Bernard Kennedy in Ankara -

Much has changed in the Turkish banking sector since it emerged battered and bruised from the last financial crisis in 2000-2001. Yet while many are upbeat about the ability of the banks to ride out the latest global shock, problems closer to home could hurt business.

Since the last crisis, a series of collapses and takeovers has reduced the number of banks from 81 to 46. Simultaneously, there have been over $20bn worth of mergers and acquisitions, involving the likes of BNP Paribas, Dexia, Fortis, GE Capital, HSBC, ING, Unicredito, National Bank of Greece and Saudi Arabia's National Commercial Bank. As a result, foreign investors have come to own over 40% of the sector.

Exposure to currency risk is strictly limited, transparency and inspection has improved dramatically, and Basel-II criteria are set to be adopted in 2009. Balance sheets too are looking very different. Total credits have soared to stand at TRY333bn (about $255bn, or 82% of deposits) as of the end of March 2008, whereas securities portfolios, consisting mainly of government debt, have dwindled to about $135bn. Capital adequacy is put at 17% - well above the 12% demanded by the Banking Regulation and Supervision Agency (BDDK), and double the global standard of 8%. Net profits continued to rise in the first quarter of this year, after an aggregate rise of 31% to around $12bn in 2007.

In these circumstances, BDDK president Tevfik Bilgin is understandably upbeat about the ability of the banks to ride out the latest global shock. "During this period of turmoil in the world, we as bankers and as the banking authority would claim that we are a sector which does not make matters worse, but which will do everything it can to support the protection of the economy," Bilgin told an Istanbul conference on banking trends and risks at the end of May.

Nevertheless, the pace of credit growth has relaxed since 2006, when interest rates picked up and the economy started to slow for the first time since the crisis. Profits have only been sustained with the aid of asset sales and other windfall revenues. And the May conference, organised by the Turkish Industrialists' and Businessmen's Association, highlighted a panoply of freshly emerging challenges in a new world of global liquidity constraints and soaring commodity prices.

Emerging challenges

Most obviously, the cost of funding is on the rise. On the one hand, the risk premium on loans from abroad has increased - reflecting, in part, the large current account deficit of around 6% of GDP. On the other, deposit rates are rising in response to a pick up in inflation (currently 9.7%), April's central bank policy rate rise to 15.75% and fierce competition for market share. As the deposit base has an average maturity of only 31 days, banks may be forced to pay higher interest to deposit-holders before they can charge it to their credit customers.

Meanwhile, a rise in typical government bond yields from around 17% to 20% has trimmed the value of government debt portfolios since March. The banks' share prices have tumbled in line with trends on international stock markets. And to make matters worse, a bill in parliament, ostensibly designed to protect consumers, threatens to impose rigid limits on credit card interest – the most profitable area of the banks' business.

However, Ergun Ozen, managing director of Garanti Bank was eager to dispel any doubts. "We have the human resources to manage our costs and risks," asserted Ozen. "Second-quarter profitability will also be high, and there will be no big surprises in the second half."

Both Bilgin and Ozen agree that the banks would be able to go on raising loans from abroad, although costs would rise. Outstanding syndicated loans amount to $26bn – a modest figure when compared to the deposit base of about $325bn. Ozen said that credit card income accounted for only 10-15% of profits. "At Garanti, our B-Plan is ready," he added.

"It will be a period of slower growth for the sector for sure," says Tugrul Belli, advisor to the board of Turkish Bank. "But remember that the Turkish banks have no exposure to the kinds of instruments which have caused all the problems at major global banks."

Weakening economy

For some bankers, however, the real danger lurks in the weakening domestic economy. Low domestic demand and difficult export conditions threaten to hit company revenues, even as inflation erodes household incomes. "The fall in growth could raise credit risk both in consumer and corporate markets, and I think this is the most important factor that will affect the banks' performance, rather than the global turmoil," remarked Cüneyt Sezgin, a Garanti Bank director. An increase in the bad-loan ratio, which is currently only 3% (6.5% for credit card debt), is regarded as inevitable.

"The second half of 2008 will be a period when we have to be careful," noted Saruhan Ozel, chief economist with Denizbank, underlining the anomaly of slowing growth and rising interest rates. GDP growth was 4.5% in 2007 and is likely to be significantly lower this year.

The ability of the corporate sector to service its debts to the banks may also be compromised in the event of any prolonged weakness in the lira. According to Ekrem Keskin, general secretary of the Banks Association, there is a "real problem of transparency in this sector which has $100bn in foreign debt and it's important that they should become as transparent as the banks are."

Corporate foreign debt has risen rapidly due to several years of ample global liquidity and relatively high domestic interest rates. Banking analysts contacted by bne were reluctant to name individual banks which might be vulnerable. While the credit card issue mainly affects the large private banks - Akbank, Isbank, Garanti Bank and Yapi Kredi Bank - bad debt is highest at the state banks Halkbank and Ziraat Bank, and the nominally private Vakıfbank is seen to have the lowest capital adequacy ratio. Vakifbank and Halkbank - for which a secondary share offering is planned this year - are also under scrutiny for their role in financing the purchase of the Sabah-ATV media group. Over 80% of syndicated loans have been raised by six banks including medium-sized Turk Ekonomi Bankasi (TEB). Medium and small-sized banks continue to lose market share - the top-10 banks control 85% of the sector's assets - and may have the worst credit quality.

Are the mergers and acquisitions over? Not necessarily, analysts say, pointing to the need to raise more capital given the prospect of lower profits and extra provisionıng, as well as the still-modest total asset/GDP ratio of 66%. In the current global context, however, any further major foreign capital injections are likely to come from the Gulf. There have even been rumours that some newly-arrived Western banks might now be on the sell side, although Citigroup's 20% stake in Akbank is not for sale, according to Akbank.

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