciencesProf. Dr. Meliha AltunıĢıkDirectorI certify that this thesis satisfies all the requirements as a thesis for the degree ofMaster of Science.Prof. Dr. Nadir ÖcalHead of DepartmentThis is to certify that we have read this thesis and that in our opinion it is fullyadequate, in scope and quality, as a thesis for the degree of Master of Science.Asst. Prof. Dr. Seven AğırSupervisorExamining Committee MembersAssoc. Prof. Dr. Gökçer Özgür (Hacettepe Univ., Econ)Asst. Prof. Dr. Seven Ağır (METU, Econ)Asst. Prof. Dr. Hasan Cömert (METU, Econ)

I hereby declare that all information in this document has been obtained andpresented in accordance with academic rules and ethical conduct. I also declarethat, as required by these rules and conduct, I have fully cited and referencedall materials and results that are not original to this work.Name, Last name: Armağan Önder HergünerSignatureiii:

ABSTRACTFINANCIAL INNOVATIONS IN DEVELOPING COUNTRIES:THE CASE OF TURKEYHergüner, Armağan ÖnderM.S., Department of EconomicsSupervisor: Asst. Prof. Dr. Seven AğırAugust 2015, 115 pagesFinancial innovation is an important phenomenon in the development scheme of financialmarkets, gaining more ground after the 1980s. The primary aim of this thesis is to investigatetwo cases of financial innovation in Turkey: Credit card installments and gold accounts.Financial innovation literature lacks an examination of financial innovations in developingcountries and does not present any alternative explanations behind their emergence.Differences between institutional structures and the effect of financial liberalization andintegration create alternative scenarios for the emergence of financial innovations. Althoughthe development level and the transaction volumes are still significantly lower especially forthe securitized financial products in developing countries as suggested by market depth,alternative products can have significant impacts on the economy. Therefore, the case studyin this thesis fills a gap in the literature by focusing on two financial innovations in Turkey,an emerging market, which have unique features endogenous to domestic economy and havebeen used mostly by households. Institutional and cultural factors affect the emergence anddevelopment of the markets for both financial innovations, and have altering effects formacroeconomic indicators.Keywords: Financial innovation, developing countries, Turkeyiv

ÖZGELĠġMEKTE OLAN ÜLKELERDE FĠNANSAL YENĠLĠKLER:TÜRKĠYE ÖRNEĞĠHergüner, Armağan ÖnderYüksek Lisans, Ġktisat BölümüTez Yöneticisi : Yrd. Doç. Dr. Seven AğırAğustos 2015, 115 sayfaFinansal yenilik özellikle 1980 sonrası süreçte kazandığı yer ile birlikte finansal piyasalarıngeliĢim süreçleri açısından önem taĢımaktadır. Bu tez çalıĢmasının ana amacı Türkiye‘dekiiki finansal yeniliği, yani kredi kartı taksitleri ve altın hesaplarını, araĢtırmaktır. Finansalyenilik yazını geliĢmekte olan ülkelerdeki finansal yeniliklerin irdelenmesinde yetersizkalmaktadırvebu yeniliklerin mlarsağlayamamaktadır. Finansal yeniliklerin ortaya çıkıĢları açısından kurumsal yapılardakifarklılıklar ve finansal liberalleĢme ile entegrasyonun etkisinin alternatif senaryolaroluĢturduğu görülmektedir. Piyasa derinliğinin gösterdiği üzere, geliĢmekte olan ülkelerdemenkul kıymetleĢtirilen finansal ürünlerin geliĢim düzeyleri ve iĢlem hacimleri oldukçadüĢük olmasına rağmen alternatif ürünler ekonomi üzerinde önemli etkilere sahipolabilmektedir. Bu nedenle, bu tezde yer alan vaka çalıĢması yükselen pazarlardan olanTürkiye‘deki özgün özelliklere sahip ve çoğunlukla hane halkları tarafından kullanılan bu ikifinansal yeniliğe odaklanarak yazındaki mevcut boĢluğu doldurmayı hedeflemektedir.Kurumsal ve kültürel etkenler söz konusu iki finansal yeniliğin hem ortaya çıkıĢlarına hemde piyasalarının geliĢimine etki etmekle kalmayıp, aynı zamanda makroekonomikgöstergelerin seyrini de değiĢtirebilmektedir.Anahtar kelimeler: Finansal yenilik, geliĢmekte olan ülkeler, Türkiyev

ACKNOWLEDGEMENTSI would like to thank my supervisor Asst. Prof. Dr. Seven Ağır, for accepting me asher student and helping me from the beginning to the end. Her guidance, patienceand kindness were invaluable for finishing this thesis.I would like to express my gratitude to Asst. Prof. Dr. Hasan Cömert for his extrasupport. His insightful comments and thorough help in writing this thesis has taughtme a lot.I would also like to thank Assoc. Prof. Dr. Gökçer Özgür for being a part of mythesis committee and for his invaluable suggestions.I also thank Prof. Dr. Ġrem Dikmen Toker for her understanding when I was in needof time. I also appreciate my colleagues‘ support throughout this study.My special thanks and deepest gratitude go to my dear friend Semih Gökatalay.Without his aid and companionship, I could not have written this thesis. I am alsothankful to Sırma Damla User for she is a caring friend. My precious thanks goes toGizem Güpür for her loving care, support, and understanding. Thank you for beingmy darling.Lastly, I thank my dear family for their limitless support and sympathy. They havealways been there for me.vi

TABLE OF CONTENTSPLAGIARISM . iiiABSTRACT . ivÖZ . vACKNOWLEDGEMENTS . viTABLE OF CONTENTS . viiLIST OF TABLES . ixLIST OF FIGURES . xLIST OF ABBREVIATIONS . xiCHAPTER1.INTRODUCTION . 12.LITERATURE REVIEW ON FINANCIAL INNOVATIONS . 62.1. What is Financial Innovation? . 72.2. Emergence of Financial Innovations . 82.3. Types and Measurements of Financial Innovations and InnovatorCharacteristics . 112.4. Change in the Perception of Financial Innovations. 132.5. A Critique and Re-evaluation of Financial Innovations . 153.FINANCIAL INNOVATIONS IN DEVELOPING COUNTRIES . 183.1. Developing vs. Developed Country Financial Innovations. 193.1.1. Institutional Differences . 213.1.2. Financial Liberalization and Integration . 253.2. Financial Structure, Innovativeness and Market Depth in Developing andDeveloped Countries after the 1980s . 293.3. Security Innovations in Developing and Developed Countries . 413.4. Additional Comments and Final Remarks . 444.A CASE STUDY OF TWO FINANCIAL INNOVATIONS IN TURKEY. 484.1. Credit Card Installments Case . 52vii

4.1.1. Literature on Credit Cards and its Concepts . 524.1.2. Defining Credit Cards and Installments as Financial Innovation . 554.1.3. Development of Credit Cards Market in Turkey . 584.1.4. Understanding a Financial Innovation: Credit Card Installments. 644.1.4.1. Developments in the Market . 664.1.4.2. Implications on Macroeconomic Conditions . 734.2. Gold Accounts Case . 754.2.1. Gold in Turkey and Links to Innovation. 754.2.2. A Series of ―Golden‖ Financial Innovations . 784.2.3. Understanding a Financial Innovation: Gold Accounts . 804.2.3.1. Developments in the Market . 804.2.3.2. Implications on Macroeconomic Conditions . 835.CONCLUSION . 85REFERENCES . 89APPENDICESA. TABLES (GDP of selected countries and Equity Linked Derivatives) . 98B. TURKISH SUMMARY. 100C. TEZ FOTOKOPĠSĠ ĠZĠN FORMU . 115viii

LIST OF TABLESTABLESTable 1: Financial Liberalization Dates . 32Table 2: Summary of International Positions of BIS Reporting Banks . 33Table 3: External Positions of Banks, All Sectors . 34Table 4: Credit to Private Non-Financial Sector in Selected DevelopingCountries . 40Table 5: Credit to Private Non-Financial Sector in Selected DevelopedCountries . 40Table 6: Total Debt Securities Statistics of selected countries . 42Table 7: Equity Linked Derivatives – Amounts Outstanding (Total Contracts) . 43Table 8: Equity Linked Derivatives – Amounts Outstanding(Forwards and Swaps) . 43Table 9: Equity Linked Derivatives – Amounts Outstanding (Options). 44Table 10: Number of POS Terminals and ATMs in Turkey (2000 – 2014) . 62Table 11: Number of Credit and Debit Cards in Turkey (2000 – 2014) . 63ix

LIST OF FIGURESFIGURESFigure 1: Deposit Money Banks‘ Assets to GDP, selected developing countries . 36Figure 2: Deposit Money Banks‘ Assets to GDP, selected developed countries . 37Figure 3: Stock Market Capitalization to GDP, selected developing countries . 38Figure 4: Stock Market Capitalization to GDP, selected developed countries . 39Figure 5: Credit Card System in Turkey . 61Figure 6: Credit and Debit Cards Shopping Volumes. 67Figure 7: Average Value of a Single Shopping Transaction . 68Figure 8: Retail Credit Card Debt Balances . 69Figure 9: Corporate Credit Card Debt Balances . 70Figure 10: Non-Performing Credit Cards / Total Non-Performing Loans . 72Figure 11: Household Consumption with Credit Cards . 73Figure 12: GDP per capita and Consumption / GDP for Turkey . 74Figure 13: CBRT Gold Reserves (in millions ). 80Figure 14: Total Deposits / Total Liabilities in Turkish Banking Sector . 81Figure 15: Precious Stones Deposit Accounts (FX) / Total Deposits . 82Figure 16: Gold Accounts / National Savings . 83x

LIST OF ABBREVIATIONSABSAsset-Backed SecuritiesATMAutomated Teller MachinesBISBank for International SettlementsBRSABanking Regulation and Supervision AgencyCBRTCentral Bank of the Republic of TurkeyICCInterbank Card CenterIGRIstanbul Gold RefineryIMFInternational Monetary FundMBSMortgage-Backed SecuritiesPOSPoint-of-SaleROCReserve Option CoefficientROMReserve Option MechanismTUIKTurkish Statistical InstituteWGCWorld Gold Councilxi

CHAPTER 1INTRODUCTIONInnovation is inevitable and it is a prerequisite condition to improve production ofgoods and services both in the industry and the financial markets in the 21st century.Based on an original idea, it is applied to the production of new goods or to alter thealready existing processes, creating new grounds for higher value added. Withincreasing technological developments in the recent decades, societies have evolvedinto a fast consumption culture, which necessitated ever important innovations to bemade in order to remain compliant to the market. When thinking innovation, the firstthing that comes to mind is ‗change‘, most of the time being positive, however insome circumstances leading to negative results.In the early 20th century, innovation is thought to be mostly related with the realsector, and the idea had been pioneered by Schumpeter in his works. However,innovation is not only confined to its occurrence in the real sector, but we observeabundant number of innovations also in the financial sector which are called‗financial innovations‘, referring to the innovations that take place only in thefinancial markets.When it comes to financial innovations, we should bear in mind that they haveexisted for a long time in history, as early as the introduction of coins, perhaps evenearlier. Although financial innovations should be treated within a broad list of newproducts or process, they are most of the time referred to as innovations that emergedafter the 1980s (e.g. securitized assets), especially in line with technologicaldevelopment and financial liberalization. In other words, as the communication andcomputer technologies are advanced, there appeared new ways of financialintermediation which provided alternative benefits for the participants of financialmarkets; but, not all financial innovations proved to be beneficial in the end.1

The recent financial innovations are novel products which have been a part of thesecuritization process that took place in the recent decades, along with others.Securities, which have many types and versions, are asset-backed securities, creditdefault swaps and derivatives, just to name a few. Still, they are complex financialproducts, only to be used by finance professionals, excluding other economic agents.They are generally thought to be favoring the extension of access to credit, reducingor transferring risks, increasing efficiency, enhancing profitability, and stimulatingfinancial development and growth. However, the last episode of the bust cycledemonstrated that financial innovations should be treated more cautiously as they canlead to volatility, macroeconomic imbalances, increased risks, increased possibilityof default, and so on.On the one hand, the global financial crisis of 2008 changed the view towardsfinancial innovations from positive to negative, and on the other hand, the literatureon financial innovation had touched upon different attributes of financialinnovations. Finding the roots of post-1980 financial innovations is one of the mostimportant topics among studies, i.e. researchers try to find the reasons why theselatest financial innovations occurred and how they emerged. One body of scholarshipis looking upon the historical side, arguing that securitization process which hastaken place within the last few decades is not the only thing to examine, but financialinnovations existed in many forms for hundreds of years.Another group of scholars is trying to find the true characteristics of innovators,focusing on the qualitative aspects of financial innovators. Many others are dealingwith their macroeconomic implications, trying to find out whether there is aconnection between innovations and financial development, which would lead toeconomic growth at the end. Furthermore, a great deal of academic work is beingdone on the measurement of financial innovations, i.e. there are studies searching forthe ways to explain innovations in a quantitative manner.In spite of lively discussions about their historical roots, characteristics and possibleeffects on macroeconomic conditions, the existing literature on financial innovationmostly focuses on developed countries, especially the United States. The reasons for2

neglect of other economies, to some degree, are existence of available data foradvanced economies which enable more comprehensive examinations of thesemarkets and also the high level of financial deepness which produce a more suitableenvironment for emergence of financial innovations.Since there are only a few studies on financial innovations in developing countries,some fundamental questions such as how financial innovations emerged indeveloping countries have not been addressed well so far. Hence, alternativeexplanations are needed in order to interpret the emanation of financial innovationsin developing countries.As such, this study intends to offer some explanations for the emergence andstructure of financial innovations in the developing countries. Using the alreadyexisting benchmarks and definitions for developed countries, we investigate whetherfinancial innovations are common or not in developing countries within theframework of mainstream understanding of financial innovations. In this regard, weargue that although developing countries have imported financial innovations fromadvanced economies, their applications might have occurred in a different way thanin their counterparts. More importantly, certain financial innovations emerged owingto the unique institutional characteristics and particular domestic economicconditions on both micro and macro levels in the developing countries. For the sakeof our study, we have chosen Turkish economy for a case study in which we analyzetwo different financial innovation cases which are credit card installments and goldaccounts. Primary rationales behind the choice of these two cases are that theseinnovations are examples from Turkish economy which are relatively recent whichattracted a wide participant basis, and they fit well into the broader definition offinancial innovations.The outline of this thesis is as follows: In Chapter 2, we provide a comprehensiveliterature review on financial innovation.1 We focus on its different definitions andits brief history, the reasons behind the emergence financial innovations, their1This chapter draws from the comprehensive literature review study of Comert and Epstein(unpublished) for the categorization of studies.3

different types and measurements, and innovator characteristics. We show that howfinancial innovation literature has shifted its stance from positive to a negativeattitude especially after the Great Recession. As financial innovation lit

financial innovations from positive to negative, and on the other hand, the literature on financial innovation had touched upon different attributes of financial innovations. Finding the roots of post-1980 financial innovations is one of the most important topics among st

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