Problems with Banking Law Negotiations

UNCLAS SECTION 01 OF 03 ANKARA 006026

SIPDIS

STATE FOR EUR/SE AND EB/IFD
TREASURY FOR INTERNATIONAL AFFAIRS - RADKINS AND MMILLS
NSC FOR BRYZA AND MCKIBBEN

SENSITIVE

E.O. 12958: N/A
TAGS: EFIN ECON TU
SUBJECT: Problems with Banking Law Negotiations

REF: ANKARA 5998

This is a joint cable with Congen Istanbul.


1. (Sbu) Summary: Despite months of extensive consultation
with bankers, and an explicit-but now postponed-IMF
deadline, a new banking law drafted by Turkish regulators is
considered far too restrictive by both bankers and the IMF.
Bank regulators and the GOT are working to revise the text,
but the latest set of proposals from the regulators remains
unacceptable to the IMF and World Bank. Setbacks in the
negotiations could well require an additional IMF-World Bank
mission in mid-November. End Summary.

Background:
--------------


2. (Sbu) At the beginning of 2004, when the IMF staff and
the GOT set the structural reform agenda for the year, it
was agreed that Turkey needed a completely revised banking
law. For months the banker's association and its membership
gave input and bank regulators looked at other countries
practices on issues such as banning bank owners from also
owning news media, industrial groups, pension funds, or
being connected with political parties. The introduction of
bans on any of these cross-holdings would have been highly
disruptive to some of Turkey's largest banks, most of whose
ownership structures violate at least one of these
restrictions. In the end, tightening cross-holding
requirements were dropped as too restrictive and, according
to Bank Regulatory and Supervisory Agency (BRSA) Chairman
Tevfik Bilgin, as not comparable to rules in other OECD
countries.


3. (Sbu) After postponement of a June 30 IMF deadline, a
draft written by BRSA staff was completed in August. In
recent weeks, however, press reports and post contacts have
made clear that it is unacceptable to the bankers
association, which has successfully lobbied the IMF to take
up many of its issues. Because of the controversy and the
press of other business, including the 2005 budget, Deputy
Prime Minister Sener indicated last week that parliament
will only take up the banking issue in the new year.

Bankers Critical:
--------------


4. (Sbu) In a series of recent press interviews and
statements, Turkey's leading bankers, led by Bankers'
Association Chairman and Disbank CEO Ersin Ozince, have
strongly criticized the draft law as far too intrusive into
bankers' actions. Ozince noted that over-regulation could
cause the sector to cease functioning. He attacked a
provision that would require banks to sell their non-bank
assets and argued that banks needed to be profitable for the
sector to be strong. Ozince called for modifications in the
banking law to be limited to measures necessary for EU
compliance.

5.(Sbu) In a recent meeting with Istanbul econoff, Bankers
Association Secretary General Ekrem Keskin elaborated on
bankers' concerns. In the association's view, the new law's
provisions penalize entrepreneurship and risk-taking and are
not well adapted to Turkish conditions. As both Keskin and
the head of one leading international bank in Turkey told
us, the draft is too punitive. In the latter's view, it is
based on the belief that if Turkey had "imprisoned bank
owners" before 2001, it could have avoided that year's
banking crisis. As a result, it makes no distinction
between bank losses caused by macroeconomic conditions and
those resulting from "bad faith." In addition, in a
revealing lack of faith in Turkey's regulators, the act
spells out in extraordinary detail the responsibilities of
the BRSA, essentially transferring regulatory power from
that organization to the parliament, and in the
association's view turning the board itself into an audit
and inspection agency. An added complication is the
continuing struggle for authority over the sector between
the recently separated BRSA and Savings Deposit Insurance
Fund (SDIF). The latter hopes to retain a role in banking
supervision, and it and the Banking Board continue to argue
over who should set premium levels for deposit insurance.
More generally, Keskin noted that Turkish banking law has
been modified a number of times in recent years, and already
is "85 percent" compatible with EU standards. The constant
changes create a climate of uncertainty that inhibit the
sector.

6. (SBU) The association criticized the draft law's
excessive capital adequacy requirements, overly strict
limits on bank's non-financial participations, and an
"unworkable" requirement that each bank board have two
"independent" members with added authority. The latter
provision, in particular, is difficult for banks to
implement, in Keskin's view, and he suggested it may be a
way for the Turkish government to give its supporters a
larger role in the financial sector. Bankers also worry
that the law will make it harder for Turkish banks to meet
the Basle-II capital adequacy requirements.

7. (Sbu) Ergun Okur, Executive Vice President of Oyak Group
and a board member of Oyak Bank, told econoffs no one could
do banking with the law as drafted. Another prominent
banker added that the draft law would likely fail in its
goal of preventing a repeat of past problems in the sector,
for while it would likely cause good capital and management
to leave the sector: "daring people would stay."

IMF Staff Sides with Banks:
--------------
8.(Sbu) The IMF Resrep told econoffs that IMF banking
experts, after a closer look at the text, were sympathetic
to the concerns raised by bankers. (Keskin noted that after
the IMF's initial clearance of the text, the association had
a full-day meeting with the fund to lay out its concerns.)
The Resrep said the Central Bank also had concerns that the
law as drafted impinged on its ability to conduct monetary
policy, by specifying circumstances under which the Central
Bank would be required to provide liquidity to banks. The
IMF objected to the draft law not taking into account the
findings of the commission of inquiry on the Imar Bank
collapse. Specifically, the commission and other observers
had cited the sworn bank auditors' monopoly of bank
inspections as overly restrictive in terms of the expertise
that could be brought to bear. On the other hand, the BRSA
Vice President in charge of on-site inspection (sworn
auditors),Mustafa Korhan, told econoffs that the sworn bank
auditors support allowing information technology experts to
join in on-site inspections, in the interest of avoiding
another Imar Bank-like case.


9. (Sbu) The Resrep confirmed that the draft would set
capital requirements above EU standards-an unnecessarily
onerous requirement at a time when banks are slowly
rebuilding their capital from the effects of the 2001
crisis. The law would also mandate regular ratings by
rating agencies-an unnecessary cost in the view of both
bankers and the IMF. The law would force banks to finance a
training center for bankers, and includes a provision
granting State-owned banks the same seniority in debt
workouts currently enjoyed by the deposit insurance agency,
the SDIF. The latter provision seems inconsistent with the
IFI-mandated state bank privatization strategy. Both
bankers and the IMF objected to a provision that would
weaken bankers' rights in workouts, by making an arbitral
body's decisions binding only on the banks rather than on
debtors as well. Finally, the IMF objected to retention of a
loophole on connected lending.

Unexpected BRSA Proposal Stops Progress:
--------------

11. (Sbu) Though the IMF Deputy Resrep told econoff last
week that Fund staff were encouraged by a newly-agreed
negotiating process that would allow the GOT to take over
the process-albeit with continued BRSA involvement-in an
October 20 meeting, a World Bank banking expert told
econoffs the whole process has been stopped by the latest
BRSA draft. He said the latest draft included the proposal
that the bankers association would take over management of
deposit insurance. Aside from the conflict of interest
problem, he pointed out the association had no experience
with this role. Worse, the World Bank expert said SDIF
officials with whom he spoke had no prior knowledge of
BRSA's proposal to take away one of SDIF's core functions.


12. (Sbu) The World Bank official said IMF Mission Chief
Moghadam forcefully rejected the new draft, and went over
BRSA Chairman Bilgin's head to seek-and later
obtain-Minister Babacan's agreement to go back to
negotiating on the basis of the August draft. The World
Bank official said this latest development meant the IMF and
World Bank banking law experts would return in two weeks and
that negotiations over a new Standby would have to be
further delayed.


13. (Sbu) Even if a new draft can be worked out with the IMF
and World Bank, it would still have to be approved by the
Council of Ministers before the World Bank's condition under
its PFPSAL3 loan facility would be met. For this reason the
World Bank official doubted the second tranche of this
facility would go to the bank board before January or
February.

Comment and Conclusion:
--------------

14. (Sbu) The group of current and former sworn bank
auditors-led by BRSA President Bilgin-have a reputation as a
tight-knit cadre with a tendency to distrust outsiders,
especially bankers. It seems they got carried away in
drafting the new banking law. Bilgin's proposal-from out of
left field-for the bankers association to take over deposit
insurance demonstrates poor judgment but also points to
serious problems between BRSA and SDIF.