Turkish Banking: Banking Under Political Instability and Chronic High Inflation (Palgrave Macmillan Studies in Banking and Financial Institutions)

Palgrave Macmillan Studies in Banking and Financial Institutions Series Editor: Professor Philip Molyneux The Palgrave Macmillan Studies in Banking and Financial Institutions is international in orientation and includes studies of banking within particular countries or regions, and studies of particular themes such as Corporate Banking, Risk Management, Mergers and Acquisitions, etc. The books focus on research and practice, and include up-to-date and innovative studies on contemporary topics in banking that have global impact and influence. Titles include: Yener Altunba¸s, Blaise Gadanecz and Alper Kara SYNDICATED LOANS A Hybrid of Relationship Lending and Publicly Traded Debt Yener Altunba¸s, Alper Kara and Özlem Olgu TURKISH BANKING Banking under Political Instability and Chronic High Inflation Elena Beccalli IT AND EUROPEAN BANK PERFORMANCE Santiago Carbó, Edward P. M. Gardener and Philip Molyneux FINANCIAL EXCLUSION Allessandro Carretta, Franco Fiordelisi and Gianluca Mattarocci (editors) NEW DRIVERS OF PERFORMANCE IN A CHANGING WORLD Violaine Cousin BANKING IN CHINA Franco Fiordelisi and Philip Molyneux SHAREHOLDER VALUE IN BANKING Hans Genberg and Cho-Hoi Hui THE BANKING CENTRE IN HONG KONG Competition, Efficiency, Performance and Risk Elisabetta Gualandri and Valeria Venturelli (editors) BRIDGING THE EQUITY GAP FOR INNOVATIVE SMEs Munawar Iqbal and Philip Molyneux THIRTY YEARS OF ISLAMIC BANKING History, Performance and Prospects Kimio Kase and Tanguy Jacopin CEOs AS LEADERS AND STRATEGY DESIGNERS Explaining the Success of Spanish Banks M. Mansoor Khan and M. Ishaq Bhatti DEVELOPMENTS IN ISLAMIC BANKING The Case of Pakistan

Mario La Torre and Gianfranco A. Vento MICROFINANCE Philip Molyneux and Munawar Iqbal BANKING AND FINANCIAL SYSTEMS IN THE ARAB WORLD Philip Molyneux and Eleuterio Vallelado (editors) FRONTIERS OF BANKS IN A GLOBAL WORLD Anastasia Nesvetailova FRAGILE FINANCE Debt, Speculation and Crisis in the Age of Global Credit Dominique Rambure and Alec Nacamuli PAYMENT SYSTEMS From the Salt Mines to the Board Room Andrea Schertler THE VENTURE CAPITAL INDUSTRY IN EUROPE Alfred Slager THE INTERNATIONALIZATION OF BANKS Noel K. Tshiani BUILDING CREDIBLE CENTRAL BANKS Policy Lessons for Emerging Economies

Palgrave Macmillan Studies in Banking and Financial Institutions Series Standing Order ISBN 978–1–4039–4872–4 You can receive future titles in this series as they are published by placing a standing order. Please contact your bookseller or, in case of difficulty, write to us at the address below with your name and address, the title of the series and the ISBN quoted above. Customer Services Department, Macmillan Distribution Ltd, Houndmills, Basingstoke, Hampshire RG21 6XS, England

Turkish Banking Banking under Political Instability and Chronic High Inflation Yener Altunba¸s Professor of Banking and Finance, Bangor University Business School, Wales, UK

Alper Kara Lecturer in Business Economics, The Business School, Loughborough University, Loughborough, UK

Özlem Olgu Assistant Professor in Accounting and Finance, Koç University, Istanbul, Turkey

© Yener Altunba¸s, Alper Kara and Özlem Olgu 2009 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No portion of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, Saffron House, 6-10 Kirby Street, London EC1N 8TS. Any person who does any unauthorized act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The authors have asserted their rights to be identified as the authors of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2009 by PALGRAVE MACMILLAN Palgrave Macmillan in the UK is an imprint of Macmillan Publishers Limited, registered in England, company number 785998, of Houndmills, Basingstoke, Hampshire RG21 6XS. Palgrave Macmillan in the US is a division of St Martin’s Press LLC, 175 Fifth Avenue, New York, NY 10010. Palgrave Macmillan is the global academic imprint of the above companies and has companies and representatives throughout the world. Palgrave® and Macmillan® are registered trademarks in the United States, the United Kingdom, Europe and other countries. ISBN-13: 978–1–4039–9711–1 ISBN-10: 1–4039–9711–X This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. Logging, pulping and manufacturing processes are expected to conform to the environmental regulations of the country of origin. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Altunba¸s,Yener. Turkish banking : banking under political instability and chronic high inflation / Yener Altunba¸s, Alper Kara, Özlem Olgu. p. cm. — (Palgrave Macmillan studies in banking and financial institutions) Includes bibliographical references and index. ISBN 978–1–4039–9711–1 (alk. paper) 1. Banks and banking—Turkey. I. Kara, Alper, 1977– II. Olgu, Özlem, 1979- III. Title. HG3256.5.A6A48 2008 332.109561—dc22 2008029939 10 18

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Printed and bound in Great Britain by CPI Antony Rowe, Chippenham and Eastbourne

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Contents List of Figures and Tables

ix

Preface

xiv

List of Abbreviations

xvi

About the Authors

1

xviii

Introduction

1

2 Overview of the Turkish Economy Introduction The Ottoman period and the early Republic State-led development strategy, 1930–50 Liberalization in the 1950s Import substitution and inward-orientated growth strategy, 1960–79 The era of financial liberalization 1980–90 1990–2000 1994 economic crises 2000–01 twin economic crises Recent economic trends Renewal of the standby agreement with the IMF, 2005 A short history of political instability Conclusion Appendix 2.1 Appendix 2.2

3 Trends in the Banking Industry

7 7 7 10 10 12 15 15 19 21 24 27 30 31 37 38 39

40

Introduction Banking in the Ottoman period The new Republic and the establishment of the new national banks The period of state-owned banks, 1932–45 Establishment of private banks, 1945–60 Banking in the planned economy, 1960–79 Banking after financial liberalization v

40 41 42 43 44 45 47

vi Contents

Banking and financial markets in the 1990s Aftermath of the 1994 crisis Establishment of the Banking Regulation and Supervisory Agency Recent developments, 2000–06 SDIF and the restructuring process Recovery Dollarization, crowding-out by government debt and maturity mismatch Conclusion Appendix 3.1 Appendix 3.2

4 A Profile ofTurkish Banking

50 54 55 57 58 60 62 64 66 68

69

Introduction Size of the Turkish banking sector Branch systems of the Turkish banking sector Employment in the Turkish banking sector Players in the Turkish banking market Big banks State-owned versus privately-owned banks in Turkey Balance sheet structure of the Turkish banks Assets structure, loans and liquid assets Liability structure, deposits and equity Income and costs Income structure of Turkish banks Cost structure of Turkish banks Performance of the Turkish banking sector Capital adequacy Asset quality Liquidity Profitability Financial strength indices Conclusion

69 69 73 74 77 77 78 79 79 86 87 87 89 90 91 92 93 93 95 96

5 The Turkish Banking Sector and Regional Economic Growth

97

Introduction A brief literature review: financial development and economic growth Data and methodology Economic growth and financial development indicators

97 98 102 103

Contents vii

Results and discussion Correlation matrices Regression results Conclusion

6 Performance of Banks in Turkey Introduction Fundamentals of efficiency and productivity Data sources Nonparametric efficiency measurement of Turkish banks Data envelopment analysis (DEA) method Tobit regression: accounting for environmental variables Nonparametric productivity measurement of Turkish banks DEA–Malmquist index technique Empirical findings Technical efficiency scores of Turkish banks Productivity scores of Turkish banks Conclusion Appendix 6.1 Appendix 6.2 Appendix 6.3

7 Other Financial Markets in Turkey

105 105 106 109

111 111 112 115 118 118 122 123 127 129 129 134 140 143 144 150

151

Introduction The stock market in Turkey Initial public offerings (IPOs) Bond markets Primary markets in Turkey Secondary market activities in Turkey Over-the-counter market ISE bonds and bills market Leasing, factoring and consumer finance companies in Turkey Special financial institutions Conclusion

151 151 157 160 160 161 161 162

8 Current Developments and Prospects for Turkish Banks

169

Introduction Reshaping the Turkish financial system towards potential EU membership

164 166 167

169 169

viii Contents

Implementation of Basel II in Turkey Pillar 1: Credit, market and operational risk Pillars 2 and 3 Can Turkish banks cope with Basel II? Introduction of a mortgage system and a new mortgage law Foreign direct investment in Turkish banking Conclusion Appendix 8.1

173 174 174 175 176 179 184 186

9 Concluding Remarks

191

Notes

195

References

198

Index

210

List of Figures and Tables Figures 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 2.10 2.11 2.12 2.13 2.14 2.15 2.A1 2.A2 2.A3 2.A4 3.1 3.2 3.3 3.4 3.5 3.6 3.7

Growth rate of Turkey, 1924–47 Growth rate of Turkey, 1948–67 Growth rate of Turkey, 1960–79 Growth in exports, 1970–2006 Yearly consumer and producer price indexes, 1983–2006 Net international flow of funds to Turkey, 1975–2006 Central Bank’s gross foreign exchange reserves, 1981–2007 Central government debt stock, 1986–2006 Gross national product by producer prices, 1988–2006 Average compound interest rates of the benchmark government security, 1990–2007 Compound yield of 10-year Eurobonds issued by the Turkish Treasury, 2002–2008 Maturity composition of central government outstanding domestic debt, 2006 Current account deficit as a percentage of GNP, 1992–2006 Unemployment, 1980–2006 Sectoral composition of outstanding foreign debt, 1996–2006 Currency denomination of central government outstanding foreign debt, 2006 Currency and interest composition of central government outstanding debt, 2006 Contribution of sectors to GNP, 1979–2003 Sectoral distribution of workforce, 1980–2003 Banks in Turkey, 1963 Top four banks’ liabilities as a percentage of total liabilities of the banking sector in Turkey, 1980 Top four banks’ liabilities as a percentage of total liabilities of the banking sector in Turkey, 1990 Total assets of banking sector, 1991–1998 Concentration in the banking sector Dollarization in deposits, 1986–2007 Crowding-out by government debt, 1986–2007 ix

9 11 13 18 20 21 22 23 24 28 28 29 30 31 32 38 38 39 39 46 48 50 53 53 63 63

x List of Figures and Tables

3.8 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 4.11 4.12 4.13 4.14 4.15 4.16 4.17 4.18 4.19 4.20 6.1 6.2 6.3 6.4 6.5 6.6

Maturities of deposits, 1986–2007 Changing numbers of banks in Turkey, 1990–2006 Numbers of branches and employees in the Turkish banking system, 1990–2006 Selected asset items of the Turkish banking sector, percentage share of each component, 1990–2006 Total assets to GDP ratio, Turkey and EU countries, 2007 Loans to total assets ratio, 1990–2006 Number of bank cards and credit cards, 1998–2005 Non-performing loans to total loans, 1990–2006 Non-performing loans (NPL) and provisions to NPL ratios, selected countries, 2004 Total liabilities of Turkish banks, 1990–2006 Income structure of the Turkish financial system, 1990–2006 Net interest income to total assets ratio, 1990–2006 Total income to total expenditure ratio, 1990–2006 Average interest income to average interest expenses ratio, 1990–2006 Operating expenses of Turkish banks, 2000–06 Average shareholders’ equity to total assets ratio, 1990–2006 Capital adequacy ratio for Turkey and selected EU countries, 2006 Loans to total assets, 1990–2006 Liquid assets to total assets ratio, 1990–2006 Return on assets (ROA) and return on equity (ROE) of Turkish banks, 1990–2006 Comparison of return on assets (ROA) and return on equity (ROE), selected countries, 2004 The distinction between efficiency and productivity Construction of a Malmquist productivity index Annual efficiency scores of the Turkish banking sector, 1992–2006 Average DEA efficiency scores of Turkish banks, 1992–2006 DEA efficiency scores of Demirbank, Koçbank and Dı¸sbank, 1992–2006 Changing trends of Malmquist decomposed components, 1993–2006

64 73 76 81 82 83 85 85 86 87 88 88 89 89 90 91 92 92 93 94 94 114 125 130 132 133 136

List of Figures and Tables xi

6.7 6.8 6.A1 6.A2 6.A3 6.A4 6.A5 6.A6 7.1 7.2 7.3 8.1 8.2

Malmquist decomposed components of Turkish banks 1992–2006 TFPC scores of Koçbank, Dı¸sbank and Demirbank, 1992/3–2005/6 Annual technical efficiency scores of Demirbank, 1992–2005 Annual technical efficiency scores of Koçbank, 1992–2006 Annual technical efficiency scores of Dı¸sbank, 1992–2006 Annual Malmquist decomposed components of Koçbank, 1992/3–2005/06 Annual Malmquist decomposed components of Dı¸sbank, 1992/3–2005/06 Annual Malmquist decomposed components of Demirbank, 1992/3–2005/06 Outstanding government securities/total outstanding securities, 1990–2005 Value of new Turkish lira bonds purchased by foreign investors, Jan 2005–Oct 2006 Composition of total assets in the Turkish financial system Size of mortgage market relative to GDP, selected countries Growth in housing loans, 2002–07

136 139 145 146 146 147 148 148 160 165 165 177 178

Tables 2.1 Some macroeconomic indicators, 1923–30 2.2 Structural reform measures of the Letter of Intent signed in 1999 with the IMF 2.3 Governments serving in Turkey, 1950 to present 2.4 IMF’s stand-by arrangements with Turkey, 1961–2005 3.1 Numbers of branches, personnel and total assets of banks in Turkey, 1980 3.2 Decomposition of deposits by currency denomination, 1989–93 3.3 Foreign exchange positions of the banking sector during the 1994 financial crises 3.4 Change in the total assets of the banking sector during the 1994 crisis 3.5 Sector shares of banking groups, 1990 and 1998 3.6 Some measures introduced by the Banking Law, 1999

9 25 33 36 47 51 51 52 53 56

xii List of Figures and Tables

3.7 3.8 3.9 3.A1 3.A2 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 4.10 5.1 5.2 5.3 5.4 5.5 6.1 6.2 6.3 6.A1 6.A2

Percentage of non-performing loans to total loans, 2000 and 2001 Banks under the Deposit Insurance Fund as of 2002, all privately-owned commercial banks Selected foreign investment deals with the Turkish banking sector, 2004–06 Banks operating in Turkey, ranked by asset size, as of December 2006 Dollarization in selected emerging markets, foreign currency deposits to total deposits, 1993–2001 Selected items of financial sector as a percentage of GDP, 2003 The Turkish banking system, number of banks, 1990–2006 Number of branches in the Turkish banking sector, 1990–2006 Number of employees in the Turkish banking system, 1990–2006 Comparison of bank structure in Turkey and EU-15 countries, 2004 Concentration of the five largest and ten largest Turkish banks, 1997–2006 Balance sheet structure of state-owned and private banks, 1993–2006 Percentage market share of Turkish banks, 1986–2005 Comparison of balance sheet items with those of selected EU countries, 2007 Financial strength indices, Turkey, 1999–2005 Regions and provinces of Turkey Correlation analysis for Turkey overall Correlation analysis of variables for the provinces of Turkey The Relation of GDP to lagged GDP and selected explanatory variables Regression analysis of provinces in Turkey Annual distribution of banks in the sample, 1992–2006 Definitions of variables Malmquist productivity decomposition of the Turkish banking sector, 1992–2006 Bank sample details Annual efficiency scores, Turkish banks

58 60 62 66 68 71 72 73 75 77 78 80 82 84 95 103 105 106 107 108 116 118 135 143 144

List of Figures and Tables xiii

6.A3 Annual technical efficiency scores, of foreign owned banks 6.A4 Average Malmquist components of Turkish banks, 1992–2006 6.A5 Total factor productivity scores of Koçbank, Dı¸sbank and Demirbank 6.A6 Correlation coefficients between TFPC, TC and TEC 6.A7 Tobit regression results of second-stage DEA analysis 6.A8 Spearman rank order correlation coefficients 7.1 Istanbul Stock Exchange members according to markets, 2008 7.2 Number of listed and traded companies and Istanbul Stock Exchange market values, 1990–2007 7.3 Istanbul Stock Exchange trade value, 1990–2007 7.4 Istanbul Stock Exchange trade volume and number of contracts 7.5 Closing values of price indices in the Istanbul Stock Exchange 7.6 Initial public offerings in Turkey, 1990–2007 7.7 Traded value of off-exchange fixed income securities, 1990–2007 7.8 Secondary market trading volumes on the Istanbul Stock Exchange, 2000 and 2005 7.9 Traded value of the bonds and bills market in Turkey, 1992–2007 7.10 Selected balance sheet items of special financial institutions in Turkey, 2002–05 8.1 Proposed legislation, 2007–13 8.2 The impact of individual portfolios on the increase in risk-weighted assets of Turkish banks after the introduction of Basel II 8.3 Changes in the capital adequacy ratio projected by quantitative impact study TR2, 2006–07 8.4 Foreign ownership of banks as a percentage of total banking sector assets, 1990, 2000 and 2002 8.5 Entry of foreign banks to the Turkish banking sector, 2001–06 8.6 Share of foreign banks in the Turkish banking sector, 2003 and 2006 8.A1 Proposed secondary legislation, 2007–13

145 147 149 149 150 150 153 154 155 156 158 159 161 163 164 167 172

176 177 181 183 185 186

Preface Despite the fact that Turkey is the seventeenth-largest economy (in 2007) in the world, and one of the oldest and more developed of emerging markets, its banking system is still relatively small. After financial liberalization in the 1980s, large budget deficits resulting from substantial public sector borrowing, chronic inflation, dollarization in the economy, lack of regulation and supervision, capital inadequacy, and an unstable economic and political environment have all contributed to the poor performance of the Turkish banking industry. The sector has faced four crises since the 1980s, with the most recent occurring in the middle of the International Monetary Fund (IMF)-led restructuring programme in 2001, resulting in the failure of thirteen banks. However, after years of mounting difficulties that brought Turkey close to economic collapse, a tough recovery programme was agreed with the IMF in 2002 to restore macroeconomic stability through structural reforms. Since then, Turkey has seen impressive progress. Economic growth has averaged over 5 per cent per annum and inflation has fallen significantly. Inspiring economic performance has led to an historical amount of foreign investments to Turkey. The banking industry was one of the recipients of this inflow: between 2004 and 2006, foreign banks – some of them world-leading financial institutions – have invested around USD 14 billion, mainly through acquiring majority shares in locallyestablished medium-sized banks, to gain a presence in the Turkish banking market. As of 2006, the level of foreign ownership with a controlling share constitutes a third of the total banking sector assets in Turkey. As well as its inspiring economic performance, Turkey’s potential EU membership, its successful banking sector restructuring programme, the enforcement of internationally accepted banking regulatory and supervisory standards, and the growth potential of local credit markets were all factors influencing such flows. We believe these recent developments in the Turkish economy and banking sector make it worthwhile to undertake a comprehensive overview of the developments in the Turkish banking market. This book, intended for both academics and practitioners, has several purposes. First, it aims to portray the phases of banking sector development in Turkey, where the major emphasis will be to examine the features of

xiv

Preface xv

financial crises and their repercussions on the banking industry. Second, the financial structure and performance of the banking sector, together with its impact on economic growth, will be analysed, looking at the role of market participants as fund providers and fund users, and the important role of the state. Third, the future prospects of Turkish banking will be considered in the context of EU integration, the potential effects of Basel II, and the newly passed mortgage law’s impact on credit markets. The authors are very grateful to Emre Er¸sen, Sinem Munano˘ glu Gökdel, Phil Molyneux, Saduman Hacer Okumu¸s and Aziz Özben, as well as to the participants of the 2007 Annual Conference of the European Association of University Teachers of Banking and Finance (The ‘Wolpertinger Club’) conference held in Valladolid, and the Turkish Bankers’ Association for very helpful comments, suggestions and support on the papers that provided original material for the various chapters of the text. Thanks are also due to Lisa von Fircks, Elodie Lecoq and Hazel Woodbridge for editing the manuscript. Finally, thanks to our families and loved ones for their patience and support during the project. The views expressed in this book are the authors’ own and do not necessarily reflect those of the University of Wales, Bangor, Loughborough University and Koç University. All remaining errors are our sole responsibility. Every effort has been made to contact all copyright-holders, but, if any have inadvertently been omitted the publishers will be pleased to make the necessary arrangement at the earliest opportunity. YENER ALTUNBA¸S ALPER KARA ÖZLEM OLGU

List of Abbreviations AMA BAT BIS BRSA CAD CAR CB CBT CPI CREDITS

advanced measurement approach (The) Banks Association of Turkey Bank of International Settlements Banking Regulation and Supervisory Agency Capital Adequacy Directive capital adequacy ratio Central Bank Central Bank of Turkey consumer price index level of credit extended to the private sector by commercial banks CRS constant returns to scale DEA data envelopment analysis DEPOSITS outstanding value of deposits in the provinces DMU decision-making units DRS decreasing returns to scale EM emerging market EU European Union EUR euro EXCHANGE exchange rate between US dollar and Turkish lira FDI foreign direct investment FX foreign exchange GDP gross domestic product GNP gross national product ICAAP internal capital adequacy assessment process IMF International Monetary Fund INCENTIVES investment incentives given to the provinces INTEREST average interest rates of treasury bills IPO initial public offering IPP investment priority provinces IRB internal rating based IRS increasing returns to scale ISE Istanbul Stock Exchange ISI import substitution industrialization IT information technology

xvi

List of Abbreviations xvii

NICA NPL OECD

non-interest current account non-performing loans Organisation for Economic Co-operation and Development OTC over the counter PM prime minister PPS production possibility set PUBINVEST public investment expenditures in the provinces QIS quantitative impact study REPO repurchase agreement ROA return on assets ROE return on equity SASP Structural Adjustments and Stabilization Programme SDIF Savings Deposit Insurance Fund SDR Special Drawing Rights SEC scale efficiency change SEE state economic enterprise SFI special financial institution SME small and medium enterprises SPO State Planning Organization TEC technical efficiency change TFP total factor productivity TL Turkish lira TUSIAD Turkish Industrialists’ and Businessmen’s Association USD US dollar USSR Union of Soviet Socialist Republics VaR value at risk VRS variable returns to scale WB World Bank YTL new Turkish lira

About the Authors Yener Altunba¸s is a Professor of Banking and Finance at Bangor Business School. He holds a BSc degree from Hacettepe University, Ankara, and a PhD from Bangor University. He worked first as an analyst with Ziraat, then as an economist with Etibank in Turkey and as a Researcher within the Institute of European Finance in the UK. He was employed as a Research Fellow with the Business School at South Bank University, London, and as a Research Associate at the Centre for Business Research at Cambridge University. Recently, he has held a Visiting Researcher post at the European Central Bank and a guest lectureship at the University of Lecce and at the Free Mediterranean University Jean Monnet (LUM), Bari, Italy. Author of many articles on the structure and efficiency of banking markets, his main fields of research interest include European banks, efficiency, stock market analysis, corporate governance, and urban economics. Recent research has also been concerned with marine biology. Alper Kara is a Lecturer at the Loughborough University Business School and previously worked as a teaching fellow at the University of Leicester, and as a lecturer at the Robert Gordon University, Aberdeen. He has also been a visiting lecturer at the Bangor Business School and the British Kazakh Technical University of Almaty. He holds a BSc (Economics) degree from Orta Do˘ gu Teknik Universitesi, Ankara, and an MBA in Banking and Finance and a PhD in Economics from the University of Wales, Bangor. Co-author of a book on syndicated lending; his main research interests and publication record cover a range of topics, including syndicated loan markets, bank lending, corporate finance and emerging market financing. Before moving to academia, he was employed by Dı¸sbank of Turkey (acquired by Fortis in July 2005) and had four years experience as a trader in the international bond and foreign exchange markets. Özlem Olgu joined Koç University as an Assistant Professor in Accounting and Finance in September 2007 after completing her MSc Finance and PhD Finance degrees at the University of Leicester. She completed her undergraduate degree in Banking and Finance at the Near East University, Cyprus, and was awarded a scholarship to continue her studies to

xviii

About the Authors xix

Master’s level. Prior to joining Koç University she worked as a lecturer in finance at the University of Hertfordshire. Her research interests and publication record cover a range of banking topics. Most recently, the focus has been on production theory, investigating the efficiency and productivity levels of European banking and transition economies, together with a more in-depth analysis of Turkey. In particular, she is interested in dealing with the economies-of-scale effects on performance measurement as well as the effects of macroeconomic factors on productivity growth.

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1 Introduction

Recently, the Turkish banking sector has become a promising target for foreign investors. Throughout the 1990s and early 2000s, with only a minuscule 3 per cent of total banking sector assets controlled by foreigners, Turkey was one of the few primary emerging markets unable to attract foreign investment. But this trend has now changed dramatically. Between 2004 and 2006 foreign banks – some of them world-leading financial institutions such as Citigroup, UniCredito, BNP Paribas and Fortis – have invested around USD 14 billion, mainly through acquiring majority shares in locally established medium-sized banks, to gain a presence in the Turkish banking market. As of 2006, the level of foreign ownership with a controlling share constituted a third of the total banking sector assets in Turkey. Despite the fact that Turkey has the seventeenth-largest economy (in 2007) in the world and is one of the oldest and more developed of emerging markets, its banking system is still relatively small. After financial liberalization in the 1980s, large budget deficits resulting from substantial public-sector borrowing, chronic inflation, dollarization in the economy, lack of regulation and supervision, capital inadequacy, and an unstable economic and political environment have all contributed to the poor performance of the Turkish banking industry. The sector has faced four crises since the 1980s, with the most recent occurring in the middle of the International Monetary Fund (IMF)-led restructuring programme, resulting in the failure of thirteen banks. After years of mounting difficulties that brought Turkey close to economic collapse, a tough recovery programme was agreed with the IMF in 2002. Since then, Turkey has seen impressive progress. Economic growth has averaged over 5 per cent and inflation has fallen significantly. Overall, economic growth, the implementation of structural macroeconomic reforms, potential EU 1

2 Turkish Banking

membership, the successful banking sector restructuring programme, the enforcement of internationally accepted banking regulatory and supervisory standards such as Basel II, and the growth potential in local credit markets have all contributed towards the attraction of an historical amount of foreign investment in the banking industry. We believe these recent developments in the Turkish economy and banking sector make it worthwhile to undertake a comprehensive overview of the developments in the Turkish banking market. This book, intended for both academics and practitioners, has several purposes. First, it aims to portray the phases of banking sector development in Turkey, where the major emphasis will be to examine the features of financial crises and their repercussions on the banking industry. Second, the financial structure and performance of the banking sector, together with its impact on economic growth, will be analysed, looking at the role of market participants as fund providers and fund users, and at the important role of the state. Third, the future prospects of Turkish banking will be considered the context of EU integration, the potential effects of Basel II, and the new mortgage law’s impact on credit markets. The structure of the book is outlined in greater detail below. Chapter 2 introduces the background to the Turkish economy by focusing on major economic and financial events throughout the twentieth century. The chronological analysis is divided into six sub-sections reflecting the periods when there were major economic policy shifts in Turkey. First, economic activity in the Ottoman period (pre-Turkish republic) and in the early years of the Turkish republic is introduced. Subsequently, the focus is on state-led development strategies between 1930 and 1950, the liberalization period and expansion of the private sector in the 1950s, import substitution and inward growth strategies in the 1960s, and the era of capital account and financial liberalization after the 1980s. We place the main emphasis in Chapter 2 on economic developments after 1990, covering topics such as the roots of chronic high inflation, the inability to control fiscal deficits and heavy government borrowing, the financial crises of 1994 and 2001, recent economic recovery, and the implementation of structural reforms. One prominent feature of Turkey since the 1950s has been instability in politics, which led directly to failures in macroeconomic policy, in turn leading to financial and economical crises. During this period, Turkey has seen four military coups and forty-one different governments, each serving on average for 1.4 years. We therefore think it is imperative for the reader to be introduced to the political scene in Turkey, and hence provide a short history of the country’s political background.

Introduction 3

Chapter 3 links to Chapter 2 and looks at the evolution of and key developments in Turkish banking in relation to economic developments in Turkey. The advent of the Turkish banking system progressed inevitable in parallel with the economic policies implemented. During the early periods, policy-makers promoted the development of a national banking sector to provide the necessary funds for investments. Furthermore, state participation, which affected the dynamics of banking business, was needed to finance the industrialization and stimulation of the economy. Once again, we pay more attention to recent developments. First, we look at the causes, effects and impact of the 1994 crises on the banking sector, when three banks failed. Second, the implications of the stabilization programme (agreed with the IMF) on the banking sector and the establishment of the Banking Regulation and Supervisory Agency (BRSA) are discussed, and the operation of the Savings Deposits Insurance Fund (SDIF), which took control of over twenty banks during the 2001 crisis, is introduced. Apart from the administration of the deposit insurance scheme, the SDIF has been busy since 1994 with the main duties of taking over the management and supervision of the banks whose operating permission has been revoked by the BSRA and fulfilling the necessary operations regarding their bankruptcy and liquidation. Finally, Chapter 3 considers dollarization, crowding-out by government debt, and maturity mismatch – typical challenges faced continuously in asset and liability management by bankers in Turkey. Dollarization and maturity mismatch, both caused by depositors’ loss of confidence in the local currency and the financial system as a result of years of high and volatile inflation and financial crises, are still prevalent in the financial system. On the other hand, the level of loans extended to private sector reached its lowest point in 2002, with only 18 per cent of the total banking sector assets being extended as loans, and 45 per cent of the total banking sector assets were financing government debt. In Turkey before capital account liberalization in the 1980s, the banks’ intermediary role was mainly between domestic savers, investors and consumers. However, after financial liberalization, the banks’ role and behaviour in channelling foreign funds became extremely important.Chapter 4 reviews traditional banking activities and the changing financial structure in Turkey. Initially, we introduce the key features of the Turkish banking industry – its size, structure and statistics on the main ownership issues. This is aimed at providing an insight into the structure and performance levels of Turkish banks in relation to different ownership categories (that is, state-owned, privately-owned, foreign and so on). The chapter first considers the overall size of the

4 Turkish Banking

Turkish banking sector, with an emphasis on the number of banks, branches and employees. The focus of attention then shifts to income and cost structures, together with the performance levels of state-owned, privately-owned and foreign banks in Turkey. Prior to Chapter 5 we cover the rapid development of Turkish banking, its structure, efficiency, the financial crises and economic developments in Turkey. No doubt macroeconomic instability, chronic high inflation, political conflicts and financial crises constituted an impediment to economic growth in Turkey. However, despite these obstacles, both the Turkish economy and the Turkish banking sector have grown. The total assets of the Turkish banking sector increased by around 300 per cent, from USD 60 billion to 180 billion between 1990 and 2003. In recent years, there has been an increased amount of interest in the relationship between financial development and economic growth. The issue of finance and growth has been researched globally, but with different outcomes. Our aim in Chapter 5 is to expand the literature further by linking the development of financial institutions, mainly represented by the banking industry, to the economic development that Turkey has experienced recently. However, unlike cross-country studies, we have used provincial data to examine the relationship between financial development and economic growth in Turkey’s provinces between 1990 and 2003. In this chapter we also provide a brief review of the extensive literature on financial development and economic development. Performance measurement has become a primary concern of investors, lenders, shareholders, and in particular to managers, in planning and controlling their activities. Therefore, examining the performance levels of Turkish banks can guide financial authorities in providing advice on possible actions that can help to maintain financial stability, minimize the risk of failure and improve the performance of banks, all core issues on the road to EU membership. In Chapter 6 we introduce an analysis of the efficiency and productivity levels of a sample of twenty-four commercial banks in Turkey over a fifteen-year period between 1992 and 2006, using data envelopment analysis (DEA). Our analysis considers a constant returns to scale (CRS) model for the nonparametric technical efficiency estimations. The nonparametric DEA analysis was then extended with an application of a Tobit regression to identify the effects of specific factors, such as the 1994 and 2000 banking crises, increased foreign investment and ownership in the Turkish banking system, and the IMF restructuring programme initiated in 1999. We further apply the DEA–Malmquist method developed by Ray and Desli (1997) for the calculation of nonparametric indices of total factor productivity change.

Introduction 5

The productivity change scores are decomposed into technical efficiency change (TEC) components. While the focus throughout this book is on the banking sector, financial markets extend beyond the banking industry alone. Therefore, in Chapter 7 we introduce other institutions and markets in the financial system. We review key statistics on the financial activities of the Istanbul Stock Exchange, the primary and secondary bond markets, special financing institutions (SFIs), leasing, factoring and consumer finance companies in Turkey. In Chapter 8 we focus on current developments and look at the prospects for Turkish banking in the future. The most imperative occurrence, not only for Turkish banking but also for Turkey as a nation, was the declaration of Turkey as an EU accession country in 2005. At the time of writing, many chapters of the EU Directives, including those on financial institutions, had been closed when political disputes over Cyprus prompted the EU to freeze talks until a resolution to the problem had been found. Nevertheless, Chapter 8 starts by outlining the requirements of EU Directives on Financial Services and the progress of the Turkish financial sector towards convergence with European financial markets. Subsequently, we switch our attention to the implementation process of newly reinforced capital adequacy directives. By focusing on the findings of quantitative impact studies (QIS) conducted by the BRSA, we additionally examine the readiness as well as the impact of the new Basel Accord Directives on current levels of capital adequacy of Turkish banks. Chapter 8 follows with the recent introduction of a mortgage law in 2007. This was an important step to further deepen financial intermediation in Turkey. The law aims to improve infrastructure in order to promote primary mortgage and housing finance markets, and to establish a secondary mortgage market. Historically, because of weak economic fundamentals, high inflation and high interest rates, and the unavailability of a longer-term bond market, the financing of housing has always been unachievable by Turkish households, and the share of housing loans in the financial system has been minuscule relative to the size of the system. The integration of financial and goods markets has accelerated greatly in recent decades. Many banks, striving to increase their share of global business, have expanded their operations beyond the borders of their local markets. The driving force of such expansion and internationalization of the banking sector was the liberalization of financial markets, in both developed and developing countries. Typically, in developing countries, foreign banks have substantial profit opportunities as a result

6 Turkish Banking

of less effective domestic competition, and the opportunity to gain a high market share because of low market value in emerging markets. Recently, Turkey experienced a major capital inflow to its banking sector. However, foreign banks did not feature strongly in the Turkish banking system until after the reforms implemented following the 2001 financial crises, despite the fact that Turkey liberalized its capital markets in the early 1980s, and had sufficient technological infrastructure and qualified human capital. The lack of interest was mainly a result of persistent macroeconomic instability and a lack of a regulatory framework for the financial sector that met international standards. Chapter 8 further looks at the motivations behind this interest of foreign banks, and some of the acquisition deals that took place during this process. Finally, Chapter 9 summarizes the main points and draws some brief conclusions.

2 Overview of the Turkish Economy

Introduction The aim of this chapter is to introduce the reader to the background of the Turkish economy by focusing on major economic and financial events that took place mainly after the establishment of the Turkish Republic in 1923. The chronological analysis is divided into six sub-sections reflecting the periods when major economic policy shifts occurred in Turkey. At the outset, the economic activity in the Ottoman period (pre-Turkish Republic) and in the early years of the Turkish Republic is introduced. Subsequent sections focus on state-led development strategies between 1930 and 1950, the liberalization period and the expansion of the private sector in the 1950s, import substitution and inward growth strategies in the 1960s, the era of capital account and financial liberalization after the 1980s, and finally, recent developments after the 2001 financial crises.

The Ottoman period and the early Republic As the predecessor of modern Turkey, the Ottoman Empire was at the centre of interactions between the Eastern and Western worlds between 1299 and 1922. The Ottoman Empire stood at the crossroads of intercontinental trade, stretching from the Balkans and the Black Sea region through Anatolia, Syria, Mesopotamia, and the Gulf to Egypt and most of the North African coast for the six centuries before the First World War. At the height of its power at the end of sixteenth century, the Ottoman Empire included twenty-nine provinces in three continents over an area of 19.9 million square kilometres. The economic power of the Ottoman Empire relates to its geopolitical structure. Standing on the main trade routes between East and West, the Ottoman Empire was 7

8 Turkish Banking

a major economic power until the discovery and opening up of new sea routes to the East. The Ottoman economic mind was closely related to the basic concepts of state and society in the Middle East, in which the ultimate goal of a state was consolidation and extension of the ruler’s power, and the way to reach this was to obtain rich sources of revenues by making the productive classes prosperous. The ultimate aim was to increase the state revenues as much as possible without damaging the prosperity of the Empire’s subjects, to prevent the emergence of social disorder and to keep the traditional organization of society intact. By developing commercial centres and routes, encouraging people to extend the area of cultivated land in their country, and international trade through its dominions, the state performed basic economic functions in the empire. But in all this, the financial and political interests of the state were dominant and the Ottoman administrators could not have realized, within the social and political system in which they were living, the dynamics and principles of the capitalist economy of the Modern Age. The modern Turkish Republic has emerged from the ruins of the Ottoman Empire, which collapsed after a war of independence between 1919 and 1922. The economy in the early years of the Turkish Republic was dominated largely by foreign capital, which was invested mainly in railways, mining, and utility and service sectors such as water, electricity, gas, telephones and transport. Economic policies introduced and implemented in the first years of the Turkish Republic were to create agricultural and industrial consensus, in co-operation with the state and individual enterprises. During this period, policy-makers focused mainly on promoting and establishing industrial manufacturing and supporting private entrepreneurship through the development of a national banking sector to provide the necessary financial instruments for investors. However, the lack of national capital enabled the private sector to set up a banking sector, and state participation for the establishment of national banks became a necessity. During this period, the decrease in the value of Turkish currency led to a decrease in the prices of agricultural products in the world markets. Between 1924 and 1929 the Turkish economy performed at an average growth rate of 10.9 per cent (see Figure 2.1). As the active population returned their own lands after the war, agricultural production, which constituted around 45 per cent of gross national product (GNP) in this period, showed a rapid increase. To sum up, up to the end of the first decade of the Republic, an attempt was made to implement a liberal economic policy. Within this

Overview of the Turkish Economy 9 Table 2.1 Some macroeconomic indicators, 1923–30 Year Growth Share of sectors (%) Foreign Exports Imports (%) exchange (USD (USD Agriculture Industry Services rate millions) millions) (TL/USD) 1923 1924 1925 1926 1927 1928 1929 1930

43.3 48.1 45.0 50.3 40.0 42.8 50.1 47.1

14.8 12.9 18.2 12.8 11.0 4.6 2.2

13.4 11.9 12.8 12.0 16.9 15.6 13.9 14.9

43.3 40.0 42.2 37.7 43.1 41.6 36.0 38.0

1.68 1.88 1.83 1.91 1.94 1.95 2.07 2.12

51 82 103 96 81 88 75 71

87 100 129 121 108 114 124 70

Sources: Central Bank of Turkey (2008) and Treasury Statistical Yearbook (2007).

0.40

Percentages

0.30 0.20 0.10 0.00

Figure 2.1

1946

1944

1942

1940

1938

1936

1934

1932

1930

1928

1926


0.20

1924


0.10

Growth rate of Turkey, 1924–47

Source: Central Bank of Turkey (2008).

context, much room was accorded to the private sector (though with the exception of a few public economic enterprises with monopoly features). Economic policies introduced and implemented at the time were geared to spreading private ownership of land, appropriating land for landless farmers and migrants, extending state credit for capital accumulation in agriculture, promoting private enterprises (so as to develop them), protecting domestic production by customs policies, and refraining from external borrowing. Despite the positive developments in this period, the insufficiency of capital accumulation in the private sector combined with the Great Depression that erupted in 1929 had a strong impact on

10 Turkish Banking

the Turkish economy and Turkey was urged to follow new policies geared towards more state-led initiatives, especially in industrial development.

State-led development strategy, 1930–50 The industrialization strategy that was pursued in the 1920s by way of encouraging the private sector, did not produce important results, because of insufficient capital accumulation (Banks Association of Turkey (BAT), 1999a). Consequently, after 1930, along with all the other countries in the world, Turkey chose state-led economic policies, partly in order to remove the negative effects of the global economic crisis of 1929 and partly because of the realization that the private sector was too weak to be the engine of growth. This new ‘statist’ strategy emphasized state-led development and assigned a secondary role to the private sector. In 1933, the government began to control interest rates. In order to accelerate industrialization, the government established state enterprises in key industries between 1932 and 1945. The investment plans of the industrial enterprises that were to be established by the state were emphasized in the First and Second Industrial Plans. Under the First Five-Year Industrial Plan, adopted in 1934, industry was divided into five categories, in line with local and natural resources, basic consumer needs and human resources. As a result of the planned economy, a significant growth rate was achieved in the selected sectors of weaving, mining operations, paper, agricultural products and chemicals. The Second Five-Year Industrial Plan, introduced in 1939, was interrupted by the outbreak of the Second World War. Turkey did not enter the war, but a major part of national resources was allocated to the defence industry, thereby reducing capacity in both production and foreign trade.

Liberalization in the 1950s The years following the Second World War and into the 1950s reflect attempts to reduce the role of the state in the economy, and support for the expansion of the private sector as an industrialization strategy. Following the elections of the 1950s, in which for the first time more than one party competed, the Democrat party came to power, with a tendency to adopt more liberalized policies, limiting the intervention of the state in the economy. Several factors played a role on this shift towards a more liberal economy. In 1946, the Turkish currency was devalued against the USD by

Figure 2.2

1967

1966

1965

1964

1963

1962

1961

1960

1959

1958

1957

1956

1955

1954

1953

1952

1951

1950

1949

0.14 0.12 0.10 0.08 0.06 0.04 0.02 0.00
0.02
0.04
0.06

1948

Percentages

Overview of the Turkish Economy 11

Growth rate of Turkey, 1948–67

Source: Central Bank of Turkey (2008).

53 per cent in order to increase exports after the war. However, this devaluation did not result in exports at the desired levels and consequently, in 1947, a liberal development plan, covering a period of five years, was adopted in order to achieve economic development that emphasized the private sector. Although this plan was in harmony with the views of the International Monetary Fund (IMF) and World Bank (of which Turkey became a member in 1947), Turkey could not achieve the desired growth rates despite military and economic aid that were offered from 1948 (see Figure 2.2) [see Figure 2.1 for gross domestic product (GDP) growth before 1948]. Between 1950 and 1953, Turkey achieved significant improvement in both agriculture and industrialization. With the adoption of new policies – the facilitation of entry of foreign capital, high-price policy and credit opportunities in agriculture, an increase in the money supply and restrictions on import – and foreign credit and aid, an 11.1 per cent growth rate was achieved during this period. State investments continued in many industries, including irrigation, energy, transport, cement, sugar, textiles, rubber and iron/steel. However, this growth rate could not be sustained between 1954 and 1958. According to Utkulu and Özdemir (2003), the most criticized aspect of the government in the 1950s was unplanned and uncoordinated economic decisions, which had originated from its perception of ‘liberal’ economic policies. These policies resulted in a decrease in growth rates to 2–3 per cent in 1958, and an increase in inflation rates. Utkulu and Özdemir (2003) stress that the economics programmes were essentially correctional and did not aim at permanently creating

12 Turkish Banking

a more liberal trade regime. Overall, the economic policies during the 1950s were essentially inward looking, but were based neither on an explicit economic theory nor on formal planning. It was argued that economic policy was made mainly on an ad hoc basis, and there was a general lack of interest in co-ordinating economic policies. One significant cause of poor performance was the utilization of the Central Bank’s resources to fund government investment. According to the BAT (1999a) this policy destabilized macroeconomic balances such as high inflation, the foreign trade deficit and increasing foreign debt, together with insufficient foreign currency reserves for imports of inputs, led to the devaluation of the Turkish lira from TL2.8/USD to TL9/USD. Although a stabilization programmme, was introduced, with the support of Europe, the government’s reluctance to limit public expenditure and the continuous use of Central Bank resources kept inflation high during this period.

Import substitution and inward-orientated growth strategy, 1960–79 Between 1960 and 1979, Turkey followed a state-led inward-orientated growth strategy by following import substitution policies and economywide planning by the State Planning Organization (SPO). The 1960s and the 1970s mark an intensive import substitution drive. This policy was implemented mainly through effective quantitative restrictions and a deliberate policy of an overvalued foreign currency regime in order to maintain low costs for supported sectors, which had imported inputs. As well as the trade restrictions and the government-determined interest and exchange rates, the state made use of heavy public investment, particularly in the manufacturing sector, to promote industrialization and economic development. In general, as in previous eras, the country faced a lack of real resources, and the financing of industrialization was funded predominantly by public-sector borrowing and Central Bank loans. Artun (1983) argues that the Central Bank loans were generally used for subsidy payments rather than to create a supply of goods and services, and these unreturned loans led to an increase in money supply and inflation. Following the establishment of the SPO, the First Five-Year Development Plan, covering the years between 1963 and 1967, achieved a growth rate of 6.7 per cent. According to Demir (2002) the implementation of the First Five-Year Plan was the starting point of the institutionalization of the import substitution industrialization (ISI) regime in Turkey in order to empower the infant industries of the country. Between 1968

Overview of the Turkish Economy 13 0.14 0.12 Percentages

0.10 0.08 0.06 0.04 0.02 0.00

Figure 2.3

1979

1978

1977

1976

1975

1974

1973

1972

1971

1970

1969

1968

1967

1966

1965

1964

1963

1962

1961


0.04

1960


0.02

Growth rate of Turkey, 1960–79

Source: Central Bank of Turkey (2008).

and 1972, during the Second Five-Year Development Plan, the growth rate surpassed the targets set at 7.2 per cent. In those two periods, the industrial sector was regarded as an engine of the economy. Ba¸skaya (1986) argues that, under these two five-year plans, the import regime acquired a quite restrictive character while the quantitative controls on trade gained momentum and overvalued exchange rates became the main features of the system. The oil shock of 1973, which shook the world economy, also affected the developing Turkish economy, mainly as a result of high cost of oil imports, which led to high inflation, energy bottlenecks, foreign exchange (FX) shortages, unemployment, and budget deficits. In order to increase the growth rate, governments considered substantial state investments. However, since consumption was not limited, this policy caused instability in the Turkish economy despite high growth rates during the Third Five-Year Plan, between 1973 and 1977 (see Figure 2.3). In this period, the gap between national savings and investments widened, together with an increasing trade deficit, both of which led to a sharp increase in budget and current account deficit.1 Thus, an external debt crisis was inevitable in 1978. Following the interim plan for 1978, the Fourth Five-Year Development Plan, covering the period 1979 to 1983, was introduced to put the economy in order. Many economists criticized the policies implemented during this period. According to Hansen (1991), an important factor that tended to make the statist policy unsustainable and contributed to its breakdown was the excessive increase in real wages, as a result of the liberalization of the labour market and legalization of labour unions that the 1961 constitution guaranteed.

14 Turkish Banking

Demir (2002) emphasizes the fact that, during the ISI years, the capital accumulation process was highly dependent on policy and politics rather than markets. Entrepreneurs became increasingly dependent on the state and bureaucracy, and on subsidies rather than exploiting the opportunities created by the market itself. Balkan and Yeldan (1998) stress that this political and economic environment created vast opportunities for wide-ranging rent-seeking behaviour among the business community as companies competed for the special set of incentives (in the form of cheap credit availability, cheap foreign exchange through state banks, the permission to import certain intermediate and final goods, and so on) provided by the state. Demir (2002) argues that strict controls and restrictions on prices, exchange and interest rates, import and export transactions (in the form of import licences and foreign exchange regulations) were some of the accompanying features of the above system. Foreign exchange and bank credit were subject to severe rationing, and fierce competition existed for the above provisions, since access to these resources guaranteed exceptionally high profits in the highly protected Turkish domestic market. Consequently, the system encouraged and generated serious moral hazard problems and rent-seeking behaviour on a systematic basis in both public and private spheres. On the other hand, Dervi¸s et al. (1981) claim that ISI policies made a remarkable contribution to the growth rate of GDP, especially during the 1960s. Within the planned period, the financial sector had largely been under state control: The interest rates applicable to deposits and bank credits, the banks’ commissions and credit limits were defined according to import-substitution policy, and the banks’ main functions were defined as financing the investments laid out in the development plans (BAT, 1999a). Denizer (1997) argues that the start of a planned development strategy in 1963, and concerns over the failure of a large number of banks during the early 1960s (these will be covered in more detail in Chapter 3), brought significant changes to banking and finance policy. In order to attain plan targets, the public sector increasingly assumed a larger role in the allocation and mobilization of resources through directed credit programmes, subsidized lending to priority sectors, and other constraints on financial intermediation. Cumulatively, these measures turned the financial system into an instrument of industrialization policy. However, governments continued to set interest rates in order to increase the role of the state in financial markets. As mentioned above, between 1963 and 1974, Turkey followed a strongly growth-orientated strategy led by both public- and privatesector investments, mainly in import-competing sectors, infrastructure

Overview of the Turkish Economy 15

and heavy industries. The public-sector investments were financed by monetizing budget deficits, and issuing low yield bonds purchased mainly by public pension funds and bank deposits. At the same time, after the mid-1960s and during the 1970s, the private sector, encouraged and supported by the government through high protection rates and a complicated incentive scheme for investments, was also expanding through a holding company structure and was in need of financing. Denizer (1997) argues that, while the government had access to capital for its large investments, the private sector did not. In the absence of capital markets they had to rely on bank loans to finance their investments. Since the public banks were primarily financing public investments, the private sector had all the incentives to establish or acquire banks to finance their investments. Consequently, as Akgüç (1989) states, with restricted entry, major groups began to acquire banks established earlier, and by the early 1970s almost all the major private banks belonged to holding groups. Although economic growth accelerated in the planned period, inflationary methods of financing industrialization and the production of the developed industries for domestic market consumption rather than export, there was a serious problem of foreign exchange in the 1970s (BAT, 1999a). Overall, with the additional impact of the global economic problems of the late 1970s, the ISI regime failed because of its dependency of industrial production on imported inputs, which in turn led to problems of balance of payments and lack of foreign currency.

The era of financial liberalization 1980–90 From the early 1930s to the early 1980s, Turkey’s economic policies are characterized as interventionist and protectionist. According to Saraço˘ glu (1987), policies were designed mainly to protect domestic industry from foreign competition, and increase government control over the allocation of resources and the production of goods, which were included in the following policies and principles: 1. Encouragement of the domestic industrial sector with minimal foreign competition through the introduction of quotas, high tariffs and licensing requirements. 2. A high level of monetary expansion to finance large fiscal deficits.

16 Turkish Banking

3. Support of the industrialization process and avoidance of bottlenecks by the creation of state economic enterprises in sectors such as steel production and mining. 4. Control over the quantity and price of credit, to influence the sectoral composition of investment within the private sector. 5. The maintenance of fixed exchange rates and exchange controls that result in overvalued domestic currency. In January 1980, a package of economic stability measures known as ‘January 24 Decisions’ were adopted to resolve the worst problems that emerged in the late 1970s as a result of the aforementioned policies adopted by government. The objectives of the reform programme, according to Arıcanlı and Rodrik (1990), were first to stabilize the economy and then to adjust its structure, from an inward-orientated strategy to an export-orientated one. New policies aimed to integrate with the rest of the world by establishing a free market economy. These policies also introduced radical changes in economic modelling and preferences, which were strongly backed by IMF, and a World Bank and Organisation for Economic Co-operation and Development (OECD) consortium. In order to support the new strategy, to restructure the economy according to the free market economy rules, and to accumulate the savings needed for stable growth, flexible exchange rate and positive real interest rate policies were implemented, together with new regulations aimed towards the liberalization and deepening of financial markets (BAT, 1999a). Ismihan et al. (2003) suggest that the role of the state has changed crucially with this programme; for example, it changed its investment strategy from manufacturing to infrastructure. The share of core public infrastructural investment in total public investment rose from 37.3 per cent in the inward-orientated period to 50.5 per cent in the outward-orientated period. Nevertheless, while the private investment– GNP ratio rose from 12.8 per cent in the 1980s to 18.1 per cent in the 1990s, the public investment–GNP ratio dropped from 8.8 per cent in the 1980s to 6.2 per cent in the 1990s. Ismihan et al. (2003) argue that the main reason behind this fall is the rising macroeconomic instability after the late 1990s, which has seriously lowered the fiscal ability of governments to make necessary investments, especially infrastructural investments. Günçavdı et al. (2002) looks at the liberalization process in Turkey in the 1980s. He suggests that, recognizing the dependence of domestic production on imported inputs and foreign exchange, Turkey liberalized

Overview of the Turkish Economy 17

its trade regime. First, the exchange rate regime was changed drastically, from a fixed exchange rate system to a more flexible and realistic one with an increased reliance on market forces. Various export incentives were launched to increase export earnings, and quantitative controls on imports such as quotas and licensing systems were eliminated. Yeldan and Voyvoda (1999) point out that, with the adoption of the new policies, export revenues increased at an annual rate of 15 per cent, and GNP rose at an annual rate of 6.5 per cent between 1983 and 1987. Utkulu and Özdemir (2003) argue that, as a result of continual real depreciations, output recovery was driven mainly by exports before 1986. While many of the countries with debt problems chose to run large non-interest current account (NICA) surpluses, mainly by cutting both expenditure and growth, Turkey opted for a high-growth strategy with fewer NICA surpluses, known as ‘growth-orientated debt strategy’. They suggest that this strategy sought to improve the debt–output ratio through output growth, and permitted the running of lower external surpluses. The new exchange rate policy raised the debt–output ratio through capital losses, but it lowered the debt–export ratio by increasing exports. Mainly as a result of this policy, Turkey’s creditworthiness was restored, and the country was distinguished from most debtor countries whose debt–export ratio rose in line with their debt–output ratio. Between 1980 and 1988, the exchange rate strategy was used actively for export promotion. Turkey’s export performance outperformed other emerging economies during the first half of the 1980s. In fact, between 1970 and 2006, 1981 was the year with the highest export growth (see Figure 2.4). Utkulu and Özdemir (2003) point out that depreciation of the Turkish lira, the new export promotion schemes, and reduction in domestic demand, together with the shift of production from domestic to foreign markets, were the reason for such a successful export performance. On the other hand, Günçavdı et al. (2002) stress that the resource gap between savings and investment, as a share of GDP, declined from 5.2 per cent between 1977 and 1980, first to 1.2 per cent in 1981–3, and to 0.6 per cent in 1984–8. The employment generating capacity of the economy also declined in the post-liberalization period. Total employment grew at an annual rate of 0.95 per cent on average in 1982, against 2 per cent in the period 1977–9. They argue that, while the economy seems to have higher growth rates after these early years of the liberalization period, it has never returned to its pre-liberalization level. Demir (2002) highlights that the introduction of more amendments were made in 1984 in order to enforce the liberal economic system. First, state intervention in the economy was reduced to a minimum and

18 Turkish Banking 70 60 Percentages

50 40 30 20 10 0

Figure 2.4

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

1978

1976

1974

1972


20

1970


10

Growth in exports, 1970–2006

Source: Central Bank of Turkey (2008).

a liberal market view was favoured in foreign exchange, trade and tax policies. The flow of foreign direct investment (FDI) was targeted by incentives, and state economic enterprises (SEEs) began to be privatized. Controls on market interest rates were also removed, in an attempt to encourage private saving. In addition, quantitative restrictions were abolished and bureaucratic controls over imports were also relaxed, especially after 1984. However, Utkulu and Özdemir (2003) argue that the import liberalization process in the late 1980s led to an increase in the import of consumer goods. According to Boratav and Yeldan (2002), two consecutive years of negative per capita growth and a new wave of populist pressures leading to distributional shocks immediately before the 1989 elections were seen as evidence by most actors that the policy model of 1980s had exhausted itself and had to be changed. The way out of the impasse turned out to be the liberalization of the capital account in August 1989. The full convertibility of the Turkish lira was realized at the beginning of 1990. A foreign exchange market was established and residents were given the right to open foreign currency accounts and hold foreign currency. The Istanbul Stock Exchange was opened in 1986, during this period. Nas and Perry (2000) emphasize the importance of the move towards Central Bank independence and change in the conduct of monetary policy during this period. Accordingly, before 1986, the Central Bank (CB) used public-sector credits and interest rates as monetary policy instruments; the money supply was determined by total credit expansion, and monetary policy was directed towards controlling private and public spending by setting borrowing limits for the banking system. After 1986, the CB took important steps toward greater autonomy by reorientating the monetary process towards contemporary CB practices; a switch to

Overview of the Turkish Economy 19

monetary reserve targeting was accompanied by a series of new legislation that allowed the CB to conduct open-market operations and monitor a newly established interbank market (Nas and Perry, 2000).

1990–2000 Balkan et al. (2002) emphasize the fact that the liberalization of the capital account in 1989 served as one of the major policy initiatives in order to sustain the fiscal deficits of the 1990s. They suggested that this policy change paved the way for the injection of liquidity into the domestic economy in terms of short-term foreign capital, popularly known as ‘hot money’. Such inflows enabled, on the one hand, the financing of accelerated public-sector expenditure, as well as providing relief from the increased pressure of aggregate demand on the domestic markets by way of cheapening the cost of imports. However, Boratav and Yeldan (2002) argued that these arbitrage-seeking ‘hot money’ inflows and outflows contributed to rising external and domestic instability. Celasun et al. (1999) further discussed the salient features of capital flows to Turkey, as follows: 1. Inflows have been much larger than outflows; Turkish investments abroad were also substantial in a number of years. 2. Net foreign direct investment in Turkey has been very small – it was never more than 0.5 per cent of GNP in the 1990s. 3. Portfolio investments have not been as important as deposits, loans and trade credits, and in most years of the 1990s, deposits and credits were dominated by short-term flows. Investments in equity securities have been less important than investments in debt securities. 4. The public sector has been a net repayer to (rather than a net borrower from) the foreign sector. 5. In the first half of the 1990s, most loans and credits were extended by foreign investors through banks. The situation changed after 1995, when the debt stock of the non-financial private sector was twice as large as that of the commercial banking sector. Turkey liberalized its foreign trade regime successfully, removed price ceilings on goods and services and other distortions in product markets, and deregulated its financial sector. However, failure to control fiscal deficits was a major factor in a volatile economic environment with very high inflation rates. In fact, Turkey is one of the few countries in the world that has experienced a high level of inflation for a long period of time (see Figure 2.5).

20 Turkish Banking 160

Percentages

140

CPI PPI

120 100 80 60 40 20

Figure 2.5

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

0

Yearly consumer and producer price indexes, 1983–2006

Source: Central Bank of Turkey (2008).

The accounts of the SEEs have been a major contributor to the overall deficit of the public sector throughout the 1980s and into the early 1990s. For Altınkemer (2003), one other main weaknesses was the exceptional treatment of state banks, both in terms of assigning certain non-bank activities to them, thereby creating duty losses which were to be financed by the central government’s budget and, in order to alleviate the problem imposed on the state banks, they were not strictly regulated, which created additional financial distortions in the market, against private banks. Altınkemer (2003) has also argued that, with capital account liberalization, the banks’ ability to obtain short-term foreign credits helped to postpone fiscal adjustments, thus increasing the budget deficit and the domestic debt stock even further, while shortening its maturity, which created doubts as to the sustainability of budget deficits. In spite of the fact that full capital account liberalization occurred, many observers have considered the full opening of the capital account to be premature. Turkey had not accomplished a stable macroeconomic environment and a strong regulatory infrastructure for the financial sector for capital account liberalization to produce the desired outcomes in the form of lower real interest rates and higher economic growth on a sustainable basis (Alper and Öni¸s, 2003). Given the weakness of the domestic environment, Turkey failed to capitalize on the benefits of financial globalization. A lopsided pattern emerged, in which a disproportionate share of capital flows were of a short-term nature and Turkey failed to attract significant long-term FDI. The level of foreign funds between 1975 and 2006 is presented in Figure 2.6. Until recently, Turkey’s performance has been poor. The annual inflow of FDI during the early 1980s has remained

Figure 2.6

2005 2006

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

1979

1977

20,000 17,500 15,000 12,500 10,000 7,500 5,000 2,500 0 1975

Millions USD

Overview of the Turkish Economy 21

Net international flow of funds to Turkey, 1975–2006

Source: Treasury Statistical Yearbook (2007).

below USD 1 billion, which is clearly a dismal figure compared with the performance of other emerging markets of similar size and level of development (UNCTAD, 2001).

1994 economic crises Heading towards the crises of 1994, GDP growth was floating in 1992 and 1993, reflecting large real wage increases and lax macroeconomic policies, and by the end of 1993, the economy was overheated. Domestic demand rose by about 12 per cent in 1993, import volumes jumped by 36 per cent and GDP grew by 8.1 per cent. At the same time, towards the end of 1993, the Turkish government was trying to reduce the burden on public debt by cutting interest rates on Treasury bills, and the Treasury started to rely on the Central Bank’s resources rather than domestic borrowing. The cancellation of several Treasury auctions and limited domestic borrowing via Treasury auctions resulted to excess liquidity in the market and to pressure on the exchange rates in the last months of 1993, which continued into early 1994 (Gümü¸s, 2002). According to Özatay (2000), these were significant policy mistakes, and Gümü¸s (2002) has argued that this excess liquidity caused a run on foreign currency and loss of international reserves, which started to decrease in November 1993 and continued until April 1994. Together with years of high fiscal deficits, which were financed by high level of public borrowing, and inflation in excess of 50 per cent per year, monetization, and a sharp deterioration in public-sector and external deficits caused a loss of confidence in the Turkish lira and triggered a severe financial crisis early in 1994. Deposit insurance was introduced

22 Turkish Banking

Millions USD

80,000 70,000 60,000 50,000 40,000 30,000 20,000

Figure 2.7

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

10,000 0

Central Bank’s gross foreign exchange reserves, 1981–2007

Source: Central Bank of Turkey (2008).

for all savings deposits during the crises to reestablish the lost confidence in the financial system (the deposit insurance system will be discussed further in Chapter 3). Crises had a negative impact on the credibility of the country in the international financial markets, and as a consequence of high demand and low supply in the domestic markets, interest rates increased dramatically. On the other hand, real GNP contracted by 6.1 per cent, while real public investment fell sharply by about 40 per cent from 1993 to 1994. Inflation rocketed to 107 per cent in 1994, and Turkish lira was devalued by more than 150 per cent against the US dollar. Özatay (2000) points out the Central Bank’s heavy intervention in the foreign exchange market, and as a result lost more than half of its international reserves; overnight, interest rates jumped from a stable pre-crisis level of 70 per cent to unprecedented levels – as high as as 700 per cent (see Figure 2.7). Alper and Öni¸s (2003) have stated that the crisis of 1994 was triggered by two proximate causes; namely, the government’s attempt to control the interest rates and the level of the exchange rate in a high inflation environment; and the lowering of Turkey’s credit rating. Accordingly, the end result was a steady decline of the foreign exchange reserves of the Central Bank, ultimately leading to a successful speculative attack on the Turkish lira, generating a large devaluation. The perverse outcome of capital account liberalization manifested itself in a striking fashion with the onset of the 1994 crisis, reflecting the inability of policy-makers to adjust themselves to the new environment; because the policy-makers still continued to operate within the parameters of a closed economy model and tended to neglect the current account as an important source of disequilibrium, on the assumption that capital

300,000 270,000 240,000 210,000 180,000 150,000 120,000 90,000 60,000 30,000 0

External

Figure 2.8

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

Domestic

1986

Millions USD

Overview of the Turkish Economy 23

Central government debt stock, 1986–2006

Source: Treasury Statistical Yearbook (2007).

flows would be irreversible and sustained on a steady course (Alper and Öni¸s, 2003). Consequently, Turkey signed a stand-by agreement with the IMF that led to a cool-down in the severe economic crisis. The inflation rate fell to 87 per cent in 1995. However, as Veiga (2000) points out, macroeconomic instability continued until the late 1990s, mainly because of the reluctance of governments to adopt the necessary painful measures. According to the BAT, (1999a) regarding the 1994 financial crises, because of the pressure of public-sector borrowing requirements, the rapidly increasing cost of Turkish lira funding led to increasing foreign debts of banks, and the foreign currency open position was enlarged (see Figure 2.8). Risks arising from interest rates and the exchange rate increased even more in the balance sheet. With these risks turning into losses because of the crises, the total assets of the banking system decreased from USD 68.6 billion to USD 51.6 billion, while equity capital fell to USD 4.3 billion from USD 6.6 billion. In the second half of the 1990s, the Turkish economy enjoyed high growth rates, though high inflation rates and structural problems remained unresolved. Despite a high annual growth (8.5 per cent on the average) from the second quarter of 1995 until 1998, Turkey entered a severe slowdown in economic activities after that. According to a report conducted by the Turkish Industrialists’ and Businessmen’s Association (TUSIAD, 2000), fluctuations in the international markets, deepened by the crisis in the Russian economy, doubled its adverse effects with the contraction in domestic demand and caused economic growth almost to fade away at the end of 1998. Moreover, the cut in the public expenditure

24 Turkish Banking 10 8

Percentages

6 4 2 0
2
4
6

Figure 2.9

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988


8
10

Gross national product by producer prices, 1988–2006

Source: Central Bank of Turkey (2008).

in line with the disinflation policies and the postponement of investment and consumption because of the soaring interest rates caused a demand-side contraction (see Figure 2.9). During this period, public sector balances were unsustainable because of reliance on domestic borrowing.2 In December 1999, with the intention of solving the public sector imbalances and inflation, Turkey signed a three-year IMF-based standby agreement for a stabilization programme (see Table 2.2). Özkan (2003) has argued that central to the stabilization programme were: (i) a strong exchange rate commitment; (ii) tight monetary control; (iii) a large fiscal adjustment to eliminate inflationary pressures; and (iv) a range of structural measures designed to liberalize the economy. Akyüz and Boratav (2003) have stated that the programme appeared to be on course in the following nine months, enjoying wide public confidence and support as well as gaining praise from IMF officials, but it started running into problems in autumn 2000, necessitating a relatively large IMF bailout to keep it on course.

2000–01 twin economic crises A severe liquidity crisis hit the economy in November 2000, barely a year after the start of the programme and while an IMF-led emergency package succeeded in normalizing the situation for a time, the Turkish lira came under heavy attack in February 2001, which turned into the most serious financial and economic crisis Turkey has experienced in its postwar history (Özkan, 2003).Even though the IMF cannot be held solely responsible for these twin crises during the implementation of the IMF

Overview of the Turkish Economy 25 Table 2.2 Structural reform measures of the Letter of Intent signed in 1999 with the IMF Agricultural policies: The medium-term objective was to point out active support policies (for example, support pricing and purchasing and credit subsidies that encumber public finances), and substitute for them a direct income support system targeting poor farmers. Meanwhile, existing support policies were to take into account the programmed targets. Pension reform: Social security reform was to be deepened by undertaking administrative reforms to improve coverage and compliance, and more importantly by creating the legal framework for private pension funds. Fiscal management: A total of 61 extra budgetary funds were to be phased out progressively by June 2001. Tax policy: Guaranteed to broaden the tax base, but no exact measures were given. Privatization: Listed 16 publicly-owned enterprises to be privatized in 2000. A further list of public companies for the privatization programme in 2001 was to be prepared. Turk Telekom and energy sectors were to be subjected to the Turkish commercial code (prior actions) with a view to preparing them for privatization. Banking regulations: The Banks Act was to be amended to strengthen prudential standards, to increase transparency and independence of the Banking Regulation and Supervision Agency. Two major state-owned banks were to be commercialized, with an eventual privatization goal. Source: Ekinci (2002).

programme, Alper and Öni¸s (2003) have criticized the Fund strongly, as it had underestimated the fragility of the Turkish financial system, notably in an environment where the success of the programme relied heavily on the availability of short-term capital inflows on a sustained basis. According to Özkan (2003), there are three areas of vulnerability in the Turkish economy that prepared the ground for the collapse of the Turkish lira and the resulting 2000–01 financial crises. The first source of vulnerability was the weak external position caused by excessive levels of debt repayments. Özkan (2003) argued that the external debt burden prior to the crisis was much higher than that experienced by the Asian countries that were deemed to have borrowed excessively during the 1990s. Furthermore, there was some considerable loss of competitiveness because of high inflation, which reduced the capacity to service the existing debt – according to Özkan, this was a clear early warning signal for impending currency crises. The second area was the weak fiscal position resulting from record levels of interest payments on domestic

26 Turkish Banking

borrowing, which placed a considerable burden on public finances when combined with the unfavourable maturity structure of existing debt, and had undesirable consequences for the functioning of the already fragile banking system. Third, Özkan points out the role of weaknesses in the financial and banking sector in preparing the ground for the liquidity squeeze in November 2000 and aggravating the situation in the wake of the devaluation in February 2001. The devaluation rate under the stabilization programme encouraged banks to borrow heavily from abroad, but since such borrowing was generally short-term, a serious maturity mismatch between the assets and the liabilities of the banking sector developed. Moreover, not only the short-term portfolio investments, which were easily reversible and made up of most of the inflows, but also the slow pace of reform under the stabilization programme and political uncertainty contributed to further exposing the fragility of the system (Özkan, 2003). According to Eichengreen (2001) there are some lessons that need to be learnt from the 2000 crisis. First, exchange-rate-based stabilizations are risky, as exit from a peg is difficult. Second, the existence of large short-term debt creates fears of crisis. Third, debt swaps only delay the problems; they do not provide a solution. Fourth, fiscal stability requires reduced public spending, which in turn implies reduced aggregate demand and growth. The decline in growth decreases the tax base, and thus the tax revenues, worsening the fiscal position. Therefore engineering fiscal consolidation while maintaining output growth is difficult. Fifth, under circumstances in which market-based solutions are not viable, it is not easy to overcome the problem of moral hazard in international lending, and thus the international financial institutions found themselves bailing out Turkey for fear of a more widespread crisis. Sixth, the Turkish government took fiscal and financial reforms to catalyse private lending in the aftermath of the crises, and the international financial institutions provided the necessary funds in the meantime, until the markets reacted. However, market reaction was delayed, as investors waited for evidence of Turkey’s commitment to the stabilization policies. In May 2001, Turkey signed a further IMF standby agreement to restructure its economy (see Table 2.4 on page 36 for a list of standby programmes signed between Turkey and the IMF). The programme, called Transition to a Strong Economy, was intended to ensure timely debt repayments, prevent further devaluation, control the rise of inflation, and support the solvency of the banking system. The strong structural reforms, prudent fiscal and monetary policies under a floating exchange rate regime, and an enhanced social dialogue are the main pillars of the

Overview of the Turkish Economy 27

revised programme. Within the scope of structural reforms, the social security system, which was in deficit for many years, has been reorganized and significant steps have been taken to ensure a balance between the system’s assets and liabilities. Some improvements in the tax system have been introduced so as to enlarge the tax base and to formalize the unregistered economy, which was 20.5 per cent of the official economy (Ö˘ gunç and Yılmaz, 2000). The programme targeted a strong reform of the weak financial system and banking sector through an operational and financial restructuring of public banks, and the regulation and supervision of private banks (these will be discussed further in Chapters 3 and 4).

Recent economic trends Since the 2000/01 crises, the Turkish economy has improved significantly. Output has grown rapidly, inflation has fallen to its lowest level in a generation, and government debt has declined markedly. The implementation of the economic programme and structural reforms, supported by IMF loans, addressing debt sustainability and debt rollover, together with prudent fiscal policy, have helped to reduce inflation. During this period, the fragility of the financial system was reduced by the recapitalization of state banks and weak private banks. Two factors also helped the implementation of the programme. First, according to IMF (2003), Turkey appeared to be keen to make good progress towards the EU, which has helped to offset market reaction to the lack of progress in some of the IMF programme’s structural areas. Second, during this period, Turkey has benefited from a generalized improvement in market sentiment towards high-yielding emerging markets assets. On the whole, the Turkish economy performed well after the 2000/01 crises. After a 9.8 per cent contraction in 2001, Turkish economic growth showed a strong trend, with an average of 7.5 per cent per year, and was well above the target level of 5 per cent of the programme. Private domestic demand, both from consumption and investment, has been strong during most of this period, with the help of credit expansion after the continuous fall in interest rates. High levels of interest rates have fallen significantly. In the domestic market, the Turkish treasury was paying 99 per cent yearly interest (nominal) for average treasury bills in 2001 (see Figures 2.10 and 2.11). This rate plummeted to 16.4 per cent in 2006. On the foreign markets, investors’ strong interest towards emerging economies has helped to narrow the spread on Turkey’s international bonds, and helped the financing needs of the government. The interest rate levels of Eurobonds

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

180 160 140 120 100 80 60 40 20 0 1990

Percentages

28 Turkish Banking

Figure 2.10 Average compound interest rates of the benchmark government security, 1990–2007

Jan-08

Oct-07

Jul-07

Apr-07

Jan-07

Oct-06

Jul-06

Apr-06

Jan-06

Oct-05

Jul-05

Apr-05

Jan-05

Oct-04

Jul-04

Apr-04

Jan-04

Oct-03

Jul-03

Apr-03

Jan-03

Oct-02

Jul-02

Apr-02

14 12 10 8 6 4 2 0 Jan-02

Percentages

Source: Treasury Statistical Yearbook (2007).

Figure 2.11 Compound yield of 10-year Eurobonds issued by the Turkish Treasury, 2002–2008 Source: Treasury Statistical Yearbook (2007).

with a 10-year maturity dropped from 12 per cent in 2002 to 6 per cent in 2007. Government net debt, facing the risk of becoming unsustainable in 2001 with 90 per cent of GNP, had fallen to levels below 50 per cent by 2007. Although the debts reduced relative to GNP, the financing need of the government has increased continuously during this period (see Figure 2.8 on page 23). After 2001, there was a sharp rise, especially in domestic borrowing requirements, which in 2007 amounted to over USD 200 billion. Moreover, even though the general level of interest rates dropped dramatically for both domestic and international debt, Turkey remained (as of 2007) one of the countries paying the highest interest rate in the world, with 16.5 per cent on its Turkish lira debt. Furthermore, the maturity structure is still fragile, even though the level of debt has been reduced to a sustainable level. Almost 75 per cent of the debt has a maturity of less than two years (see Figure 2.12; see also Figures 2.A1 and 2.A2 in Appendix 2.1 for the currency and interest composition of government debt).

Overview of the Turkish Economy 29 5 years 23%

1 year 21%

4 years 2% 3 years 2%

2 years 52%

Figure 2.12 debt, 2006

Maturity composition of central government outstanding domestic

Source: Treasury Statistical Yearbook (2007).

Full Central Bank independence was granted during this period, to pursue price stability and be freed from the responsibility of financing the government deficit. As a consequence of a successful disinflation programme, inflation reduced to levels around 8 per cent in 2005 (CPI) from an extreme of 68 per cent in 2001. In fact, Turkey, after decades of chronically high price increases, has seen an inflation figure below 10 per cent (see Figure 2.5 on page 22). A shift in the pace of disinflation can be observed after 2005, caused by a combination of oil price effects, domestic demand strength and adverse supply shocks. According to IMF (2006), oil and gold price effects alone are estimated to have contributed, respectively, about 1 and 0.5 percentage points to 12-month inflation in the first four months of 2006. Typically, because of the continuous depreciation of the Turkish lira since the 1970s, a high level of dollarization was present in the financial systems, investors and households’ confidence in Turkish lira assets were low. With lower levels of inflation, a relatively stabilized financial system and interest from international investors, demand for Turkish lira assets strengthened after 2001. Continued market confidence, particularly by international investors, led to a tremendous flow of foreign investments, especially in 2005 and 2006, which the amounts reached USD 10 and USD 20 billion, respectively (see Figure 2.6 on page 21). The reopening of international interbank credit lines, net non-resident portfolio inflows (after three years of outflows) and private sector medium-term borrowing are the main inflows that can be identified (IMF, 2005b).

30 Turkish Banking 10 8

Percentages

6 4 2 0
2
4
6

Figure 2.13

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992


8
10

Current account deficit as a percentage of GNP, 1992–2006

Source: Central Bank of Turkey (2008).

During this period, the main macroeconomic concern was the widening current account deficit, which surged, with higher oil prices, increased imports of machinery and equipment, and rising demand for imported consumption goods being major contributors. After 2001, the current account deficit reached a level of 8 per cent of GNP in 2006 (see Figure 2.13). Although external balance faced record high levels, the Turkish lira has appreciated continuously during this period as a result of massive capital inflows and reverse currency substitution. However, despite this appreciation, rising productivity and declining unit labour costs helped to sustain external competitiveness and export growth. According to IMF (2005b), despite the large current account deficit, gross reserves (see Figure 2.7 on page 22) increased as a result of strong capital inflows, a large share of which remained short-term and debtcreating. These inflows consisted mainly of foreign borrowing (traderelated credits, interbank and corporate borrowing) as foreign direct investment remained low, and portfolio investments into government bonds were larger than those into equities. Unemployment is another concern for the Turkish economy, and it has always been a chronic drawback. Since 1980, it has been 8 per cent on average, but after 2000 it soared to a record level of 10 per cent (see Figure 2.14).

Renewal of the standby agreement with the IMF, 2005 In 2005 Turkey signed another standby agreement with the IMF. The major motive behind the new agreement was a great financing needs for forthcoming USD40 billion external debt payments between 2005 and 2008. According to IMF (2005b), despite the country’s economic and

Overview of the Turkish Economy 31 12

Percentages

10 8 6 4 2

Figure 2.14

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

1984

1982

1980

0

Unemployment, 1980–2006

Source: Treasury Economic Indicators (2007).

structural improvement, the following factors (mentioned earlier) were still unresolved: 1. a social security system deficit of 4.5 per cent of GNP; 2. widespread tax evasion, a large unregistered economy, a narrow tax base, and dependence on distortionary indirect taxes; 3. high unemployment; 4. high real interest rates; 5. high domestic liability dollarization;3 6. low foreign direct investment; 7. high short-term public debt and roll-over requirements; 8. possible vulnerabilities from an accumulation of external debt by the private sector and strong foreign capital inflow (see Figure 2.15 for a sectoral composition of outstanding foreign debt); 9. the possible impact of sudden shift in investor sentiment as a result of exchange rate and interest rate developments depending on future global liquidity conditions; and 10. a continuing rapid expansion of domestic bank lending, which could pose additional challenges to financial sector stability.

A short history of political instability A significant feature of the Turkish economy since the 1950s has been instability in politics, which has led directly to failures in macroeconomic policy, which in turn led to financial and economical crises. Over this period, Turkey has seen three military coups and

32 Turkish Banking Public sector Banks Non-financial firms

Central bank Non-bank financial institutions

210,000

Millions USD

180,000 150,000 120,000 90,000 60,000 30,000

Figure 2.15

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

0

Sectoral composition of outstanding foreign debt, 1996–2006

Source: Treasury Statistical Yearbook (2007).

forty-one different governments, which served (despite the constitution requiring elections only every five years) on average for 1.4 years each (see Table 2.3 for ruling governments since 1950). Moreover, most of these governments were formed by several parties with different political ideologies as a coalition, which made it difficult to pursue consistent policies. Political stability, where single-party governments ruled, only lasted for limited time periods. Turkish politics can be characterized by terms such as: populist policies, large budget deficits, moral hazard problems, and high foreign and domestic debt. These features, coupled with high real interest rates, persistent high inflation and the devaluation of the currency, large current account deficits and volatile short-term international capital flows, produced a very weak economic structure. Here we shall outline briefly the major local and global political issues and challenges that Turkey faced during the latter part of twentieth century, to enable the reader to link these developments with the poor economic performance of the country. Turkey was formally proclaimed a republic in 1923, with Atatürk being its first president, who served until his death in 1938. During the fourteen years of Atatürk’s presidency, the country underwent a great transformation, attempting to change the religious, social and cultural bases of Turkish society as well as its political and economic structure. The Ottoman Empire, predecessor of the Turkish Republic, had been a strong Islamic Empire in the world and had powerful religious ties. The new

33 Table 2.3 Governments serving in Turkey, 1950 to present∗ Government Formed number

Dissolved

19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60

9 March 1951 17 May 1954 9 December 1955 25 November 1957 27 May 1960 5 January 1961 20 November 1961 25 June 1962 25 December 1963 20 February 1965 27October 1965 03 November 1969 6 March 1970 26 March 1971 11 December 1971 22 May 1972 15 April 1973 26 January 1974 17 November 1974 31 March 1975 21 June 1977 21 July 1977 5 January 1978 12 November 1979 12 September 1980 13 December 1983 21 December 1987 9 November 1989 23 June 1991 20 November 1991 25 June 1993 5 October 1995 30 October 1995 6 March 1996 28 June 1996 30 June 1997 11 January 1999 28 May 1999 18 November 2002 11 March 2003 3 September 2007

22 May 1950 9 March 1951 17 May 1954 9 December 1955 25 November 1957 30 May 1960 5 January 1961 20 November 1961 25 June 1962 25 December 1963 20 February 1965 27 October 1965 03 November 1969 6 March 1970 26 March 1971 11 December 1971 22 May 1972 15 April 1973 26 January 1974 17 November 1974 31 March 1975 21 June 1977 21 July 1977 5 January 1978 12 November 1979 21 September 1980 13 December 1983 21 December 1987 9 November 1989 23 June 1991 21 November 1991 25 June 1993 05 October 1995 30 October 1995 6 March 1996 28 June 1996 30 June 1997 11 January 1999 28 May 1999 18 November 2002 14 March 2003 3 September 2007

Served Prime minister for (years) 0.8 3.2 1.6 2.0 2.5 0.6 0.9 0.6 1.5 1.2 0.7 4.0 0.4 1.1 0.7 0.4 0.9 0.8 0.8 0.4 2.2 0.1 0.5 1.9 0.8 3.2 4.0 1.9 1.6 0.4 1.6 2.3 0.1 0.4 0.3 1.0 1.5 0.4 3.5 0.3 4.5

Adnan MENDERES Adnan MENDERES Adnan MENDERES Adnan MENDERES Adnan MENDERES Cemal GÜRSEL Cemal GÜRSEL I˙ smet I˙ NÖNÜ I˙ smet I˙ NÖNÜ ˙ ˙ Ismet INÖNÜ Suat Hayri ÜRGÜPLÜ ˙ Süleyman DEMIREL ˙ Süleyman DEMIREL ˙ Süleyman DEMIREL ˙ Nihat ERIM Nihat ERI˙ M Ferit MELEN Naim TALU ˙ Mustafa Bülent ECEVIT Sadi IRMAK ˙ Süleyman DEMIREL ˙ Mustafa Bülent ECEVIT ˙ Süleyman DEMIREL ˙ Mustafa Bülent ECEVIT ˙ Süleyman DEMIREL Bülent ULUSU Turgut ÖZAL Turgut ÖZAL Yıldırım AKBULUT A. Mesut YILMAZ ˙ Süleyman DEMIREL ˙ Tansu ÇILLER ˙ Tansu ÇILLER ˙ Tansu ÇILLER A. Mesut YILMAZ Necmettin ERBAKAN A. Mesut YILMAZ Mustafa Bülent ECEVI˙ T ˙ Mustafa Bülent ECEVIT Abdullah GÜL ˘ Recep Tayyip ERDOGAN ˘ Recep Tayyip ERDOGAN

Note: ∗ Entries shaded in grey indicate governments toppled by military pressure. Source: Republic of Turkey Prime Ministry (2008).

34 Turkish Banking

republic, on the other hand, pursued a secular state policy. However, the Islamist movement has always been within the political system, attempting to dilute the state’s secular roots, and this created much conflict, leading to some military (who regard themselves as the guardians of secular republic) involvement to politics. After the Second World War, Turkey, being under pressure from the Union of Soviet Socialist Republics (USSR), allied with the West and became a recipient of US assistance under the Truman doctrine. Being very close to the USSR geographically but also an ally of the USA affected the dynamics of local politics for more than forty years until the collapse of Soviet empire in 1989. As a consequence of the Cold War, Turkey became a member of North Atlantic Treaty Organization (NATO), and US air and missile bases were subsequently established at Izmir and Adana, where the USA also held nuclear weapons, in response to the Soviet threat. The USA was influential in domestic politics, especially when it put pressure on Turkey to switch to a multi-party democracy. As a result, in 1950, for the first time, Turkey practised democracy, with two parties, the Democratic Party and the ruling Republican People’s Party, competing in the elections. Economical expansion in the 1950s with the help of the Marshall Plan terminated in a serious economic crisis towards the end of 1950s, which led to demonstrations against the government and ended with a military coup in 1960. The military regime executed the prime minister (Adnan Menderes), together with several other party members, for violating the constitution. Turkish ties with the USA were later strengthened during the infamous Cuban Missile Crisis, when Turkey sided with the USA against USSR. Between 1960 and 1970, Turkey experienced eight different governments, and civil unrest caused by political conflicts between the left and right wing (a local reflection of the global conflict between the USA and the USSR), coupled with severe earthquakes in 1970 led to political instability. With the pressure from the military, the government changed once again in the early 1970s. In 1974, Turkish troops invaded Cyprus following a Greek-orientated military coup there, and gained control of roughly 30 per cent of the island. The occupation of the island has remained a political obstacle between Turkey and the EU regarding Turkey’s EU membership. Turkey faced many minority governments between 1975 and 1980. The impact of global economic crises of the 1970s on the local economy once again led to civil violence (mainly between leftists and rightists), which ended yet with another military takeover of control in 1980. In 1983, democracy was restored once again, with democratic

Overview of the Turkish Economy 35

elections. The period between 1983 and 1989 was relatively stable, and Turkey experienced export-led growth and financial liberalization. During the first Gulf War of 1990/01, once again Turkey let the USA use military bases located in Turkey to pursue operations in Iraq. Following an economic boom in the late 1980s, chronic high inflation, a large foreign debt, and large budget deficits led to a financial crisis in 1994. In 1995, Turkey joined the customs union with the EU, with hopes of getting closer to full membership. In the 1995 elections, an Islamist party, for the first time in the republic’s history, won the majority of votes and led to a coalition headed by Necmettin Erbakan. Conflict between secular and religious- orientated views became highly apparent during this period. Erbakan’s close ties with Islamic countries and his attempts to dilute the secular state structure led to pressure by the military and other secular institutions in the country for him to resign. Later, Erbakan was banned from politics for five years and his party was disbanded (but later, other parties were formed with the same political view). Two major earthquakes in 1999, killing thousands of people, had a significant impact on the economy. A standby agreement with the IMF to bring down the chronic high inflation and implement structural reforms to tackle fiscal deficits and high foreign debt failed late in 2000, with a financial crisis caused mainly caused by the weak structure of the banking system. Political disputes over the pace of reforms imposed by the IMF and the EU between the coalition government headed by Bülent Ecevit and President Ahmet Necdet Sezer, led to another political crisis, causing capital outflow and an economic crisis in 2001. Crises and political disputes among the members of the coalition government let to premature elections in late 2002. The Justice and Development party (formed mainly by the members of previously banned Islamic parties) won the majority of seats in the government, and for the first time, after twenty years of unstable coalition governments, a political party had the chance to govern alone. The political instability discussed above is also reflected in Turkey’s relations with international financial bodies, mainly the IMF. Since 1947, Turkey, struggling to solve its structural economical problems, has signed numerous stand-by agreements with the IMF (see Table 2.4). In 2002, the EU’s refusal to set a date for the start of negotiations for Turkey’s membership caused major disruptions to the relationship between the EU and Turkey. Cyprus, which became an EU member in 2004, was still a major issue between Turkey and the EU. Turkey’s ties with the USA also weakened for the first time in fifty years, when the Turkish parliament refused to grant the US permission to invade Iraq

36 Turkish Banking Table 2.4 IMF’s stand-by arrangements with Turkey, 1961–2005 Year

Duration (months)

Amount received (millions USD)

Amounts purchased (millions SDR)

1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1978 1979 1980 1983 1984 1994 1999 2002 2005

12 9 11 11 12 12 11 9 12 12 24 12 36 12 12 14 36 36 36

55 46 32 32 32 32 40 40 40 132 441 368 1,838 331 331 897 22,105 18,846 10,000

24 22 32 28 – 32 40 40 15 132 132 338 1,838 83 248 682 17,254 16,846 6,600

Total

55,638

44,386

from bases located in Turkey. After serving for five years, the Justice and Development party won the elections in 2007 with a greater majority of the vote (47 per cent). One of the factors for such a strong representation was the economic growth experienced as a consequence of the implementation of delayed structural macroeconomic reforms (with pressure from the IMF, the EU and the international financial community). However, despite a good economic performance being achieved, the political background of the Justice and Development party and its prime minister have led to concerns about a background Islamist agenda, which the party is accused of following in secret. The party’s policies, such as easing the ban on the wearing of the Muslim headscarf in public institutions, and efforts to criminalize adultery are shown as the proof of such agenda. These conflicts around secularism between the two sides of Turkish society may yet create other conflicts that have the potential to lead to more political instability within the country.

Overview of the Turkish Economy 37

Conclusion The chapter has presented major economic developments and the progress of the Turkish economy in a chronological order by looking at six sub-periods. The economy in the early years of the Turkish Republic was dominated mainly by foreign capital that was investing in infrastructure. During this early period, Turkey tried to implement a liberal economic policy and focused on establishing industrial manufacturing by supporting private entrepreneurship, though the lack of national capital and world economic crises in 1929 made it inevitable for the state to intervene. After 1930, state-led economic policies were prevalent in the economy, where the government established state enterprises in key industries. After the Second World War, policies shifted once again, towards liberalization, and the aim was to reduce the role of the state in the economy while supporting the expansion of the private sector as an industrialization strategy. Between 1960 and 1979, Turkey followed an import substitution and inward-orientated growth strategy; however, this period was affected negatively by the global economic consequences of the oil shocks of the 1970s and dependency on imported inputs for industrial production, which led to balance of payments problems. The beginning of the 1980s saw another structural change in the Turkish economy, towards export-orientated growth supported by capital account and trade liberalization, and the establishment of a free market economy. The inability to control fiscal deficits was the core problem in the Turkish economy during this period, leading to high chronic inflation that ranged between 30 per cent and 100 per cent. Irresponsible fiscal spending, high interest rates and inflation, lax macroeconomic policies, a weak financial system and the impact of sudden capital inflows and outflows led to severe economic crises in both 1994 and 2000/01. The poor performance of the Turkish economy was reflected to its relationship with global monetary institutions; between 1963 and 2005, Turkey signed eighteen standby agreements with the IMF. Since 2001, the Turkish economy has improved significantly, output has grown rapidly, inflation has fallen to its lowest level in a generation, and government debt has declined markedly. The implementation of an economic programme and structural reforms, supported by IMF loans, addressing debt sustainability and debt roll-over, together with prudent fiscal policy, have helped to reduce inflation. The fragility of the financial system has been reduced with the re-capitalization of state banks and weak private banks. However, high real interest rates and roll-over risk of government debt, unemployment, high current account deficit and high dependency on foreign capital inflows are still major problems that need to be tackled.

38

Appendix 2.1 Other 1%

SDR 12%

EUR 30%

USD 54%

JPY 3% Figure 2.A1 debt, 2006

Currency denomination of central government outstanding foreign

70

Percentages

60

Turkish lira

Foreign exchange

50 40

22.1

12.7

30 20

3 2 .6

32.6

Fixed

Variable

10 0

Figure 2.A2 Currency and interest composition of central government outstanding debt, 2006

39

Appendix 2.2 Industry

Services

Public services

Other

1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Percentages

Agriculture 1.00 0.90 0.80 0.70 0.60 0.50 0.40 0.30 0.20 0.10 0

Figure 2.A3

Contribution of sectors to GNP, 1979–2003

Figure 2.A4

Industry

Services

Sectoral distribution of workforce, 1980–2003

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

1985

1984

1983

1982

1981

1980

Percentages

Agriculture 1.00 0.90 0.80 0.70 0.60 0.50 0.40 0.30 0.20 0.10 0

3 Trends in the Banking Industry

Introduction This chapter links with Chapter 2 and looks at the evolution of Turkish banking in relation to economic developments in Turkey. The historical evolution of the modern banking sector in Turkey can be divided into seven periods. These seven phases of Turkish banking are shaped by the economic policies implemented in the country as well as developments in the global economy and financial markets.1 The first phase, which refers to the era before the declaration of the Republic of Turkey in 1923, is often called the Ottoman period. The formation of national banks to support agricultural and industrial development, together with commerce, between 1923 and 1932, constitutes the second phase. The third phase includes the establishment of state banks for special tasks, in an attempt to begin industrialization through SEEs, and dominates the years between 1932 and 1945. The fourth phase, between 1945 and 1959, saw the emergence of the private banks as a by-product of the process of shifting to a policy of industrialization by supporting the private sector. Changing once again to a mixed economy model, by implementing an import substitution policy, affected the banking sector’s structure between 1960 and 1980, which constitutes the fifth phase. An era of financial liberalization beginning in 1980 changed the shape of the banking sector and initiated the sixth phase. Finally, the restructuring of the sector and the heavy penetration of foreign banks into the Turkish banking market after the 2001 economic and financial crises constitutes the seventh and last phase.

40

Trends in the Banking Industry 41

Banking in the Ottoman period In spite of being a world economic power for such a long time, the introduction of banking business to the Ottoman Empire occurred much later than in Europe. The establishment of the first bank in the Ottoman Empire was in 1847, following the introduction of first banknote (Kaime) in 1840. Before this period, banking activities were carried out predominantly by moneychangers and the so called ‘Galatia bankers’, who were generally from the ( Jewish and Armenian) minorities living in Istanbul. According to BAT (1999a), in an attempt to fund the continuous budget deficits, the Ottoman Treasury increased the amount of national currency, but at the same time the country was facing a persistent trade deficit and the Treasury was facing difficulties in finding sources of funding to finance the imports. As a result of both developments, the value of Kaime faced a sudden devaluation. With the permission of the Treasury, I˙ stanbul Bankası was formed by the Galatia bankers to preserve the value of the national currency and help to finance the trade deficit in international financial markets. Although I˙ stanbul Bankası, which closed in 1852, is recorded as being the first official bank of the Ottoman Empire, the first significant bank established in the Empire was the Ottoman Bank (Osmanlı Bankası). The Ottoman Bank was founded in 1856 as a joint venture between British interests, the Banque de Paris et des Pays-Bas of France, and the Ottoman government. The bank, which had its head office in London, began to serve as a central bank of the empire’s financial system and was also granted the authority to print money in 1863.2 However, Akgüç (1989) argues that, because of a previous sudden devaluation of the national currency, the public had no confidence in the money printed by the Ottoman Bank and the bank was unable to pursue an effective role in defining the liquidity and credit volume of the economy. According to the BAT (1999a), the Ottoman Bank was given the authority to supervise the government budget, and the Ottoman Treasury not only held all its accounts in the bank, but also issued all bonds concerning its domestic and foreign borrowing through the Ottoman Bank. In general during this period, the financial needs of the Ottoman Empire changed considerably because of the deterioration of the financial system after the Crimean War, which led to a dependency on external support. As a consequence of this need for finance, a large number of foreign banks began to operate in Istanbul, with the intention of extending credit to the Empire at high interest rates. The majority of the banks within the Turkish financial system during this first phase of banking

42 Turkish Banking

were established by foreign capital. The main function of these banks was to earn speculative profits from foreign exchange transactions and domestic and foreign borrowings of the Ottoman government in addition to providing investment credit to foreign investors (BAT, 1999a). While the existing banks were mainly funding the Treasury, there was a lack of financial institutions to support local farmers (who constituted the bulk of the population) or economic activity. A state fund was established in 1863 to fill this gap and to extend agricultural loans to farmers. The first state bank, Ziraat Bankası, was established in 1888 by converting the state fund to a bank with a mission to make loans to the agriculture sector under state supervision. In the early 1910s, a national banking movement began in the Ottoman Empire, as a reaction to foreign banking. Between 1908 and 1923, twenty-four national banks were established with national capital in Istanbul and Anatolia. These national banks, privately-owned by tradesmen and farmers, extended loans for commerce, agriculture, trade and housing. However, foreign banks continued to dominate banking activities as a result of the wars between 1911 and 1922, capitulations granted to foreigners, and scarcity of national capital. Akgüç (1989) argues that the main reason for the establishment of the national banks was to take control of national capital away from the banks owned by foreigners and minorities, and utilize these funds to promote and develop national trade. Despite the supportive national economic policy followed by the government that paved the way for the establishment of national banks, most of these banks did not last long because of the powerful competition from the foreign banks which were dominant in the credit market (Akgüç, 1989).

The new Republic and the establishment of the new national banks After the founding of the Turkish Republic in 1923, policy-makers focused mainly on promoting and establishing industrial manufacturing, and supporting private entrepreneurship through the development of a national banking sector to provide the necessary financial instruments for investors. As indicated by Akgüç (1989), in 1923 the formal financial system comprised of thirty-five banks, of which twenty-two were Turkish-owned and thirteen foreign-owned, with a total number of 439 branches. Most of these foreign banks dealt only with foreign trade and foreign companies operating in Turkey, and their involvement with Turkish firms was limited. On the other hand, Turkish-owned banks

Trends in the Banking Industry 43

were mainly small local banks that were too weak to support the newly emerging industry and commerce. Lack of national capital enabled the private sector to set up banks to support industrialization, and state participation for the establishment of national banks became a necessity. The first main bank of this era, a joint establishment with combined ˙ s Bankası, established in 1924 state and private initiative, was Türkiye I¸ with the main aim of supporting commerce. In 1925, Türkiye Sanayii ve Maadin Bankası (which subsequently changed its name to Türkiye Sanayii ve Kredi Bankası) was founded as a development bank to provide loans to private industrial companies and to provide know-how in economic, financial and technical matters. The government also strengthened Ziraat Bankası by injecting capital and widening its operations outside the agricultural sector. Another major bank, Emlak ve Eytam Bankası (later Emlak ve Kredi Bankası), was established in 1927 to provide housing credit. Denizer (1997) argues that, during the period 1923–32, parallel to its broad strategy of industrialization via private-sector encouragement, the government’s regulatory approach to banking and finance was quite liberal and aimed at developing a national banking system. While the government provided the initial capital for four public banks and led development efforts, it allowed (and actively encouraged) the formation of private banks. As a result, around twenty-nine new private banks, mainly single-branch and local, were established, with practically no restrictions for entry. The Central Bank at the time of writing was also established during this period.3

The period of state-owned banks, 1932–45 By 1932, the number of banks had reached sixty, of which forty-five were national (up from only thirteen in 1923), and fifteen were foreign. The important aspect of this period for banking, according to Denizer (1997), was the creation of new public banks to provide support for the new state enterprises. Accordingly, during this period, Sümerbank (1933), Belediyeler Bankası (1933), Etibank (1935), Denizbank (1937) and Halk Bankası (1938), were established by the state as special-purpose banks in order to support and fund the state-led enterprises. Sümerbank provided the main funding to enterprises in the manufacturing sector, while Etibank was set up with the aim of managing and financing the enterprises in the fields of mining and energy. Belediyeler Bankası extended credit to municipalities for the development of infrastructural utilities such as water, electricity and drainage systems. Denizbank was

44 Turkish Banking

established to support the construction of maritime enterprises and finance their investments, while Halk Bankası predominantly supported small tradespeople. Although there was no significant change in the government’s regulatory policy from the previous period, there was no entry of private banks into the system. In fact, this period was characterized by the exit of most small private local banks because of the economic slowdown in Turkey resulting from the global economic crisis and the advent of the Second World War. In turn, these developments reduced the number of banks and increased the dominance of public banks in the sector. The number of banks fell to forty in 1945, with the number of branches falling from 483 to 411. Also in this period, with the introduction of the banking law, reserve requirements were forced on banks, which were obliged to reserve 15 per cent of deposits from government securities or securities that has the same interest yield as these instruments.

Establishment of private banks, 1945–60 The number of banks increased tremendously between 1945 and 1960, in parallel with an increase in investments, urbanization and population, which ultimately increased the demand for both money and credit. During this period, twenty-seven private and three public banks were established. Some of the largest private banks of today’s banking system were founded during this period: Yapı ve Kredi Bankası in 1944, Garanti Bankası in 1946, and Akbank in 1948. Denizer (1997) provides the banking statistics for this period. By 1958, there were sixty-two banks in the system, a number that was not surpassed until 1989. The number of bank branches increased around fourfold, reaching 1,759 by 1959, and the process of nationwide branching was well under way. However, most of the newly established banks did not stay in the system long, because competition on deposits and dependence on branch banking. Ten small, locally-owned banks and four foreign banks went into liquidation between 1945 and 1959, during the process of branch banking. With a net entry of sixteen banks between 1944 and 1960, and a small number of mergers among the existing banks, the total number of banks in the system at the end of 1960 was fifty-nine. The slowdown in economic activity towards the end of the 1950s, the 1958 recession, and the government’s stabilization programme led to further failures. Eventually, economic crises resulted in political crises and hence it became necessary to take new economic measures, so Turkey moved towards a centrally-planned economy.

Trends in the Banking Industry 45

Banking in the planned economy, 1960–79 As established in Chapter 2, between 1960 and 1979 Turkey followed a state-led inward-orientated growth strategy by following import substitution policies and economy-wide planning. Akgüç (1989) points out that these development plans aimed to merge small banks in the sector to reduce the overhead costs with a aim of creating a stronger financial sector. Therefore, instead of new commercial banks, government only permitted the establishment of new development and specialized banks between 1962 and 1975, which were not authorized to take deposits. These were the Turizm Bankası (Tourism Bank) in 1960, Sınai Yatırım ve Kredi Bankası (Industrial Investment and Credit Bank) in 1963, Eximbank in 1964, Türkiye Kalkınma Bankası (Turkish Development Bank) in 1975, Devlet Maden Bankası (State Metal Bank) in 1968 and Devlet Sanayi ve I˙ s¸ çi Yatırım Bankası (State Industrial and Labour Bank) in 1976. Sınai Yatırım ve Kredi Bankası was a private-sector bank aimed at sustaining the long- and medium-term loans needed to finance investments in the private sector listed in the development plans. Eximbank (previously called Devlet Yatırım Bankası), was established as a state bank to finance the credit that state economic enterprises needed for their investment projects in manufacturing industry, energy, mining and transport sectors. Figure 3.1 displays a list of the banks, with size of each sector, number of branches and number of personnel as they were 1963. Between 1963 and 1980, only two new commercial banks were established (Amerikan-Türk Dı¸s Ticaret Bankası in 1964, and Arap-Türk Bankası in 1977), which demonstrates the existence of strong regulatory entry barriers. On the other hand, twenty-three banks were either liquidated or merged, which reduced the number of banks to forty-three by 1980, from fifty-nine at the end of 1959. Another characteristic of this period, particularly after the early 1970s, has been the emergence of private banks owned by industrial groups, which Akgüç (1989) refers to as the beginning of holding banking. The period between 1963 and 1980 also saw a rapid expansion of branches of banks already in the system. In an environment where there were no risks of interest rate or exchange rate changes and price competition, the private-sector banks moved towards branch banking in order to increase the deposits they collected on negative real interest rates (BAT, 1999a). Denizer (1997) argues that rising inflation during the late 1960s and throughout the 1970s also provided another strong incentive for banks to expand their branch networks. With interest rates becoming increasingly negative in real terms, opening new branches to collect

46 Turkish Banking Banks founded according to special laws Ankara Halk Sandı˘ gı Denizcilik Bankası Etibank Iller Bankası ˙ Istanbul Emniyet Sandı˘ gı ˙ Istanbul Halk Sandı˘ gı ˙ Izmir Halk Sandı˘ gı Sümerbank TC Turizm Bankası TC Ziraat Bankası Emlak ve Kredi Bankası Halk Bank Ögretmenler Bankası Vakıflar Bankası

Other national banks Akbank Anadolu Bank Çaybank Demirbank Efesbank Egebank Eski¸sehir Bankası ˙ Istanbul Bankası ˙ sçi Kredi Bankası I¸ Kocaeli Bankası Maden Kredi Bankası Milli Aydin Bankası Pamukbank Türk Ticaret Bankası Ba˘ gcilar Bankası Garanti Bankası ˙ Imar Bankası ˙ s Bankası I¸ Kredi Bankası Tütüncüler Bankası Yapı ve Kredi Bankası

Local banks Adapazari Emniyet Bankası Afyon Terakki Servet Bankası Ak¸sehir Bankası ˙ Denizli Iktisat Bankası ˙ Elazı˘ g Iktisat Bankası Lüleburgaz Birlik Ticaret Bankası Sa˘ glık Bankası

Foreign banks Banca Comerciale Italiana Banco di Roma Holantse Bank Osmanlı Bankası Selanik Bankası

Development and investment banks Sınai Yatırım ve Kredi Bankası Sınai Kalkınma Bankası

Branches Personnel Total assets (USD) Banks founded according to special laws Other national banks Foreign banks Local banks Development and investment banks Total Figure 3.1

920 847 64 7 2

19,248 15,737 1,677 36 159

187,536,544 81,536,278 119,269,500 91,900

1,840

36,857

388,434,222

Banks in Turkey, 1963

Source: Compiled from BAT (1963: 15–19).

deposits and investing them into real assets was highly profitable. In fact, the number of branches of both public and private banks rose as deposit rates became increasingly negative in real terms. As a result of these factors, the number of branches jumped to 5,975 in 1980 from

Trends in the Banking Industry 47 Table 3.1 Numbers of branches, personnel and total assets of banks in Turkey, 1980 Branches Personnel Total Assets (USD millions) Banks founded according to special laws Other national banks Foreign banks Development and investment banks

2,490 3,374 105 6

68,248 60,596 1,842 394

9,940 9,218 598

Total

5,975

131,080

19,756

Source: Compiled from BAT (1980: 17–22).

1,840 in 1963, despite there being a significant reduction in the number of banks. According to Denizer (1997), this process resulted in excessive investment in bank branches and contributed to bank sizes that were larger than they would be if the price of capital were not distorted. At the same time, it contributed significantly to concentration in the sector, since there was very little entry, which meant that the expanding banks were the old established ones. Consequently, Denizer (1997) argues that the combination of mutually reinforcing financially and regulatory restrictive policies, coupled with the exit of twenty-three banks over the period 1960 to 1980 led to a highly concentrated market structure, and an over-branched, inefficient banking system. By 1980, the top five banks controlled about 70 per cent of deposits and 64 per cent of assets, they owned 60 per cent of all branches, and controlled more than 70 per cent of the number of deposit accounts. Overhead costs in the sector reached around 70 per cent of total assets, almost triple the OECD average by 1980. Hence, while the development strategy and its related financially and regulatory restrictive policies contributed to the industrialization of Turkey, they may have introduced distortions that were difficult to eliminate with respect to the systems’ efficiency and competitiveness. Table 3.1 and Figure 3.2 present the number of branches, personnel, asset size and concentration for the Turkish banking sector in 1980.

Banking after financial liberalization As described in Chapter 2, the beginning of the 1980s in Turkey was a period of liberalization establishing free market economy model. Together with the removal of capital account controls, Turkey adopted

48 Turkish Banking Top 4 banks’ liabilities

Ziraat Bankas 24% Others 43%

s¸ Bankas 15%

Yap ve Kredi Bankas 8%

Akbank 10%

Figure 3.2 Top four banks’ liabilities as a percentage of total liabilities of the banking sector in Turkey, 1980 Source: Compiled from BAT (1980: 21–2).

a flexible exchange rate and positive real interest rate policies. These measures reflected on the banking sector as the removal of interest rate controls. However, Odekon (2002) points out that the deregulation of deposit and lending rates in 1980 was short-lived, and was suspended with the collapse of the financial markets in 1983. Inselbag and Gültekin (1988) argue that the well-documented brokerage house crisis that led to the collapse was the result of the ‘uncontrolled’ deregulation in effect in 1980–2. According to Odekon (2002), the lack of an established legal and institutional framework enabled brokerage firms to offer high interest rates they could not afford. This situation, combined with economic downturn and financial distress in non-financial sectors led to the collapse of six banks during 1983 and 1984. As a result of the mini financial crisis of 1983, a new Banks Law came into force, and new regulations were introduced into the financial system in 1985. Keskin (1993) outlines some of these as (i) introduction of international banking standards on auditing, supervision and accounting; (ii) establishment of deposit insurance fund; (iii) commencement of open market operations by the Central Bank; (iv) shift to a transparent monetary policy; and (v) introduction of an electronic fund transfer system. The failure of banks in turn has also led to a partial reversal of reforms on deposit interest rates. The Central Bank began to re-regulate deposit interest rates, though at much higher levels relative to the pre-1980

Trends in the Banking Industry 49

situation. However, according to Denizer (1997), as much as this was to restore financial stability, it was also a measure to deal with the collusive practices of banks. The Central Bank continued with the regulation of deposit rates until 1988, occasionally adjusting them to maintain positive real rates of return. In late 1988, deposit rates were again liberalized and this policy has been maintained since then, despite a number of temporary interventions. According to the BAT (1999a), the implementation of the free market mechanism and freedom introduced in the financial markets had important effects on the banking system. New entrants to the banking system increased the competition under a market-determined interest rate regime. The typical kind of deposit banking seen in previous periods gave way to more modern banking practices, and customers were introduced to new products and services, such as consumer credit, credit cards, leasing, factoring, forfeiting, swap, forward futures, options, automated cash machines and sales point terminals. Moreover, with the use of computer systems, technological improvements, and the importance placed on human resources, productivity increased in the sector. During this period, one significant development was the shift by depositors from Turkish lira assets to hard currency assets. This was mainly a consequence of chronic high inflation in the previous two decades (details of dollarization will be examined later in this chapter). The free capital movements led to heavy foreign borrowing by banks. According to Parasız (1994), because of the free interest rate and flexible exchange rate policies, the encouragement of exports, freedom of imports, permission to open new banks, establishment of interbank Turkish lira and foreign currency markets, and developments in computer and communication technology, the number of wholesale banks with fewer branches increased, in contrast to a decrease in market shares of large-scale commercial banks. Turkish banks started to establish banks or open branches outside the country, and increased their business in foreign trade, leasing, factoring, forfeiting, acting as intermediaries in the export of securities, and short-term credit operations and increased financing from international markets. Besides diversifying their services, banks improved their technological infrastructure by extensive use of computer systems; they began to employ more qualified human resources; and at the same time placed an emphasis on training programmes (Akkurt et al., 1992). In general, the banking system underwent a rapid technological transformation in the 1980s, in order to increase the speed, quality and efficiency of banking services.

50 Turkish Banking Top 4 banks’ liabilities Ziraat Bankas 19%

Others 59%

s¸ Bankas 10% Akbank 6% Yapı ve Kredi Bankas 6%

Figure 3.3 Top four banks’ liabilities as a percentage of total liabilities of the banking sector in Turkey, 1990 Source: Compiled from BAT (1990: 26–7).

Electronic banking started in the early 1990s, and banks invested heavily in computer processing and data transmission systems. Because of a loosening of entry restrictions with the reforms, the number of banks increased from forty-three to sixty-six between 1980 and 1990. There were thirty-one new entries into the system, of which nineteen were foreign and eleven were national. Denizer (1997) points out that almost all of the new banks specialized in trade finance and wholesale corporate banking. None of the new banks, either foreign or Turkish, established offices beyond the three largest cities in Turkey, and by and large they eschewed the retail banking market despite the fact that there were no restrictions on the scope of their operations. The performance of the banking sector has improved in terms of profitability following the reforms, despite declining concentration ratios (see Figure 3.3 for the concentration in the banking sector in 1990) and new entries. As Atiyas and Ersel (1994) point out, profits in the banking sector increased substantially, particularly after the mid-1980s, and reached levels about five times the OECD average by the end of 1990. In 1990, the total number of branches was 6,560 while the banking sector employed over 150,000 people around the country (a detailed analysis and statistics of banking between 1990 and 2007 is undertaken in Chapter 4).

Banking and financial markets in the 1990s As discussed in Chapter 2, one of the most significant developments of the early 1990s was the financial crisis of 1994, which had significant adverse affects on the banking system in Turkey. Because of chronic

Trends in the Banking Industry 51 Table 3.2 Decomposition of deposits by currency denomination, 1989–93 Share of total deposits

1989 1990 1991 1992 1993

Total deposits (USD)

Turkish lira (%)

Foreign exchange (%)

75.6 74.5 66.2 60.5 53.9

24.4 25.5 33.8 39.5 46.1

28,196,411,251 33,783,886,980 39,465,185,925 41,702,143,223 40,408,626,364

Source: Compiled from BAT (1993: 8).

Table 3.3 Foreign exchange positions of the banking sector during the 1994 financial crises (USD millions) 1991

1992

1993

1994

State-owned banks Privately-owned banks Foreign banks Development and investment banks

−576 −1,063 −120 −89

−636 −2,133 −193 −194

−619 −3,714 −330 −381

105 −712 −85 −168

Total

−1,848

−3,156

−5,045

−860

Source: Compiled from BAT (1994: 18).

high inflation, the level of dollarization increased in the Turkish financial system prior to the 1994 crisis, and this was reflected in the choice of currency denomination among the depositors. Table 3.2 displays the currency denomination of deposits before the crisis. It can be seen that the share of foreign currency deposits (mainly USD) increased from 24 per cent in 1989 to 46 per cent in 1993. According to the BAT (1994), the financial sector was among the worst affected by the 1994 financial crises. The TBA argue that public banks’ share increased in the financial system, which shrank considerably because of the decrease in domestic savings. Moreover, the banking system was prone to balance sheet risk, with most banks carrying very large open foreign currency positions with foreign exchange liabilities and large Turkish lira government securities. Privately-owned banks carried the highest risk, when the total open foreign currency positions of the system reached to more than USD 5 billion in 1993 (see Table 3.3).

52 Turkish Banking Table 3.4 Change in the total assets of the banking sector during the 1994 crisis 1994 (USD millions)

Percentage change 1993–4

State-owned banks Privately-owned banks Foreign banks Development and investment banks

20,684 25,699 1,576 4,256

−23 −32 −42 −18

Total

52,186

−28

Source: Compiled from BAT (1994: 18).

Banks were also under pressure from foreign creditors to repay foreign liabilities amounting to USD 7 billion in 1994. The crisis led to the suspension of banking activities of three banks.4 In order to avoid a bank run and direct funds back to the banking system, the government introduced a full guarantee to savings deposits and a new 7-day notice deposit account facility. Table 3.4 shows the impact of the 1994 crisis on the banking sector’s total assets, which shrank 28 per cent with the impact of the crisis. According to the BAT (1994) during the early 1990s, the growth and profitability of the banking sector has been affected by frequent fluctuations in the economy, increases in the real interest rates and the inflation rate, fluctuations in the value of the Turkish lira against foreign currency, high liquidity requirements and high taxes. This is also reflected in the number of branches and employees of Turkish banks; between 1990 and 1994 the number of branches in the banking sector dropped from 6,560 to 6,087, while the number of employees decreased by 15,000. After 1994, with the expanding performance of the Turkish economy, the Turkish banking sector recovered quickly in terms of growth (Figure 3.4). The size of total sector assets relative to GDP increased from 30 per cent in 1994 to 67 per cent in 1998. This trend was observed mainly in the balance sheets of privately-owned banks. The share of state-owned banks in the banking sector gradually dropped during this period and concentration in the sector declined (see Figure 3.5 and Table 3.5). The biggest drop was observed in terms of total loans. In 1990, state banks carried 45 per cent of all loans in the system. By 1998, this ratio had dropped to 29 per cent, and privately-owned banks were the major lenders. Although a similar trend can be seen in the deposits, the change

Trends in the Banking Industry 53 Total assets to GNP 80 70 60 50 40 30 20 10 0

Billions USD

120 100 80 60 40 20 0 1991

Figure 3.4

1992

1993

1994

1995

1996

1997

Percentages

Total assets (left axis) 140

1998

Total assets of banking sector, 1991–8

Source: Compiled from BAT (1998: 41).

1990 (%)

1995 (%)

1998 (%)

54 59 57

48 53 50

43 49 40

Five largest banks Total assets Total deposits Total loans Figure 3.5

Concentration in the banking sector, as per asset size (percentages)

Source: Compiled from BAT (1998: 43).

Table 3.5 Sector shares of banking groups, 1990 and 1998

State-owned banks Privately-owned banks Foreign banks Development and investment banks

Total assets

Total deposits

Total loans

1990

1998

1990

1998

1990

1998

44.8 43.5 2.9 8.8

34.9 55.9 4.4 4.8

48.6 49.2 2.2 –

40.6 55.8 3.9 –

45.4 39.8 2.9 11.9

29.0 58.1 2.9 9.0

Source: Compiled from BAT (1998: 42).

was not as dramatic. Moreover, the share of the top five banks in total assets, deposits and loans plummeted significantly between 1990 and 1998, but smaller banks have increased their shares extensively in both loans and deposits.

54 Turkish Banking

Aftermath of the 1994 crisis In the second half of the 1990s, the foreign exchange positions that were closed after the 1994 crisis reopened and, despite the high cost of funding, borrowing from abroad began. Together with this, investors’ demand, affected by high expected inflation and interest rates, turned towards very short-term financial instruments. Repurchase agreements (repos) were the major instrument for savers, and most deposits time deposits were directed into the overnight repo market with the return of the high interest rate. At the same time, banks were funding their securities portfolios mainly with funds from the repo market. Meanwhile, foreign currency deposit demand, albeit slowed down, was still high during the second half of the 1990s. The open position on contingencies and commitments had grown. Consequently, funding longer-term loans and public debt, banks were facing a large maturity mismatch between their assets and liabilities, together with the foreign exchange risk. In addition to the fragility of private banks, public banks started to create major distortions to the financial system. Alper and Öni¸s (2001) argue that in the aftermath of the 1994 crisis public banks have created an uneven playing field in the banking sector because both their borrowing and their lending operations have been politicized. According to Alper and Öni¸s, these institutions have emerged as major instruments of rent distribution in the political process and directed lending at subsidized rates to favoured sectors has in part heavily undermined their capitalization, liquidity and profitability. The losses created for these operations were known as duty losses. The unwillingness of the Treasury in meeting these losses resulted in costly and heavy borrowing on the part of the public banks. This in turn helped to generate a major distortion in the system in the form of artificially high interest rates on deposits, as well as inter-bank borrowing. Initially, the IMF pressurized the government to stop sources of rent distribution in Turkey involving state economic enterprises, and extra-budgetary funds have largely been placed under control. However, late in the 1990s, the rent distribution mechanisms, mainly involving public banks, were reactivated once again. On top of the problems existing in the public-owned banking sector, the Turkish economy was affected significantly from the economic downturns and crises in emerging markets, such as Brazil, Russia and East Asia, in the late 1990s. This was reflected as capital outflows and a slowdown in international trade, leading to a sharp slowdown in the Turkish economy in 1999. As discussed in Chapter 2, the Turkish economy had a numerous structural problems including weak public

Trends in the Banking Industry 55

finance, high inflation and high unemployment, together with political uncertainty. In addition, Turkey experienced two great earthquakes disasters, as noted earlier, which added extra dimensions to the existing economic problems.

Establishment of the Banking Regulation and Supervisory Agency The introduction of the three-year stabilization programme with IMF support had significant implications for the banking sector in 1999. First, a new Banking Law came into force, introducing the establishment of the Banking Regulation and Supervision Agency (BRSA). This decisiontaking authority, independent of political influence, had administrative and financial autonomy and was aimed at the more efficient use of supervisory power. The BRSA became the sole authority for the licensing, regulating and auditing of banks. Previously, the duty of regulating the financial markets had been shared between the Treasury and the Central Bank. The staff working at banking evaluation and supervision departments in the Treasury and the Central Bank were transferred to the BRSA. The Savings and Deposits Insurance Fund (SDIF) became a legal entity administered by the BRSA. According to Alper and Öni¸s (2002), the establishment of the BRSA constituted a major source of progress in terms of establishing a wellregulated banking sector, which is a fundamental requirement for full capital account openness. However, the operation of the BRSA has been subjected to significant delays, and the institution was not in a position to prevent the twin crises of the early 2000s, which were very much associated with the malfunctioning banking system. Another main aim of the new Banking Law was to align Turkish banking regulations with Basel II and EU directives. In general, the new law introduced tighter risk management and control, supervision, and new principles in the calculation of capital adequacy ratio and foreign exchange exposure limits. Table 3.6 looks at these changes in detail. According to the BAT (1999b), before BRSA, the lack of internationally accepted banking principles, the problems encountered in the independent auditing process, the differences and variations from international accounting applications, the lack of satisfactory transparency and competition, inefficiency in the decision processes of auditing, and delays in the improvement of bank management quality, were all prevalent and had a negative effect on assessments of the banking sector.

Around USD 35,000 million – both for establishing a bank in Turkey or opening a branch by a foreign bank.

To be founded as a joint-stock company. 10 per cent of the minimum capital is to be deposited into the Fund as the entrance fee to the system. Founders have not been sentenced a heavy imprisonment for crimes stated in the Law. Foreign banks, which operate in Turkey by opening branches have not been prohibited or restricted from accepting deposits or engaging in banking operations in their countries. Its capital to be paid in cash.

After receiving permission to found a bank or to open a branch in Turkey, permission is also required before accepting deposits or engaging in other banking operations. This permission will be granted by the Board upon application in the form of a statement.

Banks are free to open new branches, provided that they comply with the principles set by the Board, and that they have achieved the standard ratios that came into force with the Law. If necessary, the Board may subject the opening of branches to permission. Banks established in Turkey must receive permission from the Board to open a branch or a representative office abroad. The permission of the Board is required for a bank established abroad to open a representative office in Turkey, provided it does not accept deposits and is not engaged in any other banking operations.

The transactions ensuring acquisition and transfer of 10 per cent, 20 per cent, 33 per cent and 50 per cent shares of a bank’s capital are subject to permission from the Bank Regulation and Supervisory and Board.

Cash loans and non-cash loans extended by a bank, bonds and similar capital market instruments purchased by it, loans provided by it through deposits or in any form or manner, claims arising from instalment sales of assets, overdue cash loans, non-cash loans converted to cash and participation shares shall be considered as a loan. A bank cannot extend loans to any natural or legal person, directly or indirectly, in excess of 25 per cent of its own funds. Loans directly or indirectly extended to a natural or legal person in excess of 10 per cent of the bank’s own funds shall be considered large loans. Their total cannot exceed an eightfold amount of its own funds.

Banks are obliged to set up an efficient internal audit system and a risk control and management system, with the principles and procedures defined in a regulation to be issued by the Agency.

An independent auditing firm must approve the annual balance sheet and profit and loss statement of a bank, to be submitted to its general assembly.

Banks must keep, publish and present to relevant authorities their annual balance sheets and profit and loss statements in accordance with principles and procedures to be laid down by the Bank Regulation and Supervisory and Board.

Minimum capital requirement

Principal conditions

Permission to accept deposits

Opening new branches

Transfer of bank’s shares

General risk limits on loans

Risk control and management

External auditing

Accounting and recording

Source: Adapted from BAT (1999b: 1–3).

Establishment of a bank in Turkey, or the opening of the first branch in Turkey by a bank founded in a foreign country, is permitted by the Bank Regulation and Supervisory and Board.

Some measures introduced by the Banking Law, 1999

Conditions for bank foundation

Table 3.6

56

Trends in the Banking Industry 57

Soon after the agreement and establishment of the BRSA, open positions of the banks were limited. However, according to the BAT (1999b) the limitation of forward foreign currency transactions were not welcomed by foreign investors, since it was claimed to decrease liquidity, and the domestic banks started to struggle to close their open positions in line with the new regulations. Decreases in the short-term interest rates, changes that the taxation of capital gains and withholding tax brought to banking transactions, and the impact of the Russian financial crisis on investor behaviour towards emerging markets all tightened the business of the banks prior to 1999. Turkish banks had a particularly difficult year in 1999 and displayed a poor performance due to decline in economic activity, leading to problems in loan repayments. Moreover public sector dominance of funds markets, dollarization in savings and shorter maturities composition of deposits (see Tables 3.8 and 3.9) have all put banks under pressure in a risky economic environment. These factors led to imbalances on balance sheets of banks with shorter-term liabilities and long-term assets together with foreign exchange open positions. As a consequence, five privatelyowned commercial banks failed and their operations were terminated, and the banks were taken over by the Savings Deposit Insurance Fund (SDIF).5

Recent developments, 2000–06 As noted earlier, Turkey faced two severe financial crises in 2000 and 2001. In November 2000 a major liquidity crisis together with prevailing weaknesses of the banking sector led to further bank failures and three banks were taken over by the SDIF, increasing the number of banks under the Fund’s control to eleven.6 The crisis in 2001 hit the financial system even harder, leading to a major downsizing in the banking sector. The number of commercial banks dropped to forty-six in 2001, from sixtyone in 2000, while the number of branches fell from 7,807 to 6,889. The control of eight more failed banks was handed over to the SDIF during 2001.7 Overall, the total asset size of the banking system shrank by 26 per cent to USD 115 billion. As a consequence of a series of mergers and liquidations there ware large layoffs in the banking sector and the number of employees dropped from 168,000 in 2000 to 132,000 in 2001. Worsening economic conditions also doubled the non-performing loans on the banks’ books. Non-performing loans soared to a record 17.8 per cent in privately-owned commercial banks. On the other hand, and as expected, the banks under the SDIF were the ones with the highest

58 Turkish Banking Table 3.7 Percentage of non-performing loans to total loans, 2000 and 2001 2000 (%)

2001 (%)

Publicly-owned commercial banks Privately-owned commercial banks Banks under Savings Deposit Insurance Fund Foreign banks Development and investment banks

12.5 6.2 70.6 2.9 1.6

40.7 17.8 199.7 5.4 7.5

Overall Banking Sector

11.6

23.2

Source: BAT (2002: 10).

non-performing loans. In total, the banking sector’s non-performing loans more than doubled after the 2000 crisis (see Table 3.7). In 2002 a law on the restructuring of debts to the financial sector was passed. This established a legal framework for the restructuring of the debts of companies to banks and strengthening the private banks’ capital. The aim of the adopted arrangements were to ensure the institutional and operational restructuring of the state banks; to accelerate the follow-up and collection proceedings of the banks under the SDIF; to provide capital support in order to strengthen the capital structures of the privately-owned banks; and to improve the regulatory and supervisory framework. Regarding the state banks, the main aims were to strengthen the capital base; to reduce overnight liabilities; to eliminate the usage of these banks’ funds by political motivation; to liquidate the duty losses created; and to establish an efficient loan portfolio mechanism. In the restructuring process, a joint board of directors were appointed for three state banks Emlakbank, Ziraat Bankası and Halkbank. Within a year, the number of branches and personnel under the management of a joint board of directors reduced to around 1,500 and 32,000, respectively. The total cost of the state bank restructuring was around USD 22 billion, or 15 per cent of the country’s GDP. Banks taken over by the SDIF underwent a similar restructuring process.

SDIF and the restructuring process8 The present-day SDIF was formed in 1983; the Central Bank was assigned the duty of representing the fund and carrying out administrative tasks. After the 1994 crisis, the SDIF was given the additional responsibility of strengthening and restructuring the poorly performing banks. In 1999, the SDIF was transferred under the umbrella of the newly established BRSA, and since 2003, with the passing of the new Banking Law, SDIF

Trends in the Banking Industry 59

has become an autonomous institution. Resources of the fund consist of insurance premiums, selected deposits, custody accounts and claims, contributions deposited by the founders of a bank to the fund, in an amount equal to 10 per cent of the minimum capital required, revenues from the assets of the fund, and other revenues. Currently, the SDIF provides deposit insurance which guarantees deposits in member banks up to USD 40,000 per depositor. The level of insurance has varied over the years since 1983, with a maximum of 100 per cent coverage in 1994 and 2003. Apart from the administration of the deposit insurance scheme, the SDIF have been occupied since 1994 with the main duties of taking over the management and supervision of the banks whose operating permission has been revoked by the BSRA and fulfilling the necessary operations regarding the bankruptcy and liquidation of them. A list of banks that have been transferred to the SDIF’s control is presented in Table 3.8. The immense impact of crises on the weak banking sector in 1994 and 2001 led to a takeover of twenty-five private banks by the BRSA. Some banks under the Fund’s control were consolidated into a single bank, and others were sold to national and foreign commercial banks. By the end of 2007, only one bank (Birle¸sik Fon Bankaları) remained under the Fund’s control. Most of the banks were either sold or merged into a single bank. For example, Egebank, Yurtbank, Ya¸sarbank, Bank Kapital and Ulusal Bank were merged under the name Sümerbank and sold to Oyak Bank, a privately-owned commercial bank. Similarly, Demirbank, the fifth-largest private bank in the system before the 2001 crisis, was sold to HSBC. Restructuring and liquidation operations of SDIF is funded by the Turkish Treasury and, as of February 2008, SDIF owes around USD 68 billion-worth of funds borrowed in the form of cash and secured bonds. Further amendments were made to the Banking Law regarding limits to the foreign exchange exposures of banks, loan loss reserves and provisioning, risk management, and accounting and audit practices. Subsequently, the capital structure of twenty-five commercial banks was strengthened through a special programme implemented by the BRSA. The BRSA’s decision to restructure banks that failed in the crises later proved to be a problematic one. Following a passive approach in a slowing-down economy, the BRSA had difficulty in restructuring the assets of the banks under its control. Towards the end of 2001, the BRSA switched to a proactive strategy targeting a renegotiation and restructuring of those nonperforming loans (NPLs) in banking sector balance sheets. The so-called ‘Istanbul Approach’ covered the restructuring of USD 5.1 billion-worth of loans, though, as Steinherr et al. (2004) argues,

60 Turkish Banking Table 3.8 Banks under the Deposit Insurance Fund as of 2002, all privately-owned commercial banks Bank name

Date of handover

Action

TYT Bank Marmara Bank Impex Bank Türk Ticaret Bankası Bank Expres Interbank Sümerbank Yurtbank Egebank Eski¸sehir Bankası Ya¸sarbank Kıbrıs Kredi Bankası Bank Kapital Etibank Demirbank Ulusal Bank ˙ Iktisat Bankası Sitebank Tari¸sbank Kentbank Bayındırbank

11.4.1994 20.4.1994 23.4.1994 6.11.1997 12.12.1998 7.1.1999 22.12.1999 22.12.1999 22.12.1999 22.12.1999 22.12.1999 27.9.2000 28.10.2000 28.10.2000 6.12.2000 28.2.2001 15. 3.2001 9.7.2001 9.7.2001 9.7.2001 9.7.2001

EGS Bank Toprakbank Pamukbank

9.7.2001 30.11.2001 18.6.2002

Imar Bankası

3.7.2003

Closed Closed Closed In liquidation Sold to Tekfen Group on 19.6.2001 Merged with Etibank on 15.6.2001 Sold to Oyak Bank on 9.8.2001 Merged with Sümerbank on 26.1.2001 Merged with Sümerbank on 26.1.2001 Merged with Etibank on 15.6.2001 Merged with Sümerbank on 26.1.2001 In liquidation Merged with Sümerbank on 26.1.2001 Merged with Bayındırbank Sold to HSBC Merged with Sümerbank on 17.4.2001 Merged with Bayindirbank Sold to Novabank Sold to Denizbank Merged with Bayındırbank Still under SDIF. Changed its name to Birle¸sik Fon Bankalari Merged with Bayindirbank Merged with Bayindirbank Transferred to Turkiye Halk Bankasi 12.11.2004 In liquidation

Source: Adapted from BAT (2002: 14–15).

it was not as successful as expected. Apart from the Istanbul Approach and shareholder contributions Treasury carried out a debt swap operation by switching TL-denominated bonds with USD-denominated ones. The operation reduced the foreign exchange open positions of private banks from levels of USD 8.4 billion to USD 1.5 billion. Additionally, the Treasury aimed to lower the interest rate risk by issuing floating rate, FX indexed and FX denominated bonds.

Recovery Turkey’s sustained economic performance after 2002 had a positive effect on the banking sector, and increasing confidence in the financial system

Trends in the Banking Industry 61

in general. Capital inflow from international markets, together with a local demand for TL-denominated financial assets help to reduce certain balance sheet risks for the banking sector. Financial institutions operated in a healthier environment as a result of the stability maintained in the money markets, the growth in economical activity, the recovery in competitive conditions of the operating banks because of the suspension of the activities of the financially weak banks, and the efforts of banks to strengthen their financial structure and shareholders’ equity (BAT, 2003). To strengthen the banking system, some modifications were introduced into the Banking Law in 2005. These included changes to permissions and authorization for bank licences and activities; an increase in minimum capital requirements; increasing transparency of financial institutions; the introduction of new corporate governance principles for the financial sector; limitations on loans to risk groups; strengthening internal and external audit mechanisms; and the introduction of minimum liquidity adequacy requirements. Overall, since 2002, the outstanding performance of the Turkish economy has had a positive impact on the banking sector. Furthermore, as Turkey’s credibility increased in international markets, the banks’ borrowing capacity abroad led to a growth in the banking sector. Total asset size of the banking sector was USD 347 billion in 2006, displaying a 167 per cent increase over 2002. However, the total number of banks (including investment banks) in the system, dropped to forty-six in 2006 from a record seventy-nine in 2005. Loan portfolios of banks increased significantly after the 2002 crisis, from levels of 26 per cent of total assets to 46 per cent in 2006. Economic agents’ demand for assets denominated in Turkish lira also increased during this period, reducing the foreign exchange risk of banks. Shareholders’ equity rose to USD 41.3 billion in 2006 from USD 15.7 billion in 2002. As of December 2006, the total number of branches and employees of the banking sector were 6,849 and 143,143, respectively. All these positive economic and regulatory developments increased foreign interest, and during 2005 and 2006 a significant number of foreign banks increased their shareholdings in the Turkish banking sector. Most of the deals were between large and medium-sized Turkish banks and leading banks in the global arena. A range of selected large deals are listed in Table 3.9. A list of all the banks in the banking sector as of December 2006 is provided in Appendix 3.1. These deals and foreign interests in Turkish banking in recent years will be discussed in detail in Chapter 8.

62 Turkish Banking Table 3.9 Selected foreign investment deals with the Turkish banking sector, 2004–06 Foreign bank

Target bank

BNP Paribas FortisBank GE Capital Corporation UniCredito Italiano SPA National Bank of Greece SA Dexia Participation Belgique SA Citigroup Hapoalim BM Bank

Turk Ekonomi Bankası Turk Dı¸s Ticaret Bankası Garanti Bankası Kocbank Finansbank Denizbank Akbank Bankpozitif Kredi ve Kalkınma Bankası Tat Yatırım Bankası

Merrill Lynch European Assets Holdings

Shares acquired (%) 50 89 26 50 46 75 20 58 99

Dollarization, crowding-out by government debt and maturity mismatch Dollarization is typically observed in those emerging markets where the purchasing power of the local currency has been volatile (see Appendix 3.2 for recent trends of dollarization in some emerging markets). It is usually an outcome of economic agents’ efforts to protect the value of their wealth. In Turkey, the level of dollarization has been on the rise since financial liberalization in the early 1980s. Years of high and volatile inflation coupled with the continuous depreciation of the Turkish lira have been major contributors to the loss of confidence in the local currency. Equally influential were the unsuccessful attempts of economic stabilization programmes, regular financial crises and the unavailability of alternative financial products for investors. Figure 3.6 displays the path of dollarization in Turkey. In 1986, only 18 per cent of all deposits were denominated in foreign currency, but following a generally increasing trend, dollarization in bank deposits reached a maximum of 57 per cent by the end of 2001.9 The degree of dollarization is also fuelled by government securities issued in foreign currency. In 2007, foreign-denominated securities constituted 10 per cent of domestic debt. Dollarization has been a major factor contributing to the banking sector’s open positions in general. Collecting deposits in foreign currency and extending loans in Turkish lira, banks did not have many options but to operate in a risky environment, and becoming vulnerable to

Trends in the Banking Industry 63 Foreign exchange deposits/total liabilities Foreign exchange deposits/total deposits 60 Percentages

50 40 30 20 10 2006

2007 2007

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

2006

Figure 3.6

1987

1986

0

Dollarization in deposits, 1986–2007 (percentages)

Source: Central Bank of Turkey (2008).

Figure 3.7

Govt securities/total assets

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

Percentages

Total loans/total assets 50 45 40 35 30 25 20 15 10 5 0

Crowding-out by government debt, 1986–2007 (percentages)

Source: Central Bank of Turkey (2008).

any sudden changes in the economic environment. On the asset side, banks were mainly investing in risk-free government securities, which were offering a much higher yield than domestic private borrowers. The crowding-out by government debt reached its peak in 2003, when over 45 per cent of banks’ total assets were invested in Treasury bonds (see Figure 3.7). Government securities have always been an alternative high-yield investment opportunity for Turkish banks, in particular after 1994, when the borrowing needs of the Turkish government increased greatly. The level of government securities to total assets soared after the 2001 financial crisis, and after 2003 the trend reversed. The level of loans extended to the private sector plummeted after 1997 and bottomed in 2002, when only 18 per cent of total banking sector assets were extended as loans. Apart from the credit risk another downside of government debt was

64 Turkish Banking

Figure 3.8

1 month

3 month

6 month

1 year +

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

1989

1988

1987

1986

Percentages

Sight deposits 100 90 80 70 60 50 40 30 20 10 0

Maturities of deposits, 1986–2007 (percentages)

Source: Treasury Statistical Yearbook (2007).

its fuelling of currency mismatches on banks’ balance sheets. Before 2001, only 10 per cent of domestic government debt was denominated in foreign currency or indexed to foreign currencies. Yet another contributor to the vulnerability of Turkish banks is the maturity mismatch stemming from the extremely short-term deposit structure. Inflation, wiping out the value of savings and incomes, and depositors’ distrust of the financial system led to a gradual decline in deposit maturities since the 1980s (see Figure 3.8). In 1988, the deposits with a maturity of over one year constituted more than 30 per cent of total banking sector deposits. This ratio dropped to 6 per cent in 2000 and remained at similar levels thereafter. Such a short-term maturity structure, coupled with longer term assets, especially government securities, have always been a major risk in Turkish banks.

Conclusion This chapter pinpointed the key developments and evolution of the Turkish banking sector and financial system. The advent of the Turkish banking system inevitably progressed in parallel with the economic policies that were implemented. Before 1930s, policy-makers promoted the development of a national banking sector to provide the necessary financial instruments for investors, but because of a lack of national capital, state participation was needed to develop the sector. The protective environment of an inward-orientated growth strategy between 1963 and 1979 saw a rapid expansion of banks where there was no risk of interest rate or exchange rate changes, or price competition. The uncontrolled deregulation of deposit and lending rates, and a lack of a legal and

Trends in the Banking Industry 65

institutional framework, led to a banking crisis in 1983 after financial liberalization in 1980. Banking activities in the 1990s were affected by chronic high inflation, large budget deficits, high demand for assets denominated in foreign currency which led to balance sheet risks, fluctuations in the economy, lack of international standards in regulation and supervision of the banking sector, and political instability. Consequently, Turkey faced two severe financial crises, in 2000 and 2001, which led to a consolidation in the banking sector and the suspension of the activities of weaker banks. Since 2001, sustained economic performance with lowering inflation and interest rates, the introduction of an independent Bank Regulatory and Supervisory Board, and the implementation of internationally accepted banking principles by the introduction of new laws have had a positive effect on the banking sector and increased confidence in the financial system. All these positive economic and regulatory developments increased foreigners’ interest in the banking sector, and during 2005 and 2006 a significant number of foreign banks increased their shareholdings in the Turkish banking sector. At the time of writing, a significant percentage of the Turkish banking sector is controlled by foreigners.

2,850 1,982 1,968 1,403 865 794 724

40,746 35,776 34,780 26,347 24,491 12,732 8,405 8,177 7,308 6,150 5,892 4,343 3,162 2,946 2,890

Privately-owned deposit banks Privately-owned deposit banks Privately-owned deposit banks State-owned deposit banks State-owned deposit banks Foreign banks Privately-owned deposit banks Foreign banks Foreign banks Foreign banks Privately-owned deposit banks Foreign banks Development and investment banks Development and investment banks Development and investment banks

Privately-owned deposit banks Privately-owned deposit banks Privately-owned deposit banks Privately-owned deposit banks Banks under the Dep.Ins.Fund Privately-owned deposit banks Foreign banks

53,504 51,155

1,419 1,205 980 956 14 410 452

20,160 19,458 16,010 12,837 8,285 7,950 5,207 4,856 5,353 3,444 3,523 1,257 2,450 2,425 1,559

21,214 12,359

2,168 872 1,196 802 36 541 617

24,332 21,442 22,145 17,674 19,343 8,155 5,620 5,137 4,203 3,346 3,860 3,817 0 0 0

33,010 42,439

311 236 208 130 613 83 78

5,027 3,323 2,379 3,193 2,689 1,533 695 880 908 793 393 357 2,438 1,639 419

6,695 4,681

209 48 63 29 1 31 16

683 483 598 314 588 309 349 262 193 225 170 54 19 2 4

891 1,247

3,368 1,313 1,331 680 333 567 315

12,333 11,907 13,478 7,679 10,860 7,751 5,403 5,528 5,018 4,335 3,565 2,228 2,672 368 295

18,729 20,684

Total assets Total loans Total deposits Total shareNumber of Number of (USD (USD (USD millions) holders’ equity branch employees million millions) (USD millions) offices

Privately-owned deposit banks State-owned deposit banks

Group

Banks operating in Turkey, ranked by asset size, as of December 2006

1 Türkiye I˙s¸ Bankası A.¸S. 2 Türkiye Cumhuriyeti Ziraat Bankası A.¸S. 3 Akbank T.A.S. 4 Türkiye Garanti Bankası A.¸S. 5 Yapı ve Kredi Bankası A.¸S. 6 Türkiye Vakıflar Bankası T.A.O. 7 Türkiye Halk Bankası A.¸S. 8 Finans Bank A.¸S. 9 Oyak Bank A.¸S. 10 Denizbank A.¸S. 11 HSBC Bank A.¸S. 12 Fortis Bank A.¸S. 13 Türk Ekonomi Bankası A.¸S. 14 Citibank A.¸S. 15 I˙ller Bankası 16 Türk Eximbank 17 Türkiye Sınai Kalkınma Bankası A.¸S. 18 S¸ ekerbank T.A.¸S. 19 Tekstil Bankası A.¸S. 20 Anadolubank A.¸S. 21 Alternatif Bank A.¸S. 22 Birle¸sik Fon Bankası A.¸S. 23 Tekfenbank A.¸S. 24 Millennium Bank A.¸S.

Banks

Table 3A.1

Appendix 3.1

Total

Türkiye Kalkınma Bankası A.¸S. Deutsche Bank A.S. ABN AMRO Bank N.V. WestLB AG Société Générale (SA) Turkish Bank A.¸S. I˙MKB Takas ve Saklama Bankası A.¸S. Turkland Bank A.¸S. BankPozitif Kredi ve Kalkınma Bankası A.¸S. Arap Türk Bankası A.¸S. Calyon Bank Türk A.¸S. Bank Mellat JPMorgan Chase Bank N.A. Nurol Yatırım Bankası A.¸S. Diler Yatırım Bankası A.¸S. GSD Yatırım Bankası A.¸S. Banca di Roma S.p.A. Çalık Yatırım Bankası A.¸S. Adabank A.¸S. Habib Bank Limited Merrill Lynch Yatırım Bank A.¸S. Taib Yatırım Bank A.¸S.

Foreign banks Development and investment banks Foreign banks Foreign banks Development and investment banks Development and investment banks Development and investment banks Foreign banks Development and investment banks Privately-owned deposit banks Foreign banks Development and investment banks Development and investment banks

Privately-owned deposit banks Development and investment banks

Development and investment banks Foreign banks Foreign banks Foreign banks Foreign banks Privately-owned deposit banks Development and investment banks

Source: Compiled from BAT (2006), website reports.

34 35 36 37 38 39 40 41 42 43 44 45 46

32 33

25 26 27 28 29 30 31 218 175 75 32 87 0 69 0 45 39 29 0 2 0 0 155,139

265 192 160 157 119 68 66 62 48 33 31 19 13 344,947

237 58 114 1 69 91 14

374 340

629 627 510 492 467 462 423

222,561

65 0 26 77 0 0 0 10 0 5 1 0 0

240 0

0 376 297 420 75 213 0

41,248

62 16 27 75 27 30 34 21 43 27 7 9 11

50 166

382 137 93 65 27 70 168

6,849

3 1 3 1 3 1 1 1 1 1 1 1 1

10 9

1 1 1 1 1 17 1

143,143

174 34 52 42 41 18 28 29 30 62 16 26 10

266 179

688 81 128 41 56 218 184

52.2 55.5 57.4 56.4 57.2 58.2 62.3 – –

– 59.3 66.6 67.6 68.9 73.7 71.6 73 73

8.9 7.8 5.9 6.7 12.7 12.7 13.3 13.3 13.5

Czech Republic

Source: Bahmani-Oskooee and Domaç (2002: 3).

1993 1994 1995 1996 1997 1998 1999 2000 2001

Croatia 12.7 18.9 19.6 20.1 14.2 17.1 17.2 17 –

Mexico 66.4 67.2 65 68 58.9 58.5 49.3 48.5 47

Peru 29.6 33.9 25.1 20.9 20.7 17.7 17.6 16.5 17.9

Poland 37.9 27.9 27.6 28.4 33.4 37.3 43.2 47 49.3

Romania 39.9 39.2 28.3 27.4 24.6 51.2 48.8 48.5 46.8

Russia

12.5 14.2 12.5 11.4 11.8 16.4 15.9 16.3 16.4

Slovakia

Dollarization in selected emerging markets, foreign currency deposits to total deposits, 1993–2001

Argentina

Table 3A.2

Appendix 3.2

44.3 51.7 53 48.5 50.4 46.7 45.9 45.3 57.6

Turkey

68

4 A Profile of Turkish Banking

Introduction This chapter reviews the key features of the Turkish banking industry: its size, structure and statistics on the main ownership issues over the period 1990–2006. Our main focus is on an analysis of what happened in the Turkish financial system since the 1980s. The chapter is designed to provide readers with an examination of the structure and performance levels of Turkish banks related to different specialization categories (that is, state-owned, privately-owned, foreign and so on) and compare it with European Union (EU) countries in general. Therefore, it first considers the overall size of the Turkish banking sector, with an emphasis on the number of banks, branches and employees. Then we shift the focus of our attention to income and cost structures, together with the performance levels of state-owned, privately-owned and foreign banks operating in Turkey.

Size of the Turkish banking sector Turkey is a dynamic, promising market supported by a network of developed infrastructure and a globally competitive labour force. In 2007, Turkey was the seventeenth largest economy in the world, and its banking sector forms a great part of the Turkish financial system (approximately 87 per cent). Most of the transactions and activities of the money and capital markets are carried out by banks, and the Central Bank of Turkey (CBT), founded in the early 1930s, has the usual Central Bank responsibilities such as issuing banknotes, monitoring the financial system and protecting the currency. The Turkish banking system in early 1995 consisted of the Central Bank and fifty-five other 69

70 Turkish Banking

banks, including twenty foreign, twenty-nine privately-owned and six state-owned banks. All the banks in Turkey are subject to the Banks Act, and to the provisions of other laws regarding banks. The new Banking Law brought the Banking BRSA into life to safeguard the rights and benefits of depositors, while the Banks Association of Turkey (BAT) was established to protect and promote the professional interests of its members. Heffernan (2001) described modern banks as being either highly specialized in specific activities, or offering a wide range of financial services. Following this lead, we have sorted Turkish banks into two main groups: those with the authorization to collect deposits (commercial banks) and those not accepting deposits (non-depository banks). Each group has then been divided into three sub-groups as being state-owned, privatelyowned or foreign banks according to the source of their respective capitals. We should emphasize here that 46 per cent of the banking sector’s assets in 1999 were concentrated in four banks, namely: the Ziraat Bankası (Agricultural Bank of the Republic of Turkey); Emlak Bankası; I˙ s¸ Bankası; and Akbank. The first group of banks – that is, the commercial banks – operate as universal banks, offering an extensive range of products and services using developments in information technology (IT). In addition to traditional depository and lending services, they operate in the field of investment banking as well as engaging in capital market transactions. However, there are large-scale privately-owned banks among the commercial bank group that have nationwide networks of branches and provide all kinds of banking services. For example, Akbank, reputed to be the most profitable private bank in Turkey, is owned by the Sabancı Group; the partially publicly-traded Koçbank, which merged with Yapı ve Kredi Bankası in 2005, is co-owned by the Koç Holding Company (there are detailed discussions on this merger activity in Chapter 8). In addition, there are small and middle-sized commercial banks with activities more concentrated in main populated cities and engaging more in wholesale banking. The second group of banks under focus includes state-owned banks, such as the Agricultural Bank of the Republic of Turkey, which was established to finance the agricultural sector. The third group of banks – that is, foreign banks – is divided into two groups: those that have opened branches in Turkey, and those that are established in Turkey. These banks are subject to the same regulations as other commercial banks in the country. A detailed discussion on foreign banks and their ownership in Turkey is introduced in Chapter 8.

A Profile of Turkish Banking 71 Table 4.1 Selected items of financial sector as a percentage of GDP, 2003 World

EU

USA

Emerging markets

Latin America

Turkey

Commercial banks Capital market Shares Bonds Public Private

112 230 86 144 56 88

173 233 74 159 60 99

52 321 130 191 46 146

75 84 47 37 23 15

45 84 35 49 37 12

70 82 27 55 55 0

Total

342

406

373

159

129

152

Source: Adapted from BAT (2003: 46).

Turkey’s financial system is still in development. Although it is well above the average size of emerging markets (EMs), it is relatively small compared to developed countries. Table 4.1 introduces various financial indicators, comparing Turkey with the rest of the world – namely, fifteen EU countries, the USA, Latin America and the other emerging markets, as of 2003. We observe that the percentage of the public sector is well above that of the USA, EM and Latin America. In contrast, the share of the private sector is much lower than in the other selected countries. The main reasons limiting the growth of the Turkish financial sector can be attributed to (i) a low level of savings because of low income levels; (ii) a very high inflation rate for many years; and (iii) low demand for financial assets because of the high cost of intermediation rising from heavy taxation. Moving on to regulation issues, the major reforms in Turkey were carried out in the finance sector between 1999 and 2002, linked to the ‘Programme for the Transition to a Strong Economy’ launched by the government. Thus banking legislation was adjusted to align with international regulations, Bank of International Settlements (BIS) recommendations and EU banking directives. As a result of the adjustments, the Savings Deposits Insurance Fund (SDIF) was given the authority and responsibility to restructure a bank in deficiency, to facilitate its sale in full or in part, or to liquidate it, based on existing laws. With regard to these structural reforms, the management of many banks was taken over by the SDIF and the licence of a development and investment bank was revoked (see Chapter 3 for details). Furthermore, a significant decrease in the total number of banks continued, attributable to mergers among some public banks, banks under the control of the SDIF, and private

72 Turkish Banking Table 4.2 The Turkish banking system, number of banks, 1990–2006 Number of banks

1990 1995 2000 2001 2002 2003 2004 2005 2006

Commercial banks Stateowned banks Privately-owned banks Banks in the SDIF Foreign banks Non-depository banks State-owned banks Privately-owned banks Foreign banks

53 8 25 0 20 10 3 3 4

55 6 29 0 20 12 3 5 4

62 4 31 13 18 19 3 12 4

46 3 22 6 15 15 3 9 3

40 3 20 2 15 14 3 8 3

36 3 18 2 13 14 3 8 3

35 3 18 1 13 13 3 8 2

34 3 17 1 13 13 3 8 2

33 3 14 1 15 13 3 8 2

Total number of banks

63

67

81

61

54

50

48

47

46

Source: Compiled from BAT Annual Reports, 1995–2007.

banks. Table 4.2 shows the annual figures for the total number of banks in Turkey relevant to the ownership and specialization clusters. The highest level of decline in the total number of banks was experienced after 2001, mainly as a result of the financial crisis devastating the Turkish economy and its financial system. Furthermore, the number of banks declined from fifty-four to fifty between 2002 and 2003, ˙ as a result of the revoking of the banking licence of Imar Bankası; the transfer of Fiba Bank to Finansbank; and the liquidation of ING Bank and Credit Suisse First Boston, which were operating in Turkey through branch offices. As of September 2006, the size of the banking industry comprised 88 per cent of total financial sector, and total bank assets represented 86 per cent of Turkey’s GNP. At the same date, there were forty-six banks in total, made up of thirteen non-depository banks and thirty-three commercial banks. The group of commercial banks comprised three state-owned, fourteen privately-owned, fifteen foreign and one SDIF bank. Considering the commercial banks group, state-owned banks have wide networks of branches throughout the country, mainly specializing in financing the agricultural sector and small and medium enterprises (SMEs). Figure 4.1 presents the changing numbers of banks in the Turkish banking sector according to specialization and ownership clusters during 1990–2006 period. The trend in number of banks has also been reflected in the alteration in the number of bank branches throughout the Turkish banking system. The changing number of branches is mainly a result of mergers and acquisitions, takeovers by larger institutions and transfer to the SDIF during the crisis periods. This will be discussed in the following section.

A Profile of Turkish Banking 73 Public banks Foreign banks

Private banks Banks under SDIF

45 40 35 30 25 20 15 10 5 0 1990 Figure 4.1

1995

2000

2001

2002

2003

2004

2005

2006

Changing numbers of banks in Turkey, 1990–2006

Source: Compiled from BAT Annual Reports, 1990–2007.

Table 4.3 Number of branches in the Turkish banking sector, 1990–2006 Number of branches

1990 1995 2000 2001 2002 2003 2004 2005 2006

Commercial banks 5,469 6,425 8,140 6,889 6,087 5,949 6,088 6,228 6,804 Stateowned banks 2,856 3,077 3,106 2,725 2,019 1,971 2,149 2,035 2,149 Privatelyowned banks 2,542 3,253 3,852 3523 3,659 3,594 3,729 3,799 3,582 Banks in the Fund 71 0 1,068 408 203 175 1 1 1 Foreign banks 55 95 114 233 206 209 209 393 1,072 Non-depository banks 27 42 48 19 19 17 18 19 45 State-owned banks 20 26 29 4 4 4 4 4 4 Privately-owned banks 4 12 16 12 12 10 12 12 11 Foreign Banksbanks 3 4 3 3 3 3 2 3 30 Total number of branches

5,496 6,467 8,188 6,908 6,106 5,966 6,106 6,247 6,849

Source: Compiled from BAT Annual Reports, 1990–2007.

Branch systems of the Turkish banking sector During the financial restructuring process, the BRSA and the Turkish government encouraged banks to consider merging by providing tax incentives. Additionally, small banks, which increased their market share through mergers, were given the opportunity of capital assistance. Table 4.3 demonstrates the annual figures for the number of branches of commercial and non-depository banks over the period 1990–2006. Stateowned commercial banks were seen to have relatively fewer branches than their privately-owned counterparts, but the highest level of increase was seen in foreign commercial banks over the period under analysis.

74 Turkish Banking

During 2004-2005, the increase observed in the number of branches continued, with a rise of 141 banks, comprising 140 deposit banks and one non-depository banks, to reach a total of 6,247 by 2005. The highest increase in the number of branches was achieved by the group of foreign banks, 184 branches, over this period resulting from the transfer of the Türk Dı¸s Ticaret Bankası to Fortis Bank. Moreover, the number of branches of privately-owned banks increased by seventy, against a decline of 114 among state-owned banks. The upward trend in the number of branches continued in 2006 for all groups. Compared to 2005, the total number of branches reached 6,849, an increase of 602, by the end of 2006. State-owned deposit banks also expanded their branch network by 114 in the same period. When we focus mainly on commercial banks, it can be seen that the number of branches in the private banks group decreased by 217 from 2005 to 2006. This is offset by an increase of 679 branches of foreign banks resulting from the transfer of some banks from the group of private banks to foreign banks over this period. Having discussed the changing trends in the number of banks and branches operating in the Turkish banking system, it is important to stress the effects of these changes on expenditure in the financial system. Therefore we need to look beyond these changes and consider the trends in the numbers of employees. It is well known that one of the main costs seen in the financial statements of banks is employee (personnel) expenses. We therefore provide in the next section an overview of the personnel expenses in the Turkish banking system, with a discussion regarding the changing number of employees working in each group of banks mentioned above.

Employment in the Turkish banking sector With the intention of minimizing costs and increase profitability, Turkish banks have gone through a consolidation process that resulted in the closure of unprofitable bank branches and a reduction in the number of personnel, in particular between 2000 and 2004. The numbers of bank personnel are reviewed in Table 4.4 for each group of banks in Turkey, covering the period 1990–2006. Starting from the year 1990, the total number of personnel was 154,089 which had increased by 11 per cent over a decade to 170,401 by the end of the year 2000. After the financial crises of 2000 and 2001, the number of people employed in the banking system decreased dramatically, to 123,249 in 2003. Of these, 31 per cent worked for state-owned

148,970 80,825 68,145 0 3,012 2,107 1,421 686 0

151,077

Commercial banks Stateowned banks Privatelyowned banks Banks in the Fund Foreign banks Non-depository banks State-owned banks Privately-owned banks Foreign banks

Total

141,808

135,709 72,699 63,010 0 2,985 6,099 5,245 854 0

1995

Source: Compiled from BAT Annual Reports, 1990–2007.

1990

170,401

164,845 70,191 70,954 19,895 3,805 5,556 4,456 1,021 79

2000

137,495

132,274 56,108 64,380 6,391 5,395 5,221 4,322 822 77

2001

2002

123,271

118,329 40,158 66,869 5,886 5,416 4,942 4,174 691 77

Number of employees in the Turkish banking system, 1990–2006

Number of Employees

Table 4.4

123,249

118,607 37,994 70,614 4,518 5,481 4,642 3,882 683 77

2003

127,163

122,630 39,467 76,880 403 5,880 4,533 3,800 681 52

2004

132,258

127,857 38,046 78,806 395 10,610 4,401 3,657 697 47

2005

143,143

138,570 39,223 73,220 333 25,794 4,573 3,646 692 235

2006

75

76 Turkish Banking Branches (lhs)

Employees (rhs)

180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0

9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0

1990

1995

2000

2001

2002

2003

2004

2005

2006

Figure 4.2 Numbers of branches and employees in the Turkish banking system, 1990–2006 Source: Compiled from BAT Annual Reports, 1990–2006.

commercial banks and 60 per cent for privately-owned commercial banks. Recently, with the recovery in the Turkish economy, the number of employees has increased again, reaching 143,143 in 2006, of which 27 per cent are employed in state-owned banks, 51 per cent in private banks, 18 per cent in foreign banks, and 3 per cent in development and investment banks. The number of employees increased by 15,184 in foreign banks from 2005 to 2006, while in the private banks category it decreased by 5,586 people as a result of mergers and acquisitions by foreign institutions. We also noted that there was a parallel growth in the number of employees compared to the growth in the number of branches. Figure 4.2 presents a comparison of variations in the number of branches and employees from 2002 to 2006. The highest level of increase in both number of branches and employees after the financial crisis in 2001 was observed to be 9.6 per cent and 8.2 per cent, respectively, from 2005 to 2006. As Turkey is a candidate country for the EU membership and has intensive economic ties with Europe, we weight features of Turkish banking against those of the EU to establish a comparison in readers’ minds. These figures are presented in Table 4.5. When compared to EU-15, Turkish banks display a below-average performance in number of branches, banks and personnel. We consider this to be mainly a result of the smaller size of the Turkish banking sector in comparison to the EU. Also, there are a differences in the definitions of what are credit institutions between Turkey and the EU.

A Profile of Turkish Banking 77 Table 4.5 Comparison of bank structure in Turkey and EU-15 countries, 2004 Share of five largest banks

Number of banks

Number of branches

Number of employees

Belgium Denmark Germany Greece Spain France Rep. of Ireland Italy Luxembourg Netherlands Austria Portugal Finland Sweden UK EU-15

83 67 22 67 44 47 44 27 32 84 44 63 81 54 33 53

108 203 2,225 59 348 939 80 801 172 481 814 200 366 222 426 496

4,989 2,118 47,351 3,300 3,9762 25,789 924 30,502 269 3,671 4,395 5,440 1,252 2,061 14,186 12,401

73,553 45,994 725,550 61,074 243,460 420,291 35,658 337,689 22,513 119,857 73,308 53,931 26,668 39,456 495,173 184,945

Turkey

60

48

6,152

124,141

Source: Compiled from Central Bank of Turkey (2005: 53).

Players in the Turkish banking market Big banks As mentioned above, the major share of the total assets of the Turkish banking system is held by the five largest banks in the country. During 2006, the shares of the first five and the first ten banks in the total banking sector assets increased considerably, to 60 per cent as of December 2006, against only 44 per cent in 1997 (see Table 4.6). On the other hand, the share of the first ten banks in the total banking sector assets increased from 70 per cent to 84 per cent during the same period. In terms of total asset size, there was one1 state-owned and four privately-owned banks among the largest five in 2004, but this structure changed to two stateowned and three privately-owned banks in 2005. When we focus on the ten largest banks, privately-owned banks dominate state-owned banks, with a ratio of seven to three. Following the changes in total assets, a corresponding movement was also observed in total deposits and loans. Table 4.6 illustrates the changing trends in total assets, total deposits and total loans by the largest players of the Turkish banking sector. As of December 2006, the five largest banks have shares of 60 per cent,

78 Turkish Banking Table 4.6 Concentration of the five largest and ten largest Turkish banks, 1997–2006 (percentage) 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Five largest banks Total assets Total deposits Total loans

44 48 47

44 51 40

46 50 42

48 51 42

56 55 49

58 61 55

60 62 54

60 62 48

63 66 56

60 64 53

Ten largest banks Total assets Total deposits Total loans

70 72 71

68 73 70

68 69 73

69 72 71

80 81 80

81 86 74

82 86 75

82 86 76

85 89 80

84 88 80

Source: Compiled from BAT Annual Reports, 1997–2007.

64 per cent and 53 per cent of the overall total assets, total deposits and total loans of the Turkish banking system, respectively.

State-owned versus privately-owned banks in Turkey Most state-owned banks are established to finance particular industries, whereas private banks generally have intimate connections with large industrial groups. As mentioned earlier, state-owned banks have an important share in the banking system, since their main objective is performing specific missions that they undertake rather than profit maximization. Prior to the 2001 restructuring programme, public deposits were generally gathered in state banks, which have the advantage of receiving government funding. Consequently, they hold 40 per cent of the total assets of the Turkish banking sector, despite there being fewer of them than privately-owned and foreign banks. Private banks remain the most vulnerable sector of the banking system in Turkey. During the 1980s, most private banks engaged in trade financing or in the sale of state bonds, as investment activity was in a depression. The largest private banks in Turkey are attached to the major corporations, despite the 1983 Banking Law that was enacted to discourage such links. In 1986, private-bank balance sheets began to improve, as several years of high-interest earnings made it possible for banks to write off bad loans. Much as in Germany and Japan, the major private banks in Turkey are closely linked to industrial groups such as Yapı ve Kredi Bankası, Akbank and Garanti Bankası. Regarding the discussion above, we placed state-owned banks in the ‘large-sized banks’ group. Three of the state-owned banks are in the ten

A Profile of Turkish Banking 79

largest, with their total asset size representing 35 per cent of the whole deposit banks group. Table 4.7 shows the balance sheet structure of stateowned and private banks, and state-owned banks were less liquid than the privately- owned banks. However, after 2001, liquid assets increased dramatically (in particular liquid assets relative to short-term liabilities). The main reason for holding a portfolio with such a high level of government securities is the crucial role of state-owned banks in distributing the funds that were granted to finance public deficits prior to 2001. In 2001, as a result of the restructuring process, these banks were given securities in order to compensate them for their losses in carrying out these duties. Table 4.7 also shows that the total loans to total assets ratio decreased through the years until 2003, but increased slightly afterwards in the balance sheet of state-owned banks. The decrease was mainly a result of the restriction of loan transactions in the state-owned banks as a result of the restructuring programme. Similarly, a similar ratio for privately-owned banks represented a parallel trend to their state-owned counterparts. The high ratio of past-due loans in state-owned banks indicated that credit risk management in these banks was inadequate compared to privatelyowned banks because of political pressures. Hence, the ratios of past-due loans to total assets may not reflect the true situation. On the other hand, since the privately-owned banks had indirect credit relations with their own groups, they did not allow the necessary provision for past-due loans after 2001. Specific missions allocated to state-owned banks with inadequate management caused high resource costs, which resulted in paying a high interest rate for short-termed funds.

Balance sheet structure of the Turkish banks Assets structure, loans and liquid assets Traditionally, the banking system has a majority share in the financial sector, and the total assets of the Turkish banking system account for 87 per cent of the total assets of all the institutions present in the financial sector. The assets and liabilities composition of the balance sheets of the Turkish banking sector between 1990 and 2006 show a great varieties over time. Figure 4.3 illustrates an examination of the changes of the total asset structure of the Turkish banking sector during this period. In general, it is observed that the percentage of loans in banks’ balance sheets recovered to its pre-crisis level. Also, government securities held by the banks (seen in the ‘Permanent assets and other’ category in Figure 4.3), decreased after 2001.

38.0 39.1 43.6 2.6 1.8 1.6 6.6 6.1 6.7 42.7 41.7 38.4 54.0 54.3 47.0 2.4 4.9 4.6 34.5 66 63.8 7.8 9.8 10

13.9 5.9

40.5 1.8 5.9 46.0 57.7 3.2 45.6 9.2

15.2 5.5

13.1 3.7

11.3

12.0 3.7

11.7

10.4

9.5

44.7 2.1 6.4 36.4 44.3 3.8 54.1 10.3

13.3 6.0

10.9 16.2 6.0

12.9

41.4 33.5 2.4 3.6 7.6 11.2 37.7 43.5 47.7 54.6 4.7 4.4 60.9 52 12.5 9.8

15.2 6.6

12.8

37.7 6.1 18.9 36.5 45.8 1.1 11.5 6.7

17.5 3.0

14.0

1993 1994 1995 1996 1997 1998 1999 2000

Source: Compiled from BAT Annual Reports, 1993–2007 (1995).

Shareholders’ equity/total risk weighted assets Shareholders’ equity/total assets (Shareholders’ equity – permanent assets)/ total assets Total loans/total assets Loans under follow-up (net)/total loans Permanent assets/total assets Liquid assets/total assets Liquid assets/short-term liabilities Net profit/losses/total assets Net profit/losses/total shareholders’ equity Net interest income/total assets

Private banks

−

9.4 10.9 6.1 8.0

3.7

32.8 5.1 2.3 44.3 71.0 2.6 25.1 4.2

10.4 8.0

2.9

28.0 18.3 16.3 36.4 85.8 −3.7 −34.7 9.7

30.8 4.3 12.4 40.0 79.7 2.0 16.0 5.0

10.7 12.7 −5.6 0.3

16.5 19.7

33.0 1.4 11.1 40.8 79.8 2.1 13.9 3.1

14.7 3.6

23.5

39.6 0.8 10.3 40.2 74.7 1.6 10.3 5.4

15.6 5.3

22.3

42.8 4.2 6.5 45.4 75.4 1.1 9.7 3.9

11.8 5.3

−

48.1 3.6 5.5 37.7 61.2 1.8 16.9 3.3

10.4 4.9

17.5

2001 2002 2003 2004 2005 2006

15.3 20.1 25.9 0.8 0.5 7.8 3.8 3.3 2.9 34.0 32.8 41.3 77.0 104.9 89.8 2.2 2.5 2.4 18.7 26.6 21.7 6.2 5.8 3.8

11.5 7.8

9.9 4.0 13.8 12.7 6.0 21.9 56.3 1.6 15.7 7.2

5.6

5.0

2001 2002 2003 2004 2005 2006

Shareholders’ equity/(total risk weighted 8.8 5.9 5.1 4.7 6.0 4.2 4.1 3.1 3.6 assets + amount subject to market risk) Shareholders’ equity/total assets −1.0 −4.2 −5.2 −4.0 −1.6 −2.6 −2.0 −3.3 8.8 (Shareholders’ equity – permanent assets)/ 7.0 4.5 3.8 3.6 4.4 3.1 3.1 2.3 1.8 total assets Total loans/total assets 39.9 37.6 44.2 39.5 45.6 31.9 24.3 25.8 17.9 Loans under follow-up (net)/total loans 4.5 4.0 3.0 2.8 2.8 5.6 10.0 12.5 17.2 Permanent assets/total assets 9.8 10.1 10.2 8.8 7.7 6.9 6.3 9.1 7.0 Liquid assets/total assets 37.6 36.9 32.5 35.2 28.1 24.0 23.2 18.3 21.3 Liquid assets/short-term liabilities 47.0 44.0 38.2 40.4 33.8 28.1 27.1 20.5 77.4 Net profit/loss/total assets 2.4 0.0 0.2 0.7 0.6 0.7 1.2 −0.5 −3.0 Net profit/loss/total shareholders’ equity 48.9 −0.8 3.3 17.6 14.2 16.2 38.1 −18.6 −33.5 Net interest income/total assets 6.9 5.1 2.5 5.0 3.2 4.2 3.0 2.7 16.6

1993 1994 1995 1996 1997 1998 1999 2000

Balance sheet structure of state-owned and private banks, 1993–2006 (annual percentages)

State-owned banks

Table 4.7

A Profile of Turkish Banking 81 Permanent assetsothers

Loans

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

Percentages

Liquid assets 100 90 80 70 60 50 40 30 20 10 0

Figure 4.3 Selected asset items of the Turkish banking sector, percentage share of each component, 1990–2006 Source: Compiled from BAT Annual Reports, 1990–2006.

By the end of 2004, the total assets of the banking sector amounted to USD 229 billion. The ratio of total assets to GDP was about 75 per cent. Within total assets, the share of commercial banks was 96 per cent, and of non-deposit banks was 4 per cent. The share of state-owned commercial banks in total assets was 35 per cent, and of privately-owned commercial banks was 57 per cent. In total loans, the share of the commercial banks group was 95 per cent, comprising a 21 per cent share by state-owned banks and a 69 per cent share by privately-owned banks. The Turkish banking system has deepened significantly since the 1970s. Total assets of the banking system represented only 32 per cent of Turkey’s GDP (USD 18.6 billion) in 1980. This increased to 43 per cent (USD 58 billion) in 1990, and to 83 per cent (USD 155 billion) in 2000. However, the financial crises of 2000 and 2001 reversed this situation. In the aftermath of the 2001 crisis, the ratio of total assets to GDP decreased to 78 per cent in 2002 and 70 per cent in 2003, but recovered to 85 per cent in 2006. Figure 4.4 displays the assets to GDP ratios of European countries to allow a comparison of Turkey’s banking sector with that of EU-15. We can see that the total assets to GDP ratio of the Turkish banking sector was well below the 281 per cent average of EU-15 countries. However, when we compared it to the new EU member countries, the ratio for Turkey, while being lower than the Czech Republic, was similar to that of Bulgaria, and higher than Poland’s. Focusing on the market share of groups of banks (presented in Table 4.8), we can conclude that: (i) even though the number of state-owned banks has decreased over the years, they still have a significant amount of total assets in the system; (ii) the share of non-depository banks remained low in the sector as a result of instability and high inflation in Turkey;

82 Turkish Banking 900 800

Assets/GDP (%)

700 600 500 400 300 200 100

Figure 4.4

Luxembourg

Rep. of Ireland

Denmark

United Kingdom

Belgium

EU-25

Netherlands

France

Germany

Spain

Austria

Portugal

Italy

Sweden

Greece

Latvia

Finland

Hungary

Czech rep.

Turkey

Poland

Lithuania

0

Total assets to GDP ratio, Turkey and EU countries, 2007 (percentages)

Source: Adapted from Central Bank of Turkey (2007: 30).

Table 4.8 Percentage market share of Turkish banks, 1986–2005 Years

1986–94 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

State-owned banks

Private banks

Foreign banks

Non-depository banks

Banks under SDIF

38.8 37.7 38.3 34.6 34.9 34.9 34.3 32.0 31.9 33.0 35.0 35.0

50.0 52.0 52.7 55.4 53.3 49.5 47.5 56.8 56.2 56.0 56.0 57.0

3.0 2.9 3.0 4.7 4.4 5.2 5.4 3.1 4.4 3.0 3.0 4.0

8.2 7.4 6.0 5.4 4.7 4.8 4.5 4.7 3.1 4.0 4.0 4.0

– – – 1.3 2.6 5.6 8.4 3.4 4.4 4.0 3.0 3.0

Note: *Market share calculated according to total asset size of relevant bank groups. Source: Compiled from BAT Annual Reports, 1986–2005.

and (iii) private banks performed consistent improvements in terms of number and sector share, in contrast to state-owned banks. In a further analysis of the asset structure of Turkish banks, we focused on the share of loans in total assets. As illustrated in Figure 4.5, the share of loans in total assets remained relatively stable until 1997, but plummeted to 28 per cent after the financial crises. After 2003, with strong growth in

A Profile of Turkish Banking 83

Percentages

50 40 30 20 10

Figure 4.5

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

0

Loans to total assets ratio, 1990–2006 (percentage)

Source: Data from BAT Annual Reports (1990–2006).

economic activity and an increase in demand for corporate and consumer loans, the level of loans in bank portfolios increased gradually up to the 45 per cent levels in 2006. One factor in the expansion was the increase in retail loans. Table 4.9 compares the Turkish banking sector with selected EU countries. We observe that the total deposits to GDP ratio in Turkey was lower than all EU members except Hungary, Lithuania, Poland and Romania. The share of total loans in total assets of the Turkish banking sector was about 30 per cent, which was lower than all of the EU countries except Luxembourg. In addition, asset size per bank was higher in Turkey than in most EU countries, including the newest members. Furthermore, the 27 per cent share of foreign participation in the EU-25 countries plus Bulgaria and Romania (both became EU members in 2007) is above the level of the presence of foreign participation in the Turkish banking sector. We also observe that the loans to deposits ratio, which has been an important indicator of the transformation of savings into investments in the economy, was low compared to the EU average and most of the EU countries. This was mainly because of a decrease in the volume of credits following the 2001 crisis. The loans to GDP ratio was also lower than that of Europe overall. This can be attributable to the increase in investment costs resulting from the chronic inflation since the 1990s, and the high borrowing needs of the government caused by the by high public deficit. Furthermore, from the overall analysis, we suggest that there should be a connection between the increasing amount of loans issued specifically to the public, and the number of bank/credit cards utilized. Figure 4.6 illustrates the fact that the Turkish banking industry has been catching up with technological advances and increased the number of electronic fund transfers via the issue of bank/credit cards to customers.

84 Turkish Banking Table 4.9 Comparison of balance sheet items with those of selected EU countries, 2007 Countries

Germany Austria Belgium Czech Republic Denmark Finland France Netherlands UK Rep. of Ireland Spain Sweden Italy Latvia Lithuania Luxembourg Hungary Poland Portugal Greece Bulgaria Romania EU-25 average Turkey (2006)

Deposits to GDP (%)

Loans to GDP (%)

Loans to Deposits (%)

Foreign Participation (%)

119 104 148 68 70 53 79 150 143 165 135 60 63 68 37 872 52 45 114 108 61 22 109 53

132 135 124 45 203 79 105 196 162 230 164 132 96 95 52 482 63 36 149 86 47 28 132 39

111 130 83 67 290 147 133 130 113 139 121 221 153 140 141 55 119 79 130 79 76 128 121 74

11.1 19.5 24.9 96.9 20.1 56.5 11.0 14.8 50.3 43.2 11.4 8.9 13.9 64.8 76.6 94.6 56.3 65.3 22.3 37.4 93.4 94.5 27.1 22.4

Source: Adapted from Central Bank of Turkey (2007: 31).

According to data published by the Inter-bank Card Centre, the number of credit cards issued, which totalled 19.9 million as of the end of 2003, reached 28.4 million in 2005, while the number of bank cards increased by 5 per cent and reached 45.2 million. This upward trend was augmented by the competition among banks that enabled them to expand the types of banking services they could offer their customers. For example, salary and bill payments such as telephone, electricity and so on being made via bank cards, which has become popular in recent years. For a more in-depth analysis of the balance sheet structure of Turkish banks, we introduced the percentage changes on the ratio of nonperforming loans to total loans in Figure 4.7. A minor peak can be seen in 1994; however, the biggest jump came in 2001, after a dramatically

A Profile of Turkish Banking 85 50 Credit cards

Bank cards

Millions

40 30 20 10 0 1998 Figure 4.6 cards)

1999

2000

2001

2002

2003

2004

2005

Number of bank cards and credit cards, 1998–2005 (in millions of

Figure 4.7

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

18 16 14 12 10 8 6 4 2 0 1990

Percentages

Source: Adapted from Central Bank of Turkey (2005: 22).

Non-performing loans to total loans, 1990–2006, percentages

Source: Compiled from BAT Annual Reports (various years).

upward trend between 1998 and 2001, when the ratio of non-performing loans (NPLs) to total loans rocketed to 17 per cent as a result of the sharp contraction in the economy and the financial crises. Banks recovered quickly after the financial crises, and in 2006 the number of NPLs relative to total loans dropped to less than 0.5 per cent. The two main reasons behind this improvement were the vigorous economic activity coupled with an increase in the provision made to cover bad loans. Furthermore, the debt restructuring programme implemented during 2001 has also relieved the pressure on NPLs. The increase in the debtservicing capacity of borrowers has played a significant part in this trend. In addition to the decrease in the NPL ratio, the increase in provisions maintained by the banking sector for non-performing receivables has

86 Turkish Banking Provisions to NPL

NPL to total loans (lhs)

120

20

Percentages

100

15

80 60

10

40

5

20

Turkey

Europe

Slovenia

Slovakia

Poland

Hungary

Lithuania

Latvia

Croatia

0

Czech Rep.

0

Figure 4.8 Non-performing loans (NPL) and provisions to NPL ratios, selected countries, 2004 *Europe represents EU-25. Source: Adapted from Central Bank of Turkey (2005: 84).

also brought about the improvement in credit quality since 2002. In addition to the increase in economic performance after the crises in 2000 and 2001, decreasing inflation and real interest rates helped asset quality and/or the loans portfolio to improve. Also, the increase in profitability enabled banks to enhance provisions for losses on loans. For the purpose of providing a comparison of NPL structure between Turkey and its Eastern European counterparts, we introduced NPL and provisions to NPL ratios for other selected countries. Figure 4.8 presents a taste of the situation as at December 2004 in order to give readers a picture of the financial situation in Turkey on the road to EU membership. The NPL ratio for Turkey was relatively lower than Bulgaria, Poland and Slovenia. On the other hand, provisions to the non-performing loans ratio were higher than in most of the other countries.

Liability structure, deposits and equity In this section, we shift our focus of attention to the liability structure of the Turkish financial system. For the Turkish banking sector, deposits are the most important source of funds despite their high costs. The structure of deposits indicates that, in general, deposits denominated in foreign currency increased as a result of high inflation over a number of years. Figure 4.9 illustrates the changing decomposition of total liabilities in the Turkish banking system between 1990 and 2005. On average, the deposits to total liabilities ratio was 57 per cent during 1986 and 1994. However, this figure increased substantially after the introduction of the state guarantee over deposits in 1994. In 2003, total deposits grew by 13 per cent, and the share in total liabilities decreased by 3 per cent to

A Profile of Turkish Banking 87 Non-deposit funds

Others

Equitynet income

Figure 4.9

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

Billion

1990

Percentages

Deposits 100 90 80 70 60 50 40 30 20 10 0

Total liabilities of Turkish banks, 1990–2006

Source: Compiled by from Central Bank of Turkey data, 1990–2007.

64 per cent. As a result of high inflation rates and economic instability in the 1990s, deposits became expensive as a resource, and financial institutions borrowed heavily from abroad. Non-deposit funds became an important source for the Turkish banking sector. Moreover, total deposits and non-deposit funds had a steady composition of about 80 per cent on average from the late 1990s up to 2006. The most interesting issue with the liabilities section of the whole Turkish banking sector was that the share of equity plus net income, which was 9 per cent on average up to 2001, and experienced a sharp increase in the following years. The equity plus net income ratio was about 12 per cent and 14 per cent during 2002 and 2003, respectively.

Income and costs Income structure of Turkish banks The income–expenditure structure, the net income of the Turkish banking sector, which has diminished over time, was negative for the years 1999, 2000 and 2001. The changing structure is shown in Figure 4.10, where the non-interest margin was seen to be negative up to the year 2001. However, after 2001, not only the banks started to realize interest income in their balance sheets, but the non-interest margin also began to become positive. Nevertheless, it can also be seen from Figure 4.10 that the interest margin had a tendency to decline throughout the period. In order to emphasize its importance, we know that banks’ sources of revenue are interest income, non-interest income and securities gain, while the expenses include interest expenses, non-interest expenses, provisions for loan losses, securities losses and taxes. We therefore present

88 Turkish Banking

Figure 4.10

2006

2005

2004

2003

2002

2001

Net income(loss)

2000

1999

1998

1997

Non-interest margin

1996

1995

1994

1993

1992

1991

1990

Percentages

Interest margin

100 80 60 40 20 0
20
40
60
80

Income structure of the Turkish financial system, 1990–2006

Source: Compiled from Central Bank of Turkey annual data, 1990–2007.

Percentages

20 16 12 8 4

Figure 4.11

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

0

Net interest income to total assets ratio, 1990–2006

Source: Compiled from Central Bank of Turkey annual data, 1990–2007.

the variability in the ratios of net interest income to total assets, total income to total expenditures, and average interest income to average expense in Figures 4.11, 4.12 and 4.13, respectively. As Figure 4.11 implies, the share of net interest income in total assets has been increasing gradually since 1990 in a steady trend. A sharp decline was observed in the year 2000 as a result of the financial crisis, but with recovery in the economy, substantial improvement was observed in the following years. As of 2006, the net interest income to total assets ratio was standing at about 6.3 per cent. The total income to total expenditure ratio, presented in Figure 4.12, was relatively stable between 1990 and 2006, presenting a gradual increase after the 2001 crisis. As a consequence of the declining interest income, the interest income to interest expense ratio shrank compared to previous periods, especially after the year 2000. One of the promising findings of our analysis on the income– expenditure structure of the Turkish banking sector is the decreasing

A Profile of Turkish Banking 89 3

Percentage

2.5 2 1.5 1 0.5 2003

2004

2005

2006

2004

2005

2006

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

2003

Figure 4.12

1991

1990

0

Total income to total expenditure ratio, 1990–2006

Figure 4.13

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

400 350 300 250 200 150 100 50 0 1990

Percentages

Source: Compiled from Central Bank of Turkey annual data, 1990–2007.

Average interest income to average interest expenses ratio, 1990–2006

Source: Compiled from Central Bank of Turkey annual data, 1990–2007.

trend of provisions for loan losses in comparison to loans, which can be attributed as an indicator of a recovery in the economy as a whole. Furthermore, the ratio of average interest income to average interest expenditure has also been promising since 2001. This is presented in Figure 4.13, where the highest levels were identified in 1991, 1997 and 1999. Having discussed the income structure of the Turkish financial system between 1990 and 2006, the purpose of the following section is introducing the changes on the costs side.

Cost structure of Turkish banks The economic policies after 1980s affected the balance sheet structure of the Turkish banking sector by increasing the cost of funds. These policies resulted in an increase in public deficits, which were financed by domestic borrowing. As a consequence, banks began to finance public deficits instead of supporting the real sector, since it was more profitable. BAT (2002) suggested that the factors that increased funding costs are: (i) an increase in deposit and credit interest as a consequence of the

90 Turkish Banking Operating expenses/total assets (rhs)

Operating expenses/operating income (lhs)

90 80 70 60 50 40 30 20 10 0

5 4 3 2 1 0 2000

Figure 4.14

2001

2002

2003

2004

2005

2006

Operating expenses of Turkish banks, 2000–06 (percentage)

Source: Adapted from Central Bank of Turkey (2005: 120).

removal of controls over interest rates; (ii) interest and exchange rate risk as a consequence of high inflation caused by instability in the economy and public deficits, and the increase in operating expenses; (iii) a decrease in the maturity structure of resources; and (iv) high amounts of required reserves and liquidity positions. As a result of high funding costs, banks developed new products and services, and became more cautious in terms of the management of their assets and liabilities. Personnel expenses represent 44 per cent of the total operating expenses in the Turkish banking sector, constituting a major item in total operating expenses. We have analysed and show in Figure 4.14 the ratios of total operating expenses to total operating income, and total operating expenses to total assets of the whole banking system in Turkey between 1999 and 2005. We observed a slight deceleration in the ratio of operating expenses to operating income throughout the analysis period, which may be seen as a positive sign of reduction of expenses. As of 2004, the operating expenditure to total assets remained at 4 per cent, while operating expenditure to operating income ratio was around 43 per cent.

Performance of the Turkish banking sector Performance measures have been a prime concern of bank managers as they use these in planning and controlling the activities of banks. Moreover, investors, lenders and shareholders are all expected to concern themselves with the efficiency and productivity of their companies. Therefore, we found it interesting to analyse the recent performance levels of Turkish banks as there have been changes in the economic and structural environment. In order to provide an insight into the performance of Turkish banks, the following sections present discussions on

A Profile of Turkish Banking 91 30 Percentages

25 20 15 10 5

Figure 4.15

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

0

Average shareholders’ equity to total assets ratio, 1990–2006

Source: Compiled and analysed from Central Bank of Turkey annual data, 1990–2007.

the main financial ratios such as capital adequacy, asset quality, liquidity and profitability.

Capital adequacy Capital adequacy is a measure of a bank’s capital. It is expressed as a percentage of a bank’s risk-weighted credit exposures and is used widely to protect depositors and promote the stability and efficiency of the financial system. Legislation introduced in 1993 sought to bring the Turkish banking sector into line with European standards on capital adequacy and other prudential ratios. Although depository institutions rely heavily on deposits and other liabilities, they could not operate without capital. All businesses need capital, but only financial institutions have minimum capital requirements specifically identified by regulators, and this fact indicates the importance of capital in the financial management of depositories (Gardner and Mills, 1988). The main capital adequacy ratios for the Turkish banking system are presented in the following section. One of the most important capital adequacy ratios, the average shareholders’ equity to total assets ratio, experienced a decreasing trend before the 2000/01 crises, bottoming at 8 per cent in 2000 (see Figure 4.15). This ratio improved in Turkey immediately after the crises, as a result of the restructuring programme, and in 2006 it was just above 20 per cent. In Figure 4.16 we compare the risk-adjusted capital adequacy ratio (CAR) of Turkey with that of selected EU countries. It can be seen that the risk-adjusted CAR of the Turkish banking sector was the highest among European counties as of December 2006. This can be attributed to the large government debt portfolios of Turkish banks, which are deemed to be risk-free.

92 Turkish Banking 24

Percentages

20 16 12 8 4 Lithuania

Italy

Sweden

Portugal

Czech Rep.

Spain

France

Netherlands

Austria

Hungary

Belgium

Denmark

Germany

Greece

Rep. of Ireland

Poland

United Kingdom

Luxembourg

Turkey

Figure 4.16

Finland

0

Capital adequacy ratio for Turkey and selected EU countries, 2006

Figure 4.17

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

50 45 40 35 30 25 20 15 10 5 0 1990

Percentages

Source: Adapted from Central Bank of Turkey (2007: 35).

Loans to total assets, 1990–2006 (percentage)

Source: Compiled and analysed from Central Bank of Turkey annual data.

Asset quality Asset quality assessment is one of several measurement tools used to determine the extent of a bank’s exposure to credit risk. The assessment of asset quality is crucial, because poor asset quality suggests problems for management, customers, shareholders and regulators; identifies poor managers and problem banks; and has a significant effect on earnings, capital and liquidity. We evaluated asset quality primarily by looking at the level of credit risk in a bank’s assets. One way of measuring the risk–return trade-off is the identification of the loans to total assets ratio, as presented in Figure 4.17. Since 1999, Turkish banks have gradually increased their loans to total assets ratio. We can attribute this to the fact that government was borrowing from the banks during this period, whereas the non-performing loans to total assets ratio was relatively

A Profile of Turkish Banking 93 50

Percentages

40 30 20 10

Figure 4.18

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

0

Liquid assets to total assets ratio, 1990–2006, percentages

Source: Compiled and analysed from Central Bank of Turkey annual data, 1990–2007.

constant other than at times of crisis. Specifically, we observed a very sharp increase after the year 2000.

Liquidity The liquidity ratio expresses a bank’s ability to repay short-term creditors out of its total cash reserves. We measured the liquidity risks associated with the Turkish banking sector by using the liquid assets to total assets ratio. Figure 4.18 illustrates a sharp increase in the proportion of liquid assets to total assets between 1990 and 1992, and has been relatively constant since 1992.

Profitability From a financial perspective, this section covers balance sheet ratios to present an overview of the performance of the Turkish banking system. Thus, we analysed the return on equity (ROE) and return on assets (ROA) ratios as the main profitability indicators. The ROE, which is derived from the ROA and the leverage multiplier, is the closest an accounting measure comes to revealing how well the managers have done in maximizing the shareholders’ wealth; it tells how much has been earned on the book value of common shareholders’ investment in the bank. Implicitly, ROE embeds revenue generation, operational efficiency, financial leverage and tax planning. On the other hand, the ROA reflects the bank management’s ability to utilize the bank’s financial and real resources to generate net income. Figure 4.19 displays the ROA and ROE for the Turkish banking sector. The variation in the ROA ratio is relatively small compared to the fluctuations in the ROE ratio. Therefore, the resulting ups and downs in the value of ROE may be attributed to the leverage that the banking sector undertook in the respective years. The overall result for the years 2000

94 Turkish Banking 100

6.00

50

4.00 2.00

0

0.00


50


2.00


100


4.00


150
200

ROE (rhs)

ROA (lhs)


6.00

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006


8.00

Figure 4.19 Return on assets (ROA) and return on equity (ROE) of Turkish banks, 1990–2006 (percentages) Source: Compiled and analysed from Central Bank of Turkey annual data, 1990–2007.

3.5

35 30

United States

Turkey

Russia

Portugal

Poland

Mexico

Malaysia

Korea

0 Japan

5

0.0 Hungary

10

0.5 Finland

15

1.0

Czech Republic

20

1.5

Croatia

25

2.0

Bulgaria

2.5

Brazil

Percentages

ROE (rhs)

Percentages

ROA (lhs)

3.0

Figure 4.20 Comparison of return on assets (ROA) and return on equity (ROE), selected countries, 2004 Source: Adapted from IMF (2005a: 186–97).

and 2001 was the outcome of the great losses that were realized in the pre- and post-crisis period. In 2006, the return on assets of the banking sector was realized as 2 per cent, whereas return on equity was observed as 13.6 per cent. We also introduced a comparison of ROA and ROE figures between Turkey and several other countries (see Figure 4.20).We observed that, as of 2004, Turkey demonstrated a high performance with regard to ROA. On the other hand, the country exhibited a relatively lower performance for the ROE when compared with the selected EU countries, because of its low leverage ratio.

A Profile of Turkish Banking 95 Table 4.10 Financial strength indices, Turkey, 1999–2005

1999 2000 2001 2002 2003 2004 2005

Asset quality

Liquidity risk

Profitability

Capital adequacy

Financial strength

100.0 93.3 73.0 85.6 101.0 109.7 111.2

100.0 88.0 91.6 74.9 73.3 75.0 69.5

100.0 93.7 87.9 103.9 105.7 105.3 106.7

100.0 99.4 111.0 122.4 138.7 142.3 143.3

100.0 94.5 96.9 101.6 108.1 110.8 110.4

Source: Compiled from Central Bank of Turkey (2005: 133).

Financial strength indices We decided to analyse the asset quality, liquidity, profitability and capital adequacy indices to examine the financial strength of the Turkish financial system throughout this section. By evaluating the indices summarized in Table 4.10, we reached a number of conclusions about the financial strength of the Turkish banking sector. Starting with a focus on the asset quality index, it suggested an improvement in the asset quality of the Turkish banking sector after past crises. NPL ratios decreased during the period under analysis, as mentioned previously in this chapter, which had a positive impact on the asset quality. Second, the decreasing trend in the liquidity risk index confirmed the results we have provided in previous sections of this chapter and in Chapter 3, that the share of liquid assets in total assets has been decreasing, with a less than 50 per cent ratio of assets to liabilities with up to three months’ maturity. Thus the maturity divergence was still present and a decreasing trend was seen between 2002 and 2004. During 2005, the liquidity index decelerated possibly because banks preferred to stay less liquid as economic improvements and increasing stability in the Turkish economy increased their confidence. Third, in terms of the profitability index, the banking sector suffered a loss during the 1999– 2001 period. However, this has seen an increase since 2002, as a result of the increased profits of banks, coming mainly from trading gains. Fourth, we observed an increasing capital adequacy index indicating a sign of improvement in the capital structure of the Turkish banking sector. Finally, the overall financial strength index reached its highest levels as a result of the improvements in asset quality, successful profitability performance and the stronger capital structure of the banking sector.

96 Turkish Banking

Conclusion The purpose of this chapter was to review traditional banking activities and the changing financial structure in Turkey. The chapter provided the reader with an overview of the Turkish banking system, its income and cost structure, and profitability level. In terms of financial structure, concentration in the Turkish banking system increased through the analysis period of 1990–2006. Despite the decrease in their numbers, state-owned banks still have a significant share of the system. We have identified that state-owned banks were less liquid. On the other hand, they had more risk in terms of past-due loans. The stylized facts on the Turkish banking system presented a picture of a sector that was volatile, especially during periods of financial distress since the mid-1990s. Keeping in mind the potential EU membership of Turkey, we have compared the Turkish financial system to those of EU member countries throughout this chapter. Regarding asset size, the Turkish banking sector constituted only 82 per cent of GDP compared to an EU-25 average of 300 per cent, and the industry has a colossal growth potential. Moreover, loans extended by banks in Turkey were only 40 per cent of GDP, whereas in EU-25 this ratio was 132 per cent in 2007. Finally, we observed that the levels of capital adequacy of Turkish banks have increased substantially after the re-capitalization programme of 2001.

5 The Turkish Banking Sector and Regional Economic Growth∗

Introduction In previous chapters we have covered the rapid development of Turkish banking, its structure, efficiency, Turkey’s financial crises and the country’s economic developments. No doubt macroeconomic instability, chronic high inflation, political conflicts and financial crises constituted an impediment to economic growth but, despite these obstacles, the Turkish economy and banking sector have grown. The total assets of the Turkish banking sector increased by around 300 per cent, from USD 60 billion to 180 billion between 1990 and 2003. In recent years, there has been an increased amount of interest in the relationship between financial development and economic growth. The issue of finance and growth has been researched globally, but different outcomes have arisen from researches. In this chapter, we aim to take the literature a step further, by linking the development of financial institutions, which are mainly represented by the banking industry, to the economic development that Turkey has experienced recently. However, unlike cross-country studies, we use provincial data to examine the relationship between financial development and economic growth in Turkey’s provinces between 1990 and 2003. First, we offer a brief review of the extensive literature on financial and economic development, then introduce our data and methodology, and later present our results with a discussion.

∗

An earlier version of this chapter was written by Altunba¸s and Özben (2003) as a working paper at the Bangor Business School, Bangor University.

97

98 Turkish Banking

A brief literature review: financial development and economic growth A large and diverse body of theoretical and empirical literature has investigated the importance of the financial sector for economic growth. These studies can be traced as far back as Bagehot (1873) and Schumpeter (1912). Bagehot (1873) and Hicks (1969) argued that the financial system is an important catalyst in industrialization by facilitating the amounts of funds available. Additionally, Schumpeter (1912) emphasized the importance of the banking system in economic growth, and highlighted circumstances when financial institutions can actively spur innovation and future growth by identifying and funding productive investment. Gurley and Shaw (1955) pinpointed the credit channel, and more particularly the role of financial institutions, in the supply of funds to the real sector (all sectors excluding financial sector) activity, and underscored the idea that differences in financial systems development might explain variance in economic performance between countries. More recent influences of financial development on economic growth can be credited to the works of Goldsmith (1969), McKinnon (1973) and Shaw (1973). Goldsmith emphasized the relationship between financial development and efficiency of investment. A more obvious way in which financial development can influence growth is through the mobilization of savings to finance physical and human capital accumulation. Goldsmith, studying thirty-six countries over the period between 1860 and 1963, showed that the financial structure in the economy accelerates economic growth and improves economic performance to the extent that it facilitates the migration of funds to the best user. He also argued that commercial banks generally were the first financial intermediaries during the early stages of economic development (this is certainly the case with Turkey, where banks are the main financial intermediaries). The new intermediaries, such as insurance companies, thrift institutions and capital markets, are expanded to provide services to particular classes of savers. He found that commercial bank assets increase rapidly in the early phases, while the growth rates of thrift institutions and insurance companies overtake the commercial banks as the financial system matures. McKinnon (1973) and Shaw (1973) pointed to the positive effect of financial development on savings (more appropriately, financial savings) hence also on the levels of investment. Specifically, they advocate a ‘liberalized’ financial system which (as they argue) is able to mobilize an increased volume of financial saving and

Turkish Banking and Regional Economic Growth 99

allocate capital to more productive uses, both of which enhance the volume and productivity of physical capital and contribute to economic growth. There has also been a notable revival of interest among endogenous growth theorists in exploring the link between financial market development and economic growth. These studies show that financial sector development has positive effects on steady growth rates. More specifically, they have emphasized the role of financial intermediaries in the optimal allocation of financial resources to capital accumulation (Bencivenga and Smith, 1991; Greenwood and Smith, 1997). Others have shown a bi-directional relationship between financial sector development and growth (Greenwood and Jovanovic, 1990; Berthelemy and Varoudakis, 1996). In contrast, several well-known economists are sceptical of the view that finance plays any major role in economic development. Robinson (1952: 52) argued, ‘by and large, it seems to be the case that where enterprise leads finance follows’. Kuznets (1955) pointed out that financial markets begin to grow as the economy approaches the intermediate stage of the growth process, and develop once the economy becomes mature. Chandavarkar (1992: 134) noted that ‘none of the pioneers of development economics even lists finance as a factor in development’. Thus finance is viewed as the handmaiden to enterprise by responding to the demand for the particular types of financial services generated by economic development. On the other hand, numerous empirical investigations have been carried out to test the impact of financial development on economic growth, and the causal relationship between them. Using a large cross-section of ninety-eight countries (between 1960 and 1985), Roubini and Sala-iMartin (1992) analysed the relationship between the degree of financial development and growth performance, and concluded that countries that repress their financial sectors grow less rapidly than those that do not. Hence, financial development helps to allocate inputs more efficiently, and therefore leads to aggregate output expansion. King and Levine (1993a, 1993b), looking at seventy-seven developing countries over the period 1960–89, showed that financial market development has a positive effect on economic growth. The authors examined the effects of financial intermediation on economic growth and the sources of growth, such as capital accumulation and productivity growth. Other work by Levine (1997, 1998) has shown that financial intermediary development does have a positive influence on economic growth, and these results are shown to be robust – that is, the relationships still hold

100 Turkish Banking

when other factors that are known to influence economic growth are held constant. Arestis et al. (2000) used quarterly data and applied a time series model to five developed economies. Their results showed that, while both banking sector and stock market development explain subsequent growth, the effect of banking sector development is substantially larger than that of stock market development. Graff (2001) examined the relationship of financial development economic growth in ninety-three corporatist and liberal market economies (with a dataset covering the period 1970–90). He concluded that financial development leads to economic growth, and financial development is more important to less developed countries. He also stated that financial development is more beneficial to economic growth in the more corporatist countries. Fase and Abma (2003) arrived at similar conclusions by examining the financial environment and economic growth in emerging Asian countries between 1974 and 1999. Looking at US regional data, Jayaratne and Strahan (1996) argued that changes in US growth are the result of changes in the banking system, and found a positive effect on real per capita growth rates via improvements in the quality of bank lending. Rioja and Valev (2004) examined a panel of 74 countries (covering the period 1960–95), and found that the relationship between economic growth and financial development may vary according to the level of financial development. The results of the study suggest that financial development exerts a strong positive effect on economic growth only after it has reached a certain size threshold. At low levels of financial development, additional improvements in financial markets have an uncertain effect on growth. However, while the impact of financial development is broadly positive in cross-sectional studies, panel data regressions have not corroborated such an effect. Financial sector development is found to exert a negative effect on economic growth in certain studies using panel data regressions (De Gregorio and Guidotti, 1995; Berthelemy and Varoudakis, 1998). The direction of causality has also been widely questioned by researchers. King and Levine (1993b) argued that they had proved that the initial level of financial development predicts the future growth rate, but Arestis and Demetriades (1997) showed that King and Levine’s interpretation is based on a fragile statistical basis. Moreover, King and Levine demonstrate that cross-section datasets cannot address the question of causality in a satisfactory way. Furthermore, other economists have questioned the direction of the causality relationship between economic growth and financial development, in contrast to these views. Rajan

Turkish Banking and Regional Economic Growth 101

and Zingales (1998) investigated the possibility of reverse causality. They argued that certain country-specific conditions might give an advantage to some industries, which at the same time relied heavily on external financing. Under this kind of arrangement, industries that depend more on external financing grow faster, which encourages the development of the financial sector. In this case, economic growth leads and financial sector development follows. While most of the empirical studies showed a positive correlation between measures of macroeconomic performance and financial development, not all of the results strongly support a causal relationship between the variables. Causal relationships between economic growth and financial intermediation have been observed by Jung (1986), Kirakul et al. (1993), Demetriades and Hussein (1996), Rousseau and Wachtel (1998), Luintel and Khan (1999), Hsu and Lin (2000), Shan et al. (2001), Al-Tamimi et al. (2002), and Ünalmı¸s (2002). Relating to Turkish data, Ünalmı¸s (2002) investigated the direction of causality between the financial development and economic growth of Turkey for the period 1970 to 2001. The empirical results showed that, except for one of the proxies, financial development significantly causes economic growth in the short term, and in the long run, there was a bidirectional relationship between financial development and economic growth. In other words, the Turkish case supports the supply-leading phenomena in the short term. and both the supply-leading and the demand-following cases (mutual causality) in the long run. Some studies also looked at regional effects of financial development within a country. Lucchetti et al. (2000) looked at the channels through which the banking system affects the real sector in Italy. This methodology was then applied to investigate the relationship between the banking system and economic growth in Italian regions. The authors calculated an inefficiency index for Italian regional banking and used this to analyse the convergence among regions in Italy. The empirical evidence in the study pointed out the existence of an independent effect exerted by bank efficiency on real growth, which corroborates the presence of a Schumpeterian channel, emphasizing the allocative function of banks. On the other hand, in their empirical work, Valverde et al. (2003) look at regions of Spain and conclude that, at the regional level, improvement in financial services has not played an important role in the concurrent expansion of regional GDP. Boyreau-Debray (2003) analysed the relationship between growth and financial intermediation at the sub-national level in China. The author used for his study a dataset of twenty-six provinces of China between 1990 and 1999. The results showed that China’s financial deepening has not contributed to local

102 Turkish Banking

economic performance, as shown by the insignificance of the ratio of deposits to GDP. Yet another branch of literature found a negative effect of financial development on growth. For example, Chick (1986) argued that, in less developed financial systems, credit expansion could have a negative effect on economic growth, whereas in more complicated financial systems, credit expansion stimulates economic growth. Jappelli and Pagano (1994) emphasized the possibility that the relationship between financial development and economic growth can be negative depending endogenous growth. De Gregorio and Guidotti (1995), showed that, in a sample of Latin-American countries, there was a robust and significant negative correlation between financial intermediation and economic growth. This chapter links the development of the banking sector in Turkey to the reviewed literature on financial development and economic growth. Specifically, we look at the impact of financial development, which is mainly represented by the banking sector, on regional economic growth. Although there is extensive literature about this, studies on regional growth, focusing on individual countries, are still limited. There are three major potential advantages of this study, since it examines the data within a country compared to cross-country studies, which are introduced by Valverde et al. (2003); (i) persistent heterogeneity across regions within a single country is lower and more easily controlled than across countries; (ii) the exogenous component of financial deepening – such as the degree of liberalization or the quality of the legal and institutional framework – can also affect the results significantly, and this component may be controlled more adequately at a regional level than in a cross-country perspective. Valverde et al. argued that the link between intermediation and growth is the sum of the multiple effects, and the regional analysis may capture some effects that are hidden in cross-country comparisons; and (iii) analysing regions within a country provides a greater availability of information on banking system developments, and at the same time the contractual relationships between banks and their customers are more likely to be observed on a regional than on a national basis. The next section introduces the data and methodology.

Data and methodology The dataset includes the financial and economic indicators of eighty-one provinces in Turkey for the years 1990 to 2003 (see Table 5.1 for a list of regions and provinces). In all estimates, the same time periods and the same set of provinces are used. However, some of the provinces, which

Turkish Banking and Regional Economic Growth 103 Table 5.1 Regions and provinces of Turkey Regions

Provinces

˙ Istanbul West Marmara Aegean East Marmara West Anatolia Mediterranean

˙ Istanbul Balıkesir, Çanakkale, Edirne, Kırklareli, Tekirda˘ g ˙ Afyon, Aydın, Denizli, Izmir, Kütahya, Manisa, Mu˘ gla, U¸sak Bilecik, Bolu, Bursa, Düzce, Eski¸sehir, Kocaeli, Sakarya, Yalova Ankara, Karaman, Konya Adana, Antalya, Burdur, Hatay, Isparta, Kahramanmara¸s, Mersin, Osmaniye Aksaray, Kayseri, Kırıkkale, Kır¸sehir, Nev¸sehir, Ni˘ gde, Sivas, Yozgat Amasya, Bartın, Çankırı, Çorum, Karabük, Kastamonu, Samsun, Sinop, Tokat, Zonguldak Artvin, Giresun, Gümü¸shane, Ordu, Rize, Trabzon A˘ grı, Ardahan, Bayburt, Erzincan, Erzurum, I˘ gdır, Kars Bingöl, Bitlis, Elazı˘ g, Hakkari, Malatya, Mu¸s, Tunceli, Van Adıyaman, Batman, Diyarbakır, Gaziantep, Kilis, Mardin, Siirt, S¸ anlıurfa, S¸ ırnak

Mid-Anatolia West Black Sea East Black Sea North East Anatolia Middle East Anatolia South East Anatolia

Source: SPO (2008) available at http://www.dpt.gov.tr/bgyu/biid/cog_bolge.html.

were previously counties during the period, constitute the constraint of this study. Since the aim of this study is to analyse the relationship between economic growth and financial development within provinces, the data for these newly-designated provinces begins from the date that they were re-categorized. Thus this situation has led to missing observations for some of the variables. As far as we know, this study is the first in the literature to study the relationship between financial development and economic growth by analysing provinces using cross-section regressions. The analysis is focused on the banking system because of the comparatively high weight of bank activities in the financial sector in Turkey and in the financing of Turkish firms. The next section introduces and justifies the selection of variables by looking at previous studies.

Economic growth and financial development indicators The dependent variable – the GDP of each province – represents the regional economic growth of the provinces between 1990 and 2003. This indicator is widely used in most of the studies in the literature (such as in King and Levine, 1993a, 1993b; De Gregorio and Guidotti, 1995; Valverde and Fernandez, 2004).

104 Turkish Banking

Two financial development indicators utilized in the analysis are (i) the level of credit extended to the private sector by commercial banks (CREDITS); and (ii) the outstanding value of deposits in the provinces (DEPOSITS). CREDIT indicates the importance of the role played by the financial sector, especially the deposit money banks, in the financing of the economy. The credits issued by the Central Bank are excluded. The underlying assumption is that credit provided to the private sector generates increases in investment and productivity to a much greater extent than do credits to the public sector. It is also argued that loans to the private sector are given under more stringent conditions, and that the improved quality of investment emanating from financial intermediaries’ evaluation of project’s viability is more significant for private-sector credits (Levine, 1998; Levine and Zervos, 1998). DEPOSITS is used in other studies as the amount of liquid liabilities of commercial banks. Liquid liabilities are also considered as a typical measure of ‘financial depth’, and thus of the overall size of the financial intermediary sector (King and Levine, 1993a). Liquid liabilities equal demand deposit plus time and savings deposits. This method, which is also referred to very commonly in the literature (see, for example, Demetriades and Hussein, 1996; Luintel and Khan, 1999) provides an alternative to a broad money ratio, especially when dealing with developing countries. The argument is that, in developing countries, a large component of the broad money stock is currency held outside the banking system. Therefore, in principle, a rising ratio of broad money to income may reflect the more extensive use of currency than an increase in the volume of bank deposits. Following this argument, bank deposit liabilities, which exclude currency in circulation from the broad money stock, have been used as a better measure of financial depth – and thus of the overall size of the financial intermediation. However, this indicator has been criticized in a number of ways (see Aziakpono, 2003).1 The data for variables are taken from the BAT and the SPO. Since a significant amount of fund transfers are realized over the banking sector, as mentioned earlier, the role of non-bank financing is ignored in this study. The results are tested with various conditioning information variables in order to scrutinize their sensitivity. The purpose of using these variables is to diminish the probability that the cross-section growth regression either neglects a significant variable or contains a choice group of regressors that produce a superior result. The first of the conditioning variables used in the estimates is PUBINVEST (public investment expenditures in the provinces). The variable is INCENTIVES (investment incentives given to the provinces). The dataset for these variables includes the

Turkish Banking and Regional Economic Growth 105

years 1990–2001, and they are taken from the Turkish Treasury. INTEREST (average interest rates of treasury bills), EXCHANGE (exchange rates of USD) and IPP (investment priority provinces) are also used in order to control for their effect on economic growth, bank credits and deposits. Moreover, we use cross-sectional analysis and panel data estimations. Regarding the latter, we expect panel data analysis to capture more fully the nature of the latent, or unobserved, disturbance terms in econometric relationships. The model to be estimated is as follows (Levine 1997):
Gi = α + β
FINANCEi + γ (
CONDITIONINGSET )i + εi where, the dependent variable G represents growth, FINANCE stands for the two selected financial development, CREDITS and DEPOSITS. CONDITIONINGSET represents the selected control variables of conditioning information, which are PUBINVEST, INCENTIVES, INTEREST, EXCHANGE and IPP. The next section presents our results, their interpretation and the relevant discussion.

Results and discussion Correlation matrices Table 5.2 presents a correlation matrix for Turkey as a whole (rather than in provinces). The table indicates that financial development variables are positively related and highly significant to the economic growth variable of Turkey GDP_T. Both financial development variables, CREDITS_T and DEPOSITS_T, are positively and significantly related to each other. On the other hand, PUBINVEST_T also seems to have a significant and positive relation with GDP_T ; however, the relation is not as

Table 5.2 Correlation analysis for Turkey overall CREDITS_T DEPOSITS_T GDP_T CREDITS_T DEPOSITS_T GDP_T PUBINVEST_T INCENTIVES_T

1 0.7840* (0.000) 0.9192* (0.000) 0.1466* (0.000) 0.0502 (0.1345)

PUBINVEST_T INCENTIVES_T

1 0.7197* (0.000) −0.1896* (0.000) −0.1181* (0.0004)

Notes: p-values in brackets; * significance at 1%.

1 0.3720* 1 (0.000) −0.0022 −0.4648* (0.9477) (0.000)

1

106 Turkish Banking Table 5.3 Correlation analysis of variables for the provinces of Turkey CREDITS CREDITS DEPOSITS GDP PUBINVEST INCENTIVES

1 0.9465* (0) 0.9298* (0) 0.7287* (0) 0.5142* (0)

DEPOSITS

GDP

PUBINVEST

INCENTIVES

1 0.8924* (0) 0.6495* (0) 0.4654* (0)

1 0.7638* (0) 0.5643* (0)

1 0.4133* (0)

1

Notes: p-values in brackets; * significance at 1%.

strong as that of the financial development variables and the economic growth variable. In addition, PUBINVEST_T has a positive and significant relation with CREDITS_T, and negative and significant relation with DEPOSITS_T. Finally, the relation of the control variable INCENTIVES_T to DEPOSITS_T and PUBINVEST_T is significantly negative, which indicates that they move in opposite directions. Also, the relation of INCENTIVES_T with CREDITS_T and PUBINVEST_T is not significant. Correlation results for the provinces of Turkey are presented in Table 5.3. Financial development variables are found to be positively related and highly significant with the GDP of the provinces. CREDITS and DEPOSITS are positively and significantly related to each other. On the other hand, PUBINVEST also seems to have a significant and positive relation with GDP; however, the relation is not as strong as that of financial development variables with the economic growth variable. Additionally, PUBINVEST of the provinces has a positive and significant relation with CREDITS, DEPOSITS and GDP. Finally, the relation of the control variable INCENTIVES with all the other variables is significantly positive.

Regression results We first present our results estimated with simple regression analysis to capture the basic relationship between the selected independent variables and growth (see Table 5.4). In the estimations, we utilize change in variables between the years as well as test the impact of lag values (1-year lag). CREDITS is found to be significant and positively related with provincial GDP, signifying that, ceteris paribus, GDP in the provinces will tend to increase as amount of credits rise within the region. The

Turkish Banking and Regional Economic Growth 107

Table 5.4 The relation of GDP to lagged GDP and selected explanatory variables Dependent variable: Real GDP growth 1

2

Intercept

3

4

0.029*** 0.022 0.039** 0.052* (0.016) (0.018) (0.016) (0.009)
GDP (1) −0.295* −0.369* −0.396* −0.899* (0.040) (0.039) (0.039) (0.043)
CREDITS 0.260* (0.032)
CREDITS (1) −0.017 (0.038)
DEPOSITS 0.310* (0.073)
DEPOSITS (1) 0.108 (0.082)
PUBINVEST 0.080* (0.018)
PUBINVEST (1) 0.010 (0.017)
INCENTIVES 0.001 (0.001)
INCENTIVES (1) 0.002* (0.000)
INTEREST
INTEREST (1)
EXCHANGE

6

0.033** (0.014) −0.397* (0.036)

0.203* (0.049) −0.289* (0.039)

−0.090*** (0.054) 0.540* (0.052) −0.354* (0.038) 0.118* (0.043)


EXCHANGE (1)

R2 N

5

17.74% 683

8.15% 685

8.71% 40.27% 18.28% 20.96% 676 544 685 685

Notes: * significance at 1%; ** significance at 5%; *** significance at 10%; standard error in parentheses; (1) represents lagged form.

coefficients of DEPOSITS also have a significant and positive sign. An increase in the deposit levels of the banks in a region leads to an increase in production. PUBINVEST in the provinces leads to an increase the GDP of the region, which is a consistent finding with the economic theory. Although INCENTIVES appear to have no significant relation

108 Turkish Banking Table 5.5 Turkey

Regression analysis of provinces in

Dependent variable: Real GDP growth Intercept
CREDITS
CREDITS (1)
DEPOSITS
DEPOSITS (1)
GDP (1)
PUBINVEST
PUBINVEST (1)
INTEREST (1) IPP
EXCHANGE R-Sq N

0.264* (0.068) 0.027 (0.043) −0.059 (0.038) −0.087 (0.076) −0.066 (0.079) −0.261* (0.039) 0.023 (0.017) 0.021 (0.016) 0.349* (0.069) −0.066 (0.077) −0.234* (0.053) 23.78% 674

Notes: * significance at 1%; ** significance at 5%; *** significance at 10%; standard error in parentheses; (1) represents lagged form.

with GDP, the lagged form is significant and positively associated with GDP. Therefore, the effect of the incentives on GDP in the provinces can only be observed in the following year. Both of the explanatory variables INTEREST and EXCHANGE are negatively significant, while lagged forms of these variables are significant and have a positive impact on regional GDP. After our simpler approach we integrate all the independent variables to the estimation (see Table 5.5). Contrary to the simple regression analysis of the economic growth indicator GDP, our findings suggest that the relation between economic growth and financial development in the provinces is insignificant. This is consistent with economic theory,

Turkish Banking and Regional Economic Growth 109

because in most of the emerging countries such as Turkey, economic growth depends on various other variables such as government policies. Furthermore, in untabulated regression estimations, where CREDITS is utilized as the dependent variable, we find that change in GDP has a significant and positive impact on CREDITS. Therefore, in the case of regional analysis of Turkey’s provinces, we can conclude that the causality runs from economic growth to financial development. In the literature, the relationship between financial development and economic growth is mixed in different regional cross-sectional regression analyses. In our analysis, while the relation between economic growth and financial development is found to be significant in the simple estimates, with the addition of the control variables, economic growth becomes insignificant with the financial development variables. Comparing our results to those in the literature studies, both Leahy et al. (2001) and Thiel (2001) also found an insignificant relationship between the level of credits and economic growth, while Leahy et al. (2001) reports a positively related but insignificant coefficient for level of deposits. De Gregorio and Guidotti (1995) examined the relationship of economic growth and financial development for Latin America, using the definition CREDITS as in this study, and reported a negative relationship between CREDITS and GDP. According to De Gregorio and Guidotti, this negative relationship was caused by poor regulation of the lending procedures by banks, which led to overlending and the collapse in the 1980s of the liberalization of financial markets. Boyreau-Debray (2003) analysed the relationship between growth and financial intermediation at the subnational level in China. The results suggested that credit extended by the banking sector at the state level has a negative impact on provincial economic growth. On the other hand, Valverde and Fernandez (2004), reporting a positive relation, argued that bank lending specialization plays an important role in the territories (regions) where households and firms are particularly dependent on bank credit. In conclusion, the results of the empirical studies on the relation of regional growth and financial development vary. In the case of Turkey, our results indicate that CREDITS and DEPOSITS in the provinces are not related significantly with to economic growth of the provinces.

Conclusion The Turkish economy and banking sector grew significantly between 1990 and 2003. This chapter, influenced by the extensive literature on financial development and economic growth, aimed to analyse the

110 Turkish Banking

impact of banking sector growth on regional economic development in Turkey. The dataset utilized economic indicators; GDP, level of credit and level of deposits in eighty-one provinces in Turkey between 1990 and 2003. Our findings suggest that the relation between economic growth and financial development in the provinces is insignificant; in other words, we do not find empirical evidence supporting the statement that banking sector development led to regional economic development. This is consistent with economic theory, because in most of the emerging countries such as Turkey, economic growth depends on other various variables such as government policies. Moreover, evidence shows that causality runs from economic growth to financial development.

6 Performance of Banks in Turkey

Introduction The Turkish banking industry has experienced structural changes in recent years relevant to factors such as deregulation, liberalization, an extraordinary upgrading in information technology (IT), and feedback from the IMF as a reflection of the restructuring programme. In particular, changes and developments in the deregulation process, together with the privatization of various banks being merged or bought by foreign banks, have brought about a significant increase in competition, which has put pressure on Turkish banks to become more concerned with analysing and controlling their costs and revenues, and preserving high performance levels. Performance measurement has been a primary concern of investors, lenders, shareholders, and in particular to managers, in planning and controlling their activities. Therefore, examining the performance levels of Turkish banks can guide financial authorities to provide advice on possible actions that can be engaged in to maintain financial stability, minimize risk of failure and improve the performance of banks – all core issues on the road to EU membership. This chapter aims to carry out a nonparametric performance analysis of the Turkish banking industry with an application of data envelopment analysis (DEA) and DEA–Malmquist index techniques over the period 1992–2006. The dataset analysed throughout this chapter is a representation of the industry covering approximately 95 per cent of the total assets in the Turkish financial system. For this purpose, it first applies the DEA method, which uses linear programming to obtain the relative technical efficiency of Turkish banks. Then the analysis is extended with an application of the Tobit regression model to identify the significance of the 1994 and 2000/01 crises, foreign ownership and the 111

112 Turkish Banking

1999 IMF restructuring programme for the technical efficiency scores of banks. Second, an application of the nonparametric DEA–Malmquist index technique is introduced to identify of productivity levels of Turkish commercial banks.

Fundamentals of efficiency and productivity The basic idea of performance measurement is based on production functions. Despite numerous agricultural scientists formulating and estimating production relationships with several factors, it was not popular until the Cobb–Douglas paper in 1928. Homogenous Cobb– Douglas production frontiers are specified, with the assumption that all observations are located on or beneath the frontiers. This makes it a deterministic frontier, where it is not possible to discover whether the overall performance level is a result of the effects of inefficiency or of the random variable. Even though the post-classical theory of production is a simplified version representing the production process at both microeconomic and macroeconomic levels, the idea provides a connection between the individual choice of production units and income distribution in an economy. The most basic assumption is that there is a relationship between inputs and outputs that could be written in a conventional mathematical formula, and the production function yields the maximum output for a specified input vector. In microeconomics, a production function expresses the relationship between an organization’s inputs and outputs. The key idea is that a range of levels of outputs can be obtained from various amounts and combinations of factor inputs. The purpose is to summarize information about industrial structure and productive efficiency, where the fundamental theory dates from the time of the post-classical period. It investigates the production process at both the individual organization level and in the economy as a whole (Scazzieri, 1993). In particular, it shows the maximum possible amount of output that can be produced per unit of time with all combinations of factor inputs, given current factor endowments and the state of available technology. Moreover, unique production functions can be constructed for all production technology and are generally used to find the ‘best practice technology (frontier)’. A frontier is the line that shows the production possibility set (PPS), which measures a set of outputs that is feasible when employing given technology and inputs. It depends on the nature of the technology of the production process, and measures how much of one good could be obtained by sacrificing some of another good.1 The distance of each

Performance of Banks in Turkey 113

individual unit from the production frontier measures the efficiency differences of individual decision-making units (DMUs).2 DMUs can either have an assumption of cost minimization or output maximization. This is because various combinations of inputs in a production process might yield the same level of output. Therefore, what a firm searches for is to find the factor combination of capital and labour (that is, inputs) that has the lowest total costs but still produces optimal output. This technique is known as cost-minimization and was introduced by Samuelson and Swamy (1974). A firm can decrease the total level of costs without affecting the total level of revenue, and thus increase profits by changing the proportions of capital and labour. Furthermore, it is well known that a firm can reduce costs per unit of output as long as its size gets bigger. This is the basis of economies of scale in performance measurement. A firm can have constant returns to scale (CRS), increasing returns to scale (IRS) or decreasing returns to scale (DRS) assumptions. More specifically, a bank is operating at CRS if there is a proportionate increase in all outputs according to a proportionate increase in costs, whereas with IRS a proportionate increase in outputs requires a less than proportionate increase in costs. Finally, scale diseconomies (that is, DRS) arise when costs increase more than the proportionate increase in outputs. In more detail, efficiency is defined as the production of the maximum output using the minimum level of inputs.3 Efficiency indicators are used to measure a firm’s performance as different factors affect industries differently. Efficiency measurement is important because it gives an idea about what your colleagues have accomplished, investigates what works and what does not in a specific field, makes managers aware of which factors they should focus on to improve their level of success, and captures price effects on asset products for the purpose of comparison. In such an environment, firms become increasingly concerned about controlling and analysing their costs and revenues as well as measuring the risks taken to produce acceptable returns. For example, in the case of Turkish banking performance measurement, increased competition associated with the process of liberalization and deregulation had a tremendous effect on the performance and credit risk of Turkish banks (see, for example, Altunba¸s et al., 2000). The second performance indicator, productivity, is defined as the ratio of outputs to inputs. If the case is multiple input/output, then an index is required to obtain the measure of overall productivity (Coelli et al., 1998). The total factor productivity (TFP) index is applied mainly in productivity measurement covering all factors of production. At this point, the question might be raised as to why macroeconomists care

114 Turkish Banking

about fluctuations in efficiency and productivity. Basically, the answer is that productivity provides information about the aggregate production of goods and services in the economy, and about a firm’s behaviour. Therefore, supporting the proposal of Albach and Jin (1997), it can be said that efficient use of resources is the key idea in providing the best levels of outputs, which is more important in companies with constricted budgets and reduced workforces. It is always emphasized that inefficient firms are driven from the market under perfect competition, which puts pressure on the managing authorities of firms to produce at their best level. The existing efficiency literature generally accepts that, in order to have controlling power over efficiency differentials, factors affecting both efficiency and productivity must be measured and controlled.4 Even though the words efficiency and productivity are used interchangeably, a slight distinction exists between them. Coelli et al. (1998: 5) present this phenomenon in a single input (X), single output (Y) production process (see Figure 6.1). 0F is the production frontier, which defines the relationship between an input X and an output Y, where the slope of the frontier measures productivity. Firms B and C are technically efficient and represent the maximum output attainable from each input level. Productivity is higher at point B than point A as it produces higher output by using Q amount of input. However, C is the point of optimal scale (maximum possible productivity) where 0F is tangent to the productivity line. Therefore, all other points on the production frontier represent lower productivity. This is a proof that a firm might be technically efficient but

Y

Optimal C •

O Figure 6.1

• B

F′

• A

Q

X

The distinction between efficiency and productivity

Source: Coelli et al. (1998: 5).

Performance of Banks in Turkey 115

not necessarily be productive. Technical inefficiency implies being inside or below the production frontier. However, the determinants of inefficiency may be measured based on a frontier distance function, which provides the basis for Malmquist indices.

Data sources We accomplished the empirical investigation of this chapter by using a dataset compiled from the annual publications of the BAT and CBT, where financial statements are provided for each bank over the period 1992–2006. The number of banks in the sample reduced from twentytwo to nineteen during the analysis period because of the effects of financial crises, which resulted in bank failures, mergers, acquisitions and takeovers by foreign banks and powerful public banks. The focus is only on the medium-sized and large commercial banks, which hold 95 per cent of the total assets, 97 per cent of the total loans and 96 per cent of the total deposits of the entire Turkish banking sector. In order to identify the effects of numerous country-specific macroeconomic factors on DEA efficiency scores, four dummy variables were included in the second-stage DEA model. The organization of bank specialization is achieved by considering only the principal foreign, state-owned and public banks. This is accomplished by excluding small banks that have total assets of less than USD 50 million, because of their significantly small share in the system. All DEA efficiency and productivity computations were performed using the software programme DEAP by Coelli (1996) and the second-stage DEA analysis by an application of STATA software identifying the effects of dummy variables. Table 6.1 summarizes the distribution of banks in the sample by year. The number of commercial banks in Turkey remained constant between 1992 and 1997, at twenty. The number increased after 1997, to twentytwo by the end of 2000. After the twin crises during 2000/01 numerous banks developed financial problems, so a total of nine banks were transferred to SDIF under the control of the government, and later some of them went through mergers and takeovers by foreign banks. The most important cases have been the sale of Demirbank to HSBC plc in 2001, the merger of Koçbank with UniCredito in 2002 and, most recently, the sale of an 89 per cent share of Dı¸sbank to Fortis in 2005. This is the main reason for having an unbalanced sample with changing numbers of banks during the analysis period. All these banks were commercial banks, but their ownership structure was different: some were state-owned,

X X X X NE X X X X X X X X X X X X NE X X X X NE NE

1993

X X X X NE X X X X X X X X X X X X NE X X X X NE NE

1994

Notes: X: Data available; NE: Non-existent bank. Source: Data compiled from BAT, 1992–2006.

X X X X NE X X X X X X X X X X X X NE X X X X NE NE

1992 X X X X NE X X X X X X X X X X X X NE X X X X NE NE

1995 X X X X NE X X X X X X X X X X X X NE X X X X NE NE

1996 X X X X X X X X X X X X X X X X X X X X X X NE NE

1997

Annual distribution of banks in the sample, 1992–2006

Ziraat Bankası Halk Bankası Vakıflar Bankası Alternatif Bank Anadolu Bank Oyak Bank S¸ ekerbank Tekstil Bank TEB Garanti Bankası ˙ s Bankası I¸ Yapı ve Kredi Bankası Akbank Koçbank Osmanlı Bankası Dı¸sbank Demirbank Denizbank Finansbank HSBC Citibank Emlak Bankası Millennium Bank Fortis Bank

Table 6.1

X X X X X X X X X X X X X X X X X X X X X X NE NE

1998 X X X X X X X X X X X X X X X X X X X X X X NE NE

1999 X X X X X X X X X X X X X X X X X X X X X X NE NE

2000 X X X X X X X X X X X X X X NE X NE X X X X NE NE NE

2001 X X X X X X X X X X X X X X NE X NE X X X X NE NE NE

2002 X X X X X X X X X X X X X X NE X NE X X X X NE X NE

2003 X X X X X X X X X X X X X X NE X NE X X X X NE X NE

2004 X X X X X X X X X X X X X NE NE NE NE X X X X NE X X

2005 X X X X X X X X X X X X X NE NE NE NE X X X X NE X X

2006

116

Performance of Banks in Turkey 117

some privately-owned, and others were owned by foreign financial institutions. Since the overall objectives and organizational structure of these banks were the same, and since they operated in the same environment, we included all of them in the analysis (see, for example, Altunbas et al., 2001). Furthermore, choosing the appropriate definition of bank output is an important issue. Although the multi-product nature of banks is widely recognized, there is still no agreement as to the explicit definition and measurement of inputs and outputs. Generally, each definition of input and output carries with it a particular set of banking concepts, which influence and limit the analysis of production characteristics of the industry. Specifically, the main disagreement centres on whether deposits should be treated as inputs or outputs. Our selection of variables in this study is guided by the objectives of the Turkish banking system. In Turkey, commercial banks act as intermediaries, with the aim of collecting deposits. This was highly significant in the pre-liberalization period, when there was no price competition. However, the role of deposits as the traditional main source of funds is still prevalent in the post liberalization period. We treated them as outputs, since deposits are regarded as a ‘resource-consuming activity’, and thus contain a significant portion of the value-added in the Turkish banking system. The modelling of the production function and selection of variables were achieved by following the value-added approach by Berger and Humphrey (1997). This approach has also been applied by Berger et al. (1993), Pastor (2002), Pastor, Lozano and Pastor (2002), Pastor, Perez and Quesada (1997), Resti (1997), Chaffai et al. (2001), Kumbhakar et al. (2001), Grigorian and Manole (2002), Lozano–Vivas et al. (2002), Maudos et al. (2002). Therefore, labour (PE), physical capital (non-interest expenses excluding personnel expenses, PC), permanent assets (PA) and financial inputs (interest paid by the bank, FI ) are considered as inputs used to produce total loans (L), total deposits (D), other earning assets (OEA) and interest income (II ). The production function can then be written as: L + D + OEA + II = min [L(PE, PC, FI, PA); D(PE, PC, FI, PA); OEA(PE, PC, FI, PA); II(PE, PC, FI, PA)]

(6.1)

Broad variable definitions presented by IBCA Bankscope were chosen for the empirical estimations to minimize possible bias arising from different accounting practices. The definitions presented in Table 6.2 have also been applied by Pastor et al. (1995), and Casu and Molyneux (2003).

118 Turkish Banking Table 6.2 Definitions of variables Variable

Symbol Definition

Loans

L

Loans and advances for all time periods, customer loans (loan loss reserves deducted)

Other earning assets

OEA

Deposits with banks, public debt, other investments, equity investments

Deposits

D

Demand, savings and time deposits

Personnel expenses

PE

General and administrative expenses, remuneration, social security costs and pensions

Physical capital

PC

Value of non-interest expenses, excluding PE

Financial inputs

FI

Value of interest paid by each bank

Permanent assets PA

Non-performing assets (net) + equity participations + affiliated companies + fixed assets

Interest income

Interest on (loans + securities portfolio + deposits in other banks + interbank funds sold) + other interest income

II

Nonparametric efficiency measurement of Turkish banks This section discusses the methodological issues utilized to examine the technical efficiency scores of the Turkish banking industry over the period 1992–2006. The DEA method is applied to the performance measurement problem.

Data envelopment analysis (DEA) method DEA is one of the most popular linear programming methods examining relationships between the inputs and outputs of a production process. It is interesting for researchers because of its applicability to production or cost frontier estimation. Since its introduction, the DEA model has been applied extensively in empirical studies to analyse both cross-section and panel data. It has a simple general performance ratio of weighted outputs to weighted inputs comparing each DMU with the ‘best’ DMU (the accepted benchmark bank). DEA can either be inputor output-orientated. The orientation affects the projection because an input orientation focuses on the maximal movement via the proportional augmentation of outputs, whereas an output orientation focuses on the opposite. DEA dominates the non-parametric methodologies formed as a linear combination that connects a set of best-practice observations yielding a convex production possibility set.5 DEA is not only non-parametric but is also a deterministic approach assessing efficiency. It generally

Performance of Banks in Turkey 119

assumes that there are no random fluctuations, so all deviations from the estimated frontier represent inefficiency (see, for example, Rangan et al., 1988; Elyasiani and Mehdian, 1990, Ferrier and Lovell, 1990). One advantage of DEA that attracts analysts and management is its ability to identify the potential improvement of inefficient units. In contrast to regression methods, DEA focuses on individual observations and optimizes the performance measure of each unit. Moreover, a prior knowledge of weights or prices for inputs and outputs is not required in DEA. For banks enveloped by the frontier, DEA compares each bank with a convex combination of banks located on the frontier and enables an indication of sources and level of inefficiency for each of its inputs and outputs. The indicated targets, which are shown to the inefficient banks as models, are their actual peer units.6 Charnes et al. (1978)7 reformulated Farrell’s efficiency measurement into a linear programming technique8 that provided a new way of obtaining empirical estimates. It was the first DEA model that was capable of dealing with multiple inputs and outputs. The model is improved with a supply of mathematical formulae and consists of an input and an output orientation. The CCR (1978) model has three restrictions: constant returns to scale, convexity of the set of feasible input–output combinations, and a strong disposability of inputs and outputs.9 No functional form is required in a non-parametric estimation, where the best-practice banks are located on the frontier and other banks not on the frontier are accepted as inefficient. The linear problem identified for the CCR model is: r=s


Max  =

r=1 i=m


Ur Yro (6.2) Vi Xio

i=1 s
r=1 m


Ur Yri ≤1 Vi Xij

i=1

subject to  = where Ur ≥ 0, r = 1, . . . , s Vi ≥ 0, i = 1, . . . , m Xij = amount of input i from DMU j Yri = amount of output r from DMU i i = number of inputs  = efficiency score

(6.3)

120 Turkish Banking

where o = a specific DMU to be evaluated Ur = weights of output r Vi = weights of input i r = number of outputs The objective function aims to maximize the efficiency score of the DMU under analysis and it has the constraint-providing limitation that the efficiency score of the sample cannot exceed 1; that is, 100 per cent efficient. This approach employs CRS, as it is an input-based efficiency measurement and aims to maximize outputs. The dual form of the model can be written for a specified DMU, and can be written as the following formula. It measures the efficiency level of each bank by using a j-vector of inputs (Xij = Xi1 , . . . , Xij ) to produce an r-vector of outputs (Yri = Yr1 , . . . , Yri ): Min θ = 0

(6.4)

subject to n


xj yrj ≥ yr0 ,

r = 1, 2, . . . , s

j=1

0 xi0 −

n


λj xij ≥ 0,

i = 1, 2, . . . , m

(6.5)

j=1

λj ≥ 0,

j = 1, 2, . . . , n

where 0 is the efficiency score for a particular DMU. The CRS restriction assumes that all DMUs under analysis are performing at an optimal scale. However, CRS specification yields misleading measures of technical efficiency, as the efficiency scores are biased by scale efficiencies and affected by variations in market power, constraints on finances, externalities and imperfect competition. This shortcoming has been corrected by Banker et al. (1984) and the formulation has been  extended by employing the VRS assumption, nj=1 λj = 1, into the DEA model,10 which relaxes the CRS condition by not restricting the frontier to passing through the origin (Ali, 1994). This variable serves as a convexity constraint allowing the efficient frontier to develop observations more tightly than the CCR model. Once again, the technical inefficiency is calculated by how well a DMU uses its inputs to create outputs. The

Performance of Banks in Turkey 121

resulting linear programming problem is expressed as: Min θ = 0

(6.6)

subject to n


λj xij + s− i = 0 xio ,

j = 1, . . . , n

(6.7)

r = 1, 2, . . . , s

(6.8)

j=1 n


xj yrj − s+ i = yr0 ,

j=1 n


λj = 1,

+ λj , s− i , si ≥ 0

(6.9)

j=1

where

Xij = amount of input i from DMU i Yri = amount of output r from DMU i  = efficiency score Si− or Si+ = negative and positive slacks, respectively11

For the identification of returns to scale: n
λj < 1 implies IRS, whereas j=1 n


λj > 1 implies DRS

j=1

The DMU under analysis is accepted as inefficient if θ0 is less than one. Therefore, for these inefficient DMUs, the optimal value of λj constructs hypothetical DMUs formed by the sub-set of inefficient DMUs. These are known as the slacks and could be included in the formula in equations such as 6.7 and 6.8. Even though the theoretical literature is inconclusive on the selection of input/output-orientated approaches in efficiency measurement, Casu and Molyneux (2003) emphasized the fact that many studies in the literature preferred to use an input-orientated approach because input quantities appear to be the primary decision variables. Additionally, they emphasized that ‘output and input oriented models will estimate exactly the same frontier and, therefore, identify the same set of efficient DMUs’ (Casu and Molyneux, 2003: 1867). As the empirical analysis introduced in this thesis is based on average values of banks according to groups of total asset size, the decision on selection of orientation is expected not to have a substantial impact.

122 Turkish Banking

The main concern in the DEA approach is that many DMUs in the sample might be identified as efficient and DEA would thus have little discriminatory power.12 The first thing to emphasize is a unit with the highest ratio of outputs to inputs or efficiency very close to one, if efficient. DEA assumes that all banks in a sample have the same unspecified technology, and aims to find out which banks are operating on the efficient frontier and which are not. The DEA approach has basic characteristics, such as focusing on individual observations, producing a single aggregate measure for each DMU in terms of input/output utilization, simultaneously utilizing multiple inputs/outputs, and putting no restrictions on the functional form of the production relationship (Banker et al., 1993). Another closely related issue arises from the fact that DEA constructs a frontier from the data itself. Hence the efficiency measures derived in any given analysis are only valid inasmuch as they reflect how efficient DMUs are, relative to others in that particular sample. In order to extend the analysis on the efficiency scores of Turkish banks, and identify effects of the main country specific factors, the Tobit regression can be applied. The fundamental characteristics of the Tobit model are introduced in the next section.

Tobit regression: accounting for environmental variables In order to further investigate the determinants of efficiency levels in the Turkish banking industry, a ‘two step’ approach introduced by Coelli et al. (1998) has been followed in the nonparametric analysis of this chapter. Therefore, the estimated DEA efficiency scores are regressed against selected dummy variables with an application of the Tobit model.13 The Tobit model assumes that the observed dependent variable Yj (that is, efficiency scores from the DEA model) for banks j = 1, . . . , n satisfy: Yj = max (Yj∗ , 0)

(6.10)

Yj∗ s

where the are latent variables generated by the classical linear regression model in Equation 6.10: Yj∗ = βXj + Uj

(6.11)

with Xj a vector of regressors, possibly including 1 for the intercept, and β the corresponding vector of parameters. The model errors Uj are assumed to be independent N (0, δ2 ) distributed. Since efficiency is a variable that varies between zero and one, the estimation of determinants of efficiency

Performance of Banks in Turkey 123

should be made on the basis of a Tobit-type limited variable model, which is limited between 0 and 1 as lower and upper limits, respectively. This is because estimations by ordinary least squares (OLS) may generate biased and inconsistent results among the parameters (Maudos et al., 2002). Dummy variables of the Tobit model are expressed as: Yj = 1

if Yj > 0

Yj = 0

if Yj ≤ 0

The following Tobit regression is estimated for the Turkish banks in the sample. A dummy variable is included in Equation 6.12 for the years 1997–2006 to identify the effects of the 1994 crisis, the twin crises (2000/01), the launch of the 1999 IMF restructuring programme, and the arrival of foreign banks in the Turkish banking sector: θi = β1 94c + β2 twc + β3 fo + β4 imf + εi

(6.12)

where

i = efficiency scores 94c = 1994 crisis twc = twin crises during 2000/01 fo = foreign ownership imf = 1999 IMF restructuring programme Furthermore, in order to investigate possible determinants of bank efficiency, the following hypothesis at the α = 0.05 significance level has also been tested: H0 : βx,y = 0 Hi : βx,y  = 0 β1 , β2 , β3 , and β4 are the coefficients of the variables, whereas x and y represent the intercepts of the country-specific banking systems under study.

Nonparametric productivity measurement of Turkish banks This section brings a different perspective to the purpose of this chapter on performance measurement. The productivity changes of the Turkish banks are examined and evaluated in detail throughout this section. The productivity change can be measured in two ways, either by input-orientated or output-orientated approaches. The input-orientated

124 Turkish Banking

approach measures productivity change with a reduction in input usage, which is feasible with a specified amount of outputs and technology. On the other hand, the output-orientated approach examines the amount of extra output produced, using a given level of inputs with a stated technology. Most of the studies in the banking literature have applied the Malmquist productivity index technique to measure productivity scores. The Malmquist productivity index is a technique based on distance function, which has the advantage of not requiring any price or share information. It was introduced by Caves et al. (1982a) for the first time after its initial presentation by Malmquist (1953) and Shephard (1953).14 Shephard introduced the input distance function in the context of production analysis, whereas the approach by Malmquist was in the context of consumption analysis.15 Malmquist constructed the index as an input quantity index with ratios of distance functions at period t. However, for calculating productivity growth, the ratios are considered at periods t and t + 1. The distance between these two frontiers represents the productivity growth. As the two technologies can be non-neutrally related, the geometric mean of the two ratios is taken. In the case of more than two periods, the Malmquist index is calculated for adjacent periods, such as t and t + 1, t + 2 and t + 3 to T and T − 1. The adjacent period approach interprets technical change as the distance between the frontiers, whereas the fixed base period version interprets technical change as the relative distance between the base period frontier and the frontiers in periods t and t + 1.16 The difference between these models is that the adjacent period model interprets technical change as the relative distance between the base period frontier and in periods t and t + 1.17 However, in the fixed base model, the distance in period t + 1, t + 2 . . . , T is calculated relative to the base technology.18 Malmquist indices at periods t and t + 1 are only equivalent if the technology is Hicks output neutral19 (Färe, Grosskopf and Ross, 1997). Figure 6.2 illustrates the construction of the Malmquist index for bank K which uses the inputs, x and x + 1 in periods t and t + 1 to produce the outputs y and y + 1. K(t) and K(t + 1) are the bank’s input–output bundles for the periods t and t + 1. Between these bundles in time, the frontier shifts from f (t) to f (t + 1). K(t) is an inefficient bundle compared to frontier t. However K(t) can be efficient if it is reduced by the horizontal distance function OD/OF. If the situation is compared with period, t + 1, K(t + 1) should be multiplied by the horizontal distance ratio OD/OE, so as to obtain a comparable technical efficiency. Since there has also been a movement in the

Performance of Banks in Turkey 125

Output

Frontier (t  1)

Frontier (t)

K (t  1) y (t  1) K(t )

y (t ) O

D

E

F

x (t  1) x(t )

Input Figure 6.2

Construction of a Malmquist productivity index

Source: Adapted from Färe, Grosskopf and Ross (1997).

frontier, OD/OE is now above f (t). However K(t + 1) is still inefficient compared with its own frontier, t + 1. Distance functions can deal with multiple-input and multiple-output production technology without the need for a specific behavioural objective (that is, cost minimization or profit maximization). In this section, the model summarized by Lovell (1993: 51) is presented, which was introduced by Färe et al. (1994), defining the output-orientated index between periods t and t + 1. However, in this basic model, economies of scale factors have not been considered. Grifell-Tatjé and Lovell (1996) abridged the development of the Malmquist index of productivity change and showed how linear programming can be used for the estimation and decomposition of this index, which were originally developed by Färe et al. (1994). The literature beginning with Caves et al. (1982) (hereafter abbreviated as CCD), and Nishimizu and Page (1982) applied the Malmquist index to the measurement of productivity change to compute the index for the first time in the empirical perspective that reassigns the context from a consumption to a production approach. Specifically, CCD defined an input-based Malmquist productivity index imposing overall efficiency by Farrell (1957) and a Translog structure on the distance functions. The Malmquist index was related to the Tornqvist productivity index by CCD under certain conditions such as technology being Translog, secondorder terms being constant over time. and firms assumed to be costminimizers or revenue-maximizers.20 However, the original Tornqvist index does not allow for productivity decomposition, because of the

126 Turkish Banking

assumption that production is always efficient.21 With assumptions of non-constant returns to scale, Grifell-Tatjé and Lovell (1999) proved that the geometric mean of two generalized Malmquist productivity indices is equal to the Tornqvist productivity index. Furthermore, Färe and Grosskopf (1992) and Balk (1993) showed that, under constant returns to scale and competitive cost minimization performance conditions, the Malmquist index approximation also became the Fisher (1922) index.22 The theory is based on the ratio of output distance functions with the CRS technology assumption for a specific country over adjacent years.23 Furthermore, the productivity growth was decomposed into technical efficiency change (TEC) and shifts in the technological frontier over time by Färe et al. (1994) (hereafter abbreviated as FGNZ). The analysis is based on seventeen OECD countries over the period 1979–88. The new index introduced is a geometric mean of the two Malmquist productivity indexes. Given the fact that the Malmquist decomposition of FGNZ is based on CRS reference technology, it conceptualizes a technology characterized by variable returns to scale (VRS). Therefore, the use of both CRS and VRS within the same decomposition results in internal consistency problems. If CRS is assumed to measure the technical change component correctly, then no scale effect could be identified. Thus, catch-up component of FGNZ from the combination of efficiency change and scale efficiency change is inappropriate. This proposition has been criticized by Ray and Desli (1997), who noted that, if the VRS assumption exists, then FGNZ’s approach does not measure the shift of the frontier, therefore the overall decomposition is misleading. In order to overcome this limitation, Ray and Desli (1997) developed and introduced a model that measures the correct productivity change by the ratio of CRS distance functions, even though the technology is VRS. The technical change component based on the VRS distance function could affect scale efficiency change while pure technical change remains unaffected. The Malmquist productivity index can be calculated by nonparametric techniques such as DEA, as introduced by Färe et al. (1992). GrifellTatjé and Lovell (1997) listed the most important characteristics of the Malmquist index as: (i) there is no need for price information or behavioural assumptions; (ii) quantity information alone is sufficient, and it is easy to apply even with nonparametric techniques without any functional form on production technology; and (iii) it can easily accommodate multiple-outputs and decomposes the productivity change into technical change and efficiency change components when panel data is available.

Performance of Banks in Turkey 127

DEA–Malmquist index technique The nonparametric DEA–Malmquist index can be estimated by exploiting the relationship of distance functions to the technical efficiency measures developed by Farrell (1957). This technique is a ‘primal’ index of productivity change, therefore it does not require cost or revenue shares to aggregate inputs and outputs, and was introduced to the literature by CCD). In order to calculate the Malmquist index, it is necessary first to define distance functions with respect to two different time periods, such as: D0t (χt+1 , y t+1 ) = inf { : (χt+1 , y t+1 / )} ∈ St

(6.13)

where St = production technology t = t, . . . , T χt = input vector in time t y t = output vector in time t D0 = distance function

= technical efficiency The distance function in Equation 6.13 measures the maximal proportional change in outputs required to make (χt+1 , y t+1 ) feasible in relation to technology at t (FGNZ). Then the Malmquist index reference to technology t is defined by CCD as: t MCCD =

D0t (χt+1 , y t+1 ) D0t (χt , y t )

(6.14)

whereas for period t + 1 it is: t+1 MCCD =

D0t+1 (χt+1 , y t+1 )

(6.15)

D0t+1 (χt , y t )

In order to avoid choosing ‘an arbitrary benchmark’, the output-based Malmquist index is specified to be the geometric mean of Equation 6.16. Then:  Mo (χ

t+1

,y

t+1

,χ ,y ) = t

t

D0t (χt+1 , y t+1 ) D0t (χt , y t )



D0t+1 (χt+1 , y t+1 ) D0t+1 (χt , y t )

 21 (6.16)

128 Turkish Banking

where D0t = distance function at time t t+1 D0 = distance function at time t + 1 χ = vector of inputs y = vector of outputs M0 = Malmquist productivity index Following FGNZ, the above formula can be decomposed into efficiency change and technological change, thus:  Mo (χt+1 , y t+1 , χt , y t ) =

D0t (χt+1 , y t+1 ) D0t (χt , y t ) 

×



D0t (χt+1 , y t+1 )



D0t+1 (χt+1 , y t+1 )

D0t (χt , y t ) D0t+1 (χt , y t )

 21 (6.17)

The first figure in parentheses measures the efficiency change, while the second represents the technical change component of the index. There is productivity growth if M0 > 0, stagnation if M0 = 0, and productivity decline if M0 < 0. Given the fact that the Malmquist decomposition of FGNZ is based on CRS reference technology, no scale effect could be identified. Thus, FGNZ’s catch-up component from the combination of efficiency change and scale efficiency change is inappropriate. In order to overcome this limitation, Ray and Desli (1997) developed a model which measures the correct productivity change by the ratio of CRS distance functions even though the technology is VRS. The technical change component based on the VRS distance function could affect scale efficiency change while technical change remains unaffected. The scale efficiency change (SEC) component is defined by the distance function as:

SEt (χt , y t ) =

t (χt , y t ) DCRS t DVRS (χt , y t )

(6.18)

where CRS represents reference technology with a constant returns to scale assumption, and VRS a variable returns to scale assumption. However, Färe et al. (1997b) were the first to criticize the Ray and Desli (1997) model on the grounds that it cannot measure scale efficiency change (S
), since each component uses only single-period technology

Performance of Banks in Turkey 129

(Lovell, 2001). Therefore, the equation has been extended to incorporate time and the scale efficiency change factor: S
(xt , y t , xt+1 , y t+1 )   21 SEt (xt+1 , y t+1 )/D0t (xt+1 , y t+1 ) SEt+1 (xt+1 , y t+1 )/D0t+1 (xt+1 , y t+1 ) = ∗ SEt (xt , y t )/D0t (xt , y t ) SEt+1 (xt , y t )/D0t+1 (xt , y t ) (6.19) Then the Malmquist productivity index (M0 ) can be decomposed as:  M0 =

t+1 t+1 t+1 t DVRS (χt+1 , y t+1 ) DVRS (χ , y ) × t t+1 t t t DVRS (χ , y ) DVRS (χ , y t )

 ×

 21

SEt (χt+1 , y t+1 ) SEt+1 (χt+1 , y t+1 ) × SEt (χt , y t ) SEt+1 (χt , y t )

 21 (6.20)

Thus, Equation 6.20 could be rewritten as in Equation 6.21, where TE
represents TEC, T
is the technological change, and S
is the scale efficiency change component: M0 = TE
(χt , y t , χt+1 , y t+1 ) × T
(χt , y t , χt+1 , y t+1 ) × S
(χt , y t , χt+1 , y t+1 ) (6.21)

Empirical findings The aim of this section is to identify the nonparametric efficiency and productivity scores of the Turkish commercial banks and foreign ownership of several Turkish banks covered in the sample.

Technical efficiency scores of Turkish banks We introduce the empirical findings of the nonparametric DEA method in this section, where the relative technical efficiency levels of the Turkish banking sector are assessed. Further to the analysis of the annual performance scores of each individual bank, the discussion is extended with an analysis of the major mergers and takeovers of Demirbank by HSBC, Dı¸sbank by Fortis; and merger of UniCredito with Yapı ve Kredi Bankası which has then been taken over by Koçbank. The analysis was conducted over the 1992–2006 period, which witnessed financial structural changes in the Turkish banking system as a result of the financial crises, privatization and the post-deregulation period.

130 Turkish Banking 1.2 Average efficiency scores

Percentages

1.0 0.8 0.6 0.4 0.2

Figure 6.3

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

0.0

Annual efficiency scores of the Turkish banking sector, 1992–2006

Note: 1 = 100 per cent.

The main hypotheses of the analysis are to investigate whether foreign ownership and investment has contributed positively to the performance of the entire Turkish banking sector. Figure 6.3 introduces the average annual DEA efficiency scores of the Turkish banking sector during 1992–2006. The first pattern is that between 1992 and 1994, where Turkey attracted capital flows as a result of high real interest rates, efficiency in the banking sector improved and it stayed stable until the 1994 crisis. As noted by Atiyas and Ersel (1994), the liberalization measures led to the entry of new banks and numerous brokerage houses, which resulted in intense competition in the sector. This forced banks to be more efficient, which is reflected in the results. Findings of the analysis suggest that this effect has been positive in Turkey. Liberalization of the capital account enabled banks to borrow abroad at cheaper rates than those domestically available, and to lend at market rates to both the public and private sectors. This may be taken as an indication of one of the benefits of financial integration at the banking firm level, and this development has had significant impact on the overall efficiency of the Turkish economy. However, a financial crisis occurred in 1994, which caused many brokerage houses to leave the system resulting in 1995 in a deterioration in the efficiency measures. The second pattern is the increasing efficiency scores between 1995 and 1997. We can attribute this to the low interest rate objective of the government and its implementation by relying heavily on the resources

Performance of Banks in Turkey 131

of the Central Bank at the beginning of 1994. Therefore, the accessibility of low-interest-rate borrowing can also be considered a factor in increasing efficiency scores before 1998. Furthermore, since the 1994 economic crises, Turkey has been trying to maintain economic stability measures with assistance from the IMF. Prior to the IMF restructuring programme, the Turkish economy grew steadily between 1995 and 1998, which was also reflected in a parallel manner in the technical efficiency scores of the Turkish banks. Third, looking at Figure 6.3, it can be seen that the lowest level of technical efficiency was been identified in 1998, which was the beginning of the most recent period of financial distress in Turkey. It was emphasized in the previous chapter that, following the 1999 economic slowdown, Turkey experienced its worst economic and currency crises during 2000/01 (the ‘twin crises’, as noted earlier). This was mainly a result of the effects of the Russian financial crisis of 1998, which was deepened even more by the major earthquake in Turkey in August 1999. Finally, the fourth pattern also coincides with the 2000/01 twin crises period. Despite overall slowdown being expected, the technical efficiency trend from the year 2000 was relatively positive. Some of this upward trent may be a result of the fact that biggest foreign banks of Europe had made deals to take over some of the troubled banks. This had a major impact on bank funding and investment decisions, and may have affected bank efficiency. Moreover, another new three-year stabilization programme was agreed between the Turkish government and the IMF in December 1999. The programme was a pegged exchangerate-based stabilization programme aimed to decelerate the inflation rate. The new IMF standby agreement included a USD 4 billion credit to be disbursed over a three-year period, and set goals to reduce the inflation rate to single-digit figures by the end of 2002. This might have had a positive effect on the expectations of the financial system, which was reflected by a boost to the technical efficiency scores. Furthermore, it needs to be emphasized that increased foreign bank involvement in the Turkish banking sector, specifically since 2001, can also be a positive factor affecting the technical efficiency level of the entire banking sector. This statement is also in line with the findings presented by Denizer et al. (2000, that the most important effect of foreign bank entry is an increase in efficiency as a result of decreased numbers of personnel plus more technology-intensive work. Studies on the efficiency effect of foreign bank entry show that new banks have been more efficient than the established ones, especially during the first ten years.

Figure 6.4

Vakıflar Bank

Yapı Kredi Bank

Akbank

Ziraat Bank

HSBC

Demirbank

Halk Bank

Garanti Bank

Anadolu Bank

Koçbank

TEB

Finans Bank

Tekstil Bank

s¸ Bank

Sekerbank

Alternatif Bank

Oyak Bank

s Dı¸bank

Osmanlı Bank

Citibank

1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0.0 Deniz Bank

Percentages

132 Turkish Banking

Average DEA efficiency scores of Turkish banks, 1992–2006

Note: 1 = 100 per cent.

After ten years, however, there is a limited gain from scale economies. Following the analysis of the entire Turkish banking sector, the average efficiency levels of each bank during the 1992–2006 period are shown in Figure 6.4. The conclusion reached from Figure 6.4 is that public banks appear to perform better, or at least as well as, their private and foreign counterparts, which may seem surprising. However, a number of factors may explain this; for example, public banks have always enjoyed the benefits of state support and public confidence with respect to safety of deposits. The deposits to public banks increased after the 1994 crisis in particular, which may explain the efficiency jump of public banks in the production process after 1999. Following the twin crises period, essential improvements took place in the Turkish banking sector concerning the reform programme, and various measures were undertaken to reinforce the system. The BRSA and State Banks Joint Management Board worked hard on a successful implementation of the reform programme. Banks under the management of the SDIF in 2001 were merged under a single name and some of them were sold to foreign financial institutions. The most important deals among the sale of Turkish banks under control of the SDIF were, first, Demirbank to HSBC in 2001, and second, the sale of Dı¸sbank to Fortis in 2005. The efficiency scores of Koçbank (which has 50 per cent

Performance of Banks in Turkey 133 Demirbank

Koçbank

s Dı¸bank

100

Percentages

80 60 40

Figure 6.5 DEA efficiency scores of Demirbank, 1992–2006

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

0

1992

20

Koçbank and Dı¸sbank,

Note: 1 = 100 per cent.

partnership with UniCredito), Demirbank and Dı¸sbank during the preand po-trade periods are shown in Figure 6.5. As can be seen from Figure 6.5, the least efficient bank among the three foreign-owned banks under analysis is obviously Dı¸sbank. This might be because the sale of Dı¸sbank to Fortis took place quite recently (in 2005) and the financial position of the bank at that time was downwardsloping. In contrast, Demirbank presented the highest level of technical efficiency scores during the analysis period. In particular after its sale to HSBC in 2001, it performed better than in the pre-crisis period and became very stable. Moreover, Koçbank experienced a similar efficiency pattern to Demirbank. It was approximately 100 per cent efficient during 2000–004 which coincided with the period of its partnership with UniCredito Bank. In order to complete the nonparametric efficiency analysis of the Turkish banking system, the second-stage model was applied via the use of a Tobit regression. The regression tested the correlation between the technical efficiency scores of Turkish banks and the 1994 crisis, the 2000/01 crises, increased foreign ownership in the sector since 1997, and the three-year IMF restructuring programme launched in 1999. The findings presented in Table 6.A7 in Appendix 6.3 illustrates that there is significant correlation between the technical efficiency scores of banks and the financial crises experienced in Turkey together with increased

134 Turkish Banking

foreign ownership. Surprisingly, the 1999 IMF restructuring programme has not had a significant effect in our analysis. Furthermore, the Spearman rank order correlation test has also been applied and the findings indicated significant correlation between the efficiency scores and foreign ownership in the Turkish banking sector (findings presented in Table 6.A8 of Appendix 6.3).

Productivity scores of Turkish banks The financial liberalization policies adopted in 1980s and 1990s brought radical changes to the heavily regulated commercial banking sector in Turkey. The sector attracted many domestic and foreign banks, which created dynamic competition. As a result, increased competition in the market raised important questions on bank efficiency and productivity. In this context, the previous section analysed and discussed the technical efficiency scores of the Turkish banking sector over the period 1992 to 2006. This section aims to estimate the productivity changes that took place during this period by an application of the nonparametric DEA-based Malmquist index technique. The productivity index is decomposed into frontier shifts (technical change) and catching up (technical efficiency) components. Utilizing the property of decomposition, more information can be provided on the sources of productivity growth. Recall that TEC and TC are the technical efficiency (catching up) and technological efficiency (frontier shift) changes, respectively. Using this information, we were able to examine the sources behind the productivity growth or shrinkage. Productivity growth can be achieved either by an increase in technical efficiency or by an upward shift in the frontier (a technological change), or both. On the other hand, productivity loss can be attributed to technical efficiency decrease or technological retreat, or both. Significance of the TEC and TC on total factor productivity change (TFPC) are tested by use of the Spearman and Pearson correlation and rank order tests (see Table 6.A6 in the Appendix for our findings). Table 6.3 shows that the Malmquist index components vary across the sample period. The average productivity growth decreased by 10 per cent in the 1993–4 period. This could be explained by the economic crisis in 1994, which affected the banking sector badly, and caused a contraction in the system. However, annual average TFPC scores illustrated a positive change during 1994–5 and 1995–6 periods, immediately after the 1994 financial crisis. Surprisingly, the 1999–2000 period also witnessed a positive TFPC, mainly because of high positive TEC and SEC.

Performance of Banks in Turkey 135 Table 6.3 Malmquist productivity decomposition of the Turkish banking sector, 1992–2006 Years

TEC

TC

SEC

TFPC

1992–3 1993–4 1994–5 1995–6 1996–7 1997–8 1998–9 1999–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06

0.973 0.981 1.002 1.034 0.997 0.948 0.999 1.043 0.952 1.070 1.014 0.988 0.970 1.029

1.130 1.016 1.145 1.074 0.943 0.818 0.948 1.014 0.980 0.877 1.115 1.147 1.194 1.039

0.973 0.981 1.002 1.034 0.997 0.948 0.999 1.043 0.952 1.070 1.014 0.988 0.970 1.029

1.099 0.997 1.148 1.111 0.940 0.775 0.947 1.057 0.933 0.938 1.130 1.133 1.157 1.025

Average

0.999

1.026

0.999

1.025

Notes: 1 = 100 per cent; TEC: technical efficiency change; TC: technological change; SEC: scale efficiency change; TFPC: total factor productivity change.

High real growth in the Turkish economy, and thus in banking, was achieved in the later periods, which have also been reflected in the productivity indices. Figure 6.6 illustrates clearly the changing trends of the decomposed components; a close inspection of the chart indicates that the source of productivity growth stems mainly from the frontier shift over the period 1992–3. Nevertheless, the situation changed drastically after 1993. It seems that the predominant source of productivity growth was the change in technological efficiencies (TC), with the exception of the period 2001–2. Interestingly, this period also reported a productivity loss, which is explained by the decrease in TC. This is probably because the banks could not cope with the changing economic and technological environment that arose from the twin crises and know-how transferred into the system by foreign investors. However, with the establishment of stability and economic growth, which reflected on to the structural improvements in the industry, it is observed that the main source of productivity growth is that the banks improved their technological efficiencies after 2002. High-tech investments played a crucial role in the increased efficiency of banks, and thus also productivity growth, in the following years.

136 Turkish Banking 1.2

Percentages

1.1 1.0 0.9 0.8 0.7

TEC

TC

TFPC

Figure 6.6

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

0.6

Changing trends of Malmquist decomposed components, 1993–2006

Notes: TEC: technical efficiency changes; TC: technological change; TFPC: total factor productivity change.

TEC

TC

SEC

TFPC

1.15

Percentages

1.1 1.05 1.0 0.95 0.9 0.85

Figure 6.7

Average

Citi bank

HSBC

Finans bank

Akbank

Yapı Kredi

s¸ Bankas

Garanti

TEB

Tekstil

Sekerbank ¸

Oyak

Alternatif

Vakıflar

Halk

Ziraat

0.8

Malmquist decomposed components of Turkish banks, 1992–2006

Notes: TEC: technical efficiency changes; TC: technological change; SEC: scale efficiency change; TFPC: total factor productivity change.

In Figure 6.7, we plot the output-weighted mean Malmquist index and show the output-weighted catching up and output-weighted frontier shift effects between the years 1992 and 2006. The change in the Malmquist productivity index (TFPC) shows that all banks in the Turkish

Performance of Banks in Turkey 137

financial system achieved some productivity growth during the analysis period, apart from Oyak Bank and Citibank. It is important to note that the average productivity declined by 2.7 per cent and 9 per cent for these banks, respectively. Once again, this result is product of the TC component. Further research is needed to identify what characterizes these shifts in the frontier. It is evident that the sector was marked by major developments in high-tech banking operations, which shifted the frontier upwards. In contrast, the highest average achievements in the TFPC scores were experienced by Halk Bankası, Ziraat Bankası, Türkiye Ekonomi Bankası (TEB), Garanti Bankası and Akbank, which were also identified as the most technically efficient banks in the DEA analysis examined in the previous section. The 1999 economic stabilization programme had a favourable impact on the Turkish economy during the first ten months of its implementation. During this period, the programme reduced Turkey’s exchange rate risk and sovereign risk significantly, starting a capital inflow. The programme did not require any sterilization for capital inflows; hence, money market liquidity increased as the capital inflows increased. This created a downward pressure on the interest rates, from 100 per cent in December 1999 to 35 per cent in September 2000; and lowered the future burden of interest payments on the debt stock, further accelerating the capital inflows resulting from the reduced default risk. Thus falling interest rates reinforced expectations that the government would be able to sustain the 1999 economic stabilization programme and achieve the pre-announced stabilization goals, such as the single-digit inflation target. In addition, increasing confidence in the government’s economic policies encouraged some mid-size banks (according to their total asset size), such as Koçbank, Demirbank, Oyak Bank, Dı¸sbank and TEB, to borrow large amounts of loans from abroad and make long-term investments in government securities. These banks also offered large volumes of consumer credits which, in turn, increased consumption and investment, stimulating economic growth. On the other hand, these banks, which engaged in excessive foreign borrowing and long-term investment, put themselves at risk by ignoring the fact that the government might not be able to sustain the stabilization programme and keep the interest rates down. A review of the findings above demonstrates that there are three emerging patterns that should be interpreted within the context of the overall macroeconomic environment as well as the ownership of banks. Before discussing the emerging patterns, it must be noted at the outset that

138 Turkish Banking

during the period under study inflation was high and variable, averaging more than 70 per cent during the early 1990s, and a number of stabilization programmes failed to control inflation. This volatile environment affected the banks’ asset and liability choices, and had the effect of reducing financial intermediation (Denizer et al., 2000). In particular, commercial banks reduced their lending and share of credit as the percentage of total bank assets declined over time. The fact that Turkey does not have a stable macroeconomic environment, which has contributed to uncertainty and the risks banks faced, has probably reduced system-wide efficiency. Another noteworthy aspect of the public ownership of banks is related to credit. Because of political pressure, public banks such as Ziraat Bankası, Halk Bankası and Vakıflar Bankası issued loans more easily than did private banks. This has had the effect of increasing their output and making them appear more efficient. However, this may not be the case on a risk-adjusted basis, as public banks carry a large number of nonperforming loans. If adjustments to their outputs were made to reflect loan losses, public banks might in fact be found to be much less efficient than private banks. The lack of detailed data on the bad loans of public banks prevents an in-depth examination of this hypothesis. As noted throughout this chapter, the banking sector in Turkey has been undergoing major structural reforms, with growing foreign market involvement. The foreign bank investments in Turkey have been growing since 1997, from 3 per cent to approximately 40 per cent in 2006. Similar to the situation in newly-joined EU countries (for example, Bulgaria and Romania), the banking sector in Turkey started to be dominated by foreign banks, which held majority interests in newly privatized banks. Specifically, since the most recent financial crisis in Turkey, substantial reforms were executed the country’s economy. In 2005 and 2006, a number of foreign investments took place in the Turkish banking sector, mainly from European banks. Turkey is pursuing a different approach concerning foreign investors compared to other EU accession countries. Turkish bank owners prefer to form strategic partnerships and joint ventures with their foreign partners, but retain a controlling share. The formal beginning of negotiations to join the EU might be a starting point for more foreign investment. Turkey was declared an EU accession country in October 2005, causing a rise in interest in Turkish banks among foreign investors. Despite Turkey suffering from a major financial and economic crisis in 2000/01, it was successful in implementing reforms and in regaining stability. Therefore, Figure 6.8 spotlights the

Koçbank

s Dı¸bank

1996–97

1998–99

Performance of Banks in Turkey 139 Demirbank

100 90

Percentages

80 70 60 50 40 30 20 10

Figure 6.8

2005–06

2004–05

2003–04

2002–03

2001–02

2000–01

1999–00

1997–98

1995–96

1994–95

1993–94

1992–93

0

TFPC scores of Koçbank, Dı¸sbank and Demirbank, 1992/3–2005/6

TFPC on the foreign banks’ participations in Turkey, focusing mainly on Koçbank, Dı¸sbank and Demirbank over the period 1992–2006. Figure 6.8 illustrates clearly that there have been frequent fluctuations in the TFPC scores of the banks under analysis. The most devastating productivity regressions were observed during 1993–4, 1997–8, 2000–01 and 2004–05. The first three were mainly the result of financial distress experienced in the country. In general, Koçbank presented the highest positive productivity change throughout the analysis period (98.6 per cent) compared to Demirbank (98.5 per cent) and Dı¸sbank (88.1 per cent). Furthermore, Koçbank showed a 4 per cent productivity growth from 2001–02 to 2002–03, while this growth is about 24 per cent when compared with 2000–01 figures. This period coincides with the point in time of its merger with the Italian bank, UniCredito, in 2002. The TFPC scores of Dı¸sbank have been the most volatile of all. It has presented a pattern of great sensitivity to macroeconomic and policy changes in the country, which can be a sign that it was not as powerful a bank as were its counterparts under focus. Its most recent recovery (31 per cent) was identified after its sale to one of the most reliable banks of Europe, namely Fortis Bank of Belgium, in 2005. Contrary to the productivity growth experienced during various periods, all three banks experienced productivity decline during the financial crisis periods in the country.

140 Turkish Banking

Conclusion This chapter summarized the nonparametric technical characteristics of methodologies applied in the empirical estimations of technical efficiency and productivity levels of the Turkish banking industry. Traditional DEA was followed to estimate technical efficiency scores, and the nonparametric DEA–Malmquist productivity index technique was applied to investigate the productivity changes. Decomposition of the productivity indices into technical change, technological change and scale efficiency change components were also presented. DEA is a linear programming method that is easy to apply and is capable of handling multiple-input and multiple-output models, comparing each DMU against a peer or combination of peers; that is, the efficiency scores obtained are only relative to the best banks in the sample, and there is an assumption of a linear relation between variables without restrictions on the functional form relating inputs and outputs. Banks that are not located on the frontier are only attributed to inefficiency without considering the random error. Because noise in the data can cause significant problems, and applications of statistical hypothesis tests are difficult in DEA, the absence of statistical properties increases the probability of misspecification. From a productivity point of view, the Malmquist index has a number of desirable features, such as not requiring input or output prices; and not requiring behavioural assumptions, such as cost minimization or output maximization. Decomposition of the total factor productivity change scores into TEC, technological change and scale efficiency change is important and has been emphasized in the literature. In an aim to decompose the productivity scores into their relevant components, the Ray and Desli (1997) model was revised for the DEA–Malmquist index decompositions. In more detail, the Ray and Desli model is accepted as being advantageous in producing accurate results because of its property of considering the VRS assumption. This is important in real-life examples where there is evidence of competition. In contrast, the Färe et al. (1994) model ignores the scale factor and focuses on the CRS assumption. Our sample covers an unbalanced sample of commercial banks in the Turkish banking industry over the period 1992–2006 period, covering approximately 315 observations. The specific input variables are personnel expenses, physical capital, permanent assets and financial inputs; whereas total deposits, total loans, other earning assets and interest income are identified as outputs. We analysed technical efficiency and productivity growth in the Turkish commercial banking sector during

Performance of Banks in Turkey 141

the period 1992–2006 within the framework of DEA and the DEAMalmquist productivity index. This has allowed us to analyse not only the productivity performance of the sector, but also the sources of any productivity change that occurred in the sector. In general, Turkish commercial banking experienced productivity growth over the period under consideration, with the exception of 1996–8, 2000–01 and 2005–06. Productivity loss in the sector during these periods can be attributed to the economic crisis that contracted the banking system in Turkey. Overall, the decomposed figures indicate that the significant factor in the total factor productivity change scores of the Turkish commercial banks is the technological change component. Major investments in high-tech bank operations shifted the frontier upwards, in particular after the entry of foreign banks to the sector. This is because foreign involvement created pressure on public banks as a result of increased competition and forced them to diminish their cost structure, in particular by decreasing the numbers of employees and increasing the adoption of technological advances. Nevertheless, substantial improvements occurred in the technical efficiency and productivity of most banks during the period. The analysis we have presented in this chapter tested the hypothesis that the financial crises experienced in 1994 and 2000–01, the 1999 IMF restructuring programme, and increased foreign ownership in the Turkish banking sector since 1997 have had significant effects on the core processes of bank efficiency. Every phase of the analysis, the total efficiency scores, the percentage of efficient banks, and the sources of inefficiency suggest that the IMF restructuring programme did not provide the anticipated efficiency gains. None of the efficiency scores displayed consistent increases after the introduction of the programme, and the correlation coefficient between the DEA technical efficiency scores and the IMF’s restructuring programme is not significant at the 95 per cent confidence level. The fact that the macroeconomic environment during the study period was not stable has probably affected the financial system’s efficiency, and our results. As a matter of fact, almost all of the efficiency and productivity scores displayed a significant increase after 2002. This result may speculatively suggest that the increased foreign bank investment into the Turkish banking sector might be the reason for the efficiency and productivity growth. Future research that extends the study period beyond 2006 may answer the long-term effects of the increased attention of foreign investors to the Turkish banking sector. The observed productivity differentials can also be explained by the different forms of organization. Among the three ownership types,

142 Turkish Banking

private and public banks showed greater productivity growth compared to foreign-owned banks. However, Demirbank, which was sold to HSBC in 2001, experienced enormous productivity growth in the post-sale period. Our analysis, concluded that, in the post-foreign-investment era, productivity growth had been observed. Furthermore, the increase in the productivity growth of both private and state-owned banks were a result of technological advances: that is, the outcome of the competition that arose in the post-foreign-investment period.

State-owned Privately-owned Privately-owned Privately-owned State-owned State-owned Privately-owned Privately-owned Privately-owned Privately-owned Privately-owned Foreign banks Foreign banks Privately-owned Privately-owned Foreign banks Privately-owned Privately-owned Privately-owned

Ziraat Bankası A.¸S. ˙ s Bankası A.¸S. I¸ Akbank A.¸S. Garanti Bankası A.¸S. Vakıflar Bankası Halk Bankası A.¸S. Yapı ve Kredi Bankası A.¸S. Koçbank A.¸S. Finansbank A.¸S. Denizbank A.¸S. Oyak Bank A.¸S. HSBC Bank A.¸S. Fortis Bank A.¸S. Türk Ekonomi Bankası A.¸S. S¸ ekerbank T.A.¸S. Citibank A.¸S. Anadolubank A.¸S. Tekstil Bankası A.¸S. Alternatif Bank A.¸S.

1863 1924 1948 1946 1954 1938 1944 1985 1987 1997 1984 1990 1964 1927 1953 1980 1996 1986 1992

Year established

Source: Data compiled from Banks Association of Turkey, 2006.

Group

Bank sample details

Bank name

Table 6.A1

Appendix 6.1

40,976 40,134 32,998 22,972 20,399 17,041 15,034 9,318 7,757 5,895 5,277 4,949 4,294 3,415 1,977 1,594 1,302 1,234 926

Total assets (EUR millions) 8,457 13,071 13,925 10,669 7,499 3,917 7,122 4,523 4,797 2,872 3,208 3,225 2,182 1,851 715 711 596 761 553

Total loans (EUR millions) 32,616 23,559 19,812 14,852 14,454 13,164 10,631 6,006 3,852 3,297 3,546 3,005 2,240 2,042 1,555 1,192 843 669 449

Total deposits (EUR millions) 1,146 875 660 432 305 584 405 174 208 236 307 158 186 113 203 24 65 41 26

Number of branches

20,373 17,111 11,186 10,523 7,164 10,509 10,211 3,590 6,499 5,059 4,585 4,180 4,048 2,619 2,593 355 288 3,405 1,529

Number of employees

143

0.804 1 1 0.84 1 0 1 0.568 0.886

0.783 0.921 0.812 1 1 0 1 0.735 0.768

Note: 1 = 100 per cent.

0.574 0.76 1 1 0 1 0.797 0.925 0.876 0.693 0.835 1

1993

1 0.832 1 1 0 0.638 0.902 0.961 0.855 0.689 0.916 0.798

1992

1 1 1 1 1 0 0.518 1 1

1 1 1 0.414 0 0.432 0.749 1 0.755 0.773 1 1

1994

0.862 0.712 0.671 0.6 1 0 0.804 1 0.617

1 1 0.859 0.998 0 0.744 0.81 0.597 1 0.87 0.803 1

1995

0.839 0.652 0.795 0.834 0.602 0 0.87 1 0.499

1 0.855 1 1 0 0.674 1 0.966 1 1 0.859 1

1996

Annual efficiency scores, Turkish banks

Ziraat Bankası Halk Bankası Vakıflar Bankası Alternatif Bank Anadolu Bank Oyak Bank S¸ ekerbank Tekstil Bank TEB Garanti Bankası I˙ s¸ Bankası Yapı ve Kredi Bankası Akbank Koçbank Osmanlı Bankası Dı¸sbank Demirbank Denizbank Finansbank HSBC Citibank

Table 6.A2

Appendix 6.2

1 0.757 0.712 0.672 0.912 1 0.891 1 0.678

1 0.887 0.975 0.706 1 0.965 1 0.858 0.859 1 0.843 1

1997

1 0.665 0.662 0.541 0.83 0.699 0.668 1 0.434

1 1 1 0.635 0.721 0.743 0.937 0.617 0.837 0.819 0.908 1

1998

1 0.817 0.729 0.439 0.849 0.781 0.601 1 0.341

1 1 0.832 0.78 1 0.806 0.951 1 0.705 0.772 0.782 1

1999

1 1 1 0.73 0.973 0.671 1 0.802 0.314

1 1 1 0.696 1 0.782 0.902 0.613 0.634 0.904 0.924 1

2000

1 1 0 0.485 1 0.485 1 1 1

0.706 0.706 0.891 0.891 0.97 0.97 0.86 0.86 0.86 0.86 0.86 0.86

2001

1 1 0 0.754 1 1 1 1 0.83

0.961 1 0.874 0.81 1 0.808 0.84 0.827 1 1 1 1

2002

1 0.999 0 0.923 1 0.948 1 1 0.861

1 1 0.983 1 1 1 0.928 1 1 1 0.854 1

2003

1 1 0 0.763 1 0.905 1 1 0.781

1 1 1 0.812 1 1 0.769 1 0.945 1 0.879 0.945

2004

1 0.956 0 0.649 0.878 1 0.928 0.878 0.696

1 0.943 1 1 0.798 0.995 0.621 1 0.898 1 0.827 0.956

2005

1 0.889 0 0.567 1 0.834 0.981 1 1

1 1 1 1 0.787 1 0.776 1 1 1 0.903 0.889

2006

144

145

Table 6.A3

Annual technical efficiency scores, of foreign owned banks Demirbank

Koçbank

Dı¸sbank

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

1.000 1.000 1.000 1.000 0.602 0.912 0.830 0.849 0.973 1.000 1.000 1.000 1.000 0.878 1.000

0.921 1.000 1.000 0.712 0.652 0.757 0.665 0.817 1.000 1.000 1.000 0.999 1.000 0.956 0.889

1.000 0.84 1.000 0.600 0.834 0.672 0.541 0.439 0.730 0.485 0.754 0.923 0.763 0.649 0.567

Average

0.940

0.890

0.720

Note: 1 = 100 per cent.

1.2

Percentages

1.0 0.8 0.6 0.4 0.2

Figure 6.A1

Annual technical efficiency scores of Demirbank, 1992–2005

Note: 1 = 100 per cent.

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

0.0

2005

2006 2006

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

2005

Figure 6.A2

1993

1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1992

Percentages

146

Annual technical efficiency scores of Koçbank, 1992–2006

Figure 6.A3

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1.0 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1992

Percentages

Note: 1 = 100 per cent.

Annual technical efficiency scores of Dı¸sbank, 1992–2006

Note: 1 = 100 per cent.

147 Table 6.A4

Average Malmquist components of Turkish banks, 1992–2006

Bank name

TEC

TC

SEC

TFPC

Ziraat Bankası Halk Bankası Vakıflar Bankası Alternatif Bank Oyak Bank S¸ ekerbank Tekstil Bank TEB Garanti Bankası I˙ s¸ Bankası Yapı ve Kredi Bankası Akbank Finansbank Citibank

1 1.003 1 1 1.001 0.983 1.001 1.004 1.012 0.993 0.994 1.001 1 1.002

1.067 1.088 1.035 1.019 0.973 1.032 1.005 1.058 1.045 1.015 1.03 1.068 1.047 0.91

1 1.003 1 1 1.001 0.983 1.001 1.004 1.012 0.993 0.994 1.001 1 1.002

1.067 1.091 1.035 1.019 0.973 1.014 1.005 1.063 1.058 1.007 1.025 1.069 1.047 0.91

Average

0.999

1.026

0.999

1.025

Note: 1 = 100 per cent; TEC: technical efficiency change; TC: technological change; SEC: scale efficiency change; TFPC: total factor productivity change.

TEC

TC

SEC

TFPC

1.6

Percentages

1.4 1.2 1.0 0.8 0.6 0.4 0.2

Figure 6.A4 3–2005/06

2005–06

2004–05

2003–04

2002–03

2001–02

2000–01

1999–00

1998–99

1997–98

1996–97

1995–96

1994–95

1993–94

1992–93

0.0

Annual Malmquist decomposed components of Koçbank, 1992/

Note: 1 = 100 per cent.

148

Figure 6.A5 3–2005/06

TC

SEC

TFPC

2005–06

2004–05

2003–04

2002–03

2001–02

2000–01

1999–00

1998–99

1997–98

1996–97

1995–96

1994–95

1993–94

1992–93

Percentages

TEC 2.0 1.8 1.6 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0

Annual Malmquist decomposed components of Dı¸sbank, 1992/

Note: 1 = 100 per cent.

TC

SEC

TFPC

Figure 6.A6 3–2005/06

2005–06

2004–05

2003–04

2002–03

2001–02

2000–01

1999–00

1998–99

1997–98

1996–97

1995–96

1994–95

1993–94

0.8 0.6 0.4 0.2 0.0

1992–93

Percentages

TEC 1.8 1.6 1.4 1.2 1.0

Annual Malmquist decomposed components of Demirbank, 1992/

Note: 1 = 100 per cent.

149 Table 6.A5 Total factor productivity scores of Koçbank, Demirbank

Dı¸sbank and

Koçbank

Dı¸sbank

Demirbank

1992–3 1993–4 1994–5 1995–6 1996–7 1997–8 1998–9 1999–2000 2000–01 2001–02 2002–03 2003–04 2004–05 2005–06

1.113 0.644 0.972 0.989 1.054 0.798 1.118 1.105 0.817 1.013 1.053 1.018 1.061 1.051

0.802 0.542 1.004 1.071 0.840 0.659 0.941 1.091 0.588 1.006 1.038 1.044 0.704 1.010

1.172 0.520 1.195 0.831 1.130 0.768 1.090 1.096 0.815 1.129 1.024 1.028 0.950 1.043

Average

0.986

0.881

0.985

Note: 1 = 100 per cent.

Table 6.A6

TEC TC TFPC

Correlation coefficients between TFPC, TC and TEC TEC

TC

TFPC

1.0000 −0.0635 0.2148

1.0000 0.9559

1.0000

Notes: TEC: technical efficiency change; TC: technological change; TFPC: total factor productivity change.

150

Appendix 6.3 Table 6.A7

Coef.

Std. Err.

t

P > |t|

[95 per cent Conf. Interval]

0.1117467 −0.1690674 0.147849 0.095218 0.8566411 0.3952392

0.1082747 0.1177173 0.0580684 0.1039034 0.0459826 0.0242706

1.03 −1.44 2.55 0.92 18.63

0.303 0.052 0.041 0.360 0.000

−0.1012969 −0.4006905 0.0335923 −0.1092246 0.7661647 0.3474839

EFF 94c twc fo imf cons sigma

Tobit regression results of second-stage DEA analysis

0.3247904 0.0625556 0.2621056 0.2996606 0.9471175 0.4429945

Notes: 94c : dummy variable for 1994 financial crisis; twc: dummy variable for 2000–01 twin crises; fo: dummy variable for foreign ownership; imf: dummy variable for IMF financial restructuring programmes. Tobit regression: Number of obs = 315 LR chi2 (4) = 8.88 Prob > chi2 = 0.0641 Pseudo R2 = 0.0216

Table 6.A8

Spearman rank order correlation coefficients EFF

EFF 94c

twc

fo

imf

1.0000 315 0.0319 315 (0.5730) −0.0376 315 (0.5060) 0.1141∗ 315 (0.0430) 0.0285 315 (0.6149)

94c

twc

fo

imf

1.0000 315 −0.1034 315 (0.0669) −0.3780∗ 315 (0.0000) −0.1336∗ 315 (0.0176)

1.0000 315 0.2735∗ 315 (0.0000) 0.7737∗ 315 (0.0000)

1.0000 315 0.3536∗ 315 (0.0000)

1.0000 315

Notes: 94c : dummy variable for 1994 financial crisis; twc: dummy variable for 2000–01 twin crises; fo: dummy variable for foreign ownership; imf: dummy variable for IMF financial restructuring programmes. ∗ 95 percent significance level.

7 Other Financial Markets in Turkey

Introduction In previous chapters we have focused mainly on the changing trends in bank structure, regulation, liberalization, financial crises and IMF restructuring programmes, together with the efficiency and productivity level of the Turkish banking sector. However, other operating financial markets should also be considered in order to see a full picture of what happened in Turkey in recent decades. We therefore aim to examine and introduce readers to other financial markets operating in Turkey, and to review key statistics on financial activities in stock and bond markets in this chapter. It is organized as follows. First, there is a review of the operation of the Istanbul Stock Exchange (ISE). This section goes on to look at the initial public offerings (IPO) in the ISE, with some statistics. The structure, aim, participants and operations of bond markets in Turkey are reviewed in the following section, with an emphasis on primary and secondary market operations. Next, the chapter presents stylized figures on the activities of special finance institutions (SFIs) operating in Turkey, together with leasing, factoring and consumer finance companies. This is followed by the Conclusion.

The stock market in Turkey Starting with a short history of the stock market in Turkey, this section introduces readers to the number of firms and contracts, trade values of shares, and trade volume of transactions in the Turkish stock market. The first securities market operating in Turkey was established in 1866, during the time of Ottoman Empire, and was known then as the Dersaadet Securities Exchange. Its name was changed to Istanbul Securities and 151

152 Turkish Banking

Foreign Exchange Bourse in 1929, after the announcement of the formation of the Republic of Turkey. A striking improvement was achieved with regard to the legislative framework of the Turkish capital markets during the beginning of 1980s. The Capital Market Law was enacted in 1981, and this was followed by the establishment of the Capital Markets Board in 1982, as the main regulatory body supervising and regulating the Turkish securities market. The journey from the time of Ottoman Empire reached to its conclusion with the establishment of the Istanbul Stock Exchange (ISE) in 1986 after an announcement of the ‘Regulations for the Establishment and Functions of Securities Exchanges’ in the Official Gazette in October 1984. The ISE is the only securities exchange in Turkey established to provide trading in equities, bonds and bills, revenue-sharing certificates, private-sector bonds, foreign securities and real estate certificates, as well as international securities. The ISE is governed by an Executive Council composed of five members elected by the General Assembly. The members represent the Chairman and Chief Executive Officer of the ISE, development banks, commercial banks and brokerage houses. The ISE enjoys a high degree of self-regulation,1 and its revenues are generated from fees charged on transactions, listing procedures and miscellaneous services. The profits of the ISE are retained to meet expenses and to undertake investment, and are not distributed to any third parties, which results in it having its own budget. The stock market index of Turkey is known as the ISE National 100 Index, and the ISE has followed the most recent technological advances and updated into a fully computerized trading system. The stock trading activities are carried out in two separate sessions; that is, morning and afternoon sessions. Computerized trading has significantly improved the speed of execution and increased the daily trading capacity. Prices are determined using a multiple price-continuous auctions method, utilizing a computerized system that automatically matches buy and sell orders on a price and time priority basis. At the time of writing there are approximately 1,000 workstations in the ISE building, and each brokerage house has one remote workstation in their head office. Table 7.1 introduces the most recent statistics on the number of ISE members trading in relevant markets. The financial liberalization process during the 1980s in Turkey promoted the development of capital markets in order to enhance the efficiency of the financial system. This was done by providing direct finance as an alternative to banks for both the corporate and household sectors. In order to be listed on the ISE, corporations must have at least

Other Financial Markets in Turkey 153 Table 7.1 Istanbul Stock Exchange members according to markets, 2008

Stock market Bonds and bills market outright purchases and sales market Bonds and bills market repo– reverse repo market Foreign securities market international bonds market

Brokerage houses

Investment and development banks

Commercial banks

104 91

– 12

– 29

64

12

28

91

12

29

Source: Adapted from Istanbul Stock Exchange (2008).

15 per cent of their shares floating; and their audited financial statements must have displayed profits in the previous two years. The ISE has shown remarkable growth, both in terms of trading value and in the number of listed companies (see Table 7.2). As of the end of 2000, there were 287 listed companies with a total market value that reached USD 69 billion. These figures put the ISE ahead of many emerging markets, and comparable to smaller Western European stock markets. The ISE began its operations with 350 listed companies in 1986, and it experienced an extraordinary increase until it reached 1,284 in 1993. On the other hand, the number of companies whose equity shares are traded on the ISE was eighty in 1986, and had increased to 315 by 2000. Thirtysix new companies were added and six companies withdrawn from the market during this period. The number of companies listed on the ISE has been diminishing in recent years, with only 292 companies in operation while the ones being traded reached 319 in 2007. Out of the 319 companies traded on the ISE, 292 belong to the National, fourteen to the Secondary, three to the New Economy and ten to the Watch List Companies markets. Currently, 100 companies selected from the listed companies in the National Market are included in the ISE National 100 Index, which is the main index of the ISE. Settlement of securities traded in the National Market is realized by the ISE Settlement and Custody Bank Inc. (Takasbank), the single central depository in Turkey. The number of listed companies trading during the period 1990–2007 period is shown in Table 7.2, while the trade values of each of the above markets trading in the ISE are presented in Table 7.3 for the same period. The daily averages of each

Number of listed and traded companies and Istanbul Stock Exchange market values, 1990–2007

916 1,092 1,238 1,284 1,204 922 788 743 686 319 287 278 262 265 275 282 291 292

110 134 145 160 176 205 228 258 277 285 315 310 288 285 297 304 316 319

18,737 15,564 9,922 37,824 21,785 20,565 30,329 61,348 33,473 112,276 68,635 47,189 33,773 68,624 97,354 161,630 162,525 288,290

– – – – – 217 377 410 470 1,140 344 224 312 349 606 997 1,137 1,452

– – – – – – 61 73 9 16 – – – – 76 154 55 102

– – – – – – 30 48 24 839 529 276 317 30 37 33 58 141

18,737 15,564 9,922 37,824 21,785 20,782 30,797 61,879 33,975 114,271 69,507 47,689 34,402 69,003 98,073 162,814 163,775 289,986

– – – 14.86 10.97 5.48 7.72 13.28 6.36 24.95 14.05 411.64 23.78 13.19 13.96 19.33 15.32 13.48

2.62 3.95 6.43 1.65 2.78 3.56 2.87 1.56 3.37 0.72 1.29 0.95 1.20 0.94 1.37 1.71 2.10 1.90

Notes:* The ‘Second National Market’ was established with the aim of promoting trading in stocks of small and medium-sized companies in all parts of the country. The Second National Market consists of companies de-listed temporarily or permanently from the ISE’s National Market, as well as companies that fail to fulfil the listing requirements and lack the necessary qualifications for trading on the ISE’s National Market. ** The ‘New Economy Market’ was formed in order to enable telecommunications, information technology, electronics, internet, computer manufacturing, software and hardware, media or technology companies to offer their stocks to the public via the ISE. *** The ‘Watch List Companies Market’ was established with the aim of providing an organized and liquid market for the trading of stocks of companies under special surveillance and investigation because of extraordinary situations with respect to stock transactions and/or companies traded on the ISE. **** P/E: USD = USD-based total market capitalization/sum of last four USD-based three-month net profits. Source: Adapted from Istanbul Stock Exchange (2008).

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Years No. of No. of National Second national New economy Watch list Total market P/E ratios**** Dividend companies companies market market(*) (USD market** companies value (USD (USD) yield (%) listed traded (USD millions) (USD millions) market*** millions) millions) (USD millions)

Table 7.2

Other Financial Markets in Turkey 155 Table 7.3 Istanbul Stock Exchange trade value, 1990–2007 Year Stocks Second New economy (USD national market (USD millions) market (USD millions) millions) 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

5,854 8,502 8,567 21,770 23,203 52,311 36,698 57,178 69,696 82,931 180,123 79,945 69,990 99,406 146,511 197,074 222,399 291,409

– – – – – 46 976 587 465 894 1,554 376 549 658 947 2,226 3,406 3,416

Watch list Total (USD Daily average companies millions) (USD millions) market (USD millions)

– – – – – – 59 184 218 46 36 – – – 209 694 512 433

– – – – – – 5 155 17 162 220 79 218 102 88 94 80 131

5,854 8,502 8,567 2,177 23,203 52,357 37,737 58,104 70,396 84,034 181,934 80,400 70,756 100,165 147,755 201,763 229,642 300,842

24 34 34 88 92 209 153 231 284 356 740 324 281 407 593 794 919 1,194

Source: Adapted from Istanbul Stock Market (2008).

individual year are also calculated. In general, there has been a continuous increase in the trade value of stocks in each market during the revised period. The first considerable increase in the stock market was recognized after 1990, with a boost in total trade value in 1991 from USD 5.9 billion to USD 8.5 billion compared to the previous year. Then the Second National Market started its first trading operations in 1995, followed by the New Economy Market and the Watch List Companies Market in 1996. In 2000, the total trading volume in the ISE market rose by 201 per cent to USD 182 billion, of which USD 180 billion was on the National Market. However, the trading volumes in other markets did not register such a sharp increase. There has been a continuous increase in the total ISE trade values since 2002. The daily averages have presented a continuous upward trend since 2003, which increased by approximately 300 per cent between 2003 (USD 407 million) and 2007 (USD 1.2 billion). As of December 2007, the total trading volume on the ISE National Market was USD 291 billion, an increase of 25 per cent compared to 2006. Trading volume and the number of contracts traded on the ISE are shown in Table 7.4.

525 893 1,202 2,438 2,605 5,016 3,507 4,383 7,052 10,642 16,358 16,468 20,442 41,765 50,878 58,956 63,289 98,461

766 1,446 1,682 2,815 5,085 11,667 11,912 17,006 21,091 25,243 31,746 30,670 28,064 29,093 39,821 41,710 42,842 45,054

– – – – – – – – – – – – – – – 223 309 413

– – – – – – – – – – – – – – – 91 179 258

Traded No. of volume contracts (USD (000s) millions) – – – – – – 119 58 56 97 96 98 197 489 800 966 1039 1272

– – – – – – 492 402 273 342 500 532 618 689 1,387 1,678 2,022 2,473

Traded No. of volume contracts (USD (000s) millions)

Second National Market

9 33 58 17 6 – – – 49 202 163 200

– – – – – –

– – – – – – 35 139 177 59 35 – – – 127 305 311 269

Traded No. of volume contracts (USD (000s) millions)

New Economy Market

2 19 4 27 27 63 122 86 143 172 187 362

– – – – – – 7 92 30 141 145 178 285 162 172 158 137 286

– – – – – –

Traded No. of volume contracts (USD (000s) millions)

Watch List Companies Market

Note: *EFT: electronic funds transfer. Source: Adapted by the author from Istanbul Stock Exchange, Publications, Stock Markets in Turkey, March, 2008.

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

Traded No. of volume contracts (USD (000s) millions)

EFTs*

National market

Istanbul Stock Exchange trade volume and number of contracts, 1990–2007

Year Stocks

Table 7.4

525 893 1,202 2,438 2,605 5,016 3,636 4,492 7,171 10,783 16,487 16,629 20,761 42,340 51,870 60,522 64,989 100,710

766 1,446 1,682 2,815 5,085 11,667 12,446 17,639 21,571 25,785 32,427 31,380 28,967 29,944 41,508 43,943 45,491 48,340

Traded No. of volume contracts (USD (’000) millions)

Total

2 4 5 10 10 20 15 18 29 46 67 67 82 172 208 238 259 399

3 6 7 11 20 46 50 70 87 109 132 127 115 122 167 173 182 192

Traded Number of volume Contracts Million (’000) US$

Daily average

Other Financial Markets in Turkey 157

Looking at Table 7.4, we can comment that the general upward trend during 1999, coupled with the announcement of the anti-inflation programme in December 1999 stimulated the ISE National-100 index to rise. In 2000, the slowness in the implementation of the structural reforms, and the smaller than expected slowdown in the inflation rate, affected expectations negatively, which was eventually reflected by a deceleration. Because of the late November 2000 crisis in the financial markets, the ISE National-100 index fell with respect to the previous month’s close. However, ISE National-100, services and financial indices rose slightly after the crisis because the tightness in the liquidity had been partially overcome. Throughout 2001, the ISE National-100 index denominated in USD followed a downward trend similar to the declining trend in the trading volume. The announcement of the restructuring programme in April 2001 brought temporary optimism but the National-100 index maintained its downward trend. The index reached its lowest point in the last quarter of 2001, then in parallel to the increase in the trading volume on the ISE, the index started to follow an upward trend. Furthermore, the National-100 index, which followed an upward trend during 2005, increased by 59 per cent based on closing values compared to year-end 2004. During the same period, the industrial index and financial index increased by 49 per cent and 77 per cent, respectively.

Initial public offerings (IPOs) In connection with the macroeconomic conditions discussed in Chapter 2, the decelerating interest rates in 1999 and positive expectations about the future of the Turkish financial system increased the attention of firms and investors towards the Turkish securities market. Firms generally announce IPOs following a period of increase in the stock market index. We can define IPOs as the first sale of stocks by private companies to the public where the issuer requires the assistance of an underwriting firm, helping the company to determine the type of security it needs to issue (i.e. either common or preferred), together with the best possible offer price and timing of the offer. Underwriters purchase IPO shares from the issuer and then sell them on to investors. We need to emphasize here that the commissions, fees and other related expenses incurred in IPOs are relatively small compared to other short- and long-term loan or bond findings. This characteristic makes IPOs the least expensive way for firms to obtain funds from small and institutional investors. However, investing in IPOs is a risky and speculative decision, and investors need

642.63 501.50 272.61 833.28 413.27 382.62 534.01 982.00 484.01 1,654.17 817.49 557.52 368.26 778.43 1,075.12 1,726.23 1,620.59 2,789.66

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

– – – – – – – – – – 802.79 550.37 361.00 777.16 1,075.83 1,710.86 1,608.88 2,790.19

National-50 (USD millions) (28.12.99 = 1654.17) – – – – – – – 1,155.00 581.03 2,106.54 1,031.67 708.56 457.62 1,016.03 1,384.29 2,190.14 2,011.43 3,539.04

National-30 (USD millions) (27.12.96 = 534) – – – – – – – – – – – – – – – – – 2,783.03

Corporate governance (USD millions) (29.08.07 = 2.114,37) – – – – – – – 940.00 468.12 1,544.12 769.65 528.10 358.20 740.42 1,027.12 1,669.61 1,589.02 2,677.61

National all-shares (USD millions) (31.12.90 = 643) – 569.63 334.59 897.96 462.03 442.11 572.33 757.31 362.12 1,081.74 602.47 461.68 351.17 681.22 899.19 1,351.41 1,280.01 2,037.67

National industrials (USD millions) (31.12.90 = 643)

Notes: ISE National-30 is composed of national market companies apart from investment trusts and will also be used for trading in the derivatives market. ISE National-50 is composed of national market companies apart from investment trusts; the 50 constituent companies are selected for inclusion in the indices on the basis of predetermined criteria. The ISE National-50 Index includes the ISE National-30 Index companies. ISE National-100, which has been calculated since the inception of the ISE, is composed of national market companies apart from investment trusts. The constituents of the ISE National-100 Index are selected for inclusion in the indices on the basis of predetermined criteria. The ISE National-100 Index includes the ISE National-50 and ISE National-30 Index companies. Source: Adapted from Istanbul Stock Exchange (2007).

National-100 (USD millions) (Jan. 1986 = 100)

Closing values of price indices in the Istanbul Stock Exchange, 1990–2007

Years

Table 7.5

Other Financial Markets in Turkey 159 Table 7.6 Initial public offerings in Turkey, 1990–2007 Years

Number of IPO companies

Total nominal value (USD millions)

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

35 23 13 16 25 29 17 27 20 10 35 1 4 2 12 1 4 8

864 291 75 123 200 175 65 65 67 53 158 0 17 2 107 1 88 478

Total

282

2,829

Source: Compiled from Istanbul Stock Exchange, Public Offerings, 1990–2007.

to analyse the pros and cons carefully before investing in them. Their prices are mainly based on firm size, market trend, size of the offer, the investment banker’s reputation, the method of intermediation, the stock price range and investor type. Information about the annual number of IPO companies in Turkey in the period 1990–2006 is shown in Table 7.6. In 1990, the number of IPO companies in Turkey was thirty-five, with a USD 865 million total nominal value. A very volatile trend was observed throughout the analysis period. The number of IPO companies reached the initial level of thirty-five in the year 2000, and then there was an enormous decrease in 2001, with only one company going public that year. The fluctuations in the number of IPO companies continue and had a closing balance of eight in 2007, with total nominal value of USD 478 million. A total of 282 companies went public during the 1990–2007 period in Turkey, selling their shares to investors for the first time. The total nominal values of IPOs over the same period were USD 93 billion.

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

100 90 80 70 60 50 40 30 20 10 0 1990

Percentages

160 Turkish Banking

Figure 7.1 Outstanding government securities/total outstanding securities, 1990–2005 Source: Adapted from Central Bank of Turkey (2006: 47).

Bond markets The bond market includes government-issued securities and corporate debt securities, and facilitates the transfer of capital from savers to issuers. The bond market is a part of the capital market and is divided into two main streams. Most trading in the bond market occur over-the-counter (OTC) through organized electronic trading networks.

Primary markets in Turkey We aim to introduce the reader to the primary market operating in Turkey in this section. An overview of the changing share of outstanding government securities to total outstanding securities in Turkey between 1990 and 2005 is shown in Figure 7.1. We need to emphasize here that a corporate bond market does not exist in local markets such as Turkey. However, there are big companies such as Vestel, Arçelik, Petrol Ofisi A.S., and many more who are issuing Eurobonds. In 1990, the share of outstanding government securities in total outstanding securities was around 63 per cent, but experienced a decline up until the end of 1991. Over the 1992–4 period the trend increased from 72 to 84 per cent, which experienced approximately 2 per cent deceleration during 1995 just after the 1994 crisis. Then, up to 2000, the trend was quite stable, at between 82 per cent and 85 percent. Once again, a decline was observed during the second crisis year of 2000. As of December 2000, the share of outstanding government securities in total outstanding securities declined by 3 per cent compared to 1999, to

Other Financial Markets in Turkey 161 Table 7.7 Traded value of off-exchange fixed-income securities, 1990–2007 Year

Outright sales transactions (USD millions)

Repo transactions (USD millions)

Total (USD millions)

Daily average (USD millions)

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

37,664 67,205 88,632 167,119 262,083 443,867 58,371 82,335 235,294 404,278 502,253 88,101 89,463 100,423 157,597 173,733 140,301 184,015

– – – – – – 741,586 1,047,214 1,141,506 1,264,336 1,621,603 764,740 276,790 253,970 281,311 251,331 351,303 375,258

37,664 67,205 88,632 167,119 262,083 443,867 799,957 1,129,548 1,376,800 1,668,614 2,123,855 852,841 366,254 354,393 438,907 425,064 491,605 559,274

152 272 353 679 1,036 1,761 3,174 4,482 5,507 6,701 8,495 3,384 1,436 1,423 1,742 1,673 1,959 2,219

Source: Adapted from Istanbul Stock Exchange (2008).

81 per cent. Since 1999, the Treasury has favoured government bonds with longer maturities over Treasury bills when issuing debt securities. Thus, the amount of outstanding Treasury bills has diminished, while government bond stocks have risen.

Secondary market activities in Turkey We should emphasize that the development of a secondary market for government securities is a major step in the development of capital markets in general. Thus, secondary market activities in Turkey are the key to the development of its capital market and are managed under two different streams; namely, the OTC and the ISE bills and bonds market.

Over-the-counter market The OTC market enables dealers and brokers to trade bonds and stocks by telephone and computer rather than at a physical exchange. Table 7.7

162 Turkish Banking

presents the traded values of off-exchange fixed-income securities over the period 1990–2007. Focusing on the most recent financial crises period in Turkey, internal borrowing requirements have been decreased as a result of the anti-inflation programme in 1999. This development caused securities portfolios of banks to decrease, which resulted in a decrease in the share of the securities portfolios to total assets. In order to cope with this problem, the Treasury initiated the Market Maker System in May 2000 to increase the effective issue of Public Internal Borrowing Bills and secondary market transactions. This new system forced selected banks to specialize in the securities portfolio market and increase the share of government securities in their portfolios.

ISE bonds and bills market The bonds and bills market is the only organized, fully-automated market for both outright purchases and sales, and repo/reverse repo transactions, in Turkey. It was established in 1991, while the repo/reverse repo transactions began in 1993. The purpose of the bonds and bills market is to provide a transparent, liquid, competitive and efficient environment for the secondary market trading of fixed-income securities comprising government bonds, Treasury bills, revenue-sharing certificates, bonds issued by the Privatization Administration, and corporate bonds listed on the ISE. Although there is a market for all the securities listed above, most transactions are conducted on Treasury bills and government bonds. In Table 7.8, we present a comparison of the monthly trading volumes of government bonds, Treasury bills and the total volume of secondary market operations in Turkey during 2000 and 2005. Total trading volume of the secondary market declined by 54 per cent from the year 2000 to 2005. We attribute the lessening volume to the contraction in the amount of outstanding treasury bills that led to a significant reduction in the secondary market trading volume of these securities. In contrast to the general upward trend in the trading volume of government bonds during the first ten months of 2000, the volume in November and December of that year declined considerably. The total volume of Treasury bills also experienced a decline of more than 50 per cent between 2000 and 2005. It is well known that a great number of people in Turkey still use the simplest method of investing money (that is, depositing their savings in banks in return for an interest payment). However, as a result of developing other financial markets in the world, specifically large corporations and people dealing with large amounts of money began to invest in other financial markets. In addition

Other Financial Markets in Turkey 163 Table 7.8 Secondary market trading volumes on the Istanbul Stock Exchange, 2000 and 2005 (USD billions) Government bond

Treasury bill

Total

Month

2000

2005

2000

2005

2000

2005

Jan Feb Mar April May June July Aug Sep Oct Nov Dec

42,546 56,885 48,805 55,311 53,675 74,814 69,109 72,526 80,318 96,267 80,740 49,456

35,625 41,714 51,700 35,889 39,960 36,204 26,878 30,313 37,362 34,085 28,387 31,148

12,489 10,808 11,785 7,806 17,272 8,475 9,717 12,007 2,165 16,085 2,116 2,553

4,328 4,441 4,504 4,491 5,094 4,403 4,438 3,846 4,049 4,260 3,735 3,868

55,035 67,693 60,590 63,117 70,947 83,289 78,826 84,533 82,482 112,352 82,856 52,009

39,953 46,155 56,204 40,380 45,054 40,608 31,316 34,159 41,411 38,346 32,122 35,016

Total

780,452

429,266

113,276

51,456

893,729

480,723

Source: Adapted from Capital Markets Board of Turkey information.

to the money market, foreign and public investors also invested large amounts in the stocks, securities and bonds markets in Turkey. These will be discussed in the following sections. The Turkish stocks and bonds markets are open to foreign investors, without any restrictions on the repatriation of capital and profits. In order to develop our discussion on the changing value of the bonds market in Turkey, we show the relevant figures for the 1992–2007 period in Table 7.9. While the ISE outright purchases and sales market showed a significant expansion in terms of trading volume between 1991 and 2000, it experienced a sharp decline in 2001. Trading volume in the outright purchases and sales market was USD 263 billion in 2000, up from USD 84 billion in 1999, but declined to USD 37 billion in 2001. The decline was experienced as a result of increasing economic uncertainty, a lessening in the values of bonds and bills as a result of the jump in discount rates, the banks’ use of bonds and bills as collateral in repurchase agreements with their clients, and as free reserves held at the CBT. When we move on to the repo/reverse repo market, the decisive stance of monetary policy has also contributed to the decrease in medium and long-term real interest rates. The trading volume in the repo and reverserepo market, of which 97 per cent was overnight repo transactions,

164 Turkish Banking Table 7.9 Traded value of the bonds and bills market in Turkey, 1992–2007 Year

Outright purchases and sales market (USD millions)

1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

2,406 10,728 8,832 16,509 32,737 35,472 68,399 83,842 262,941 37,297 67,256 144,422 262,596 359,371 270,183 278,873

Repo-reverse Total Daily average repo market (USD millions) (USD millions) (USD millions) – 4,794 23,704 123,254 221,405 374,384 372,201 589,267 886,732 627,244 480,725 701,545 1,090,476 1,387,221 1,770,337 1,993,283

2,406 15,522 32,536 139,763 254,142 409,856 440,601 673,109 1,149,673 664,541 547,982 845,967 1,353,072 1,746,591 2,040,520 2,272,156

10 66 129 555 1,008 1,626 1,762 2,714 4,58 2,648 2,166 3,384 5,369 6,876 8,13 9,016

Source: Adapted from Istanbul Stock Exchange (2008).

increased by 121 per cent, to USD 887 billion, in 2000 compared to 1999. The increasing trend continued until 2007. As of the end of 2007, the total transaction volume on the repo/reverse repo market operating under the ISE bonds and bills market reached USD 1.99 trillion, with an increase of 22 per cent compared to 2006. Furthermore, the extraordinary increase in investments by foreigners has also been reflected on the figures of the Turkish bonds market, specifically since the beginning of 2005. Figure 7.2 shows the increasing trend in the volume of YTL bonds purchased by foreign investors. The YTL-denominated debt securities purchased by foreigners reached a record level of USD 12.2 billion in November 2006, from USD 8.4 billion at the end of 2005. We suggest that the main reason of this is the positive expectations of foreign investors in Turkey.

Leasing, factoring and consumer finance companies in Turkey Banks hold approximately 87 per cent of the total assets in the Turkish financial system, and the rest is held by other institutions providing financial services (see Figure 7.3). According to 2007 statistics, apart from

Other Financial Markets in Turkey 165 12

Billions USD

10 8 6 4

Oct 06

Sep 06

Jul 06

Aug 06

Jun 06

Apr 06

May 06

Mar 06

Jan 06

Feb 06

Dec 05

Oct 05

Nov 05

Sep 05

Jul 05

Aug 05

Jun 05

Apr 05

May 05

Mar 05

Jan 05

0

Feb 05

2

Figure 7.2 Value of new Turkish lira bonds purchased by foreign investors, Jan 2005–Oct 2006

Figure 7.3

4.0

3.3

1.8

1.1

0.6

1.9

Insurance companies

Leasing companies

Factoring companies

Consumer finance companies

Other finance institutions

87.3

Mutual funds

100 90 80 70 60 50 40 30 20 10 0

Banks

Percentages

Source: Adapted from Central Bank of Turkey (2006: 35).

Composition of total assets in the Turkish financial system

Source: Adapted from Central Bank of Turkey (2007: 29).

banks, there were 5 special finance institutions, 58 insurance companies, 92 factoring companies, 81 leasing companies, 7 consumer finance institutions, and 151 intermediary institutions operating in the Turkish financial sector. Even though individual sectors other than banking have not reached the desired size as yet, insurance and leasing sectors have made significant progress. In Figure 7.3 we show the composition of the total assets of banks and other finance companies operating in Turkey. The largest share belongs to the banks, as expected, while the second-largest share is from mutual funds.

166 Turkish Banking

Special financial institutions We introduce in this section the special financial institutions (SFIs) that operate in Turkey. SFIs are not authorized to collect deposits, but they amass funds via special current accounts, and profit and loss participation accounts, allocating the funds raised by financial leasing, factoring and trade financing transactions. SFIs have existed in the Turkish financial system since 1984, but have never been as popular as banks. Since 2001 there have only been five, with a limited share in the system. They are authorized and supervised by the BRSA and have had their own uniform chart of accounts since 2004. SFIs operating in Turkey have been using Islamic finance techniques since the late 1980s. As noted above, they are authorized by the Banking Act to collect deposit funds from the public through profit-and-loss participation accounts and special current accounts. The profit-and-loss accounts can be considered as a version of the Islamic finance instrument known as the mudaraba, where the bank utilizes funds deposited by account holders and are accumulated in a pool for specific business activities. Any profits earned are shared between the account holder and the bank in agreed proportions. SFIs principally offer two types of financing: first, murabaha, under which the funds are made available to companies in need of capital; and second, financial leasing, which is similar to that offered by other leasing companies. Islamic banking activities began in Turkey with the opening of two Islamic finance houses in 1985. At the end of 1996, four more finance houses had been founded, but after 2001 this number decreased to five. Initially, a special rule was passed to regulate these houses. Although the assets of Islamic institutions grew at an approximate average annual rate of 15 per cent globally, Turkish Islamic houses have not experienced significant growth. Initially, foreign Islamic banks formed partnerships with Turkish investors and created the joint companies of Al Baraka Turkish Special, Faisal Finance Company and Kuwait Turkish Evkaf Finance Company. Later, three institutions with only Turkish investors were formed: Anadolu Finance Company, Ihlas Finance Company and Asya Finance Company. Since the 1980s, the percentage of deposits and loans of these institutions among traditional banks has been at most 3 per cent. After the 2001 financial crisis in Turkey, one finance house was declared bankrupt (Ihlas Finance Company) and two have been sold to new owners. The number of branches and personnel, together with selected balance sheet items of the five remaining SFIs, are shown in Table 7.10. SFIs had 189 branches and 3,502 personnel at the end of 2003,

Other Financial Markets in Turkey 167 Table 7.10 Selected balance sheet items of special financial institutions in Turkey, 2002–05

Number of branches Number of personnel Funds extended (USD millions) Due from banks (USD millions) NPL (net) (USD millions) Funds raised (USD millions) Equity (USD millions) Off-balance-sheet liabilities (USD millions) Total assets (USD millions)

2002

2003

2004

2005

148 2,530 1,288 336 150 1,966 245 490 2,431

189 3,502 2,248 380 89 2,945 481 1036 3,763

255 4,790 3,651 510 83 4,465 712 2,305 5,501

259 5,213 4,234 507 84 4,895 492 2,781 5,393

Source: Adapted from Central Bank of Turkey (2005: 57–8).

increasing to 259 branches and 5,213 personnel by 2005. The selected balance sheet items were introduced in Table 7.10 to give readers an idea about the SFIs’ operating size compared to data on banks given earlier. It can be seen from Table 7.10 that the total asset size of SFIs operating in Turkey increased by 41 per cent to USD 5.5 billion in 2004, compared to 2002. These figures indicate that 54 per cent of the total assets and 40 per cent of the total liabilities of the SFIs were denominated in domestic currency in 2004. Interestingly, there was little change in total assets in 2005, but the composition of total liabilities increased to 45 per cent. Furthermore, we observed that the share of funds extended in total assets increased, but the share of fixed assets declined over the period under analysis. The fixed assets of SFIs were USD 408 million in 2004, but declined to USD 122 million in 2005 probably as a result of the effects of the Uniform Chart of Accounts for SFIs applied by the BRSA on 1 January 2005. Therefore, assets used for financial leasing have been accounted as funds extended since then. Finally, the main source of funds for SFIs, other than equity, come from current accounts and participation accounts, which are mainly held in foreign currency. The net non-performing loans (NPL) of the SFIs, which totalled USD 89 million in 2003, decreased to USD 84 million in 2005.

Conclusion This chapter provided the reader with a flavour of the changing trends and statistics of the financial markets operating in Turkey. Recently, increasing competition and interest among foreign investors

168 Turkish Banking

has expanded investment capacity in the Turkish stocks and bonds markets. The ISE outright purchases and sales market showed a significant expansion in terms of trading volume during 1991–2000, but it experienced a sharp decline in 2001, as a result of increasing economic uncertainty in Turkey during the financial crisis period and a lessening in the value of bonds and bills traded in the ISE secondary market. We also discussed the activities of other financial institutions, such as special finance institutions. SFIs operating in Turkey have been using Islamic finance techniques since the late 1980s. Since 2003, there have only been five Islamic finance institutions in Turkey. Their total asset size increased by 41 per cent during 2002–04, but there was very little change in 2005.

8 Current Developments and Prospects for Turkish Banks

Introduction In the penultimate chapter we focus on current developments and take a look at the prospects of Turkish banking for the future. Above all, the most important occurrence, not only for Turkish banking but also for Turkey as a nation, was the declaration of Turkey as an EU accession country in 2005. The first section of the chapter reviews the structural and institutional preparations of the Turkish banking and financial system towards meeting EU regulations and systems. Then we switch our attention to the implementation process of newly reinforced capital adequacy directives (Basel II), followed by the readiness for and the impact of the new Basel Accord directives on current levels of capital adequacy of Turkish banks. Subsequently, we discuss the developments in housing loans with the introduction of the Mortgage Law. Potential EU membership, the successful banking sector restructuring programme after the 2000/01 financial crises, the enforcement of internationally accepted banking standards such as Basel II, and the growth potential of the sector, attracted an historical amount of foreign investment to the banking industry. In the final section, we review the recent acquisitions by foreign banks and assess the impact of a large foreign presence on Turkish banking.

Reshaping the Turkish financial system towards potential EU membership Turkey has been a European Union (EU) associate member since 1963, when the parties signed the ‘Agreement Creating an Association between the Republic of Turkey and the European Economic Community’. Later, 169

170 Turkish Banking

in 1987, Turkey made a formal application to join the then-called European Community. In 1995, the integration of Turkey into Europe went one step further, with the Customs Union agreement signed between the two parties. Eventually, in 1999, Turkey was officially recognized as a candidate for full membership with other potential candidates, and later, in 2005, Turkey was declared an EU accession country and the negotiation process officially began. The general view on the length of time needed to complete all negotiations with the European Commission on each of the thirty-five chapters of the EU’s acquis is expected to be a minimum of ten years. Furthermore, after all chapters are closed successfully, the member states must agree unanimously to Turkish membership. At the time of writing, only the chapters on Science and Research, Enterprise and Industrial Regulations, Statistics and Financial Control, Health and Consumer Protection, and Trans-European Transport had been open and negotiated. Many chapters were closed when political disputes over Cyprus prompted the EU to freeze talks until a resolution was found. Nevertheless, here we shall outline the requirements of EU Directives on Financial Services and the progress of the Turkish financial sector towards convergence with European financial markets. Financial institutions can operate across the EU in accordance with the ‘home country control’ principle, either by establishing branches or by providing services on a cross-border basis. In general, the acquis (directives) in the field of financial services include rules for the authorization, operation and supervision of financial institutions in the areas of banking, insurance, supplementary pensions, investment services and securities markets. It aims to create an open market for financial services with transparent, consistent governance and supervisory practices across the member states. The acquis in financial services is divided into four subsections as; (i) banks and financial conglomerates; (ii) insurance and occupational pensions; (iii) financial market infrastructure; and (iv) securities markets and investment services. Most of the legislation regarding these items is already in line with EU Directives. This is mainly attributable to the financial and economic restructuring programme that was implemented successfully after the 2001 financial crisis. The Turkish authorities, in preparation for potential EU membership, pursued policies that will raise the standard of the Turkish banking sector to the level of that of the EU and harmonize the legislation with the EU acquis. Here we shall focus on the section of the acquis that corresponds to banks and financial conglomerates, and sets out requirements for the authorization, operation and prudential supervision of credit institutions, together with

Developments and Prospects for Turkish Banks 171

requirements on capital adequacy and its calculation. In addition, the acquis outlines the rules relating to the supplementary supervision of financial conglomerates and to the taking up, pursuit of and prudential supervision of the business of electronic money institutions. According to an EU screening report (2007), in general, Turkey’s legislation is aligned satisfactorily with the financial services acquis, though there are areas still in need of improvement. For example, in the area of banking, a framework for the supplementary supervision of financial conglomerates is still missing; and legislation concerning the supervision of electronic money institutions has yet to be developed. Regarding the deposit insurance scheme (see Chapter 3, page 58), Turkey has already established a deposit guarantee scheme under the SDIF, which (at the time of writing) guarantees up to a31,000. The scheme is partially in line with EU acquis. Although the directive requires credit institutions to join an officially recognized deposit guarantee scheme, the minimum limit of protection is set to be a20,000 per depositor. The protection scheme in Turkey is well above this benchmark. However, deposits of legal persons and deposits of Turkish branches of credit institutions abroad are not covered. EU reports also disapprove of the availability of Central Bank credits for the SDIF. The legislation concerning cross-border banking services and authorization and supervision of branches is also expected to be aligned with EU Directives. EU negotiators are content with recent improvements in the BRSA’s administrative capacity to supervise the banking sector, especially on the introduction of risk-based supervision, organizational changes and enhancement of staff. For the future, the BRSA is advised to strengthen its administrative and institutional capacity to accommodate more demanding supervisory requirements. A list of proposed legislation to be amended between 2007 and 2013 is presented in Table 8.1. One of the most important items in the acquis on financial institutions is the harmonization of capital adequacy regulations. The latest EU Directive that sets out the capital adequacy framework is the Capital Adequacy Directive 3 (CAD 3). CAD 3, which took effect in 2007 and applies to all credit institutions in the EU, simply translates Basel II into EU legislation. The adaptation of a Basel II type regulatory framework for financial institutions by the EU facilitated Turkey’s efforts to comply with this section of the acquis, as the Turkish authorities have already opted to implement Basel II provisions fully as of January 2008 to cover capital adequacy requirements for banks in Turkey. The next section discusses these preparations and implementation of Basel II, together with the impact of new provisions on the capital adequacy levels of Turkish banks.

Proposed legislation 2007–13

Ensuring Turkish legislation on capital markets is ready for membership by drawing up a law that is fully harmonized with EU legislation.

Harmonization with rules such as the EU passport and country of origin control.

Capital Markets Law (The amendments will be made if considered necessary after the enactment of the Payment Systems Law)

Law Amending the Insurance Law

Source: Adapted from Secretariat General for EU Affairs (2007:111–13).

Ensuring that netting and settlement in payment systems are final and irrevocable.

Payment Systems Law

Specification of procedures and principles on the group of financial companies. Specification of procedures and principles on electronic money institutions. Establishing trust and stability in financial markets, ensuring effective operation of the credit system, and protection of the rights and interests of savers.

Harmonization of quotation rules with EU legislation.

Amendment of the Decree Law on Stock Exchanges

Period 2009–13 Amendment of the Banking Law and/or enactment of a new Law

Ensuring Turkish legislation on capital markets is ready for membership by drawing up a law and related communiqués that are fully harmonized with EU legislation.

More effective regulation and control of the insurance sector. Aiming at harmonization with EU legislation regarding official authorization of corporations, minimum capital requirements in respect of branches, reasons for annulment of official authorization, qualifications of managers and shareholders, the free tariff system, issues of liquidation, merger, acquisition and portfolio acquisition as well as bankruptcy, technical reserves, guarantees, security account, insurance intermediaries and so on. Harmonization within the framework of EU legislation on workers’ entitlement to contributions where these are paid partially or fully by the employer, and establishing a legal basis for designating business-based retirement plans.

Aim

Capital Markets Law

Period 2007–08 Insurance Law

Name of legislation to be amended/enacted

Table 8.1

172

Developments and Prospects for Turkish Banks 173

Implementation of Basel II in Turkey Capital adequacy requirements in Turkey were already established in line with Basel I, which was adopted in Turkey in 1989, and market risk was incorporated into the calculation of the capital adequacy ratio in 2002. The Banking Law required banks to maintain a minimum capital adequacy ratio of 8 per cent. The capital charges were not required for operational risks but only for credit and market risks. The capital requirements of credit risks were calculated based on Basel I methodology, where market risk consists of interest rate, equity position and foreign exchange risks. Market risk could be calculated using a standardized method or an internal risk-measurement model. Interest rate and equity position risks covered risks arising from the trading book only, while the foreign exchange risk applied to all the bank’s activities. Banks were not required to hold capital for risks to underwriting, credit derivates, collective investment undertakings, settlement/delivery, counter party credit, or commodities. Turkey is among more than 100 countries that will put into practice Basel II to regulate and supervise the banking sector to the highest international standards. The BRSA is the sole authority to plan the implementation of Basel II, and later to oversee the system, and strongly supports the approach of the Basel Committee on Banking Supervision that envisages creating a more robust and risk-sensitive capital adequacy framework. Early in 2003, the BRSA established an efficient co-operation and discussion forum, the ‘Steering Committee on Basel II’, which meets regularly with banks’ representatives to hold discussions on how best to implement Basel II (and CAD 3) and enhance awareness of its requirements. In May 2005, the BRSA announced a plan entitled ‘The Road Map for the Transition to the New Basel Capital Accord (Basel II)’, which outlined in detail for Turkish banks the path for the transition process from the current system to Basel II . With the plan, the BRSA asked each bank to appoint a Basel II co-ordinator at senior manager level and a committee, to initiate internal road plans and to decide on approaches that will be used in risk measurement and to invest in necessary IT and other systems infrastructure for the application of advanced methods. The banks were required to report on their progress every three months. The plan also set out the dates and periods for quantitative impact studies and questionnaires that will be carried out by the BRSA. The BRSA planned to implement Basel II as of January 2008, with the model-based approaches to be implemented at the beginning of 2009. Here we outline the methods that are expected to be used by Turkish banks.

174 Turkish Banking

Pillar 1: credit, market and operational risk Regarding the calculation of credit risk, all the small banks and most of the medium-sized ones are planning to use the standardized approach initially. On the other hand, large private banks and foreign banks are planning to apply an internal rating based (IRB) approach in the near future. According to BRSA questionnaires, by 2012, thirteen banks, constituting 53 per cent of the total banking sector assets, will be using the IRB approach. By 2016, this ratio is expected to increase to 80 per cent. BRSA (2006) reports that the cost of investment in database generation and credit risk measurement models is the main reasons for applying a standardized approach in the initial phase of the transition period. Together with the standardized approach, value at risk (VaR) was already a common practice among large and medium-sized banks to measure market risk before the implementation preparations of Basel II. BRSA (2006) estimates that, by 2012, nineteen banks, constituting 73 per cent of the total banking sector assets, will be using the VaR approach. Most of the banks in the Turkish banking system can measure operational risk by basic indicator and standardized approaches. The number of banks planning to use an advanced measurement approach at the preliminary stage of Basel II implementation is limited; the expectation is that there will be only twelve banks using this in 2012, representing 40 per cent of the total banking sector assets.

Pillars 2 and 3 The second pillar requires banks to put in place systems to assess the adequacy of their economic capital in relation to their risk profile, and maintain an appropriate level of capital at all times. This is termed the internal capital adequacy assessment process (ICAAP). This encompasses quantifiable risks such as interest rate, risk in the non-trading book, concentration risk, transformation risk and residual risk, as well as risks that require a more qualitative approach (such as reputational and strategic risk). BRSA (2006) reports that, as of December 2006, systems for ICAAP were fully established in banks owning 27 per cent of the total banking sector assets, and partially established in around half of the banking sector in terms of total assets. The third pillar increases the banks’ disclosure requirements and is designed to allow the market to gain a better picture of the overall risk position of the bank. Most of the banks had approved such disclosure policies.

Developments and Prospects for Turkish Banks 175

Can Turkish banks cope with Basel II? The BRSA conducted two quantitative impact studies (QIS) similar to those carried out by the Basel Committee between 2001 and 2005.1 Put simply, a QIS is a data-gathering exercise via questionnaires to assess the progress and readiness of the banks, and the impact of Basel II on capital adequacy levels of the banking system in general. The latest QIS study at the time of writing (QIS TR2), which included thirty-one banks representing 97 per cent of total banking sector assets, was carried out between October 2006 and June 2006, and the results were released in July 2007. Here, we will be looking at the results of this study, reported by the BRSA (see BRSA, 2007, for further details). The highest impact of the new measures on capital adequacy ratios stems from the sovereign, corporate and retail portfolios of Turkish banks. The large amount of government debt obligations carried in sovereign portfolios has a significant negative impact on current levels of capital. This is because of changes in risk weightings of sovereign debt in Basel II. Previously, under Basel I, the debt of governments that were members of OECD countries were assigned zero per cent risk weightings. With current changes, the risk weighting of sovereign debt depends on the countries’ credit ratings. At the time of the QIS TR2, the credit rating of Turkey corresponded to a 100 per cent risk weighting for foreign currency denominated debt, and therefore increased the risk of large amounts of Turkish Eurobonds greatly. As Basel II tolerates national discretion on the choice of risk weighting on local currency denominated debt, the authorities decided to assign a zero per cent risk weight on debt denominated in Turkish lira. Overall, new risk weights on foreign currency denominated government debt increased the level of risk weighted assets in the sovereign portfolio significantly (see Table 8.2). The corporate loan portfolio, which has two sub-groups, small and medium enterprises (SMEs) and non–SMEs, constitutes the secondlargest exposure of the Turkish banking sector after the sovereign portfolio. Under the current approach (Basel I), 80 per cent of the total loans extended to non–SMEs have a risk weighting of 100 per cent; however, with Basel II, almost all of these loans are positioned lower than the 100 per cent risk weighting category. The main reasons for such an increase is, first, the fact that very few of these firms have external credit ratings, and second, they are either not secured or secured with instruments that are not recognized as credit-risk mitigating tools under the standardized approach. Similarly, the riskiness of SME portfolios is also observed to be increased by these factors. The addition of operational

176 Turkish Banking Table 8.2 The impact of individual portfolios on the increase in risk-weighted assets of Turkish banks after the introduction of Basel II

Non-SME corporate loans SME corporate loans Sovereign portfolio Banks portfolio Residential mortgage exposures Other retail exposures Revolving retail exposures SME – retail exposures Trading book Equity portfolio Investments in related entities Operational risk Total

Share in the total increase (%)

Distribution of shares (%)

4.43 1.44 18.58 2.69 −1.53 −4.12 −2.96 −1.50 6.29 0.00 0.28 14.54 38.15

11.62 3.78 48.71 7.06 −4.00 −10.81 −7.76 −3.94 16.48 0.00 0.75 38.12 100

Source: Adapted from Banking Regulation and Supervisary Agency (in Turkish, BDDK) (2007: 40).

risk, which was not applied under Basel I, also has a negative impact on the capital needs of Turkish banks. The expected change, as projected by QIS TR2, in the Turkish banking system’s capital requirements and the impact of particular risks after the adaptation of Basel II is presented in Table 8.3. Overall, we can see that the level of capital adequacy ratio within the current system is well above the required level of 8 per cent. Although adaptation of Basel II reduces the capital adequacy levels of Turkish banks significantly, the level of capital within the system will be considerably greater than the required ratio. Therefore, in light of QIS TR2’s findings, we can argue that, overall, Turkish banks will easily satisfy the capital adequacy requirements.

Introduction of a mortgage system and a new mortgage law Historically, because of weak economic fundamentals, high inflation and interest rates, and the unavailability of a longer-term bond market, the financing of housing has never been achievable by Turkish households and the proportion of housing loans in the financial system has been minuscule relative to the size of the system. Housing loans account for less than 5 per cent of the USD 380 billion economy, compared to an average of around 50 per cent in the EU-15 (see Figure 8.1). In 2002, housing

Developments and Prospects for Turkish Banks 177 Table 8.3 Changes in the capital adequacy ratio projected by quantitative impact study TR2, 2006–07 Current approach

Basel II standard approach

50,084 46,609 3,475 0

50,354 46,661 3,692 0

Risk weighted assets Credit risk Counterparty risk Market risk Specific risk Settlement risk Operational risk Related entities risk Other assets

259,335 230,998 232 8,031 112 0 0 4,915 15,046

368,195 280,414 1,823 8,031 16,763 0 42,184 3,934 15,046

Capital adequacy ratio

19.31%

13.68%

Capital Tier I Tier II Tier III

Figure 8.1

India

Turkey

Poland

China

Bulgaria

Hungary

Czech Rep.

Chile

Croatia

Israel

S. Korea

South Africa

Japan

Malaysia

Germany

USA

100 90 80 70 60 50 40 30 20 10 0 United Kingdom

Percentages

Source: Adapted from Banking Regulation and Supervision Agency (BDDK) (2007: 43).

Size of mortgage market relative to GDP, selected countries

Source: Adapted from Demirkol (2007: 6).

loans accounted for only 0.2 per cent of the total assets of all banks in Turkey (see Figure 8.2). However recent trends, after 2002, have displayed extensive growth between 2002 and 2007, and these are expected to continue with Turkey’s first ever Mortgage Law, approved in early 2007. In a country of 74 million people, the new law is expected to increase home ownership for middle- and lower-income households, who have traditionally relied on family borrowings or expensive short-term home loans from banks.

178 Turkish Banking

25,000

12.0

20,000

10.0 8.0

15,000

6.0 10,000

4.0

5,000

2.0

0

0.0 2002

Figure 8.2

Percentages

Millions USD

Total housing loans Share of housing loans in total assets Share of housing loans in total loans

2003

2004

2005

2006

2007*

Growth in housing loans, 2002–07

Note: * As of September 2007. Source: Adapted from BDDK (2007–39); available at http:www.bddk.org.tr/turkce/Raporlar/ Finansal_Piyasalar_Raporlari/4179fpreylul_internet_271136.pdf.

The Mortgage Law is an important step to further deepen financial intermediation in Turkey. The law aims to improve infrastructure in order to promote the primary mortgage and housing finance markets, and to establish a secondary mortgage market through new debt instruments, namely ‘mortgage covered bonds’ and ‘asset covered bonds’, which will be issued by housing finance institutions, to provide alternative funding mechanisms to primary lenders. The new law amends certain provisions of the Execution and Bankruptcy Law, the Capital Markets Law, the Consumer Protection Law and various tax laws. The law defines mortgage covered bonds as financial instruments secured by assets in the cover pools, such as the housing finance receivables, receivables secured by mortgages on other real estate properties, substitute assets varying from cash and domestic public debt instruments to securities issued by governments or central banks of OECD members. According to a Turkish law firm (see Ünal, 2007, for more detail), these pools of assets have been afforded quasiimmunity, since the assets included in these cover pools may not be used for any purposes other than securing these bonds. Moreover, they are not subject to pledges, attachments, interim injunctions or bankruptcy processes until the redemption of the mortgage covered bonds. The new law also introduces ‘housing finance funds’ and ‘asset finance funds’, which will be backed by funds collected in return for mortgage- and asset-backed securities, and provide securitization of the receivables arising from mortgage lending through mortgage-backed securities. Ease of

Developments and Prospects for Turkish Banks 179

buying and selling these securities, which provide participation rights in the funds portfolio, will enhance liquidity and diminish the cost of funds provided eventually for mortgage finance (Ünal, 2007). Regarding customer protection, the law requires mortgage finance institutions to provide customers with a ‘pre-contract’ form setting out the terms and conditions of the relevant loan or financial lease agreement. The law also allows banks to pass on the interest rate risk to customers by lending at variable rates rather than the fixed rates in use traditionally for housing loans. In terms of overseeing the system, the law gives the BRSA sole supervisory responsibility for mortgage lending over all the institutions it supervises. The BRSA can also specify further requirements to be met by the financial leasing, factoring and financing institutions by their incorporation and application for relevant permits. The Capital Markets Board will be in charge of supervising housing finance companies and mortgage finance companies owned by non-financial organizations. Overall, the new system is expected to increase real estate development, construction, real estate finance, secondary markets and related sectors in the Turkish economy. Solving the problems of housing and housing finance through a modernized financial and real estate system will have many positive social and economic effects on the country, including an increase in home ownership, the promotion of economic development through planned urbanization, a decrease in unauthorized construction, and a steady rise in the market value of real estate as it becomes more widely available to the public (Hanlı, 2007). The declaration of Turkey as an EU accession country, together with Turkey’s commitment to establish a sound and strong financial sector adopting international standards, caused a rise in interest among foreign investors in Turkish banks. The next section looks at these flows of foreign direct investment (FDI) to the Turkish banking sector.

Foreign direct investment in Turkish banking The integration of the financial and goods markets has accelerated to a high degree in recent decades. Many banks, striving to increase their share in global business, have expanded their operations beyond the borders of their local markets. A driving force of such expansion and internationalization of the banking sector was the liberalization of financial markets in both developed and developing countries. The literature (see, for example, Claessens et al. 2001; Clarke et al. 2001; Green et al. 2002; Lensink and Hermes, 2002) has pointed out several motivations for

180 Turkish Banking

the banks’ penetration of foreign markets. Clarke et al. (2001) summarize the factors that affected the pattern and timing of foreign bank entry, and link them to the degree of economic integration between a foreign bank’s home country and the host country it enters, the market opportunities available in the host country, and entry restrictions and other regulations (including tax treatment). Typically, in developing countries, foreign banks have substantial profit opportunities because of less effective domestic competition and the opportunity to gain a high market share as a result of low market value in emerging markets. Banks also seek for business and income diversification in overseas markets where the business cycles and economies of the countries are unparallel. Foreign bank entrance may also benefit domestic economies and local financial markets. Levine (1997) argues that banks may (i) improve the quality and availability of financial services in the domestic financial markets by increasing bank competition, and enabling the greater application of more modern banking skills and technology; (ii) serve to stimulate the development of the underlying bank supervisory and legal framework; and (iii) enhance a country’s access to international capital. Counter-arguments are also provided by the literature; for example, Stiglitz (1993) points out the potential costs to domestic banks, which may incur costs, since they are not as reputable as the large international banks with better reputations. Moreover, since these large banks are associated with large multinational firms, local entrepreneurs may receive less access to financial services, and government controls on the domestic economy might diminish, since foreign banks are less sensitive to their policies. As in many other developing countries, the Turkish financial markets have been open to foreign institutions, particularly after the financial liberalization in the early 1980s, However, foreign banks were not very common in the Turkish banking system until after the reforms implemented following the 2001 financial crisis, despite the fact that Turkey liberalized its capital markets in the early 1980s, and had sufficient technological infrastructure and qualified human capital. The lack of interest was largely because of persistent macroeconomic instability and a lack of regulatory framework meeting international standards for the financial sector. In fact, when the level of foreign ownership in Turkish banking prior to 2004 is compared with other main emerging countries’ banking sectors, it is evident that Turkey ranks as one of the lowest in the list. We present this data in Table 8.4. A common trend in all emerging markets between 1990 and 2000 was an increase in foreign ownership in domestic banking markets.

Developments and Prospects for Turkish Banks 181 Table 8.4 Foreign ownership of banks as a percentage of total banking sector assets, 1990, 2000 and 2002

Hong Kong India Korea Malaysia Thailand Argentina Brazil Chile Colombia Mexico Peru Venezuela Czech Republic Hungary Poland Russia Turkey

Assets owned by banks with 50 per cent or greater foreign ownership

Assets owned by banks with at least 10 per cent but less than 50 per cent foreign ownership

1990

2000

2002

1990

2000

2002

46 21

87 42 33 25 6 48 25 33 18 55 33 50 65 70 70 10 4

89 40 32 25 6 42 22 45 16 82 30 37 86 90 67 8 3

4

7 4 8 31 46 13 7 17 14 0 9 8 22 24 1 3 –

6 5 14 39 49 13 6 3 14 1 14 1 8 0 2 2 –

22 0 17 19 4 0 0 26 11 0 7 3

34

6 7 11 64 8 0 6 1

Source: Adapted from Moreno and Villar (2005: 14).

Steinherr et al. (2004) provide some explanation for this lack of foreign interest in the Turkish banking sector, especially as Turkish legislation was not an obstacle to foreign bank ownership, and Turkey is more liberal than many countries that have received more foreign direct investment into their financial sectors. Comparing Turkey to its close neighbours who are former Soviet countries in Eastern Europe, they argue that the battleground was not similar. These countries did not have any historical commercial banking activity when they opened up their markets, and the most efficient way of quickly transforming their banking system was to invite foreign banks to become strategic investors. Conversely, the Turkish banking sector was long established, with local players. Moreover, foreign banks, which were mainly interested in corporate banking, could manage their business easily with just one representative office the existing legislation. According to Steinherr et al. (2004), banks were not willing to expand operations to the retail sector because

182 Turkish Banking

of macroeconomic instability, corrupt banking practices, and they were also unsure whether they could be competitive with local banks, which were achieving high profits through holding government securities. Additionally, legal uncertainties, family ownership of banks and heavy connected-lending practices were other concerns for consideration by potential foreign investors. This trend has changed dramatically since the economic recovery programme and the restructuring of the financial sector after 2001. Specifically, the banking sector restructuring programme reduced the financial risk and strengthened the capital structure of Turkish banks, which gave rise to potential profits and growth. Since 2004, Turkey has attracted a very large amount of investment from abroad, in total around USD 33 billion, and a significant proportion of this flow has been directed to the banking sector. Positive economic and regulatory developments increased foreigners’ interest in the banking sector after 2001, and during 2005 and 2006 a significant number of foreign banks increased their shareholdings in the Turkish banking sector. Most of the deals were between large and medium-sized Turkish banks and leading banks in the global arena. Between 2001 and 2006, twelve foreign banks entered the market, typically thorough acquiring majority shares in locally established banks. These deals and values are listed in Table 8.5. Analysing announcements of seven major merger and acquisition (M&A) deals on an individual basis, Aysan and Ceyhan (2006) conclude that two noteworthy motivations of banks are to take advantage of the high growth potential in the Turkish financial market and the mortgage industry, both of which are influenced by increasing population. The earliest entrant to the market was HSBC. Having started to operate in the Turkish market in 1990 (then named Midland Bank Inc.), HSBC expanded its operations in Turkey through the acquisition of Demirbank, which was the fifth-largest private bank at the time (in 2001). In 2007, HSBC announced its goal of 100 per cent organic growth based on investments in Turkey up to 2010. Opening 200 new branches and employing 4,000 more people are part of this growth plan. The 50/50 shareholder partnership agreement between Koçbank (owned by Koç Financial Services and the sixth-largest private bank at the time of the deal) and UniCredito of Italy, one of Europe’s largest banks, was the first foreign partnership to be established in the Turkish financial sector. In 2005, a Koçbank/UniCredito joint venture bought the majority share of Yapı Kredi, one of the largest and long-established private banks in Turkey, and with the biggest merger project in the history of the Turkish banking sector, they combined their operations,

Developments and Prospects for Turkish Banks 183 Table 8.5 Entry of foreign banks to the Turkish banking sector, 2001–06 Year

Target local bank

Foreign bank

Country of origin of foreign bank

2001 2002 2005

Demirbank Koçbank YKB

HSBC UniCredito UniCredito/ Koçbank BNP Paribas Fortis GE Capital Corporation Bank Hapoalim National Bank of Greece EFG Eurobank Dexia Bank BTA Arab Bank/ Bank Med Citigroup

UK Italy Italy/Turkey

TEB Dı¸sbank Garanti Bank C Bank Finansbank 2006

Tefkenbank Denizbank S¸ ekerbank MNG Bank Akbank

Stake bought (%)

Value of deal (USD millions)

100 50 57

350 240 1,495

France Belgium USA

50 89 26

217 1,051 1,556

Israel Greece

58 46

113 2,800

Greece Belgium Kazakhstan Lebanon/ Jordan USA Total

70 75 34 91

185 2,400 255 160

20

3,100 13,922

Source: Adapted from Arslan (2007: 40).

but retaining the name Yapı Kredi. Following UniCredito, BNP Paribas, one of the main banks in Europe, bought a 50 per cent stake in TEB (Turkiye Ekonomi Bankası) while Fortis of Benelux, another well-known international bank, acquired 89 per cent of Dı¸sbank, a privately-owned medium-sized bank. Most of the new foreign entrants to the Turkish banking sector are banks of European origin. This is mainly because of expectations of positive negotiation talks between the EU and Turkey. The largest deals in terms of value were those of Citigroup, National Bank of Greece (NBG), Dexia Bank of Belgium and the General Electric (GE) Capital Corporation. Citigroup and GE Capital Corporation, both US based financial institutions, preferred to be minor shareholders and strategic partners in two of the largest privately-owned banks in Turkey. In their analysis, Aysan and Ceyhan (2006) point out the following factors as major determinants of most of these deals: 1. Increasing population and per capita income; 2. Reforms in the foreign investment area;

184 Turkish Banking

3. High foreign trade and growth potentials; 4. EU accession process; 5. Lower interest rates, declining inflation rates, and a flexible exchange rate system; 6. An improving corporate governance system; 7. Improving auditing and regulation with the implementation of Basel II; and 8. Potential growth in consumer credits and mortgages. Overall, since 2002, foreign banks have invested almost 14 billion USD to gain a presence in the Turkish banking market. Although most of the deals were completed, negotiations between Bank Intesa and Garanti Bank, BNP Paribas and Finansbank, Citibank and TEB, Rabobank and S¸ ekerbank, and Alternatif Bank and Alpha Bank of Greece have failed during this intensive M&A period in Turkish banking. The presence of foreign banks in the Turkish financial sector increased drastically between 2003 and 2006 (see Table 8.6). Throughout the 1990s and the early 2000s, the share of foreign banks (in terms of total assets in the banking sector) has been stable at around 3 per cent. The FDI inflows observed in the financial sector has increased the level of foreign ownership with a controlling share to 33 per cent of total assets in 2006. Furthermore, banks’ assets that have a significant amount of foreign shareholding (between 10 per cent and 49 per cent) rose to 23 per cent of total banking sector assets in 2006, whereas in 2003 such foreign influence did not exist. A similar pattern is observed in other ratios in Table 8.6.

Conclusion This chapter reviewed the recent developments and prospects for Turkish banking. Becoming an EU accession country, Turkey had to adjust its legislation and regulatory environment to agree with that of the EU by adapting the EU acquis during the convergence process. Although there are areas still to be improved, in general Turkey’s legislation is aligned satisfactorily with the financial services acquis, thanks to the financial restructuring programme that was implemented successfully after the 2001 crisis. Turkish authorities were also keen to implement the new Basel II directives, which will be put fully into practice for all banks in 2009. Qualitative impact studies conducted by the BRSA concluded that while the new regulations will reduce the capital adequacy

Developments and Prospects for Turkish Banks 185 Table 8.6 Share of foreign banks in the Turkish banking sector, 2003 and 2006

Total assets Total loans Total deposits Total shareholders’ equity Paid-in capital Net income/loss Off-balance-sheet commitments Number of branches Number of employees

Foreign banks with 50 per cent or greater foreign ownership (%)

Foreign banks with more than 10 per cent but less than 50 per cent foreign ownership (%)

2003

2006

2003

2006

6 8 5 6

33 38 32 26

– – – –

23 26 22 21

7 5 9

32 28 11

– – –

18 25 7

6 7

31 36

– –

20 19

Source: Compiled from BAT (2004 and 2007), online tables available at http://www.tbb.org.tr/turkce/kitap2006/tablolar/default.htm and http://www.tbb.org.tr/turkce/kitap2003/tablolar/default.htm.

level, it will still be well over the required ratio of 8 per cent. The introduction of new mortgage markets and housing loans with a change in legislation is expected to increase real estate development, construction, real estate finance, secondary markets and related sectors in the Turkish economy. Between 2004 and 2006, the Turkish banking sector attracted an unprecedented 14 billion USD-worth of FDI, which increased foreign shareholding to 33 per cent of total banking sector assets in 2006. This trend is expected to continue.

Specification of investment principles of technical reserves of companies, and enabling the utilization of technical reserves by means of foreign financial instruments. Specification of the initial capital of companies within the scope of the branch in which they want to operate, by comparing and determining the differences between 18 branches in the EU and 11 branches in Turkey. After the Insurance Draft Law comes into force, the Regulation on the Establishment and Working Principles of Insurance and Reinsurance Companies will be rearranged to meet the changed conditions. Rearrangement of the technical principles of tariffs, principles concerning the assets on which technical reserves are invested on, and the issues regarding announcements and advertisements. Specification of procedures and principles on credit risk management. Specification of procedures and principles on market risk management. Specification of procedures and principles on operational risk management. Specification of procedures and principles on interest rate risk management. Harmonization with EU legislation on the presentation of investment recommendations.

2007 Implementing Regulation on the Technical Reserves of Insurance and Reinsurance Companies and the Assets on which these Reserves will be Invested Council of Ministers Decision on the Identification of Insurance Branches and Initial Capital of Insurance Companies according to Branches

Implementing Regulation on the Establishment and Working Principles of Insurance and Reinsurance Companies

Amendment of the Implementing Regulation on Life Insurance

Secondary legislation on Market Risk Management

Secondary legislation on Operational Risk Management Secondary legislation on Interest Rate Risk Management Communiqué on the Principles Concerning the Presentation of Financial Recommendations and the Disclosure of Conflicts of Interest

Secondary legislation on Credit Risk Management

Aim

Proposed secondary legislation, 2007–13

Name of Legislation to be amended/enacted

Table 8.A1

Appendix 8.1

186

Amendment of the Communiqué on the Principles of Disclosure of Special Cases to the Public

Secondary legislation on IRB and advanced measurement approach (AMA).

Communiqué on the Implementing Principles of Legal Protection Insurance

Implementing Regulation Amending the Implementing Regulation on the Measurement and Assessment of the Capital Adequacy of Insurance, Reinsurance and Pension Companies Implementing Regulation Amending the Implementing Regulation on the Insurance Accounting System Communiqué Amending the Communiqué on Uniform Chart of Accounts and Prospectus of the Insurance Sector Implementing Regulation on Insurance Intermediaries

Implementing Regulation on the Transfer of Supplementary Trusts and Pensions Funds to the Private Pensions System

2008 Implementing Regulation on the Implementation Principles of Group Retirement Plans

(Continued)

Within the scope of the Regulation Amending the Regulation on the Establishment and Working Principles of Insurance and Reinsurance Companies, aims to enable insurance companies in Turkey to have a special structure, especially in terms of personnel, should they wish to operate in the Branch of Legal Protection Insurance. Specification of procedures and principles on the internal-ratings-based approach and advanced measurement methods, which are to be applied within the scope of Basel II. Harmonization with EU legislation with regard to transparency requirements in public disclosure of publicly held companies.

Regulation of the mentioned branches within the scope of the EU legislation. Determination of rules for the branch of assistance insurance.

Specification of the rules in drawing up consolidated financial statements

Specification of the rules in drawing up consolidated financial statements

Specification of the principles of participation in business-based retirement plans, rules for plan changes, rules on the use of personal rights, thus establishing actuarial standards. Specification of procedures and principles of the transfer of funds of persons participated in business-based retirement plans serving within supplementary trusts and pensions funds to the Private Pensions System with their vested rights. Enabling supervision of insurance, reinsurance and pension companies. Enabling the identification of rules regarding capital adequacy in credit insurance.

187

Continued

Drawing up legislation fully harmonized with EU legislation

Communiqué on the Principles in Relation to the Identification of Manipulative Orders and Operations, and Accepted Market Practices Communiqué on the Public Disclosure of Information Drawn up in Companies Registered to the Stock Exchange

Drawing up legislation fully harmonized with EU legislation.

Enacting legislation fully harmonized with EU legislation. Making the necessary amendments to the legislation in relation to investment services and stock exchanges to harmonize fully with EU legislation, and to portfolio management and investment counselling within the scope of harmonization studies yet to be carried out.

Enacting legislation fully harmonized with EU legislation. Making necessary amendments to the legislation in relation to investment services and stock exchanges to harmonize fully with EU legislation, and to portfolio management and investment counselling within the scope of harmonization studies yet to be carried out.

Preparing Turkey’s capital markets for EU membership.

Preparing Turkey’s capital markets for EU membership.

Preparation of legislation fully harmonized with EU legislation on the admission of securities to official stock listings. Enacting legislation fully harmonized with EU legislation on capital adequacy. Preparing Turkey’s capital markets for EU membership.

Preparation of legislation fully harmonized with EU legislation on the admission of securities to official stock listings.

Aim

Communiqué on the Public Disclosure of Information Drawn up in Companies Registered on the Stock Exchange

2009 Amendment of the Implementing Regulation on the Establishment and Working Principles of Stock Exchanges Amendment of Implementing Regulation on Quotation of Istanbul Stock Exchange Communiqué on the Capital Adequacy of Intermediary Institutions Amendment of the Communiqué on the Principles Regarding Investment Funds Amendment of the Communiqué on the Principles and Rules Regarding the Financial Statements and Reports of Securities Investment Funds Amendment of the Communiqué on the Principles as Regards Portfolio Management Activity and the Institutions to Undertake this Activity Amendment of the Communiqué Series V, No. 46 on the Principle A42 of Intermediation Activities and Intermediary Institutions

Name of Legislation to be amended/enacted

Table 8.A1

188

Amendment of the implementing principles regarding the current Obligatory Financial Insurance for Highway Motor Vehicles in view of membership of the EU.

Implementing Regulation on the Implementing Principles Regarding Obligatory Financial Responsibility Insurance for Highway Motor Vehicles

(Continued)

Harmonization with EU legislation such as the EU passport rule and requirement of home member state supervision.

Harmonization with EU legislation such as the EU passport rule (which enables free operation within the community based on the authorization of a EU member state) and requirement of home member state supervision. Harmonization with EU legislation such as the EU passport rule and requirement of home member state supervision.

Specification of procedures and principles as regards implementation after the legal basis on payment systems is established.

Preparing Turkey’s capital markets for EU membership.

Harmonization of prospectus principles in public offerings with EU legislation. Preparing Turkey’s capital markets for EU membership.

Harmonization of prospectus principles in public offerings with EU legislation.

Legislation in harmony with EU legislation.

Implementing Regulation Amending the Implementing Regulation on the Principles regarding the Establishment and Working Principles of Insurance and Reinsurance Companies Implementing Regulation on the Implementing Principles Regarding Co-insurance

2010–13 Secondary legislation to be applied within the framework of the authority, which will be given after enactment of the Payment System Law Council of Ministers Decision on the Activities of Foreign Insurance Companies in Turkey

Communiqué on Exemptions for Buy-Back Programmes and Maintaining the Price Stability of Financial Instruments Amendment of the Communiqué on the Principles as Regards the Exemption Conditions and Exclusion from the Board Register of Issuers Amendment of the Communiqués on Sale and Inclusion of Securities to the Board Register Amendment of the Communiqué on the Principles as Regards Portfolio Management Activity and the Institutions to Undertake this Activity Amendment of the Communiqué on the Principles as Regards Investment Counselling Activity and the Institutions to Undertake this Activity

189

Amendment of the implementing principles regarding the current Obligatory Financial Insurance for Highway Motor Vehicles in view of membership of the EU. Adopts regulations in the foreign exchange legislation in order to allow residents of Turkey to obtain consumer and real estate credit from abroad. Adopts regulations in the foreign exchange legislation in order to allow financial institutions other than resident banks to carry out money transfer operations abroad from Turkey. Addition of the statement, ‘adopts a regulation in the foreign exchange legislation in relation to offshore foreign exchange buying and selling from abroad’. Inclusion of legal persons to the types of deposits and profit sharing funds subject to insurance. Re-specification of the types of deposits and profit-sharing fund accounts to be excluded from the scope of insurance. Harmonization of the scope of deposits subject to insurance by taking into consideration the home-host relationship that has been applied in the framework of EU banking directives. Increasing confidence in the banking system by elaborating the steps taken in paying the insured deposits in a bank, the official authorization of which has been revoked, and the liquidation of such a bank.

Tariff and Instruction amending the Tariff and Instruction on Obligatory Financial Responsibility Insurance for Highway Motor Vehicles Decree No. 32 on the Protection of the Value of the Turkish Currency

Decree No. 32 on the Protection of the Value of the Turkish Currency

Enacting legislation fully harmonized with EU legislation for the protection of investors; amendment of the gradual liquidation regulation. Enacting legislation fully harmonized with EU legislation for the protection of investors; amendment of the gradual liquidation regulation.

Draft Implementing Regulation on the Protection Fund for Investors Amendment of the Regulation on the Gradual Liquidation of Intermediary Institutions

Source: Adapted from Secretariat General for EU Affairs (2007: 114–19).

Review of sources of the Fund and the use of these sources in accordance with legislation amendments foreseeing harmonization with EU directives.

Implementing Regulation on the Procedures and Principles Regarding the Payment of Insured Deposits and Profit Sharing Funds in the Banks, Official Authorization of which have been Revoked, and on the Bankruptcy and Liquidation of such Banks Amendment of the Implementing Regulation on the Sources of the SDIF and the Use of these Sources

Amendment of the Implementing Regulation on Deposits Subject to Insurance and the Premium to be Collected by the Savings Deposit Insurance Fund

Decree No. 32 on the Protection of the Value of the Turkish Currency

Aim

Continued

Name of Legislation to be amended/enacted

Table 8.A1

190

9 Concluding Remarks

The unifying aim of this book has been to present an overview of the history and development of the Turkish banking sector, with the major emphasis being on the causes and effects of financial and economic crises, both in the banking industry and the overall economy, to study the financial structure and performance of the banking industry and to look at the future of Turkish banking by examining recent and future developments towards Turkey’s EU membership. Overall, the book contributes to our knowledge of the Turkish banking sector’s past, present and future. Specifically, it is one of few works that have examined and brought together various sources in one place. Our findings can be summarized as follows. First, an apparent and detrimental feature of Turkey in the past was political instability, a direct cause of failures in macroeconomic policy, which in turn led to financial and economical crises. In the second half of the twentieth century, Turkey experienced four military coups and forty-one different governments – generally coalitions – which served on average for 1.4 years each. Turkish politics were often defined as populist and attached to moral hazard problems. Moreover, the inability to select and implement appropriate macroeconomic policies meant that, in its short history, Turkey tried all manner of options, switching between state-led growth, import substitution, industrialization, exportorientated growth, protectionism and liberalization. Inability to control fiscal deficits was the core problem of the Turkish economy during this period, leading to high chronic inflation ranging between 30 per cent and 100 per cent. Irresponsible fiscal spending, high interest rates and inflation, lax macroeconomic policies, a weak financial system and the impact of sudden capital in- and outflows led to severe economic crises in 1994 and 2000/01. The poor performance of the Turkish economy was 191

192 Turkish Banking

reflected to its relation with global monetary institutions; between 1963 and 2005, Turkey signed eighteen stand-by agreements with the IMF. The advent of the Turkish banking system inevitably progressed in parallel with the economic policies implemented. Before 1930s, policymakers promoted the development of a national banking sector to provide the necessary financial instruments for investors and because national capital state participation was needed to develop the sector. The protective environment of an inward-orientated growth strategy between 1963 and 1979 saw a rapid expansion of banks where there were no risks of interest rate changes, exchange rate changes or price competition. The uncontrolled deregulation of deposit and lending rates, and the lack of a legal and institutional framework, led to a banking crisis in 1983 after the financial liberalization in 1980. Banking activities in the 1990s were affected by chronic high inflation, large budget deficits, a high demand for assets denominated in foreign currency, which led to balance sheet risks, fluctuations in the economy, a lack of international standards in the regulation and supervision of the banking sector, and political instability. Consequently, Turkey faced two severe financial crises, in 2000 and 2001, which led to a consolidation in the banking sector and the suspension of the activities of weaker banks. On the other hand, since 2001, the Turkish economy has improved significantly, output has grown rapidly, inflation has fallen to its lowest level in a generation, and government debt has declined markedly. The implementation of the economic programme and structural reforms supported by IMF loans, addressing debt sustainability and debt rollover, together with prudent fiscal policy, have helped to reduce inflation. The fragility of the financial system has been reduced with the re-capitalization of the state-owned banks and weak private banks. Furthermore, the introduction of an independent Bank Regulatory and Supervisory Agency, and the implementation of internationally accepted banking principles through the introduction of new laws has had a positive effect on the banking sector and increased confidence in the financial system. However, high real interest rates and the roll-over risk of government debt, unemployment, high current account deficit and high dependency on foreign capital inflows are still major problems that need to be tackled. And dollarization and the short-term nature of deposits are factors that are still creating risk in banks’ balance sheets. In terms of financial structure, concentration in the Turkish banking system increased through the years. The impact of the financial crises and foreign competition reflected as a consolidation in the banking sector, leading to drops in numbers of banks. Furthermore, competition also led

Concluding Remarks 193

to a more efficient structure where, while the total assets of the Turkish banking sector increased spectacularly, from USD 60 billion to USD 345 billion between 1990 and 2006, the total number of people employed in the sector did not change. Despite the decrease in their numbers, state-owned banks still have a significant share of the system. We have identified that state-owned banks are also less liquid and have more risk in terms of past-due loans compared to their private counterparts. The data on the Turkish banking system presented a picture of a sector that has been volatile, especially during the periods of financial distress since the late 1990s. Throughout the book, keeping in mind Turkey’s potential EU membership, one of our aims, was to compare the Turkish banking sector to those of European countries. Regarding the asset size, where the Turkish banking sector constitutes only 82 per cent of GDP compared to an EU-25 average of 300 per cent, the industry has a colossal growth potential. Moreover, loans extended by banks in Turkey are only 40 per cent of GDP, whereas in EU-25 this ratio was 132 per cent in 2007. It has also been observed that the level of capital adequacy of Turkish banks increased substantially after the re-capitalization programme of 2001, and places Turkey’s as one of the most highly capitalized banking sectors in Europe. Regarding the impact of banking sector expansion on economic development at a regional level, our findings suggest that the relationship between economic growth and financial development in the provinces is insignificant – we do not find empirical evidence to state that banking sector development has led to regional economic development. This is consistent with economic theory, because in most of the emerging countries such as Turkey, economic growth depends on other various variables, such as government policies. Moreover, our evidence shows that causality runs from economic growth to financial development. Turkish commercial banking has experienced productivity growth overall, apart from during a few periods. Investments in high-tech bank operations shifted the frontier upwards, in particular after the entry of foreign banks to the sector. This is because foreign involvement created pressure on public banks as a result of increasing competition and forced them to diminish their cost structure, in particular by decreasing the numbers of employees and increasing the use of more advanced technology. Nevertheless, substantial improvements have occurred in the technical efficiency and productivity of most banks in Turkey. Furthermore, the financial crises experienced in 1994 and in 2000/01, the 1999 IMF restructuring programme and increased foreign ownership in the Turkish banking sector since 1997 have had significant effects on the

194 Turkish Banking

core processes of bank efficiency. Almost all of the efficiency and productivity scores have displayed a significant increase since 2002. This result may speculatively suggest that increased foreign bank investment into the Turkish banking sector might be the reason for the growth in both efficiency and productivity. Future research that extends the study period beyond 2006 may report on the longer-term effects of the increased attention of foreign investors towards the Turkish banking sector. Looking to the future, we have drawn optimistic conclusions. On becoming an EU accession country, Turkey had to adjust its legislation and regulatory environment to be compatible with that of EU by adapting the EU acquis during the convergence process. While there are areas to be improved, in general Turkey’s legislation is aligned satisfactorily with the financial services acquis, thanks to the policies of the financial restructuring programme that was implemented successfully after the 2001 crises. The Turkish authorities were also keen on implementing the new Basel II directives, which will be put fully into practice for all banks in 2009. Qualitative impact studies conducted by the BRSA concluded that, while the new regulations will reduce the capital adequacy level, it will still be well over the required ratio of 8 per cent. The introduction of new mortgage markets and housing loans with a change in legislation is expected to increase real estate development, construction, real estate finance, secondary markets and related sectors in the Turkish economy. Positive economic and regulatory developments increased foreigners’ interest in the banking sector. Between 2004 and 2006, the Turkish banking sector attracted a historical USD 14 billion-worth of FDI, which increased foreign shareholding to 33 per cent of total banking sector assets in 2006. The trend is expected to continue.

Notes 2 Overview of the Turkish Economy 1. Current account deficit was 8 per cent of GNP and 92 per cent of foreign currency income in 1977. 2. Real interest rate on domestic debt almost doubled between 1994 and 1999. 3. Turkey is still among the most dollarized economies and, despite significantly improved inflation expectations, attempts at reversing this currency substitution have been limited.

3 Trends in the Banking Industry 1. Akgüç (1989) suggests examining the historical evolution of Turkish banking in six periods. In this chapter we add an additional period representing the era after the 2001 financial crises and the reformation of the banking sector. 2. The bank served as a central bank until 1930. 3. The Law on the Central Bank of the Republic of Turkey was enacted on 11 June 1930. The Bank was established on 3 October 1931 and opened officially on 1 January 1932. The Bank had, originally, the privilege of issuing banknotes for a period of thirty years. In 1955, this privilege was extended to 1999, and in 1994 was prolonged indefinitely. 4. TYT Bank, Marmara Bank and Impex Bank. 5. These banks were Egebank, Esbank, Turkiye Tütüncüler Bankası – Ya¸sarbank, Sümerbank and Yurtbank. 6. These banks were Demirbank, Interbank and Bank Express. ˙ 7. These banks were Ulusal Bank, Iktisat Bankası, EGS Bank, Bayindirbank, Kentbank, Tari¸sbank, Sitebank and Toprakbank. 8. The first legal arrangement relating to the protection of savings deposits was established in 1933. The law stated that the deposits kept in reserve requirement accounts in the Central Bank by banks are accepted as a provision of savings deposit accounts opened by the public, and these reserves are exempted from seizure by third parties. Subsequently, in 1936, 40 per cent of all deposits on banks balance sheets were granted a privileged claim status over all other securities in banks’ books. The requirement implied that, in case of bankruptcy, deposits were to be paid regardless of the liquidation process. This ratio was increased to 50 per cent in 1958, and in 1960 a Banks Liquidation Fund was established. 9. Although dollarization has generally been high in terms of deposits, the two observed peaks in 1994 and 2001 are also the result of sharp and large devaluations of the Turkish lira during the crisis periods.

5 The Turkish Banking Sector and Regional Economic Growth 1. A very important variable that is commonly added in empirical studies (Levine, 1997), but could not be included in the present analysis because of data

195

196 Notes limitations, is human capital accumulation – often measured by level of educational attainment among the population. Growth theory suggests a positive relationship between education and economic growth.

6 Performance of Banks in Turkey 1. Different types of production function have been applied by Forsund and Hjalmarson (1979) and Kumbhakar et al. (1991). On the other hand, the distance function context is used by Lovell et al. (1994), Coelli and Perelman (1996), Grosskopf et al. (1997) and Morrison-Paul et al. (2000), whereas the production function model is used by Greene (1980) and others (MorrisonPaul, 1999). 2. See Charnes et al. (1978) for more details. 3. See Lovell (1993). 4. According to Lovell (2003), productivity, which in turn affects efficiency, varies as a result of changing production technology, efficiency and environmental factors where the production process is taking place. 5. Sherman and Gold (1985), Ferrier and Lovell (1990), Berg et al. (1993) and Brockett et al. (1997) are the best-known to have studied this approach. 6. DEA compares inefficient units with a convex combination of units located on the frontier and indicates the sources and the level of inefficiency for each of its inputs and outputs. The indicated targets, which are shown to the inefficient units as models, are their actual peer units. 7. This is known as the CCR model of efficiency. 8. A mathematical programming model was applied to observe data that provides a way for the construction of production frontiers. 9. See Murillop (2004). 10. The same argument has been presented in Ray and Desli (1997), that the CRS assumption of Färe et al. (1994) on Malmquist index measurements might create misleading results. Thus, VRS might be a more realistic assumption. 11. The decision of the estimation whether to omit slacks or not provides the assumption of strong or weak disposability in the DEA estimation. 12. Färe et al. (1994) provide a guide to the nonparametric approach. 13. The model is called Tobit because it was first proposed by Tobin (1958), and involves aspects of Probit analysis. 14. It has been emphasized by Malmquist (1953) that ‘no treatment of productivity change aspects would be complete without reference to work by Diewert (1976, 1978, 1981), Caves, Christensen and Diewert (1982a and 1982b), Färe, Grosskopf and Lovell (1985, 1994), Färe and Primont (1995), and Balk (1997) (Battesse et al., 1998: 100). 15. Although distance functions were developed by Shephard (1953, 1970), it was only recently that applications involving distance functions have appeared (Färe et al., 1993; Lovell et al., 1994; Grosskopf et al., 1997). The principal advantage of the distance function representation is that it allows for the possibility to specify a multiple-input/multiple-output technology when price information is not available or, alternatively, when price information is available but cost, profit or revenue representations are prohibited because of the required behavioural assumptions (Färe and Primont, 1995).

Notes 197 16. For details on the interpretation and estimation of both versions of Malmquist Productivity Index, see Berg et al. (1992), Grosskopf (1993) and Bjurek (1994). 17. See, for example, Grifell-Tatje and Lovell (1996). 18. For details on both versions of the model, see Berg et al. (1992), Grosskopf (1993) and Bjurek (1994). 19. Hicks-neutral is an attribute of an effective variable in a production function in such a way that it does not affect one of the inputs differently from the way it affects another. 20. Caves et al. (1982) showed that if period t technology is characterized by a Translog output distance function and if period t + 1 technology is identified by a different Translog output distance function having the same second order parameters, and if the procedure maximizes profit in both periods, then the Malmquist productivity index is a Tornqvist productivity index. However, this would not consider the scale factor. 21. Later, this approach was measured by a nonparametric linear programming technique by Färe et al. (1989) developing Malmquist into an applied index instead of a theoretical index, and then expanding it to treat scale economies of either CRS or VRS. 22. See Lovell (2003) for detailed explanations. 23. Technical change and catching up components were introduced by Färe et al. (1992).

7 Other Financial Markets in Turkey 1. Decree-Law No. 91, concerning securities exchanges, is published in the Official Gazette No. 18183, dated 6 October 1983. The Decree foresaw the establishment of a stock exchange in Turkey for the purpose of creating a medium for securities operations, with the objective of making Turkey’s capital markets more efficient. The regulations outlining the functions and operations of a stock exchange in Turkey were published in the Official Gazette No. 18537, dated 6 October 1984. The Regulations outline the nature and functions of members and their responsibilities, as well as other aspects of trading on the ISE.

8 Current Developments and Prospects for Turkish Banks 1. These are QIS 2, QIS 3, QIS 4 and QIS. Please see BIS website (http://www.bis. org/bcbs/qis/) for more information.

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Index Abma, R.N. 100 adjacent period model 124 Akbank 70, 137 Akgüç, Ö. 15, 41, 42, 45 Albach, H. 114 Alper, C.E. 22–3, 25, 54, 55 Altınkemer, M. 20 Arestis, P. 100 Arıcanlı, T. 16 Arslan, H.B. 183 Artun, T. 12 asset-covered bonds 178 asset finance funds 178–9 assets 52, 53, 66–7 quality assessment 92–3, 95 structure 79–86 assets to GDP ratios 81, 82, 83, 85 Atatürk, Mustafa Kemal 32 Atiyas, I. 50, 130 average interest income to average interest expenditure ratio 89 Aysan, A.F. 182, 183–4

period of state-owned banks (1932–45) 43–4 planned economy (1960–79) 45–7 recent developments (2000–06) 57–64; dollarization, crowding-out by government debt and maturity mismatch 62–4; recovery 60–2; SDIF and restructuring process 58–60 banking industry profile 3–4, 69–96, 192–3 balance sheet structure 79–87 banks operating in Turkey ranked by asset size 66–7 branch systems 61, 66–7, 72, 73, 73–4, 76 cost structure 89–90 employees/personnel 61, 66–7, 74–7 income structure 87–9 performance 90–5 players 77–9; big banks 70, 77–8; state banks vs private banks 78–9 size 69–73 Banking Law (1999) 55, 56, 173 modifications in 2005 61 Banking Regulation and Supervisory Agency (BRSA) 3, 59, 70, 166, 171, 192 Basel II 173 establishment of 55–7 mortgage lending 179 QIS TR2 175, 176, 177 Banks Association of Turkey (BAT) 10, 12, 41, 49, 52, 55, 57, 70, 89–90 Basel II 5, 171, 173–6, 194 implementation in Turkey 173–4 Turkish banks and 175–6, 177 Ba¸skaya, F. 13 Belediyeler Bankası 43

Bagehot, W. 98 balance sheet structure 79–87 assets structure, loans and liquid assets 79–86 liability structure, deposits and equity 86–7 Balk, B. 126 Balkan, E. 14, 19 bank cards 83–4, 85 banking industry evolution 3, 40–68, 192 after financial liberalization 47–50 establishment of BRSA 55–7 establishment of new national banks 42–3 establishment of private banks 44 1990s 50–5; aftermath of 1994 crises 54–5 Ottoman period 41–2

210

Index 211 Berger, A. 117 big banks 70, 77–8 BNP Paribas 1, 183 bond markets 160–4 primary markets 160–1 secondary market activities 161–4, 165 bonds and bills market 162–4, 165 Boratav, K. 18, 19 Boyreau-Debray, G. 101–2, 109 branches banking industry evolution 45–7, 50, 52 banking industry profile 61, 66–7, 72, 73, 73–4, 76; Turkey compared with EU countries 76, 77 capital account liberalization 18, 19–20 capital adequacy Basel II 5, 171, 173–6, 177, 194 performance of banks 91, 92, 95 capital flows 19, 30 Capital Market Law (1981) 152 Capital Markets Board 152, 179 Casu, B. 121 Caves, D.W. 124, 125 CCR model 119–20 Celasun, O. 19 Central Bank 69 change in monetary policy 18–19 establishment of 43, 195 foreign exchange reserves 22 independence 29 loans and industrialization 12 regulation of deposit rates 48–9 resources used to fund government investment 12 centrally-planned economy see planned economy Ceyhan, S.P. 182, 183–4 Chandavarkar, A. 99 Charnes, A. 119 Chick, V. 102 China 101–2, 109 Citigroup 1, 183 Clarke, G. 180

Coelli, T. 114, 122 commercial banks 70, 115–17 concentration 47, 48, 50 constant returns to scale (CRS) 113, 120, 126, 128 consumer finance companies 164–5 contracts, number of 155, 156 corporate loan portfolio 175–6 correlation analysis 105–6 cost minimization 113 cost structure 89–90 credit cards 83–4, 85 credit extended to private sector by commercial banks 104–9 credit risk 173, 174 crowding-out by government debt 62–4 Cuban Missile Crisis 34 current account deficit 30 Cyprus 34, 170 data envelopment analysis (DEA) method 118–22, 140, 196 efficiency scores of Turkish banks 129–33 see also DEA–Malmquist index technique De Gregorio, J. 102, 109 DEA–Malmquist index technique 127–9, 140 productivity scores of Turkish banks 134–9 debt swap 60 decreasing returns to scale (DRS) 113 Demetriades, P. 100 Demir, F. 12, 14, 17–18 Demirbank 59, 182, 183 efficiency 132–3, 145 productivity 139, 142, 148, 149 Democratic Party 10, 34 Denizbank 43–4 Denizer, C. 14, 43, 44, 45–7, 49, 50, 131 deposit insurance 21–2, 59, 171, 195 deposit rates, regulation of 48–9 deposits 52–3, 66–7, 117 balance sheet structure 86–7 currency denomination 51

212 Index liquid liabilities of commercial banks 104–9 Dervi¸s, K. 14, 15 Desli, E. 126, 128, 140 devaluation 10–11, 22 Dexia Bank 183 Dı¸sbank 183 efficiency 132–3, 145, 146 productivity 139, 148, 149 disclosure 174 distance functions 124–5, 196 diversification 49 dollarization 29, 51, 62–3, 68 duty losses 54 earthquakes 35, 54 Ecevit, Mustafa Bülent 33, 35 economic crises 1994 21–4, 35, 50–2; aftermath and banking 54–5 2000–01 twin crises 24–7, 35, 57–8, 131, 192 economic growth 1 after 2000–01 crises 27 early Republic 8, 9 financial development and 4, 97–110, 193; correlation analysis 105–6; financial development indicators 103–5; literature review 98–102; regression analysis 106–9 inward-oriented growth strategy 12–15 1948–67 11 1960–79 12–13 1990s 23–4 efficiency 112–15, 193–4 nonparametric efficiency measurement 118–23; DEA method 118–22, 140, 196; Tobit regression 122–3 technical efficiency scores of Turkish banks 129–34, 141, 144–6 Eichengreen, B. 26 emerging markets 71 Emlak Bankası (Emlakbank) 58, 70 Emlak ve Eytam Bankası (later Emlak ve Kredi Bankası) 43

employees/personnel 47, 50, 52, 57 banking industry profile 61, 66–7, 74–7 endogenous growth theorists 99 equity 66–7, 86–7 Erbakan, Necmettin 33, 35 Ersel, H. 50, 130 Etibank 43 Eurobonds 27–8 European Union (EU) 27, 35, 138 comparison of EU countries’ and Turkish banking sectors 96; balance sheet structure 81, 82, 83, 84; bank structure 76, 77; capital adequacy 91, 92; ROA and ROE 94 Cyprus and Turkey’s membership of 34, 35 Financial Services Directives 170–1 potential membership and reshaping the financial system 5, 169–72, 194; proposed legislation 170–1, 172, 186–90 exchange rate 105, 107, 108 Eximbank 45 exports 17, 18 external debt 23, 25, 31 crisis of 1978 13 sectoral composition 32 factoring 164–5 Färe, R. 125, 126, 128 Farrell, M.J. 125, 127 Fase, M.G. 100 Fernandez, F.R. 109 financial development 4, 97–110, 193 financial development indicators and economic growth 103–9; correlation analysis 105–6; regression analysis 106–9 literature review of economic growth and 98–102 financial leasing 166, 167 financial liberalization 15–27 banking after 47–50 and efficiency 130 1980–90 15–19

Index 213 1990–2000 19–21 1994 economic crises 21–4 2000–01 twin economic crises 24–7 financial markets 5, 151–68 bond markets 160–4, 165 IPOs 157–9 leasing, factoring and consumer finance companies 164–5 in the 1990s 50–5 special financial institutions 166–7 stock market 151–7 financial strength indices 95 Fisher index 126 Five-Year Development Plans 12–13 fixed base model 124 foreign banks see foreign direct investment foreign currency banks’ foreign exchange positions 51 currency denomination of deposits 51 foreign direct investment 20–1, 70 banking industry evolution 41–2, 42–3 developments and prospects for Turkish banks 5–6, 179–84, 185, 194 and efficiency 131–2, 132–4, 141, 145–6 and productivity 138–9, 141 2004–06 1, 29, 61–2 Fortis Bank 1, 132, 133, 139, 183 Galatia bankers 41 Garanti Bankası 137 General Electric (GE) Capital Corporation 183 Goldsmith, R. 98 government bonds 160–1, 162, 163 government debt 23, 25, 26, 38 crowding-out by 62–4 maturity 28, 29 governments 32, 33 Graff, M. 100 Great Depression 9

Grifell-Tatjé, E. 125, 126 gross domestic product (GDP), provinces’ 103–9 gross national product (GNP), contribution of sectors to 39 Grosskopf, S. 126 growth-orientated debt strategy 17 Guidotti, P.E. 102, 109 Gulf Wars 35, 35–6 Gültekin, B. 48 Gümü¸s, I. 21 Günçavdı, O. 16–17 Gurley, J.G. 98 Halk Bankası (Halkbank) 43–4, 58, 137 Hansen, B. 13 Heffernan, S. 70 Hicks, J. 98 ‘home country control’ principle 170 housing finance funds 178–9 housing loans 5, 176–9, 194 HSBC 59, 132, 133, 142, 182, 183 Humphrey, D. 117 import substitution industrialization 12–15 income structure 87–9 increasing returns to scale (IRS) 113 Industrial Plans 10 inflation 19, 20, 23, 29, 138, 191 initial public offerings (IPOs) 157–9 Inselbag, I. 48 interest rates 27–8 financial development and economic growth 105, 107, 108 regulation of deposit rates 48–9 internal capital adequacy assessment process (ICAAP) 174 internal rating based (IRB) approach 174 International Monetary Fund (IMF) 1, 11, 16 1994 economic crisis 23 1999 programme 24, 25; and performance 131, 137, 141; and twin crises of 2000–01 24–6

214 Index International Monetary Fund (IMF) – (continued) renewal of standby agreement in 2005 30–1 standby arrangements with Turkey 35, 36, 192 2001 programme 26–7 internationalization 179–80 investment incentives 104–9 inward-oriented growth strategy 12–15 Iraq 35–6 ˙s Bankası 70 I¸ Islamic financial institutions 166–7 Islamism 34, 36 ˙ Ismihan, M. 16 ‘Istanbul Approach’ 59–60 Istanbul Bankası 41 Istanbul Stock Exchange (ISE) 18, 151–7, 197 bonds and bills market 162–4, 165 IPOs 157–9 ISE National-100 index 152, 157, 158 Italy 101 ‘January 24 Decisions’ 16 Jappelli, T. 102 Jayaratne, J. 100 Jin, J. 114 Justice and Development Party 35, 36 Keskin, E. 48 King, R.G. 99, 100 Koçbank 70, 182, 183 efficiency 132–3, 145, 146 productivity 139, 147, 149 Kuznets, S. 99 Latin America 102, 109 Leahy, M. 109 leasing 164–5, 166, 167 legislation, proposed 170–1, 172, 186–90 Levine, R. 99–100, 100, 180 liability structure 86–7

liberalization financial see financial liberalization in 1950s 10–12 liquid assets 79–86 liquidity 93, 95 listed companies 152–3, 154 loans 52–3, 66–7 balance sheet structure 79–86 credit extended to private sector by commercial banks 104–9 loans to assets ratio 82–3, 84, 92–3 Lovell, C.A.K. 125, 126 Lucchetti, R. 101 Malmquist, S. 124 Malmquist productivity index 124–6, 140 see also DEA–Malmquist index technique Market Maker System 162 market risk 173, 174 market share 81–2 Marshall Plan 34 maturity government debt 28, 29 mismatch 64 McKinnon, R.I. 98–9 Menderes, Adnan 33, 34 mergers and acquisitions 182–4 military coups 31, 34 Molyneux, P. 121 mortgage covered bonds 178 Mortgage Law (2007) 5, 177–8 mortgage system 5, 176–9, 194 murabaha financing 166 Mustafa Kemal Atatürk 32 Nas, T.F. 18–19 National Bank of Greece (NBG) 183 national banks 42–3 net income interest to total assets ratio 88 New Economy Market 155, 156 Nishimizu, M. 125 non-depository banks 70 non-performing loans 57–8, 138 non-performing loans to total loans ratio (NPL ratio) 84–6

Index 215 North Atlantic Treaty Organization (NATO) 34 number of banks 71–2, 73 Turkey compared with EU countries 76, 77 Odekon, M. 48 oil shock 13 Öni¸s, Z. 22–3, 25, 54, 55 operating expenses 90 operational risk 174 Organisation for Economic Co-operation and Development (OECD) 16 Ottoman Bank 41 Ottoman Empire 7–8, 32 banking 41–2 outright purchases and sales market 163, 164 over-the-counter (OTC) market 161–2 Oyak Bank 59 Özatay, F. 21, 22 Özdemir, D. 11–12, 17, 18 Özkan, F.G. 24, 25–6 Pagano, M. 102 Page, J.M. 125 ˙ 49 Parasız, I. performance 90–5 asset quality 92–3, 95 capital adequacy 91, 92, 95 financial strength indices 95 liquidity 93, 95 profitability 93–4, 95 performance analysis 4–5, 111–50, 193–4 data sources 115–18 empirical findings 129–39; productivity scores 134–9, 141–2, 147–9; technical efficiency scores 129–34, 141, 144–6 fundamentals of efficiency and productivity 112–15 nonparametric efficiency measurement 118–23, 140, 196 nonparametric productivity measurement 123–9, 140

Perry, M.J. 18–19 planned economy 12–15 banking in 45–7 political instability 31–6, 191 primary bond markets 160–1 private banks 44, 70 establishment (1945–60) 44 vs state banks 78–9, 80 production frontier 112–13, 114–15 production function 112 performance analysis of banking 117–18 production possibility set (PPS) 112 productivity 112–15, 193–4 nonparametric productivity measurement 123–9; DEA–Malmquist index technique 127–9, 140 productivity scores of Turkish banks 134–9, 141–2, 147–9 profitability 93–4, 95 public investment expenditures in the provinces 104–9 quantitative impact studies (QIS) 175, 176, 177 Rajan, R. 100–1 Ray, S. 126, 128, 140 recovery 60–2 regional economic growth 102–10 regression analysis 106–9 rent distribution 54 Republic People’s Party 34 repurchase agreements (repos) 54 repo/reverse repo market 163–4 reserve requirements 44 restructuring banks 58–60 economy 26–7 return on assets (ROA) 93–4 return on equity (ROE) 93–4 Rioja, F. 100 risk weightings 175–6 Robinson, J. 99 Rodrik, D. 16 Roubini, N. 99

216 Index Sala-i-Martin, X. 99 Samuelson, P.A. 113 Saraço˘ glu, R. 15 Savings and Deposits Insurance Fund (SDIF) 3, 55, 57, 71, 171 and the restructuring process 58–60 scale efficiency change (SEC) 128–9, 135, 147–8 Schumpeter, J.A. 98 Second National Market 155, 156 Second World War 10 secondary bond markets 161–4 ISE bonds and bills market 162–4, 165 OTC market 161–2 Sezer, Ahmet Necdet 35 Shaw, E.S. 98, 98–9 Shephard, R.W. 124 Sınai Yatırım ve Kredi Bankası 45 size of banking sector 69–73 slacks 121 sovereign portfolio 175, 176 Spain 101 special financial institutions (SFIs) 166–7 stabilization 12 1999 programme 24, 25; and performance 131, 137, 141; 2000–01 twin crises and 24–6 state banks 70 banking industry evolution 42, 43–4 vs private banks 78–9, 80 restructuring 58 state-led development strategy 10 State Planning Organization (SPO) 12 ‘Steering Committee on Basel II’ 173 Steinherr, A. 59–60, 181–2 Stiglitz, J.E. 180 stock market 151–7 see also Istanbul Stock Exchange (ISE) Strahan, P.E. 100 Sümerbank (established 1933) 43 Sümerbank (formed by merger by SDIF) 59 Swamy, S. 113

technical efficiency change 126, 128, 129, 134–7, 147–8, 149 technological efficiency change 126, 128, 129, 134–7, 147–8, 149 technological progress 49–50 Thiel, M. 109 Tobit regression 122–3 efficiency scores of Turkish banks 133–4, 150 Tornqvist productivity index 125–6 total factor productivity change (TFPC) 134–7, 138–9, 147–9 total factor productivity (TFP) index 113 total income to total expenditure ratio 88, 89 trade liberalization 16–17 trade value 153–5 trading volume 155, 156 ‘Transition to a Strong Economy’ programme 26–7, 71 Treasury 60 Treasury bills 161, 162, 163 Turkish economy 1–2, 2, 7–39, 191–2 early Republic 8–10 economic crises see economic crises financial liberalization 15–27; 1980–90 15–19; 1990–2000 19–21 import substitution and inward-oriented growth strategy 12–15 liberalization in 1950s 10–12 Ottoman Empire 7–8 political instability 31–6, 191 recent economic trends 27–30 renewal of standby agreement with IMF in 2005 30–1 state-led development strategy 10 Turkish Republic establishment of 8–10, 32–4 establishment of new national banks 42–3 Türkiye Ekonomi Bankası (TEB) 137, 183 ˙s Bankası 43 Türkiye I¸

Index 217 Türkiye Sanayii ve Maadin Bankası (later Türkiye Sanayii ve Kredi Bankası) 43 Ünalmı¸s, D. 101 unemployment 30, 31 UniCredito Bank 1, 133, 182, 183 Union of Soviet Socialist Republics (USSR) 34 United States of America (USA) 34, 35–6 Utkulu, U. 11–12, 17, 18 Valev, N. 100 value at risk (VaR) 174 Valverde, S.C. 101, 102, 109 variable returns to scale (VRS) 126, 128, 196

Veiga, F.J. 23 Voyvoda, E. 17 Watch List Companies Market 155, 156 workforce, sectoral distribution of 39 World Bank 11, 16 Yapı Kredi 182–3 Yeldan, A.E. 14 Yeldan, E. 17, 18, 19 Zingales, L. 100–1 Ziraat Bankası (Agricultural Bank of the Republic of Turkey) 42, 43, 58, 70, 137

120–1,