Turkey’s banks have taken advantage of a large-scale government stimulus programme aimed at restarting the recently flailing economy, but both analysts and senior bankers say there are still obstacles to navigate as the country recovers from a year of political turmoil.
Since a failed coup attempt almost succeeded in ousting president Recep Tayyip Erdoğan’s government in July 2016, Turkey has experienced a widespread post-coup purge, the imposition of a state of emergency, and a hard-fought constitutional referendum campaign. The extent of the post-coup purges, which have seen more than 50,000 people arrested and hundreds of businesses seized in the past year, has shaken the confidence on which the economy is built.
Turning a corner
Turkey’s banks remain well capitalised, but trying times have introduced new pressures on their profitability. The country's gross domestic product (GDP) contracted in the third quarter of 2016, following the failed coup, after 27 consecutive quarters of expansion, and the banks felt the natural after-effects with loan-to-deposit ratios reaching record highs. However, in the first quarter of 2017, the economy appeared to turn a corner, recording 5% GDP growth.
Turkey has the second largest banking system in emerging market Europe after Russia, with 32 deposit, five Islamic and 13 investment banks currently operating. The sector is nonetheless highly concentrated, with the top five owning 58% of the total banking sector assets.
The country’s banks, which have grown consistently since 2004, faced a high level of risk at the beginning of 2016’s political turmoil, but the government stepping in to provide state guarantees through the credit guarantee fund appears to have boosted their profits, for now. While sentiment has improved, the quality of the loans that have been issued and their capacity to produce real growth are still being debated.
Meanwhile, banks are under more political pressure than ever. Turkish politics is widely viewed as becoming increasingly authoritarian, with Mr Erdoğan consolidating ever more power in the office of the presidency – a development from which banks have not been entirely immune.
Speaking to the Trabzon Chamber of Commerce and Industry on August 8, Mr Erdoğan took aim at banks specifically. “Banks have almost doubled their profitability. This is a disaster,” he said, in the televised address. “I think it is our right to expect banks to lower interest rates and contribute to the country’s growth. If the banking sector can be more courageous in funding the markets, our economic growth will pick up pace.”
Despite these developments, the economy has nonetheless begun to recover from the shake-up of the last year, and senior bankers are cautiously optimistic that business will improve.
High volatility
Now that a recovery of sorts has begun, Turkey’s fundamental demographics will offer banks the potential for high business growth, according to Hakan Ates, chief executive of Denizbank. “Turkey’s banking sector has high growth potential because the population is young and fast growing and this environment creates broad investment opportunities through every banking segment,” he says.
Senior Turkish bankers are confident that the system has the capital and funding structures needed to provide for the new economy. Capital adequacy has traditionally been high in Turkish banks (averaging 16% in the past five years), and with leverage lower than their equivalents both in other emerging markets and developed economies, they have some protection against high volatility.
“Banks have reasonably high levels of profits and as of May this year, return on equity for the sector stands at 15%, which is well above the EU average of 7%,” says Mr Ates. “And most of these earnings are injected back into capital so that growth can become perpetual.”
The loan-to-deposit ratio in Turkish banks recently rose to 118%. However, managers claim years of prudent strategy have allowed them to weather crises in the past and will keep them in good stead now. “The banking system entered the turbulent period with a strong capital base and stable liquidity – relying mostly on local deposits – allowing them to remain prudent while assisting those fundamentally sound clients facing hardships,” says Mr Ates.
The banks have benefited considerably from the government’s more active fiscal policy programme. Under the Treasury’s newly extended credit guarantee fund, the government is underwriting 7% of any loan the banks issue – a move that has precipitated a credit boom estimated at $50bn in Turkish denominated loans. The regulator, the Banking Regulation and Supervision Agency, has also softened provisions on unsecured retail loans and increased the term limits for consumer loans and credit cards to encourage household lending.
Navigating bottlenecks
As a result, Turkey’s six largest banks posted strong first-quarter profits this year despite the recent turbulence. According to the regulator’s data, year-on-year loan growth has increased six percentage points over the past six months, with most of the rise coming from commercial loan growth stimulated by the credit guarantee fund. A total return on equity of 15% was recorded in May.
According to the official figures, banks have managed to see through the credit injection without a significant deterioration in the sector’s asset quality. The non-performing loan ratio decreased from 3.3% at the end of 2016 to 3.2% at the end of the second quarter of 2017. But while headline figures might suggest banks have successfully kept non-performing loan ratios low, Turkey’s banks still hold substantial amounts of distressed debt.
Privately, banks concede that as much as 40% of the vaunted credit guarantee fund support has in fact gone into renewing distressed loans, allowing banks to avoid writing off those debts for another 24 to 36 months. A much smaller slice is believed to have gone into investment that can reasonably be expected to add economic capacity.
Denizbank’s Mr Ates says the government’s measures have been important in allowing the banks and the wider economy to avoid damaging bottlenecks. “The authorities took all necessary measures that would assist banks to weather the shock with least possible impact,” he says. “The credit guarantee fund is a very smart and timely mechanism through which banks use their existing resources to relieve liquidity strains, primarily in the small and medium-sized enterprise sector, which is the backbone of the economy.”
But these measures are not without consequences. “The rapid increase in bank lending and Treasury borrowing has raised the funding costs of the banking system,” says Mr Ates. “The sustainability of economic growth and the current levels of profitability in the banking system will need lower inflation and more reasonable funding costs through the remainder of the year.”
Tougher competition
The immediate result of the credit boom is manifest in the improved GDP and banking sector figures recorded this year, says Huseyin Ozkaya, chief executive of Odea Bank. But there are also side effects. “The acceleration in lending activity has intensified the competition among banks for Turkish lira deposits, raising costs, and loan-to-deposit ratios are beginning to stretch.
“We expect the increases in deposit rates [we saw] during April and May to decelerate the improvement in the sector’s profitability to some extent,” he adds, “but as inflation declines in the medium term, the sector’s net interest margin and profitability should improve.”
There is a wide margin between the rates Turkish banks offer on deposits in Turkish lira, which are typically about 15%, and those they offer on foreign currency deposits, which are closer to 3%. However, residents have been moving more of their money into foreign currency since 2016’s troubles in anticipation of further currency depreciation.
Attracting domestic deposits in Turkish lira may be getting more challenging by the day, but Mr Ozkaya says there are still plenty of opportunities for growth if banks can focus on the right areas. “We think that there is a high growth potential in both consumer and commercial loans in the banking sector, which are important drivers of growth,” he says. “The high amount of infrastructure and renovation investment in the country is creating opportunities in some segments of the construction sector and large-scale project financing.”
Cutting rates
It is in the mortgage market that the effects of fiercer competition are perhaps showing most clearly. Traditionally, Turkish banks have faced constraints on mortgage lending and have been unable to securitise mortgage loans to hedge against interest rate rises. The banks know that, just as in other emerging markets, when interest rates are volatile, banks often lose on their mortgage holdings.
However, in August 2016 Mr Erdoğan publicly called on the banks to cut rates on mortgage loans to spur growth (and described any that would not comply as treasonous). Whether due to this call or not, there has certainly been a change in the market. Rates are down and according to senior bankers, mortgages are now increasingly being seen as 'hooks' to lure in new customers and cross-sell other products such as life insurance and credit cards. Overall mortgage lending has grown by 11% since the beginning of 2017, and a gap has opened up between interest rates on mortgage loans and other consumer and commercial products, indicating that some banks may be taking losses on mortgages in pursuit of market share.
Odea Bank’s Mr Ozkaya argues that this development is a function of strategy, not political pressure. “Some banks’ mortgage loan rates might be below the market average funding costs but we think this reflects different business strategies of those banks rather than a pressure on them to reduce the interest rates,” he says. “While banks naturally have different funding structures and costs, they are able to differentiate their business models and loan type concentrations in parallel with their long-term strategies. Accordingly, some banks can charge low interest rates thanks to their low funding costs, to grow faster.”
Balancing controls
While rating agencies acknowledge the better financial performance of Turkish banks in 2017, outlooks are far below the expectations of some in the Turkish banking sector. Standard & Poor's currently rates Turkey’s sovereign BB with a 'negative' outlook, which is weighing on banks.
“Our negative outlook on Turkish banks principally reflects longer term structural risks such as the high reliance on wholesale foreign funds, which exposes the system to potential shifts in investor sentiment,” says Magar Kouyoumdjian, associate director at S&P Global Ratings.
In March, the arrest of a senior official at Turkey’s Halkbank in the US in relation to a high-profile sanctions-busting case involving the gold trader Reza Zarrab provided just such a sentiment shift, badly damaging the bank’s share price. Ownership of Halkbank has since been partly transferred to Turkey’s new sovereign wealth fund.
According to Mr Kouyoumdjian, there are concerns about asset quality vulnerability to the volatile economic and geopolitical environment in Turkey, and the wider region. “We assess the inherent creditworthiness of most rated Turkish banks as slightly better than the sovereign creditworthiness of Turkey, but their ratings and outlooks are constrained by the sovereign rating and outlook,” he says.
The performance of the wider Turkish economy is still seen as uncertain going forward, as is the level of investor confidence. “But despite significant stress in Turkey in recent periods, the economy continues to grow. Hence, the banking system has not been adversely impacted by these events so far,” adds Mr Kouyoumdjian.
The slew of credit support has made rating agencies more positive on the outlook for Turkey’s banks, but despite slight up-ticks in investment in the small and medium-sized enterprise sector, the measure is seen as a partial and temporary solution.
However, the regulator has provided a well-balanced level of controls without hindering the performance of the banking system, according to Mr Kouyoumdjian. “They have used various tools to control the growth risks in the banking system, such as foreign currency lending and short-term wholesale borrowing,” he says.
Loss of trust
The tremors from 2016’s coup attempt are still being felt in Turkey, and have made it much more difficult to be confident that debtors will be able to pay back loans, or to put long-term confidence in business partners. “It's fine to prime the pump, and to force or induce banks to lend, but at some point the economy should be able to pull itself up by its own boot laces,” says Atilla Yeşilada, an analyst at GlobalSource Partners Turkey. “For growth to be sustainable, the economy must generate sufficient income for residents and companies must invest in their own business; that is still not happening.”
According to Mr Yeşilada, a closer look at confidence indices, import and export data and fixed capital investment figures shows there are deep-seated problems that banks will have to address in the near future. But the broader problem of the trajectory of Turkish politics may have a greater effect on banks over the next few years. “The path the government has chosen is clear – increased pressure on banks, and bringing in the threat of confiscation, to make sure credit continues,” says Mr Yeşilada.
Ultimately, he says, the government’s increasingly draconian methods of rooting out suspected sympathisers of the religious or political movement that it blames for the attempted coup are the real threat to the business environment. “The major problem of the business community now is that anyone can be arrested on flimsy evidence or based on mere suspicion and have their assets confiscated,” he says. “Law doesn’t work properly here at the moment. The law has become arbitrary and you need guarantees, you need trust, to assure the continuing of flow of a modern economy.”
The Turkish model, in which business relationships are often based on implied mutual trust between partners, is deeply affected by the new political environment. While the government has acted to stimulate the economy through these troubles, hazards remain.
“The authorities have replaced the trust that was so important with a government insurance policy. But the risk that casts such a chill on business environment is still there,” says Mr Yeşilada. “The government has introduced a temporary circuit breaker but what happens when it expires?”
