Why Turkish Banking Sector?
OPPORTUNITIES AND CHALLENGES OF THE TURKISH BANKING SECTOR
The Turkish banking sector is strictly regulated and highly monitored by two powerful agencies; Banking Regulation and Supervision Agency (BRSA) and Central Bank of the Republic of Turkey (CBRT).
According to the BRSA sector data as of December 2018, there are 50 banks operating in Turkey (29 private commercial banks, 3 state banks, 13 development and investment banks, 5 participation banks). The top seven banks, three of which are state-controlled, are holding more than 70% of the banking sector’s total assets, loans and deposits in Turkey. The current fragmented structure presents future opportunities for mergers and acquisitions between the banks.
Turkey’s 55% of the population is younger than 35 years old and bankable population is only 60%2 . These are among the key indicators of the growth dynamic of the Turkish banking sector. The Turkish banking sector had a cumulative average growth rate of 20% since 2002. Despite this outstanding performance, sustainable credit growth is considered around 15%, given the population dynamics and the banking penetration levels. However, below-potential growth rates emerged as a result of the decelerated economic activity particularly in the second half of the year. This could live on in the second half of 2019, as well. In the second half of 2019, credit growth is expected to pick up with the normalization in inflation outlook leading to an easing in interest rates which will eventually support the loan demand.
Another driver behind the growth of the Turkish banking sector is the high liquidity and solid capital structure of the banks. The Turkish banking sector is in compliance with Basel III guidelines. Although capital adequacy ratios suffered a downturn due to 2 Per World Bank’s “Turkey: Financial Inclusion Conference” notes dated June 3-4, 2014. the volatile exchange rates in the third quarter of 2018, they are still strong at 17.3% thanks to the actions taken and the recovery in exchange rates. An in-depth analysis of the capital structure of Turkish banks indicates that the banking sector’s capital is mainly made up of Common Equity Tier I capital (as high as 80%), namely paid-up capital, legal reserves, profit for the period and retained earnings. It is just the opposite, however, for European and US banks.
BRSA has been monitoring the liquidity position of the banks closely. Liquidity Coverage Ratio requires banks to carry high quality liquid asset reserve sufficient to cover their net cash outflows and the ratio is well-above required levels indicating at Turkish banks’ solid liquidity position.
Customer deposits constituting 50% of the total assets, serve as the main source of funding of the Turkish banking sector. However, average maturities of deposits are mostly 1 to 2 months due to the high inflation/high interest period in Turkey’s past. Given this short-term nature of deposits, maturity mismatch is unavoidable for the Turkish banking sector. As it leads to faster deposits pricing versus loan pricing, net interest margin is exposed to short-term pressure when funding costs rise. However, Turkish banks also invest in CPI-linkers in order to hedge their balance sheets against increasing interest environment. Despite the pressure on the margin stemming from the rise in funding costs especially in the second half of 2018, the Turkish banking sector managed to increase its margin to 4.6% compared to 2017 on the back of the high returns on CPI-linkers. From the second half of 2019, loan to deposit spread will likely expand as a result of deposit costs in connection with the anticipated downtrend in inflation, and net interest margin will possibly improve significantly in 2020 in connection with the increasing growth rates.
The sector funds 25% of its assets from external financing resources. As Turkish banks do not fund their long-term loans such as project finance loans or mortgages with short-term deposits, they turn to long-term borrowings from international markets. While that indicates at the sector’s sensitivity to external developments, the Turkish banking sector’s dependence on external borrowing decreased from 2017 given the slumped demand for long-term FC loans and their redemption, and it will continue to do so.
Resulting from the significant volatility in exchange rates from the second half of 2018, high inflation, increased interest rates, and the associated decelerated economic growth created pressure on the sector’s asset quality. Having started the year with an NPL ratio of 3%, the sector ended the year with 4%. While this ratio is relatively reasonable, expected rise in the unemployment figure coupled with the decelerated growth make asset quality a critical topic also in 2019. In this sense, there could be some increase in non-performing loans in the year ahead. However, at 14%, low household indebtedness strengthens the sector’s hand with respect to managing risks in the retail segment. The balanced structure of the sector’s credit portfolio also offers an advantage in the sense of credit risk management. TL loans continue to constitute the majority of total loans with 60% despite the devaluated Turkish Lira, and thus, balances the default trend arising in loans from the exchange rate risk. On the other hand, FC loans are mostly big project finance loans which are granted to companies with FC revenues and relatively more eligible for restructuring. This nature of FC loans reduces the probability of loss for the sector in the long term.
In the period ahead, there are several critical factors with respect to rendering the funding and liquidity structure of the Turkish banking sector more resilient and ready for any potential development. Among these are introduction of initiatives aimed at increasing household savings in the medium term, increasing the depth of capital markets in Turkey, extending the maturities of funding resources, and steps targeted at stabilizing the shift to foreign currency.