Turkey’s banks enjoyed a bumper year in 2017, but a combination of foreign currency debt, internal strife and strained relations with the US could spell the end for the good times. Tom Stevenson reports.


By almost every measure, Turkey’s banks enjoyed one of the best years in the country’s recent history in 2017, with strong performances across the board as the economy recovered from a series of difficult years. Despite a challenging political environment and deteriorating relations between Turkey and its Western allies, banks took advantage of a generous government stimulus mechanism to make it a boom year.

In 2017, Turkey’s economy is estimated to have grown by about 7%, but the banking sector far outdid even the overall gains. The combined net income of the country’s banks increased by 31% in 2017 to $13bn, according to data collected by Turkey’s banking regulator. Total bank assets rose 19% to $870bn, and total lending rose by 18% to $550bn.

Banks also saw profitability rise, with return on equity increasing by about 2 percentage points to 16% in late 2017, from about 14% a year earlier. The banking sector’s capital adequacy ratio rose to a healthy 16.9%.

Turkey has the second largest banking system in emerging Europe after Russia, and the sector is highly concentrated, with the top five banks owning about 60% of total banking assets.

Government support

The main driver of the 2017 boom for Turkish banks was the establishment of the Credit Guarantee Fund (CGF) programme, a massive government-backed credit mechanism that sent bank lending soaring. In addition, the government tweaked regulations to extend the maximum maturity in retail loans to 48 months from 36 months, increased the number of instalments in credit card payments, and increased loan-to-value ratios in mortgage lending by 5 percentage points, to 80%.

Senior Turkish bankers praise the government’s initiatives as not only timely but technically innovative.

“The government guarantees allowed the banks to deploy their existing resources to relieve liquidity strains in the small and medium-sized enterprise sector, which would otherwise be locked out of the system due to local and global uncertainty,” says Hakan Ates, CEO of Denizbank, a Turkish bank majority owned by Russia’s Sberbank.

The CGF led to Turkey’s banks extending about Tl220bn ($57bn) in loans. The lending stimulated new projects and allowed heavily indebted companies to honour their liabilities. According to headline figures, banks’ non-performing loans (NPLs) have remained low at about 3%. The NPL ratio on the CGF loans is estimated at just 0.7%.

A tougher year

While the CGF ushered in a burst of additional lending, banks kept to their established loan rating systems, says Mr Ates. “In other words, CGF guarantees did not result in banks giving loans to customers they had ignored before; they simply allowed banks to continue lending in a politically uncertain environment. This move has paid off, and the economy has achieved high growth,” he says.

However, it is predicted that the government-backed credit will have a much smaller impact in 2018. In addition, the banks will have to deal with tighter monetary policy to tackle inflationary pressures and the depreciation of the Turkish lira against the US dollar.

CGF guarantees did not result in banks giving loans to customers they had ignored before; they simply allowed banks to continue lending in a politically uncertain environment

Hakan Ates

“We believe that the potential effects of decreased guarantee limit availability in 2018 will be balanced as the economy is in a significantly better shape compared with the end of 2016,” says Mr Ates. “The CGF support will be tapered gradually and become more selective, with the majority of the remaining limit allocated between investment projects, entrepreneurs and sectors that provide foreign currency income, such as exporters.”

However, 2017’s lending frenzy has pushed up loan-to-deposit ratios to record highs of about 130%, forcing Turkey’s banks to turn to international markets, where the volatility of the Turkish lira weighs heavily.

Problem loans

Foreign currency debt is beginning to stretch even the largest Turkish corporates, and banks may have to deal with the knock-on effects. The clearest sign of strain came on January 29, when Yildiz Holding, Turkey’s largest food company and the owner of Godiva Chocolates and United Biscuits, made a request to restructure about $7bn in loans.

Yildiz Holding’s 10 major creditors were forced to hold emergency negotiations until an agreement was reached in early February. “As a first step of the deal we reached, we have secured a long-term loan of $1bn on the terms we had requested,” said Yildiz Holding’s chairman and Turkey’s richest man, Murat Ülker, at the time.

According to Magar Kouyoumdjian, associate director at S&P Global Ratings, the fast credit growth Turkish banks have shown is in fact starting to put pressure on asset quality. “Despite good headline numbers, if we add back problem asset sales since 2010, the NPL ratio rises by 1.5 percentage points,” he says. Restructured loans classified as group one and group two represent a further 3.8% of problem loans.

“Hence, when adjusted to include problem asset sales by large Turkish banks and restructurings that are not included in NPLs, the figure for problem loans rises to more than 8%,” says Mr Kouyoumdjian. 

While it is unclear how much of the CGF support was used by the banks to renew distressed loans and delay writing off debts, some estimates put the figure as high as 40%.

In addition, much of the productive lending has gone into Turkey’s construction sector. There are signs of mounting financial pressure on leveraged property developers due to an excess of residential housing in key metropolitan markets such as Istanbul and Ankara, where developers often fund land purchases in foreign currencies.

Denizbank’s Mr Ates says Turkey’s banking sector is well placed to overcome any challenges that might emerge. “Turkish banks have crisis know-how; they managed the period after the coup attempt in 2016 with the support of the right government policies,” he says.

Out of steam?

Some in Turkey’s banking sector appear chastened by the rate of credit growth. In February, Ersin Ozince, chairman of Turkiye Is Bankasi, Turkey’s largest bank, said publicly that the sector may have “run out of steam” for further expansion. Capital, profit margins and return on equity ratios are at their limits, Mr Ozince added.

Standard & Poor's expects loan growth in the country to fall to below 15% in 2018, compared with more than 21% in 2017, as support from the CGF programme diminishes and loan-to-deposit ratios in the banking system rise.

Declining loan growth will come at a time when the net interest margin on wholesale funding is contracting, corporate income tax has been hiked by 2 percentage points, to 22%, and inflation is hovering between 10% and 13%.

“Turkish banks cannot sustain high credit growth at similar levels to those of the past decade without fundamentally weakening their financial profiles,” says Mr Kouyoumdjian. “Higher levels of credit growth would weaken capitalisation and liquidity, and increase vulnerability to external funding, so the levels of growth seen in 2017 are just not sustainable.”

In the coming year, the CGF programme is not only being reduced, but new loans will have to fulfil further criteria to qualify for support from the smaller pool of government guarantees.

According to Omer Aras, chairman of QNB Finansbank, which was taken over by Qatar National Bank in 2016, this will temper the lending frenzy. “The bulk of this new tranche will be utilised with specified targets, such as export, manufacture, investment and female entrepreneurship,” he says. “In this respect, not only the additional amount of stimulus will be limited compared with 2017, but also the pace of utilisation will likely be slower due to such targets.

“We foresee a gradual normalisation of loan growth rather than a severe slowdown. The asset quality of the sector will likely prove resilient as well.” 

Strained relations

The challenges Turkey’s banks face are not all local. Turkey’s deteriorating relations with both the EU and the US carry some risk for the sector.

Turkey’s heavy dependence on external financing means diplomatic disputes with its Western allies that affect capital inflows can have serious effects. In November 2017, tensions between Turkey and the US and Europe almost halted capital inflows to the country.

“The Turkish lira was subject to depreciation pressures, especially through the September to November period, as diplomatic ties between Turkey and its Western allies were strained,” says Mr Aras. “However, the trend has rather improved as additional tightening by the central bank and a strong risk appetite in international markets helped stabilise the currency.”

The rise in foreign borrowing costs could cause Turkish banks to rely more on domestic borrowing

Omer Aras

Turkish policy-makers have taken measures to tackle the volatility, including initiating non-deliverable forward foreign exchange auctions. In May, the authorities also plan to place restrictions on foreign exchange borrowing by companies.

“In our view, both measures will contribute towards curbing the volatility in the foreign exchange markets and improve the means for the real sector to hedge itself against currency risk,” says Mr Aras.

However, should the US choose a tighter monetary policy course than is currently forecast, the risk to the Turkish lira would be amplified. “The rise in foreign borrowing costs could cause Turkish banks to rely more on domestic borrowing, and consequently that would push lira-denominated borrowing costs higher as the lira-denominated loan-to-deposit ratio of the banking system is already elevated, standing just shy of 150%,” says Mr Aras.

All eyes on Zarrab

Turkish banks are watching the developments in the US more closely than ever, and not just for signs of a rate hike.

The image of Turkey’s banking sector is not improved by the ongoing court case concerning alleged violations of US sanctions on Iran by the Iranian-Turkish gold trader Reza Zarrab, involving Turkey’s former economy minister, Zafer Caglayan, and Turkish bank executive Mehmet Hakan Atilla, a former deputy chief executive at Halkbank, Turkey’s seventh largest bank.

The financial crimes investigation into Halkbank by the US Treasury’s Office of Foreign Assets Control could result in hefty fines or sanctions. This would have significant political and economic implications for Turkey and damage investor perceptions of risk in the country.

For a banking system highly reliant on wholesale foreign funding, the effects could be serious.

“The court decision could have economic results for Halkbank,” says Mehmet Hasan Eken, professor of banking and finance at Istanbul Commerce University. “The deputy prime minister in charge of the economy [Mehmet Simsek] openly declared that any fine imposed on Halkbank by the court would be paid. The larger the amount, the more damaging the effects will be.”

Much hangs on the outcome of the Zarrab case, according to Mr Eken. Turkey’s ties with the US are already strained over the latter’s support for the Kurdish People’s Protection Units in northern Syria.

“If the eventual court decision is not limited to economic measures, and includes political issues such as imposing sentences on the individuals, including high-ranking government officials, that will really fuel tensions between Turkey and the US,” says Mr Eken.

Calling off the party?

The political environment within Turkey has been fraught since 2015. The dissolution by constitutional referendum of the parliamentary system in April 2017, in place since Turkey’s founding, is widely seen to have strengthened president Recep Tayyip Erdogan's grip on power, as well as increasing political polarisation between the president’s supporters and detractors.

The climate has worsened amid a country-wide crackdown on political opponents of Mr Erdogan, including Kurdish nationalists and alleged members of the Gülen movement, an organisation of followers of the Pennsylvania-based Turkish cleric Fethullah Gülen, whom the Turkish government believes masterminded the 2016 coup attempt.

The prospect of national elections in 2019, and rumours that the vote may be brought forward to mid-2018, presages much uncertainty.

Turkish banks will be competing to take advantage of the opportunities presented by shifts in the market environment, while protecting against the downside risk. Those banks that are able to manage the risks will find opportunities to push up their profit margins, but only if the international disputes do not drag on too much longer, according to Mr Eken.

Turkey’s internal political problems show few signs of going away. Greater risk perception is likely to increase borrowing costs, meaning banks will face higher funding costs at a time when profit margins are set to be squeezed. The outlook is certainly less uniformly positive for Turkey’s banks when set against the high bar of 2017’s successes.

“Last year the government hosted a party for the banks through its stimulus programme. Now it seems like the host will call the party off, and thus the banks will be on their own in combatting default risk,” says Mr Eken. “The present political and economical risks will probably make it harder for businesses to meet their obligations to banks. If this happens, the banks’ profit will shrink for sure.”

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