Turkish banks are being hit by rising funding costs that spell danger for the government's attempt to engineer a credit boom, Ersin Ozince, the chairman of Is Bankasi, Turkey’s largest listed lender by assets, told Bloomberg on May 8.

“Capital erosion is the most important issue in the Turkish banking industry, because capital has become the most important limited resource,” Ozince told the news service in an interview.

Bloomberg calculated that profitability measured by the average return on equity for deposit-taking Turkish banks was 13% last year, compared with a typical yield on 10-year sovereign debt of 10.2%. In the face of government pressure to increase loans to boost economic activity, lenders have turned to subordinated debt, it added.

“This isn’t a bad thing, but it shows that investors prefer not to be a shareholder due to better alternative yields plus risk. Return on equity is approaching 14 or 15 percent, but when you add risk, this is even lower than government bonds,” Ozince said.

Among other risks, Ozince cited currency weakness, higher interest rates due to soaring inflation and the possibility of a spike in non-performing loans. “We have to manage those risks because it’s not just the banking sector, but also the real sector that’s exposed,” he said.

The central bank reported last week that the net short FX position of non-financial firms declined to $199.7bn at end-February from $201.7bn a month previously. Their foreign exchange liabilities and assets stood at $303.9bn and $104.2bn, respectively at the end of February.

While a credit guarantee fund helped boost lending in the first quarter, banks are working at “full capacity" and other initiatives floated by the government may not have the intended impact, Ozince reportedly said.

Loans securitisation plan

Deputy PM Canikli last week unveiled how the government is working on legislation to allow commercial lenders to securitise and sell all of their $515bn of outstanding loans to investors.

“We’ve always wanted securitisation. The reason it’s not being done is because it’s thought that there wouldn’t be enough demand. What’s important is stability in the country. If we have that, of course the demand will also come,” Ozince added.

The government pledged in December to extend up to TRY250bn in credit to private companies under the Credit Guarantee Fund (CGF). Deputy PM Nurettin Canikli said this week that a total of 225,358 companies had so far drawn TRY160bn in loans under the CGF.

"As the CGF scheme allowed banks to transform part of their corporate loans into the government-guaranteed assets with no capital requirement, banks have ramped up their lending markedly since December. The flow of credit, which averaged 1.4% of GDP a quarter in 2016, surged to 2.9% of GDP in Q1 2017, thanks mainly to the CGF loans," the Institute of International Finance (IFF) said in a research note on Turkey, published on May 4.

“Driven mainly by the ongoing fiscal easing and quasi-fiscal impulse through the credit guarantee fund, growth is likely to accelerate this year to 4.2% before slowing to 3.5% in 2018,” the institute added.

The IFF revised up its real GDP growth forecast for Turkey to 4.2% for 2017 from its previous forecast of 3% and to 3.5% for 2018 from a previous 3.2% “thanks in part to the reduced political uncertainty after the April referendum outcome”.

CGF money "deposited"

Haberturk newspaper, however, reported last month that some companies and business owners use loans provided under the CGF to buy luxury cars or property, such as land and offices, or keep the money in deposit accounts until they need it, thus not necessarily utilising the loans to fund investments.

“The burst in bank lending during early 2017 is bound to have more limited growth effects than credit growth in previous years. The government guaranteed scheme has encouraged banks to restructure some of their existing (and often nonperforming) loans into the CGF program. Such portfolio shifting provides little support to economic activity but it should give support to bank profits in 2017,” argued the IFF.

The country’s lenders registered a strong 65% y/y increase in their combined net income to TRY13.5 (€3.5bn) in Q1. In the quarter, their lending increased by 6% q/q to stand at TRY1.83tn while the banking industry’s NPL/total loans ratio slightly declined to 3.3% at the end of March from 3.4% at the end of February.