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WorldOctober 1 2013

Is Turkey set to embrace Islamic finance?

Sharia-compliant banks have occupied only a small proportion of Turkey’s banking market to date, but with rising global demand and the government’s focus on Islamic finance, that looks set to change.
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Is Turkey set to embrace Islamic finance?

It was just over a year ago that Turkey tapped into the growing Islamic finance market when it issued sukuk lease certificates – Islamic securities – for $1.5bn, with a maturity of 5.5 years. According to the Turkish Treasury, the certificates attracted an order book of nearly five times the actual issue size. Now the Treasury plans to issue more certificates as part of its “strategy to broaden its investor base and diversify financing resources”.

As Islamic finance grows worldwide, its presence in Turkey – where more than 99% of the population is Muslim, but which operates as a secular country – is also spreading. All four of Turkey’s ‘participation’ banks, as Islamic banks are known in Turkey, are diversifying their product range and services, and competition is growing.

Slow start

Islamic banks in Turkey have been around since the 1980s but were limited in their activities until they were incorporated into Turkey’s banking law in 2005, allowing them to receive the same legal rights as commercial banks, according to Bank Asya chief executive Ahmet Beyaz.

Inflation and several crises, such as an economic crisis in 1994 and Turkey’s banking crisis in 2001, have hindered the growth of participation banks and their subsequent market share, says Mr Beyaz. But that is changing. In 2001, participation banks accounted for just 1.08% of assets in the local market, according to the Participation Banks Association of Turkey. At the end of 2012, participation banks accounted for 5.1% of assets worth Tl70.3bn ($34.8bn). By the end of June this year, their assets had risen to Tl83bn. 

Based on the strong demand for the first issuance, the Turkish Treasury has decided to issue sukuk twice a year. This benefits participation banks in two ways, according to Muzaffer Colmek, senior area manager for Turkey, Europe and Asia in financial institutions at Albaraka Türk. “Previously, participation banks had hardly any options to diversify their assets with interest-free instruments. Funds were usually kept as cash. Stocks and global sukuk accounted for a small amount of their balance sheets. This meant that participation banks’ capital adequacy and profitability was negatively affected,” he says.

“The Treasury’s sukuk issuance helped participation banks to diversify their assets and spread risk. Another benefit has been on the liquidity management side. These sukuk serve as collateral for repurchase transactions with the central bank. Before, we were not able to access any of the funding instruments of the central bank. Now that problem no longer exists. That has led to a lot of flexibility in our business.

“This year, we issued a sukuk with a 10-year maturity, priced at $200m. We plan to issue new sukuk in future. So far, we have purchased Tl800m from the sukuk that the Treasury issued. This way, we have diversified our assets and our capital adequacy has been improved.” 

Ready for take off

Another example is that of Bank Asya, which in March issued the first Turkish lira-denominated Islamic bond for Tl125m and a subordinated Tier 2 structure internationally for $250m. The bond has a 10-year maturity, one of the longest in Turkey so far, according to Mr Beyaz.

Despite participation banks’ small market share, they are likely to grow faster in future in both capital markets and retail banking thanks to rising global demand, the local industry’s aspirations and the government’s focus on Islamic finance, says Selim Elhadef, head of advisory at Ernst & Young in Turkey.

Mr Colmek agrees. He says that thanks to Turkey’s stable banking sector, which weathered the financial crisis well, there is a lot of attention from global financial institutions and banks interested in establishing a new bank or buying a bank in Turkey. 

Mr Elhadef adds: “Growth in participation banks will have a direct positive impact on the Turkish banking sector as those customers who do not use the conventional banking system will have the opportunity to be included. On the asset side, the availability of Islamic banking products should entice Islamic investors outside of Turkey to invest in the country. This will be especially true for investors from the Gulf Co-operation Council region.” 

Foreign interest

For Noor Islamic Bank from the United Arab Emirates, for instance, Turkey is the place to invest when it comes to sharia-compliant financing. By the end of 2012, the bank had closed Islamic mandates in the country worth close to $3bn in the previous three years. Its latest such mandate was a facility for $450m for Albaraka Türk, a deal that Hussain Al-Qemzi, the chief executive of Noor Islamic Bank, describes as “the largest Islamic finance deal in the history of Islamic banking in Turkey”.

This foreign interest is good news for both participation banks and Turkey's government, which, since the onset of the financial crisis, has been steering the country's economy and its exports towards the Middle East and north Africa (Mena).

Albaraka Türk, which is part of Bahrain-based Al Baraka Banking Group (ABG) but has an independent listing on the Borsa Istanbul, welcomes the growing interest in Islamic finance. ABG is present in 15 countries. “As Turkey has shifted its export focus to the Mena region and further away from Europe, it has been beneficial for us to use the correspondent banking relationships of ABG,” says Mr Colmek. Until this year, Albaraka Türk had never accessed the debt capital markets, funding its growth primarily through the bank financing market, complying with Islamic principles.

Mr Colmek adds that Turkey’s participation banks have been making good progress in product diversification on the retail side too. Among those products, he cites ‘gold banking’ as the most important. “Participation banks are looking to bring the gold that is typically held under the pillow into the banking system. Banks can use this gold as funding. This new service has resulted in the integration of more conservative consumers into the banking system,” he says.

Innovation drive

Bank Asya’s key focus is on small and medium-sized enterprises and retail banking, and Mr Beyaz emphasises that, just like commercial banks, Bank Asya is also oriented towards innovation. “We use our own in-house IT company, with about 280 IT staff who create everything from core banking to all banking products. This helps us to be more competitive,” he says.

“In retail banking, we aim to provide the products and services that commercial banks do, just in a sharia-compliant way. Our credit cards are fundamentally different from the credit cards of commercial banks. The fundamental principle is that participation banks do not give out credit and customers cannot withdraw cash on their cards. Instead, Islamic banks facilitate instant financing of goods and products. With our credit cards, customers make purchases and pay the bank back. So effectively, we buy a product on behalf of our customers and sell it back to them.” 

Bank Asya is also looking beyond retail. Last year, it established a pension fund and is now in the process of building a portfolio management subsidiary, which it plans to have established by the end of this year. Mr Beyaz says the Islamic pension fund currently ranks ninth among 17 players in Turkey by customer numbers, with about 100,000 users. “Other projects we are working on include Asya Yatirim Menkul Degerler, a securities house through which we aim to give our customers access to capital markets. We’re also building a company called Asya Gelisim and will use this to invest in companies where we see potential,” he says.

But the competition is no longer between four players. Earlier this year, Turkey’s deputy prime minister Ali Babacan announced that two state-owned banks, Ziraat and Halkbank, would establish Islamic banking operations. Considering Turkey still has a large unbanked population, these new entrants could help bring that part of the population into the system, in part thanks to the existing branch networks of Halk and Ziraat.

“This could lead to increased competition, which in turn would mean better and more products and services for customers. This could lead to more job creation for both young and experienced professionals in this field and help to grow talent, which is very scarce at present,” says Ernst & Young’s Mr Elhadef. Furthermore, these developments would align well with the government’s ambitions to establish Istanbul as a regional finance centre, he adds.

For a country with a secular constitution, could the announcements of Islamic banking operations offered by state-owned lenders signal the rise of religious influence in business? Mr Elhadef thinks state-owned banks looking into participation banking subsidiaries could be considered a response to the demand from the market, rather than a religious direction.

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