Banking sheds old habits

Turkey has gone a long way from the days of crisis in early 2001 when the country nearly defaulted on its debt obligations for the first time in its turbulent economic history. Although considerably affected by the recent dry-up of global liquidity, the country is now able to maintain its policies of fiscal austerity, institutional reform and setting about building a viable business environment. The cleaning-up and restructuring of the banking sector has contributed significantly to this newly-found stability, arguably as much as an unstable banking sector dragged the economy down in 2001.

The crisis of 2001 unfolded in a macroeconomic environment similar to the one preceding this summer's economic hiccup: Oil prices were on the rise and the US Federal Reserve was about to increase interest rates. With investor confidence strained, intense discussions between the then-prime minister Bülent Ecevit and President Ahmet Necdet Sezer about the pace of reforms led to an abrupt outflow of foreign capital. At the end of 2000, $6.4 bn (€4.9bn) left the country within 15 days, resulting in a deep plunge of the Turkish Lira and skyrocketing prices of import goods.

The situation was exacerbated by the deficiencies of the Turkish banking sector at the time. Until 2001, setting up a bank was fashionable and easy, as Ilhami Koc, chairman of IS Investment, ISBank's investment banking arm, recalls. It was fashionable because banks were used by Turkish conglomerates to obtain cheap financing facilities.

It was easy because with government bonds yields extremely high due to high levels of inflation and government debt, banks focused on trading and holding government bonds and could afford to neglect individual and corporate customers' needs for loans and consumer credits and failed to monitor credits at risk. As a result, Turkish banks did not live up to their role as facilitators of economic growth.

As foreign investors evacuated their money and liquidity dried up, companies were struggling with the shortage of long-term credit lines and the rising costs of imported production factors. With companies defaulting on their debt and a weak deposit base, the Turkish banking sector experienced a major shake-up.

The ratio of non-performing loans to total loans of the Turkish banking sector rose from 4.2 in 1990 to 11.5 at the end of 2000 . From 1999 to 2001, the number of Turkish private banks fell from 52 to 31, with banks held in receivership by the SDIF (State Deposit Insurance Fund) shooting up to 11 in 2000 and 6 in 2001.

It is no surprise, therefore, that in the aftermath of the crisis the Turkish government put special emphasis on reforming the economy in general and the financial sector's regulatory framework in particular. In what according to Yarkin Cebeci, chief economist of JP Morgan in Turkey, can be called a ‘normalisation' of the economy, two government commitments have been playing an important part.

Both the National Convergence Program towards the EU acquis and the second stand-by agreement with the IMF have proved to be powerful anchors to implement institutional reforms whilst shielding governments from popular pressure. In order to restore investor confidence, governments have been working hard to reduce the public sector borrowing requirement (PSBR).

As the OECD notes in its last country report, due to the significant share of the state in economic activity in Turkey, the PSBR not only influences the level of taxation, but also interest and exchange rates, thereby heavily impacting on both trade and investment.

In a second step, in April 2001, the Turkish Central Bank became fully independent from the government, with a mandate to maintain price stability.

In May 2001, the government responded to criticism on the weak regulation of the banking sector by initiating a Banking Sector Restructuring Program. Aimed at reducing the role of the state in banking, at strengthening private banks' capital structure and at installing a sound supervisory framework, it has proved to be an important step in restoring investors' confidence in the Turkish market.

And as a result, investors galore have flocked to the sector. Before and shortly after the crisis, foreign banks had mainly established subsidiaries, with HSBC being active in the market ever since 1990. Following the European Council's December 2004 announcement to open accession negotiations with Turkey
the year 2005 saw a massive buy in of foreign banks into the Turkish market (see table).

The biggest deals came towards the end of the year, with GE Consumer Finance taking over a 25.5% stake in Garanti and Unicredito and Koc Holding acquiring a majority stake in Yapi ve Kredi Bankasi. Take-overs continued in the first half of 2006 when both the National Bank of Greece and Belgium's Dexia launched multi-billion dollar bids for Finansbank and Denizbank, respectively. And although the most attractive banks have now been sold, experts believe that the foreign banks' shopping spree is far from being over.

With population of 70m people growing at more than double the European average and an economy projected to expand by 6% in 2006 and 5% in 2007, Turkey is an attractive market for retail, commercial and investment banking. With a normalisation of the economy, a young population is currently realising postponed consumption potential.

Decreasing interest rates and a rapidly rising GDP per capita are further fuelling what can be called a rush for credit on the retail side. Consumer loans totalled $21bn in 2005, roughly a quarter of all Turkish Lira-denominated bank loans and nearly 26 times the level of 2000 ($800m).

According to the Interbank Credit Card Centre, Turkey has become one of the fastest growing markets for credit cards. After the summer break, parliament is expected to pass legislation establishing a mortgage system which would replace long-term credits as a source of housing finance.

Rising consumer indebtedness, however, poses a certain risk to macroeconomic stability, says Dormus Yilmaz, governor of the Turkish National Bank, especially in the case of a reversal of the interest rate trend.

For banks, however, the credit business constitutes a significant opportunity to make money by serving customers' needs. It is no surprise, therefore, that besides raising the number of branch offices by a modest 5% from 2003 to mid-2006, Turkish banks have made serious efforts to revamp their sales channels.

Technology plays an increasing role in delivering specific products to specific market segments, says Handan Saygi, senior vice president at Garanti Bank, which as an early mover in the market sparked GE Consumer Finance's interest. In the last two years, Turkish banks have embarked on a frenzy of technological innovations in retail banking, often placing them ahead of their western European competitors.

Turkish customers not only enjoy ATMs equipped to handle utilities bills, but they can also be authorised to debit a third person's account by entering a PIN that person sent them on their mobile phone. The use of internet banking facilities is growing, as is their sophistication, including eg trading of international securities on SWEET, a new online platform of Sekerbank.

But retail banking is far from the only opportunity both foreign and Turkish banks are looking at. With the economy picking up and interest rates coming down, Turkish corporates have started to invest again. With memories of massive defaults in the recent past, however, borrowing at competitive rates is still very much restricted to big blue-chip companies.

According to Andrew Vorkink, the IMF's country director for Turkey, the banking sector's credits to the private sector as a share of GDP remains low in comparison to other emerging markets and financial-industrial conglomerates still account for a the majority of the outstanding debt .

As the Turkish economy remains dominated by small and medium sized enterprises, corporate lending to these operations would not only stimulate the economy, but would also be an excellent opportunity to put a foot in the door for providing other products such as mortgages or financial advisory services in the future. On the investment banking side prospects are bright. The ongoing restructuring of the economy, privatisation and the need for structured transactions are providing plenty of business opportunities. It is no surprise, therefore, that both investment banks and brokers are competing for their share of the market.

While the bigger larger Turkish brokerage houses want to move into investment banking, the Turkish investment banks are facing stiff competition from their global counterparts.

Besides a lively M&A-scene, senior bankers expect the issuing of
corporate bonds to be a major source of revenues. With a strengthened regulatory framework, healthier fundamentals and capital markets expected to deepen significantly with the rise of the Turkish institutional investor, the Turkish banking sector is much more resilient to crisis than half a decade ago.

The share of non-residents in total assets of the banking sector, amounting to more than 12% in 2005, is a strong anchor for financial stability in itself. Seizing opportunities with servicing Turkish customers on a long term basis, therefore, not only benefits foreign banks, but considerably contributes to breaking the Turkish boom-and-bust cycle.

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