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Western EuropeMay 1 2005

Back to basics

Turkey’s banking system recorded strong growth in 2004 but systematic weaknesses continue. The country’s 48 banks are having to learn to cope with a low inflation environment.
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Driven by a red-hot economy, fuelled by a rise in consumer spending and a burst of growth in foreign trade, the total assets of Turkey’s banks expanded 27.7% in 2004 to a record $228.3bn, corresponding to 77.5% of the gross national product (GNP), according to the annual report of the Banks’ Association of Turkey.

Banking income climbed 15.9% from 2003 to $4.7bn in 2004, the Banking Regulatory and Supervisory Authority reported. Total bank loans reached $74.0bn, up from $47.4bn in 2003 and deposits rose 27.9% to $142.3bn from $111.3bn in the previous year.

Non-performing loans (NPLs), which accounted for 20% of the total loans in the banking system in 2001,were beaten back to 6.3% in 2004 by the vitality in the economy and increased provisions against bad loans. One other reason why NPLs were down was the massive debt-restructuring programme carried out from 2001 to 2003 to bail out many major companies in financial difficulties.

Although the banking system has undergone considerable consolidation in the past six years, systematic weaknesses, such as maturity mismatches and vulnerability to sudden changes in the exchange rates, continue to lurk behind the glossy facades of financial operations. A Moody’s Investors Services report published in January warned that any fluctuations in exchange rates could have adverse effects on the asset quality of the Turkish banks.

Core fundamentals

Turkey’s banks are rediscovering the fundamentals of banking as inflation and interest rates fall, putting pressure on profit margins and further tightening the sector. The banks have begun to return to core commercial banking, corporate finance, consumer banking, financing mortgages and lending to small and mid-size companies – the backbone of Turkey’s industry – to maintain their earnings.

The developments come as further consolidation in the sector is expected through a flurry of mergers and acquisitions (M&A) and entry of more foreign investment into the banking sector.

The number of banks operating in Turkey has declined from 81 in 1999 to 48 in March this year as a result of M&A activity and the exit of financially weak banks. The sector has become highly concentrated. The top five banks hold 60% of the assets and 62% of all deposits, compared with 56% and 55% respectively in 2001 And the top 10 banks control 82% of all assets, up from 80% four years ago, the Banks’ Association of Turkey reported.

 

Inflation dropped from 149.6% a decade ago to single digits in 2004. Interest rates on government bonds and T-bills nose-dived from 193.71% on March 23, 2001, the height of Turkey’s worst recession since 1945, to 16.1% at the end of this March.

In the past, the main business of Turkey’s banks was financing government debt through the acquisition and trading of high-yield government bonds, treasury bills and repurchasing agreements and making a hefty profit in the process. The banks were taking in deposits from investors and buying government securities, instead of lending to customers. There were no risks involved and real returns from the transactions were as high as 30%.

“High inflation and real interest rates, and prohibitive intermediary costs prevented credit markets from developing,” Zafer Kurtul, general manager of Akbank said in a newspaper interview. “Banks failed to support the real sector sufficiently because credit risks were very high in this type of environment.”

But with inflation and interest rates down, margins have declined, forcing banks to do business differently. Banks that are able to cope with low inflation and take part in M&A activities, teaming up with local and foreign banks, will come out strongest in 2005 and 2006, foreign bank analysts say.

“Handling disinflation will be the key theme [for Turkish banking] for 2005 and 2006 alongside M&A,” according to a Morgan Stanley report on Turkish banking published on February 3. “The banks are increasingly turning to customer lending as a means of sustaining earnings. At this stage, the perpetual question is will volumes compensate for margin contraction?”

 Loans to small enterprises 

As a change in lending strategy, the banks are shifting some of their loans from big corporations to small and medium-sized companies (SMEs). SMEs – companies that employ less than 150 people and have less than $15m in annual sales – account for 99.5% of the total number of firms in Turkey, 61.1% of the total employment and 27.3 % of the value-added of the manufacturing industry. Yet their share in total bank credits is only about 4%, bankers say.

Turk Eximbank Bank set aside 40% loans to SMEs in 2004. “We realise the export potential of the SMEs. This is why we are giving them priority in our loans,” says H Ahmet Kiliçoglu, general manager of state export bank Turk Eximbank.

Turkey’s Garanti Bankasi says it plans to extend $1.1bn on SME loans in 2005 and make small and midsize banking a separate line of business..

Ersin Özince, president and chief executive officer of Türkiye Is Bankasi (Isbank), Turkey’s largest private bank and second biggest overall, says his financial institution plans to increase the percentage of consumer loans and credits to SMEs. Isbank provided loans to 42,000 SMEs in 2004.

“We intend to raise the amount of consumer loans and credits to SMEs from 51% to 65% of our total loan portfolio,” Mr Özince told business magazine Kobi Efor.

 Mortgage exchange

As the economy improves, many banks and brokerage firms are examining the possibilities of establishing a general mortgage system in Turkey, with a mortgage exchange that would revive the construction markets and create jobs for hundreds of thousands of unskilled workers and revenues for the financial system.

The construction sector has been in the doldrums since catastrophic earthquakes struck western Turkey in 1999, triggering a rise in national unemployment from less than 6% in 1999 to more than 9.3% in June 2004.

“The lack of a system that finances mortgage markets is the biggest shortcoming of Turkish banking,” Omer Aras, vice-chairman of Fiba Holding, a group with interests in banking and finance and retailing, said in a newspaper interview. To be able to create such a mortgage system, the banks would have to come up with funds that could be used over a period of 15 to 20 years, he said.

Bankers also said that a strong regulator was needed in a mortgage market to share risks with the banking system. “What happens when an economic crisis strikes and individuals who took out loans lose their jobs and no longer pay their mortgages? This happened in the US during the great depression and the banks ended up owning 40% of the country’s housing,” one banker said.

At present, only 3% of Turkey’s dwellings are bought through bank loans because maturities of loans are up to five years and interest rates on the loans reach 40% annually. Middle and low income families can not benefit from housing loans because they are still too costly.

Foreigners enter sector

One development in the banking sector is the increasing rise in foreign investment. Foreign banks that have acquired banking interests in Turkey in the past four years include HSBC, Unicredito of Italy and BNP Paribas.

In February, France’s BNP Paribas acquired 50% of TEB Financial Investments from Turkey’s Colakoglu Group for $216.8m, gaining control of a 42.2% stake in Turk Ekonomi Bankas¦ (TEB), a midsize Turkish bank.

In a related development, Koç Financial Services Company, a joint venture between the Koç Group and Italy’s Unicredito, are close to concluding negotiations with Turkey’s financially ailing Cukurova Holding to acquire a 57% stake in Yapi ve Kredi Bankasi, Turkey’s fourth biggest bank. “Our goal is to become the leader among private sector banks,” Kemal Kaya, chairman of Koç Financial Services, told The Banker in an interview.

Holland’s Rabobank was expected to sign an agreement in April to acquire a 51% stake in Sekerbank, a midsize, Ankara-based bank. France’s Société Générale and Deutsche were said to be shopping around for Turkish banks.

Turkey’s Dogus Holding hired Morgan Stanley in March to explore the possibility of selling its Garanti Bankasi, Turkey’s fifth biggest bank.

“The owners of the banks that entered the system in the past decade want out because banking has become a risky business. They want to sell their banks,” says Mehmet Ercan Kumcu, chairman of Tekfenbank, a commercial bank.

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Read more about:  Western Europe , Turkey