With Turkey's economy in a downturn, the interventionist Erdogan government is keen for state and private banks to provide cheaper credit. Tom Stevenson reports.
At the beginning of January 2019, Turkey’s central bank made a surprising announcement. The bank’s annual general meeting (AGM), held every year in April, would be brought forward three months. Turkey analysts, former officials, and government critics all agreed there could be only one interpretation: the government had brought the AGM forward so that the central bank would pay its annual dividend to the Treasury early, before elections scheduled for the end of March.
Over the past year the Turkish economy has experienced a string of setbacks that have left market confidence at an all-time low. The Turkish lira has fallen against the US dollar by more than 30%, inflation is running at just below 20%, and the central bank was forced to raise interest rates to 24% to stop a market rout. President Recep Tayyip Erdogan and his Justice and Development Party (AKP) had succeeded in every electoral test since Mr Erdogan was elected prime minister in 2003 and won the most votes in the March election. However, as local elections approached, the government was in need of funds to support the national accounts.
The last-minute rescheduling of the central bank’s AGM foreshadowed bad news for the economy. On March 11, government statistics showed that Turkey had fallen into a recession in the second half of 2018, the first in more than a decade.
Banking intervention
Turkey was once seen in international markets as a large middle-income country with a growing population and low government debt. It is now experiencing a souring of investor sentiment, matched by the deteriorating international opinion of Mr Erdogan’s increasingly authoritarian government. Rating agencies Moody’s and Fitch both class Turkey’s credit outlook as 'negative'.
The Erdogan administration’s interventionist tendencies have led it to turn to the country’s banks for a solution. In early March, Bloomberg reported that the Ministry of Finance, under the guidance of Mr Erdogan’s son-in-law and finance minister Berat Albayrak, was working on plans to bolster the capital levels of the two main state-owned banks, Ziraat Bankası and Halk Bankası, in order to promote cheaper credit and stoke the economy.
On April 10, Mr Albayrak announced a Tl28bn ($4.9bn) recapitalisation for the state banks. In addition, the minister of finance said the government would establish and oversee two funds designed to relieve Turkish banks of bad loans and shore up their balance sheets. The moves represent the largest intervention in the banking sector since a financial crisis in 2001.
Government pressure
Turkey’s state banks have been under pressure from the government to increase lending levels in the interests of creating higher economic growth. At the end of February 2019, Ziraat Bankasi announced that it was reducing its monthly mortgage interest rates and consumer debt rates. An anonymous manager at one of the state-owned banks told the Financial Times that the bank had been ordered to “lend even to companies with no prospects of repaying”. In its latest credit brief, ratings agency Moody’s warned that the government’s pressure to sustain lending was “adding risk and negatively affecting margins”.
Halk Bankası is currently subject to an open investigation in the US over its role in the Reza Zarrab Iran sanctions case in 2016. In January 2018, the bank’s deputy chairman, Mehmet Hakan Atilla, was found guilty of sanctions-busting charges.
In a credit note published on March 27, Fitch said while the risk to the bank’s credit profile from the investigation had reduced, the rating agency was maintaining a 'negative' outlook on Halk Bankası because of “a more aggressive risk appetite than private bank peers and relatively higher strategy execution risk”.
A serious impact
The pressure on state-owned banks contrasts with the environment within Turkey’s private banks. Where state-owned lenders are being encouraged to expand borrowing, private banks are mostly retrenching. Lending dropped significantly after the lira crisis took hold in August 2018, while real banking credit shrank by 7.2% on a quarterly basis in the last three months of that year. Over the past 12 months, XBank, the index of 13 Turkish banks, fell 16%, significantly greater than the 8% fall in the country’s main stock market index, the Borsa Istanbul 100.
According to Ömer Aras, chairman of QNB Finansbank, the government’s measures to promote state bank credit growth “leans against” an overall contraction in bank lending, but high interest rates mean private banks are unlikely to make an about-turn on deleveraging until inflation drops. “Banks turned more cautious against currency volatility after the market turmoil last August,” says Mr Aras. “Assuming that lira depreciation will remain moderate throughout this year, we expect headline inflation to drop notably in the second half of 2019 and that would enable lower rates and a notable stimulus to loan growth.”
Some of the government’s provisions have been designed to encourage lending by the private banks. On February 18, the central bank reduced the reserve ratios that banks are required to maintain on liabilities denominated in Turkish lira by between 50 and 100 basis points. Mr Aras says this freed up as much as $3bn in liquidity.
Turkish corporates are carrying a heavy burden in foreign currency debt (about $200bn at the end of 2018) and further drops in the lira’s value would put bank liabilities at risk. Banks have outstanding liabilities of $14bn in short-term foreign currency loans to the Turkish private sector, which are sensitive to further lira depreciation.
Mr Aras says the currency crisis and high interest rates have had a serious impact. “In past years, Turkish banks have achieved fast credit growth, which in fact started to put additional pressure on asset quality and cost of risk,” he adds. “Now the cost of funding has increased sharply and demand for loans has fallen.”
No NPL crisis?
While the risks are clear, Turkey’s banks and regulators say non-performing loan (NPL) ratios are still better than those of many other developing countries. With effective collateral and collection management, and restructuring, banks believe a liquidity crisis in the sector can be averted.
A fall in inflation with moderation in growth and the external deficit would foster sustainable growth not only in the banking sector, but also in the overall economy, according to Mr Aras. “In the coming period, there is an opportunity for Turkish banks to focus on the export and tourism sectors, and banking sector growth would be mainly local currency loans driven,” he says.
Financial institutions and rating agencies have warned that Turkey’s banks may be holding a larger proportion of bad debts than is currently acknowledged. In December 2018, Standard & Poor’s predicted that bad loan levels were likely to double over the proceeding 12 months. On December 27, Turkey’s banking regulator, BDD, projected a sharp rise in NPLs in 2019. The regulator predicts that NPL ratios could rise to 6% this year, from 3.7% in 2018 and 3% in 2017.
The aggregate NPL ratio across Turkey’s major banks is currently estimated at about 4%, but distressed debt figures are higher. The International Financial Reporting Standards methodology indicates that stage two loans may add around another 10 percentage points to NPL ratios. In March 2019, Reuters reported that Turkish distressed debt had attracted the interest of Japanese financial services company Orix and US private equity firm Bain Capital.
A healthier picture?
The Turkish banking system as a whole currently boasts high capital adequacy, estimated at about 17% (well above the regulatory limit of 12%) and a liquidity buffer that has given banks a cushion against bad debt. The national accounts also appear to have a healthy public debt profile, with debt standing at about 13.7% of GDP, and a low budget deficit.
However, the sharp deterioration of the lira in 2018 and the recessionary economic environment have taken a toll on debt repayments. Several large companies have recently either applied for or closed restructuring deals with major banks. In March, Ebru Dildar Edin, executive vice-president of Garanti Bank (which is part-owned by BBVA), said banks plan to restructure between $7bn and $8bn of debt in the energy sector alone. In 2018, large corporates including Yıldız Holding, Türk Telekomunikasyon, and Dogus Holding completed restructuring processes valued at more than $14bn.
“The NPL ratio has gone up a little more than expected,” said Burak Saltoğlu, an economist at Istanbul’s Boğaziçi University. “After the local elections, some policy changes will be needed to support corporates, but it will be a while before we reach the level of loan growth we saw pre-crisis.”
An unstable aftermath
When Turkey’s economy experienced high growth rates in 2017, observers predicted that high inflation and a widening current account would lead to overheating. Having suffered a downturn in 2015 and 2016, when a civil war in the country’s south-east and a failed coup attempt shook the economy, the government pursued recovery through an unprecedented fiscal stimulus programme designed to bring on what then prime minister Binali Yıldırım called a “year of salvation”.
The authorities announced a Tl250bn credit guarantee mechanism that saw the state support bank lending, along with a temporary cut to value-added tax. According to some estimates, the measures pushed unemployment figures down by three percentage points. The programme was then extended into 2018.
In 2018, the International Monetary Fund warned that a positive output gap, high inflation and a wider current account deficit would risk a slump that now appears to have materialised.
Concerns also began to mount that Mr Erdogan’s interventionist tendencies were proving excessive. Since 2016, the government has been seeking to nationalise the country’s largest listed bank, Türkiye İş Bankası. The bank is currently part owned by the main opposition party, the People’s Republican Party, due to the bequeathal of the shares by the founder of modern Turkey, Mustafa Kemal Atatürk. In February, Mr Erdogan called for a parliamentary vote on moving the shares into state ownership.
Freedom to act
To plot a course away from a deeper crisis, many are looking towards Turkey’s central bank. Its stock among international investors has increased recently, particularly after it raised interest rates by 625 basis points – against Mr Erdogan’s atypical monetary policy views – to 24%, in reaction to the lira crisis in August 2018. However, doubts remain over how free the bank is to control inflation and stabilise the currency.
The credibility of the central bank and its monetary policy framework are critical to the health of the banking system, according to Hakan Ateş, chairman of DenizBank, a Turkish bank purchased by Emirates NBD in a deal announced in May 2018 and set to be finalised in 2019.
While the credibility of Turkey’s central bank has improved since August 2018, questions about its capacity to manage the economy and Turkey’s chronic current account deficits will carry greater weight than micro-liquidity measures to stimulate lending.
“Liquidity conditions in Turkey depend in the end on the extent of the flow of foreign capital,” says Mr Ateş. “And this flow in turn will depend on whether the authorities show that they can bring down inflation to single digits and keep it there with sustainable policies.”
Tightening monetary policy proved important in establishing much-needed credibility. When the central bank also defied concerns that it would ease monetary tightening too early, and held course, its reputation improved further. Inflation has begun to fall from highs of 25% and currently stands at 19.7%, according to official figures.
Once bitten, twice shy
Turkey’s banks are subject to strict limits on their foreign exchange positions imposed by the banking regulator, which stipulate that banks cannot raise net foreign exchange liabilities above 20% of total capital. However, Turkey's banks are exposed to exchange rate volatility through weighty foreign exchange debts held by the country’s corporates. While some of the foreign currency debt burden accrued through investment in export industries, the level of debt is cause for concern. Net liabilities have risen by 270% in the past 10 years.
Corporate debt is mostly long duration, with firms often running foreign exchange surpluses over the short term to hedge debt repayments. Turkish banks and the public sector run a foreign exchange surplus. Households are also estimated to be holding about $100bn in gold, with levels rising as the lira has depreciated.
Turkey’s current account deficit has dropped by about half over the past 12 months amid reduced and then negative growth, which may lower lira volatility. Turkey’s banks are therefore confident they will push through the recession, according to Mr Ateş. “Bitten once during the infamous banking crisis of 2001 and twice shy since then, banks in Turkey pay utmost attention to remaining hedges in foreign exchange, and the factors causing the lira volatility have turned benign lately,” he says.
In search of an upside, Turkey’s banks are looking to digital technology as a source of growth and profitability. Fintech companies and e-commerce marketing, where new business models and technological developments are still to be found, are being increasingly targeted by banks. “This has changed the nature of competition in Turkey’s financial sector,” says QNB Finansbank’s Mr Aras.
Banks are competing to establish relationships with fintech companies, not only as investors but to improve their own customer experience services, including credit rating, customer-specific pricing and identifying customer behaviour patterns. In 2018, Yapı ve Kredi Bankası produced promotional material describing itself as “the world’s most innovative digital bank”.
Digitisation will be critical to the expansion of Turkey’s financial sector as a whole, according to Mert Öncü, general manager of Odeabank, Bank Audi’s subsidiary in Turkey. “There is a considerable unbanked population in Turkey, and digitisation will help with financial inclusion,” he says.
The advantages of digital banking, particularly in sparse times, is expansion without the necessity of growing branch networks. “Turkish banks are well placed to manage erosion in financial metrics and indicators,” says Mr Öncü.
Righting the ship
Turkey’s favourable demographics, strategic geopolitical position and economic diversity may provide a route back to high economic growth, if the authorities can steady the ship. Banks and analysts hope prudent fiscal policy and independent central banking will return.
The current recession may offer an opportunity for the economy to rebalance, particularly in the relationship between domestic and foreign demand. In the finance ministry, talk dominates of leading the country out of the middle-income trap, according to sources close to the minister.
While international confidence towards Turkey is currently low, should the government prove able to achieve a V-shaped recovery and reduce the economy’s reliance on foreign debt, sentiments may improve. For the flow of foreign capital to resume, prudent capital allocation through the banking sector to high-value production-based sectors with lower import dependence will be crucial, according to analysts.
After elections
Serious concerns surround areas of the economy. The construction sector, which has been brought to the fore by Mr Erdogan’s infrastructure drive, has experienced a series of hiccups described by some analysts as “mini-bubbles”. Housing projects on the peripheries of Istanbul and other major cities lie empty as home sales have sharply dropped. Lending to the construction industry is expected to fall.
The 6% NPL ratio for 2019 projected by the banking regulator currently seems “very optimistic”, according to Mehmet Hasan Eken, professor of banking and finance at Turkey’s Kırklareli University and a former commercial banker, who predicts a figure of about 10%.
In Turkey’s financial crisis of 2001, NPL ratios rose by more than 10 percentage points. Forecasts of bad debt loads that approach that figure cast a shadow over recovery plans. “An economy in recession simply does not allow businesses to work properly and this slowdown is definitely resulting in difficulties for Turkey’s banks as companies struggle to pay down their loans,” says Mr Eken.
As banks seek to exhaust every avenue to float loans, more and more corporate debts are falling into delinquency. A full recapitalisation strategy is unlikely to be needed, says Mr Eken, because Turkey’s banks have healthy capital stock. Under banking regulations, Turkish banks are prohibited from distributing dividends without official approval. These regulations have meant banks retain extra reserves not distributed to shareholders.
However, the government’s efforts to promote lending through state banks at the expense of proper risk assessment has some investors worried. According to Mr Eken, this policy was an expected response to the slowdown. “The government is trying its best to fuel industry with liquidity and to recover the economy; that’s its intention,” he says. “It is encouraging banks to extend loans and it has made some progress.”
Now that the local elections at the end of March have wrapped up, the banking sector is expecting government pressure on banks to ease up. “The policy [of encouraging banks to extend loans] will last until the end of March, and then will likely finish,” says Mr Eken.
