David O'Byrne in Istanbul -

News that Turkey's banking regulator BDDK has drafted regulations that will allow banks to sell all kinds of gold has been greeted with anger by Turkey's jewellers, who have until now held a near monopoly on the trade, and with surprise by those unfamiliar with the "unorthodox" monetary policy being implemented by the Turkish central bank.

While the draft regulation allowing banks to sell gold is new, it is a natural extension of existing regulations brought in last year that allow banks to buy gold. This sudden move to allow Turkish banks to trade in what many would regard as a luxury item having no relation to the business of banking reflects the twin realities of Turkey's still developing financial services sector and the central bank's ongoing "unorthodox" monetary policy.

On the one hand, it recognises that despite legal changes obliging employers to pay employees salaries into bank accounts, the irregular nature of much of the Turkish economy means that many are still paid in cash - leaving Turkey as a country that those within the industry readily describe as "under banked". And, thanks in no small part to Turkey's recent history of runaway inflation, many Turks who are financially secure prefer to save their money in "under the pillow" physical gold, rather than trust it to interest bearing savings accounts, even though inflation has been brought below 10%.

On the other, it reflects the central bank's monetary policy, which has seen it seeking to control inflation, stabilise the Turkish lira and stem inflows of "hot money" by means of an unorthodox mix of variable interest rates and strict controls on the reserve requirement ratios (RRR) of Turkish banks. More specifically, in the central bank's decision last year to increase the level of RRR banks can hold in gold from 10% to 20% and then again more recently to 25% while at the same time allowing them to take "under the pillow" gold direct from customers.

The new policy has seen banks launch special gold promotion days when customers can deposit physical gold in the bank in exchange for investments in a range of gold-based banking products: including gold deposits, gold funds and gold-linked capital-protected funds.

The success of these promotions has been unprecedented with around 170 tonnes of physical gold collected in little over a year, causing the value of gold deposits held collectively in Turkish banks to jump by over 500% over the same period from TRY2.4bn ($1.3bn) to around TL14.4bn.

With many of those holding substantial amounts of physical gold belonging to the conservative segments of Turkish society, Turkey's participation banks - ie. banks which operate on strict Islamic principles and don't charge or pay interest - have been reporting particular success in attracting gold investments. Two of these, Kuveyt Turk and Bank Asya both collected around 2 1/2 tonnes of gold over the first half of this year alone.

The benefits of such schemes are clear. On the one hand, they offer the owners of the gold the opportunity to keep their investments in a safer location than "under the pillow," while at the same time earning a return on the investment which is not based solely on fluctuating gold prices. On the other, they offer the banks an easy route to making a substantial part of their RRR without having to dip into the Turkish lira reserves they need to maintain their loan books. It also aids the slowing Turkish economy by making liquid a huge reserve of moribund capital, putting it to work in the economy.

Current estimates put the amount of gold held "under the pillow" by Turkish households at as much as 5,000 tonnes, which valued at around $240bn at current prices is not far off two and a half times Turkey's total foreign exchange reserves.

And with less than 300,000 of Turkey's estimated 75m population thought to have opened gold accounts, clearly there still exists both huge potential for getting more liquidity back into the Turkish economy and righting one of its long-term imbalances, namely the low level of bank savings which has left Turkey's banks disproportionately dependent on foreign loans to fund their domestic loan books.

According to World Bank data, the level of bank savings held by Turks fell from around 23.5% of GDP in the mid-1990s to around 12.7% by 2010, way below that of other high growth countries such as China where savings peaked at 46% of GDP in 2008.

Ironically, this fall has come about as a direct result of the country's strong economic performance over the past decade. While younger earners have preferred to spend and enjoy higher lifestyles, older and more conservative Turks with money to save have preferred traditional "under the pillow" gold.

Attracting more of that gold back into the real economy, will both benefit the economy and the banks - providing domestic resources for funding loan growth, not to say benefit consumers guaranteeing them an income on investments beyond possible growth in the gold price.