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Western EuropeMay 2 2016

Turkey’s banks stay healthy amid domestic instability

Despite a slowing economy, political turbulence and currency depreciation, Turkey’s banks have remained healthy. But rising costs and falling profitability have some in the industry worried, as Tom Stevenson discovers.
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Turkey’s banks stay healthy amid domestic instability

Turkey’s banks have been riding the same rollercoaster as other emerging market banks over the past year, but with the added strains of a civil war just across the border in Syria and a Kurdish insurgency in the country’s south-east. Nonetheless they appear to be weathering the storm and look set to emerge in good health.

The overall size of Turkey’s financial sector has been growing as a share of gross domestic product (GDP) over the past decade thanks to sophisticated mobile and online banking systems, though it remains smaller than that of other emerging markets. 

The five largest Turkish banks – Isbank, Ziraat Bankasi, Garanti Bankasi, Akbank and Yapi Kredi Bankasi – hold a combined market share of about 60%. Multinationals including Citigroup, BBVA, BNP Paribas and UniCredit have bought into Turkish banks.

Turkey is known for its strict regulation, and as of March 2016 its banking system was fully Basel-compliant, something the sector achieved without significant changes in capital ratios.

Period of adjustment

On the surface, Turkey has much in its favour. It has a young, educated and consumerist population, an advanced society and GDP growth that has remained around the 5% mark for decades. Public debt, at 33% of GDP, is low by international standards. In addition, national statistics agency Turkstat recorded higher than expected GDP growth of 4% in 2015.

However, the Turkish lira has depreciated by about 50% since 2008, a development that caused a public spat between former central bank governor Erdem Basci and president Recep Tayyip Erdogan, who at one point in early 2015 came close to accusing Mr Basci of “treason” for maintaining high interest rates. Mr Basci was eventually replaced by the deputy governor of the central bank, Murat Cetinkaya, after a period of uncertainty that went down badly in the domestic markets.

And even the biggest banks are not immune to political disquiet. In January, Yigit Bulut, a key adviser to Mr Erdogan, called for the government to “urgently” nationalise Isbank, in which the opposition Republican People’s Party has a 28% share, causing the bank’s share price to drop by 5%.

Between February and May 2015 the assets of another private bank, Bank Asya, were seized by the government over alleged links with the US-based Turkish preacher Fethullah Gulen, a former ally of Mr Erdogan who has fallen from favour.

Tough times

Turkey’s nominal GDP actually fell by 11% in dollar terms between 2014 and 2015 as a result of the strength of the dollar and weakness of the lira. However, ratings agency Standard & Poor’s is forecasting real GDP growth averaging 2.7% between 2016 and 2018, well below the historic trend.

The loan-to-deposit ratio at Turkish banks has been growing, and reached 120% in November 2015, a 50% increase over just five years.

The 2008 financial crisis hit Turkey hard when it came to foreign investment. While Turkey is one of the leading recipients of FDI in the region, flows have fallen far from a high of $22bn in 2007 to just above half that level in 2015.

In 2015, almost $10bn in short-term foreign investment, or 'hot money', left Turkey. However, foreign investors with more long-term ambitions invested $16.6bn in Turkish companies, driving the biggest inflow since 2011.

The deterioration of security in Turkey caused by the Syrian civil war, the Turkish army’s suppression of a domestic Kurdish insurrection and a spate of attacks by militant groups across the country has prevented flows from making a full recovery.

Stress test

Turkish banks have been subjected to a stress test over the past year but have come through relatively unscathed, according to Akbank vice-president Kerim Rota.

“There was a level of instability that for the past 13 years we have not been used to,” says Mr Rota. “For a country that had just got used to stability we have faced two years of uncertainty.”

Despite some setbacks, Mr Rota says Turkey’s banks experienced a lower than expected rise in non-performing loans and weathered the foreign exchange risk. This was achieved thanks to the banks’ management of their Tier 1 capital, he believes. The drop in the overall Basel III Tier 1 capital ratio for Turkey’s banks was about 25 to 30 basis points over the year, leaving the ratio at 13.3, a fall that was on the right side of expectations given the high percentage of loans Turkish banks hold in foreign exchange, and the extent of the currency depreciation. About 40% of bank loans are in foreign currencies.

The biggest weakness in the system now, according to Mr Rota, is the country’s low savings ratio. The banking sector has a loan-to-deposit ratio of about 120%, though for the tranche denominated in Turkish lira the ratio is higher still, at about 130%.

“The loan-to-deposit ratios are really on the border right now and in order to support growth or create new loans, the first prerequisite has to be to correct that,” says Mr Rota. Since 2010 the loan-to-deposit ratio of Turkey’s banks has risen sharply, necessitating a change in strategy. “With the levels we see now, it’s difficult to sell securities or create external borrowing and lend to Turkish customers,” adds Mr Rota.

Keeping tourists

Turkish banks may recognise the need for local deposits, but competition in the deposit market is much higher in 2016 than it was three years ago or even one, which is adding a premium and cutting into profits.

“For this year we are more optimistic and think net interest margins will start to increase, but there is also risk due to the troubles in the tourism sector,” says Mr Rota. Tourism accounts for about 4.5% of the Turkish economy, and has been hit hard by security concerns and in January 2016 saw the biggest collapse in foreign visitors for 10 years.

The sector may be diversified, but there has been a drop in visitors from both Russia and western Europe, two of the primary sources of wealthy guests. Lenders have seen non-performing loans rise to 3.2% of total credit and expect more bad loans from the tourism sector.

Banks are looking to target the remaining unbanked population, but most of the unbanked are in the east of the country, and the collapse of the peace process between the Turkish government and the Kurdish rights movement makes it difficult for banks to reach that population.

“The biggest opportunity now is in the small and medium-sized enterprise market,” says Mr Rota. “And there are also big infrastructure projects in Turkey that make for good investment, such as hospitals. We will be looking carefully at those.”

Healthy regulation

In 2001, Turkey experienced a financial crisis that severely damaged the country's economy and saw a handful of banks fold. But as a result, a set of carefully judged regulations were put in place by the Banking Regulation and Supervision Agency (BRSA) to maintain the banking system. 

“The Turkish banking system is healthy and robust, in part because of the regulator, which was really ahead of its time,” says Huseyin Ozkaya, CEO of Odeabank, a new bank founded in 2012. “It kept the banks lean and well capitalised, which really helped them weather the financial crisis of 2008.”

The BRSA ensures teams of auditors are permanently based in all Turkish banks, and as a result most banking operations are closely scrutinised and regulated. Though the Turkish economy certainly suffered during the 2008 financial crisis, none of the country’s banks were taken into state ownership or went bankrupt.

Odeabank has followed what Mr Ozkaya refers to as a technology-centric, customer-centric, low-cost strategy that has helped the bank maintain low asset-to-cost ratios. The bank currently has 55 branches and $11bn in assets.

“Because of the size of its economy, its geopolitical importance and the general health of its banks, Turkey and its banks have become a major target for emerging market investors and those capital flows have been instrumental here,” says Mr Ozkaya.

Since 2012, however, the profitability of the Turkish banking system has fallen by a considerable margin. “The growth in the early years when the sector was getting on its feet was huge and macro-prudential measures made less of an impact. Return-on-equity levels were high, whereas now it’s down to more like 10%,” says Mr Ozkaya.

“Odeabank got started during the period when profitability was falling but there have still been plenty of opportunities. We’ve had to manage the balance very carefully, and it has been challenging, but every day there is progress and there are encouraging signs for the second half of 2016.”

Declining profitability

“The large Turkish banks are not struggling exactly, but they are certainly in a more challenging operating environment,” says Irakli Pipia, vice-president and senior credit officer at Moody’s and the author of a recent study on the Turkish banking system. “These banks are a mirror that represents the whole system and we don’t anticipate a marked improvement for them this year. In fact, the system’s profitability has already been on a declining trend for the past five years.”

Moody’s forecasts that nominal lending growth in Turkey will slow considerably to between 12% and 16% in 2016, down on the 20% to 30% of the past few years.

“Domestic demand is expected to continue to drive growth this year, owing to the higher minimum wage, lower oil prices and supportive monetary and fiscal policies,” the International Monetary Fund said in an assessment in Turkey in February. However, the fund also expects external financing needs to remain high and inflation to continue to rise.

Turkish banks are having to manage lower overall demand because of a slowdown in economic growth and large hedging costs rooted in their foreign currency liabilities. “The swings in currency in Turkey tend to be quite sizeable and that has a significant impact on the volatility of customer deposits,” says Mr Pipia.

The extent to which the banks must rely on external financing is a major concern for Turkish bankers. In comparison with other heavyweight emerging markets, Turkey has high external refinancing needs and low foreign exchange reserves. Net banking sector external debt reached $160bn in 2015.

External challenge 

External financing will be perhaps the main challenge for Turkey's banks in the future, according to Omer Aras, CEO of Finansbank, the fifth largest private bank in Turkey.  

In December, Finansbank announced that Qatar National Bank had agreed to buy the bank from National Bank of Greece, its majority shareholder. Mr Aras believes that the takeover, which is expected to be finalised by June, will give Finansbank a stronger financial parent and put it in a good position when it comes to external financing. 

“At present any significant slowdown in the economy could cause a rise in non-performing loans and problems with financing, so we have to be very careful going forward.” says Mr Aras.  

Despite the problems Turkey's economy has faced over the past two years, Mr Aras notes that the stocks of the major Turkish banks have in fact risen, in contrast to the falling market values of large European and US banks.  

Nonetheless, he says Turkey's banks must now focus on their profitability. “The banks have to look at productivity and at the expense side, whether it is by cutting costs or making operations more efficient with digitalisation and mobile banking,” says Mr Aras. 

“It will be the banks that select the right clients that will be ahead of the game.”

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Read more about:  Western Europe , Turkey