The effects of loose monetary union between a small country and a large developing country in crises: Experience from Turkey and North Cyprus

Abstract

After the Turkish intervention in 1974, Cyprus was divided into two parts, North (Turkish) and South (Greek). In 1983, the Turkish Republic of Northern Cyprus (TRNC) was established and a sort of loose monetary union between the TRNC and Turkey started. The Turkish Lira (TL) replaced the Cyprus pound as the legal currency in the TRNC and a central bank - with no authority to issue money - was established. When Turkey tightened its monetary policy after signing an agreement with the IMF in December 1999, this immediately affected the weak banks in the TRNC - along with Turkey - and some of them collapsed. This study aims to look at how the banking crises that started in Turkey affected the banking sector in the TRNC. How it started, what were the reasons behind it, what caused it, could it have been prevented or what measures needed to be taken to reduce the effects of such crises in the TRNC. Results show that monetary union and economic integration between a small country and a large developing economy, even if it is a loose one, requires a careful preparation before unification and a good deal of cooperation and coordination between the two countries as regard to monetary policies. At the time of the crises, this cooperation and coordination between the central banks of two countries become even more important in guiding and supervising the sectors. © 2005 Yoser Gadhoum.