The North Cyprus banking sector: the effect of a speculative attack on the Turkish Lira

Abstract

PurposeThe purpose of this research is to investigate the effect of a speculative attack on the Turkish Lira in the North Cyprus banking sector during the period 1984‐2002.Design/methodology/approachA mutivariate logit model is the empirical methodology employed in this analysis that allows us to identify the determinants of the probability of bank failure. In the model, the existence of contagious currency crises is constructed as an index of exchange market pressure, which is a weighted average of changes in interest rates, international reserves and the nominal exchange rate.FindingsThe empirical result reveals that the a speculative attack on the Turkish Lira in 1994 and 2001 put stress on banks operating in North Cyprus and led to banking sector distress. The findings also suggest that bank‐specific weaknesses, high interest rates, high credit, low trade and the fixed exchange rate policy significantly increased the bank fragility.Research implications/limitationsFor further research this paper may better distinguish contagion if it uses economic and financial ties from Turkey that are practically susceptible to bank failure in North Cyprus.Practical implicationsThis paper presents a practical application of a currency crisis model in the North Cyprus banking sector. In addition to the risk of currency crises, risk under fixed rate regimes, interest rate risk, trade risks and credit risk are also used to encourage correct risk management behaviour in the North Cyprus banking sector.Originality/valueThis analysis would appear to be the first systematic evidence that investigates the effect of a speculative pressure on Turkish Lira in the North Cyprus banking sector.