TURKEY'S BANKING SECTOR: ON FIRMER GROUND, BUT NOT

UNCLAS SECTION 01 OF 03 ISTANBUL 000635

SIPDIS


SENSITIVE


STATE FOR E, EUR AND EB
TREASURY FOR U/S TAYLOR AND OASIA - MILLS
NSC FOR QUANRUD AND BRYZA


E.O. 12958: N/A
TAGS: EFIN ECON TU
SUBJECT: TURKEY'S BANKING SECTOR: ON FIRMER GROUND, BUT NOT
OUT OF THE WOODS


This is a joint Ankara-Istanbul cable. Sensitive but
Unclassified - not for internet distribution.

SIPDIS



1. (SBU) Summary: Industry and government contacts in
Istanbul and Ankara concur that Turkey's banking sector has
improved considerably since the 2001 crisis. Government
moves to impose effective and independent oversight through
the creation of the Banking Regulatory and Supervision Agency
(BRSA) in September 2000 increased transparency and public
confidence. The takeover and resolution of 19 insolvent
banks, and partial restructuring of public banks, have
eliminated unfair competition and eliminated the worst
performers. Most concur, however, that serious problems
remain, and that the sector remains extremely fragile, with
bank exposure not just to individual balance sheet problems,
but also to systemic risk as a result of Turkey's tenuous
macroeconomic fundamentals. Turkish banks operate more as
hedge funds than commercial lenders, with government
securities making up a higher percentage (an average of 40
percent) of their assets than loans. Having gotten into the
government securities game, however, the banks have no easy
exit, other than through a long-range strategy of increasing
their capital and growing out of the problem. However, the
quick end to war in Iraq, and declining interest rates have
given the sector some breathing room, providing profits in
place of the heavy paper losses that March's high rates
caused. In the medium term, the sector needs increased
capitalization, either through foreign direct investment or
public offerings. Either solution involves diluting
ownership of family-owned businesses, however, which will
face traditional barriers. End Summary.



2. (SBU) Snapshot of the Sector: Turkey's banking sector is
small by world standards, with total assets at the end of
2001 of only USD 122 billion. Forty percent of that total is
accounted for by three state banks: Ziraat, Halk and Vakif
Banks (the first two being Turkey's largest banks). On the
private side of the sector there are the big four-- Akbank
(the market leader),Isbank, Garanti Bank and Yapi Kredi (the
last being managed by the BRSA with a view towards its sale
in the medium term). There are also six significant
medium-sized banks (by Turkey's standards)-- Kocbank,
Denizbank, Finansbank and TEB are the leaders in this
category. In addition to small traditional banks, there are
also a number of "Special Finance Houses" (in Turkish legal
parlance) which follow Islamic banking principles. Though
they account for only 4 percent of total banking sector
assets, they are politically important to the AK party, as
several ministers (including Finance Minister Unakitan) and
senior officials rose through their ranks. Foreign
participation in the sector is extremely limited. While a
number of foreign commercial and investment banks have
correspondent offices in Turkey, only two commercial banks
have entered the market recently-- HSBC through the purchase
of the bankrupt Demir Bank and Unicredito (Italy) through a
50/50 partnership with Koc Bank. Analysts note that overall
the market is thin and undercapitalized, as is evident in the
fact that the "big four's" total assets barely equal those of
the National Bank of Greece (at around USD 40 billion).



3. (SBU) Improvements Since the Crisis: If challenges remain
in the sector, all agree that the specific problems that
contributed to the 2001 crisis have been partially addressed
by post-crisis reforms. BRSA Vice President Ceyla
Pazarbasioglu, in an April 17 meeting, pointed specifically
to the system's enormous short foreign exchange position
(addressed through a debt swap, and subsequent bank attempts
to avoid overexposure to exchange risk); high levels of group
lending (being brought down over four years to an
internationally accepted level-- Finansbank Chairman Husnu
Ozyegin noted to us on April 29 that whereas his FIBA group
was once his bank's number one customer, it is now only
number 7); and the sector's high level of non-performing
loans (being addressed by debt restructuring, as through the
Istanbul approach, and other steps). In addition, we would
mention two big improvements: BRSA's intervention and
resolution of 19 private banks, which took out the sector's
worst performers; and the GOT's recapitalization of Halk and
Ziraat Banks (at a cost of about USD 25 billion).



4. (SBU) But problems remain: Those we canvassed in recent
weeks agree, however, that the sector is not by any means out
of the woods. Key remaining issues include the lack of free
capital and the sector's overall need for increased
capitalization, maturity mismatches between assets and
liabilities, overexposure to government securities and
resultant "systemic" risk, and lack of other profitable
assets. Though a range of banks have recently trumpeted
advantageous loan programs for members of such business
associations as the Istanbul Chamber of Commerce, TEB General
Manager Akin Akbaygil notes that overall there is no
significant loan demand by local clients, given prevailing
high interest rates and transaction costs. That lack of
demand has led banks to shift more of their resources into
the government bond market, an area that Akbaygil quipped is
a little like "hell," in that it is easy to get into and very
hard to escape. Indeed most analysts believe that
notwithstanding the fact that ownership of bonds by
individuals is at its highest level ever, the banks are now
trapped in a "pyramid scheme" from which they cannot escape.
The banks are clearly aware of the treadmill on which they
find themselves: Koc Bank General Manager Kemal Kaya
confirmed rumors that the big four have been exploring the
possibility of a government debt restructuring with the
government in Ankara, perhaps to be accompanied by a change
in reserve requirements. Kaya indicated that then Treasury
U/S Oztrak had not responded to the proposal when he received
it in late March.



5. (SBU) Systemic Risk: Pressure from the banks for
restructuring has likely eased in recent weeks, as the
overall market mood has lightened with the end of the war.
While banks were worried about heavy losses at the end of the
first quarter, as a result of high interest rates, they are
now enjoying windfall profits, given those rates decline.
However the long-term problem of their overexposure to
government debt remains, as does the maturity mismatch that
accompanies it. While most deposits held by banks are one or
at most three month terms, government bond maturities have
increasingly been extended, and now average just over 14
months. Given that most bank-held bonds have a floating rate
or are denominated in foreign currencies, the banks no longer
face a large foreign exchange risk (it has effectively been
shifted to the government, which has been managing it well),
but the overall credit risk remains, and in the view of some
outside analysts should be provisioned against (though
currently government bonds are treated as no risk for
accounting purposes). Akbaygil also alerted us to another
looming risk that has attracted little attention to date: the
banks' exposure to the liabilities of the Turkish insurance
industry, which it largely controls through wholly-owned
subsidiaries. Like the banks themselves the sector is
undercapitalized.



6. (SBU) Structural Problems: Beyond the difficult
macroeconomic environment in which they work, banks also face
a tough operating environment. Akbank CEO Zafer Kurtal noted
that in addition to high interest rates, intermediation taxes
and fees can easily add another fifteen percent to the cost
of a loan, even before any bank margin is considered. Banks'
problems are compounded by the continued lack of inflation
accounting (though the government has promised to introduce
it for the sector this year),which results in situations
like that faced by industry leader Akbank in the first three
months of this year, when it paid an effective 80 percent tax
rate on its profits. The larger banks (especially Is and
Garanti) hold large real estate portfolios and other fixed
assets which cannot be easily liquidated in the present
economic environment. Isbank, given its extensive industrial
subsidiaries, has faced extensive group losses which have
dragged down its bottom line. Bender Securities analyst
Murat Gulkan notes that as a result the banks' position is a
bit deceiving, in that they are not as solvent as their
current liquidity would otherwise indicate.



7. (SBU) The Lethal Bank/Media Mix: At least three of
Turkey's biggest banks are owned by groups with large media
holdings (YPK, Disbank, and Garanti). The media subsidiaries
often slant "news" stories to promote their holding and bank
interests. Thus Dogan's (Dis' parent) recent series on the
BRSA's failure to collect from bankrupt banks' former owners
also coincided with Dis' attempt to acquire assets from the
BRSA. Even so, there is legitimate public concern with the
failure to date to collect from former bank owners. The
BRSA's inability to agressively pursue these debtors has been
the one black mark on an otherwise strong record.



8. (SBU) Comment: As TEB CEO Akbaygil noted to us, banking is
the superstructure of the overall economy, and consequently
will prosper or suffer in line with the economy's health and
the government's effectiveness in implementing the economic
reform program. If reform implementation continues, analysts
see a strong upside-- a view that led one brokerage to
upgrade both Akbank and Isbank late last year. Improvement
of the macroeconomic climate alone will not be enough,
however. In the medium term, more capital is needed. The
two most likely sources of this capital are direct foreign
investment or selling off more equity on the Istanbul Stock
Exchange. Either choice will result in dilution of
family-owned bank businesses. While some CEO's like
Finansbank's Husnu Ozyegin tell us they are prepared to
accept this (in the expectation that they will be able to
retain effective control even with a 25-30 percent share),
traditional attitudes on protecting the family "jewels" will
doubtless prove a barrier. End Comment.
QUINN