Financial Sector In Turkey

Financial sector depth is a key ingredient of strong, sustained national income growth. Greater financial depth requires attainment of low, single-digit intermediation spreads, but this, in turn, hinges on lower regulatory imposed costs and a reduction in the in flation rate. Recent banking sector restructuring in Turkey lays the infrastructure for such a

Decades old chronic inflation has limited financial depth in the Turkish economy. Fallout from a deep recession has further shrunk financial markets. At the end of 2001, gross outstanding loans as a proportion of GNP stood at a mere 32%.

Turkey endured twin crises in 2001 in the aftermath of an unsuccessful IMF sponsored exchange rate based stabilization scheme. The banking and currency crises resulted in the deepest economic contraction since World War II. The sharp economic contraction reflected poorly on the banking sector. Total assets shrunk by 2% year-on-year in real terms in 2001, and contracted by 30% in US dollar terms from US$155 billion to US$119 billion. Bank loans as a proportion of GDP declined to pre-1996 levels. Non-performing loans, as measured by CBRT data, and excluding banks under the Savings Deposit Insurance Fund (SDIF), rose to 10.9% of gross loans at the end of 2001. In this climate, high credit interest rates have remained an impediment to greater financial sector depth. Farreaching structural reforms have been undertaken to remedy these problems.

Financial sector restructuring has proceeded on several fronts. To quote verbatim from a Banking Regulation and Supervision Agency report, "The Restructuring program is based on the following main pillars: (1) Restructuring of the state banks to improve the financial and operational structures of these banks and to prepare them for privatization (2) Resolution of SDIF banks (those taken over by the deposit insurance fund) (3) Strengthening of the private banks and (4) Strengthening of the regulatory framework".

Summer 2001 debt exchange led to the elimination of short currency positions of the banking sector, both laying the infrastructure for alleviating pressure on the currency and improving prudential ratios. Headway has also been mAe in resolving failed banks under the SDIF and merging state banks, and branch closures.

Restructuring of state banks has focused on duty loss elimination, reduction of short-term liabilities, and setting deposits rates in line with private sector counterparts. Public sector bank rationalization has led to an increase in private banks' share of the sector to 57.2% in 2001, up from 49.5% a year earlier. Meanwhile, consolidation and rationalization has continued apace with the number of banks declining from 61 at the end of 2001 to 58 in 2002Q1. Since 1997, 19 banks were taken over by the SDIF, and eight of those that had been taken over were merged under two bridge banks, while four were sold to suitable parties, including foreign financial institutions. Finally, private banks underwent a three step-audit process. The audit process led to a call for an additional capital injection of US$146 million and the takeover of one bank. A corporate debt workout plan was also put into action in order to relieve some of the burden on the non-financial sector.

The whirlwind pace of reforms will, however, take time to show up more tangibly in the form of greater financial sector depth. A primary cause of low credit penetration is no doubt crowding out by public sector borrowing. An immediate culprit must, however, be extremely high local currency intermediation spreads. Turkish lira intermediation spreads have ranged in mostly double, but at times triple digit levels in the past decade, whilst foreign currency transaction spreads have been more range-bound at single digit levels. Various factors, ranging from regulatory to macroeconomic elements, affect spread levels. The wide differential between Turkish lira loan interest rates and deposit rates - the intermediation spread -- may be ascribed to the influence of several factors. Prime among these is chronic, volatile inflation. Gradually tackling price instability will no doubt bring intermediation spreads in Turkey closer in line with global levels. Meanwhile, other factors that directly affect spread levels could be dealt with much more speedily. Local currency intermediation spreads are clearly higher in Turkey than in other countries, in part because of relatively higher imposed costs.

High spread levels do not necessarily mean inefficient intermediation, but may simply be a reflection of high non-performing loans, taxes, and so on. In this regard, costs faced by the Turkish banking sector compare unfavourably with international counterparts. Deposit insurance risk premium, for instance, is among the highest in the world. A high risk premium is the inevitable result of banking sector crises. Reserve requirements are also several points above European counterparts. Economies under the European Monetary System have adopted uniform, remunerated reserve requirements of 2% of deposits. This contrasts with a roughly 8.8% weighted deposit reserve requirement in Turkey. Quarterly remuneration has been in place since August 2001 for reserve funds, but its impact remains marginal. Sector operating costs per assets of roughly 6% looks rather unfavourable in an international comparison as well. Non-performing loans is another area where Turkish banks are disadvantaged in comparison to their European counterparts. CBRT data for February 2002 indicate that nonperforming loans, excluding SDIF banks' share, stood at 10.1 % of gross loans. The overall level of NPLs is, however, hovering in the 20% range. Banks operating with high NPLs would clearly have to pass on the carried cost of this burden to their customers. The proposed establishment of an asset management company should ease this burden, however.

Banking sector reform in Turkey will no doubt tackle regulatory imposed costs in order to bring financial sector depth in line with global benchmark levels. Ultimately, Turkish banking will emerge as an efficient, globally competitive and sound sector, and the resulting low intermediation spreads will enable strong, sustained growth of the Turkish economy.