A New Accounting System for Turkey
Turkey is facing a severe economic crisis, with annual inflation reaching 61.5% in September 2023. To cope with the impact of hyperinflation on businesses and consumers, the government has decided to introduce a new accounting system that will adjust financial statements according to the changes in purchasing power and profitability. This system, known as inflation accounting, will apply to Turkish companies’ end-2023 balance sheets, and is expected to continue until 2026, based on current inflation forecasts.
Inflation accounting is a method of accounting that reflects the effects of inflation on the value of assets, liabilities, revenues, and expenses. It aims to provide a more realistic picture of a company’s financial performance and position, as well as to reduce the distortion caused by inflation on tax calculations. Inflation accounting is not a new concept, as it has been used by many countries that have experienced high inflation in the past, such as Argentina, Brazil, Chile, and Iran.
An Exception for Financial Institutions
However, not all sectors will be subject to the new accounting system. According to Treasury and Finance Minister Mehmet Simsek, financial institutions may be excluded from the practice, as he said in a parliamentary commission on Tuesday. He did not give further details on the scope or rationale of the exemption, but it could affect banks, brokerages, insurers, and factoring companies.
The possible exclusion of financial institutions from inflation accounting has raised some questions and concerns among analysts and investors. On one hand, some argue that it could be a way to protect the state’s tax income, as banks are a major source of corporate tax revenue for the government. Earlier this year, the government raised the corporate tax rate for financial entities to 30% from 25%. On the other hand, some worry that it could create a lack of transparency and consistency in the financial sector, as well as a disadvantage for foreign investors who want to see more commitment to orthodoxy.
The Impact on Banks’ Profits and Valuations
One of the main reasons why financial institutions may be negatively affected by inflation accounting is that it could significantly reduce their reported profits and valuations. This is because inflation accounting would require banks to restate their non-monetary assets, such as loans, securities, and fixed assets, at their current market values, which are likely to be lower than their historical costs due to inflation. This would result in higher depreciation and amortization expenses, as well as lower net interest income and capital gains. In contrast, monetary assets, such as cash and deposits, would not be adjusted, as they already reflect the current purchasing power.
According to some estimates, inflation accounting could reduce banks’ profits by up to 75%, as well as their book values by up to 50%. This would have a negative impact on their return on equity, dividend payouts, and share prices. For example, Garanti BBVA, one of the largest banks in Turkey, reported a net income of 23.4 billion liras ($826 million) in the third quarter of 2023, but its parent company BBVA accounted it as a 158 million euro loss after adjusting for hyperinflation and higher taxes.
A Challenge for the Banking Sector
The banking sector is already facing a number of challenges due to the economic crisis, such as rising bad loans, falling deposits, currency depreciation, and regulatory pressure. The introduction of inflation accounting could add another layer of complexity and uncertainty to the sector, as it would require banks to adopt new accounting standards, systems, and procedures, as well as to communicate the changes to their stakeholders. Moreover, it could affect the comparability and reliability of financial information, as different banks may use different methods and assumptions to adjust their financial statements.
The banking sector is a vital part of the Turkish economy, as it provides credit and liquidity to businesses and households, as well as contributes to the fiscal and monetary stability of the country. Therefore, it is important that the government and the regulators provide clear and consistent guidance and support to the sector, as well as to ensure a level playing field for all financial entities. Inflation accounting is a necessary and inevitable step to cope with hyperinflation, but it should not compromise the soundness and transparency of the banking sector.
