July 24, 2017    5 minute read

Turkish Banks: Bridge Over a Troubled Bosphorus

Trouble Ahead?    July 24, 2017    5 minute read

Turkish Banks: Bridge Over a Troubled Bosphorus

Strategically speaking, Turkish banks benefit from their location between East and West to build their financial stature. Sadly, a highly volatile geopolitical (Iraq and Syria) scene combined with an unstable domestic political environment (i.e. Kurdish question, Islamic State terrorist attacks, the failed/ orchestrated July 2016′ coup, and the growing authoritarian regime under Erdogan) dissuade foreign investors and tourists alike.

Not only are (geo)political jitters causing Turkish banks a headache, but also the actions of the rating agencies taken in late 2016 and early 2017 further deteriorated the operating environment. Indeed, all three major credit rating agencies slashed the outlook from Stable to Negative both for Turkey and the Turkish banking sector as a whole.

Junk Rating

Furthermore, the rating agencies also put the long term credit rating of Turkey in the junk zone (thereby imposing a de facto rating ceiling on all Turkish counterparties). These rating actions have resulted in an additional strain on Turkish banking assets.

Despite an accommodative monetary policy – evidenced by the reduction in key reference rates in an attempt to stir up the Turkish economy – competition for lira customer funding keeps interest rates, and concomitantly, funding costs elevated. Also, the foreign currency funding in the banking system represents up to 50% of total liabilities. Henceforth, volatility in the Turkish lira exchange rate has a direct impact on the Turkish banks’ profitability.

Non-Performing Loans

Not only does the funding cost remain high, but Turkish banks also face an asset quality problem as non-performing loans continue to deteriorate (i.e. expected to reach 4% and above by the end of the year (up from 3.2% previously in 2016). For the sake of a comparison, Turkish NPLs remain way lower than their cousins in Europe (average of 5.1% in 2016).

Still, the trend with Turkish banks is worrying, and a combination of three factors causes this rise in NPLs: depreciation of the TL (-20%) affecting firms with loans labelled in foreign currencies, slower economic growth, and accommodative regulatory changes about retail banking.

As already mentioned, current external ratings for the government of Turkey are speculative grade at BB+, with negative outlook representing a ceiling for the ratings of Turkish banks. Turkey’s biggest banks (total assets as of December 2015) are Ziraat Bankasi, Turkiye Is Bankasi, Garanti Bank, Akbank, Yapi ve Kredi Bankasi, Halk Bankasi, VaikfBank, Finansbank, Turk Ekonomi Bankasi, and Denizbank.

Questions over Resiliency

While banks are showing satisfying capital ratios and operating profits, questions about their overall resiliency to macro economic headwinds arise, as illustrated by the negative rating outlook given by all three credit rating agencies to the Turkish banking industry as a whole.

Worth mentioning is the fact that international capital markets are equally concerned about the Turkish economy. This is illustrated by the inverted yield curve as the yields on short-term Turkish government bonds are higher than the longer term government bonds.

The perceived lack of resiliency is mainly due to a system-wide reliance on wholesale funding making Turkish banks particularly vulnerable in a context of increasing benchmark interest rates internationally. And, what is notably a concern is the fact that 50% of the short-term wholesale liabilities will mature within the next 12 months thereby creating a significant refinancing risk. The only way for Turkish banks to face those headwinds and even reverse this situation is by building stronger loss-absorption capacities and liquidity cushions.

Negative Rating

In practice, a negative rating outlook translates into a lower risk appetite to conduct business in Turkey with both foreign investors and lenders. However, this statement needs clarification:
– On the positive side, government-owned banks are typically expected to benefit from a stronger systemic support than commercial banks (i.e. as a reminder the three state-controlled Turkish banks represent an aggregate market share of around 30% of the banking assets).
– On the downside, the country’s FX reserves are starting to melt under the sun (from $150bn as of year-end 2014 down to $128bn mid-2017). And, last but not least, the long term debt rating of the Turkish government became speculative as of year- end 2016 thereby limiting the bail-out capacity provided by the Turkish authorities.

While the depreciation of the Turkish lira is a boon for Turkish exporters, it is a burden for any imports to the country. Indeed, on the one hand, Turkish exports increased during the first seven months of 2017, but on the contrary, energy and food prices rose thereby pushing up CPI (around 10.9% in May 2017 compared to 7% as of year-end 2016).


Practically speaking, trade finance related activities should be limited to maximum 12 months provided there are being conducted with the top five largest commercial banks, Turkish government banks, or subsidiaries of Western foreign banks.

Long-term investment activities, such as corporate banking and project finance, for example, should be considered on a case-by-case basis. Those activities should be restricted to deals with robust local Turkish counterparties that have partnered up with Western companies. Additionally, contracts should not be written according to Turkish Law (and, instead preferably English Law), and payments need to be made in non-Turkish lira currencies (preferably in USD, Euro, GBP, etc.) and executed outside the country thereby reducing transfer risk.

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