Turkey: The Banking Sector Needs Profitability-Enhancing Reforms

Turkey: The Banking Sector Needs Profitability-Enhancing Reforms

photo: Jeremy Vandel

Key takeaway – Turkey’s economy remains resilient, but low savings hinder growth prospects and weaken the banking sector. Turkish banks – essential for economic growth and job creation – need to raise additional capital by end-2016, but suffer from declining profitability. Meanwhile, macro risks are rising, driven by geopolitical risks, foreign exchange (FX) volatility, and a rising loan-to-deposit ratio. Micro risks are also rising: the legal framework remains inadequate (e.g.: there isn’t a personal bankruptcy law), and a high FX-debt depresses firms’ investments. In 2016, the Turkish banking sector needs profitability-enhancing reforms. If improvements are enacted, banks could attract foreign direct investment (FDI). Investors need exchange rate stability, capital protection and a clear, uniform legal environment for bankruptcies and personal guarantees.  

Turkey’s economy is showing resilienceDuring 2016, a slowdown in exports and a decrease in tourist arrivals will weaken economic growth, nonetheless expected at 3.5 percent. Inflation will remain over 8 percent, above the Central Bank of Turkey (CBT)’s 5 percent target. The Turkish Lira (TRY) will stay under pressure[1], and depreciate against the US Dollar (USD) by a further 11.5 percent from current levels, to reach USD/TRY 3.242 by end-2020[2]. Over 2016-2020, Turkey’s growth will average 3.8 percent per annum, above the recent performance of most peers[3].

… but low savings hinder growth … In 2014[4], the ‘savings to gross domestic product’ (GDP) ratio declined to 15 percent[5], the lowest – together with South Africa – of all emerging markets (EMs)[6]. As a result, the country needs to make use of foreign savings. The resulting current account (c/a) deficit[7] increases dependence on global liquidity conditions.

… and banks’ prospects. Over 2007-15, deposits grew by 12 percent (if measured in USD) or 25 percent (in TRY). Over the same period, loan growth outpaced deposit growth. As of December 2015, the ‘loan-to-deposit’ ratio (LTD) stood at 119 percent[8], up from 80 in December 2007. Managing the TRY cost of funding is a struggle: given low profitability (see below), banks need to rely on bond issuances[9] and foreign credit via syndicated loans to fund any asset expansion.

The growth of the banking sector is essential for economic growth and job creation. Over 2007-15, total – i.e.: both TRY- and FX-denominated – banking sector assets grew at a compound annual growth rate (CAGR) of 19.1 percent[10]; over the same period, nominal GDP grew at an estimated CAGR of 11.3 percent[11]. In 2014, the banking sector represented around 6.4 percent of Turkey’s GDP[12]. In 2015, while total banking sector assets grew by 18.2 percent year-on-year (y-o-y), TRY-denominated assets grew by 11.7 y-o-y. As of December 2015, the banking sector employed about 217,500 people (including staff abroad), a 29.6 percent increase from the 167,000 employees of December 2007. As of December 2015, 51.2 percent of total employees in the banking sector were women.

The ongoing decline in foreign direct investment (FDI) … Over 2007-2015, overall FDI into Turkey declined by 41 percent. FDI peaked at USD 22 billion (bn) in 2007, but declined to an estimated USD 12.5bn in 2015, mainly due to: i) uncertainty about the economy[13]; ii) high inflation[14]; iii) a weakening TRY (see below); and iv) regulatory unpredictability, as investors complain about often arbitrary interpretations of the legislation. Going forward, TRY depreciation will keep eroding returns, and FDI is unlikely to flow in at the pace of economic growth. Indebted in hard currencies, local investors will serve a growing debt (in USD terms) and reduce their investments, stifling growth.

… could be countered by the banking sector. Over 2007-15, the banking sector attracted a total of over USD 27.1bn in FDI: this figure represents over 26.0 percent[15] of Turkey’s total FDI, and is only second to the manufacturing sector ( 27.0).

The banking sector in Turkey has strong growth prospects … In 2014, the formal savings rate – i.e.: the percentage of the population aged 15-or-above with savings at a financial institution – was only 9.1 percent, well below the average of upper-middle-income countries17 (32.2). In the same year, the percentage of the population aged 15-or-above with an account at a financial institution – i.e.: the penetration rate – was 56.7, lower than the average of upper-middle-income countries[16] (70.5). In December 2015, the estimated ratio of banking assets to GDP stood at 118.7 percent, well below Middle East and North Africa (MENA[17]) average (151)[18].

… but banks are hindered by low profitability. Over 2007-15, banking sector’s profitability – measured as ‘return on equity’ (ROE) – decreased by 54.4 percent, from 24.8 percent in December 2007 to 11.3[19] in December 2015 (Figure 1). As of December 2015, the differential between banks’ ROE and risk-free returns (at 9.8 percent)[20] was 1.5 percent, lower than both the average of Central and Eastern Europe (7.5) and the average of Europe’s developed markets (DMs) (7.8). Over 2007-2015, profitability measured as ‘net interest margin’ (NIM) [21] decreased by 22.2 percent, from 4.5 percent in 2007[22] to 3.5 in 2015. Over 2007-2015, the ‘return on assets’ (ROA) decreased from 2.8 percent in 2007 to 1.2 in 2015 – its lowest level since 2002[23].

Figure 1: Turkey – 2007-15: the decline of banking sector profitability

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Source: BRSA, author’s calculations, 2016.

 Turkish banks remain adequately capitalized and now meet Basel III standards … A declining profitability[24] hinders organic growth and negatively impacts ‘capital adequacy ratios’ (CAR)[25]. Yet, the loss-absorption capacity of banks remains adequate. As of the end of September 2015, the average ‘common equity Tier 1’ (CET1) ratio[26] for the largest seven banks was 11 percent, well above the 9 percent Basel III target set for 2019. In 2015, the ‘bank capital to assets’ ratio[27] stood at 11.0 percent, in line with the US (11.6) and significantly higher than in other DMs such as Germany (5.8) and Japan (5.8).

… but will need to raise more capital by end-2016 … In 2016, Turkish banks will have to meet additional Basel III capital buffers, to satisfy: i) higher minimum capital requirements[28], as the minimum CET1 for larger institutions will rise from 4.5 to 5.625 percent, and up to 9 percent by 2019 ; ii) increased risk-weights[29]: the proposed risk-weighting increase of FX reserves held at CBT from 0 to 50 percent will reduce the CET1 ratios of the largest seven banks by 55-85 basis points; and iii) further TRY depreciation2 will erode CARs. In February 2016, Turkey’s Banking Regulation and Supervision Agency (BRSA) issued 16 regulations (some new, some amended) to make the regulatory framework more compatible with Basel III standards[30].

… and raising further capital is a challenge. The gradual introduction of Basel III will increase capital needs. It will prove a challenge, because: a) raising funds at the local level is expensive: as of March 29, 2016, in Turkey the benchmark interest rate was 7.50 percent compared with zero percent in the Eurozone (EZ) and 0.25-0.50 percent in the US; and b) TRY depreciation will make raising capital from foreign sources a challenge. Hedging is expensive due to large interest rate differentials, and the low profitability impedes capital accumulation through organic growth. If capital is scarce, banks will ultimately be unable to lend – loan growth is unlikely to exceed nine percent[31] – and grow.

Macro risks are rising: Turkey’s vulnerability to FX volatility and geopolitical risks is rising. Low reserves, a rising external debt and low domestic savings are making the economy more dependent on foreign finance. In January 2016, FX reserves fell to USD 127.1bn[32], down 4.3 percent month-on-month (m-o-m), and 15.5 percent from an all-time high of USD 150.4bn in July 2014. In December 2015, the gross external debt stock reached USD 398bn or 55.3 percent of GDP, against a Q3-2010-Q3-2015 average of 45.0 percent: most of this debt is private (71.3 percent), making Turkey vulnerable to a rise in US interest rates. Escalating geopolitical risks are also taking a toll. Sanctions due to political tensions with Russia[33] are affecting tourist inflows, construction firms and food exports. Internal instability – due to the collapse of the Kurdish peace process and Islamic State (IS) terrorist activities – is also impacting tourism[34] and jeopardizing exports to Middle East [35]. The plunge in oil and other commodity prices is negatively affecting Turkey’s exports (a loss of around USD 11.0bn in 2015)[36], as the demand for Turkish products and services has dried up in the major oil exporters in the region. As a result, exports are decreasing: in 2015, total exports declined to USD 143.7bn, an 8.7 percent drop from 2014 levels.

As TRY depreciation erodes returns, locals are hedging and investment declines. Between December 31st, 2007 and March 30th, 2016, the TRY lost 58.8 percent of its value against the USD [37] and 46.6 percent against the Euro (EUR) [38]. As a result, individuals and banks increased their FX positions: in February 2016, FX deposits at Turkish banks stood at TRY 533bn (USD 181bn) — up 40 per cent since January 2014. In February 2016, 61.0 percent of bank assets and 55.0 percent of bank resources in balance sheets were held in TRY, down 4.0 and 2.1 percent respectively if compared to 2014.

Micro risks are also rising: higher debt and lower commodity imports are further impacting the economy. Due to an increase in debt, firms will reduce investments: as of Q4-2015, total foreign debt of Turkish firms had risen to USD 283.8bn[39] in, up 0.4 percent y-o-y, and 18.5 percent above the Q3-2010-Q3-2015 average of USD 239.5bn. As TRY depreciation outpaced the drop in USD-based commodity prices, companies are holding on to minimum stocks and cutting commodity imports[40].

The legal framework for bankruptcies and personal guarantees needs improvement. In 2015-2016, Turkey dropped 22 positions in ‘Resolving Insolvency’ category of the World Bank’s Doing Business 2016 ranking – and it is now classified 124th out of 189 economies. The average duration of insolvency procedures is 4.5 years, higher than the average of Europe and Central Asia (ECA – 2.3 years). At the end of insolvency proceedings, secured creditors recover from insolvent firms 18.7 cents on each USD (ECA average: 38.3 cents). As of December 2015, the banking sector’s ‘non-performing-loans’ ratio (NPL[41]) stood at 3.1 percent (up 0.3pps in 2015), a comparatively[42] low level. Yet, it is important to highlight that NPL rates might be artificially low: at the moment, Turkey has no personal bankruptcy law, which results in keeping in the books loans that would otherwise be classified as non-performing. In absence of a uniform legal framework, insolvencies cannot be resolved by the calling of personal guarantees. In practice, personal guarantees are not always enforced, in particular those on deposits held abroad, and execution mechanisms remain unclear.

In 2016, the Turkish banking sector is at a crossroads: reforms are needed. The banking sector runs the risk of getting stuck in lower-than-potential growth rates, with historically low levels of profitability. To avoid stagnation and foster growth, the Turkish authorities should enable risk-taking by reforming banking policies and procedures. These changes could be the catalyst for achieving macroeconomic stability and overcoming the middle-income trap[43]. Of course, they need to be properly regulated and implemented – otherwise, they could trigger the next banking crisis.

Banks are important income-tax contributors, and should not be overburdened. In 2014, 41.1 percent[44] of all gross banking revenues were paid to the state via direct taxes, transactional taxes, levies, penalties, et alia. For the nine months ending in September 2015, the banking sector paid TRY 1.77bn in corporate tax, 7 percent of total corporate tax[45].

Reserve requirements ratios (RRRs) on deposits are high and could be reduced. The RRRs on deposits and participation funds[46] in TRY with up to 1-year maturity range between 6.5 percent and 11.5 percent[47]; deposit and participation funds in FX up to 1-year maturity require a RRR of 13.0 percent. These requirements are high if compared to RRRs in the EZ which stand at 1.0 percent for up to 2 years’ maturity.

Investors need safeguards against FX fluctuations … Protection against TRY volatility can be obtained by: i) allowing accounting in hard currency; in other words, allowing bookkeeping to apply hedge accounting[48], a multi-currency portfolio of assets independently-appraised and marked-to-market would de facto de-risk the balance sheet (B/S). To ensure fair valuations, a government-agency could be one of the appraisers. Asset appreciation would be reflected both in B/S (by increasing the capital) and in the profit and loss (P&L – via generation of an equity reserve); and ii) relaxing limitations – and tax treatment – of investments in hard currency accounted in TRY; currently, an on-shore entity can invest in FX assets (e.g.: equities, fixed-income securities) just up to 20 percent of the capital base as net open FX position; the TRY equivalent of the value is entered in the entity’s books, with total income – including FX appreciation – being subject to taxation. The existing 20 percent limit is too stringent: these limits should be raised and/or made more flexible, and the income from revaluation should be tax-exempt until the asset or participation is sold.

… capital protection, in order to raise capital that allows lending and, ultimately, growth ... Possible measures to protect the capital could be: i) allow accounting in hard currency (see above); ii) relax limitation on investments in hard currency assets (see above); iii) allow real estate assets to work as a hedge. Currently, an appreciation can be reflected (in TRY), as long as the real estate asset is used by the bank in its ordinary business activity. Yet, hedge accounting could be used for the value appreciation of buildings: the asset appreciation would be reflected both in B/S (by increasing the capital) and P&L (via generation of an equity reserve); iv) insure the banking system’s structural asset-liability mismatch [49]: a governmental fund could be created with the mission to provide liquidity if the asset-liability mismatch in domestic banks widens and causes a liquidity crunch; this measure would prevent investors to have to step in with additional equity. More diversified funding instruments (e.g.: retirement plans) would help correcting the mismatch and would provide depth to the markets; and v) more flexible capital ratios and risk-weighted assets (RWA) calculation.

… and a clear, uniform legal environment for bankruptcies and personal guarantees. Investors need the Government to create a level-playing-field, via: i) a personal bankruptcy law, in order to allow a swift clean-up of the banks’ balance sheets, followed in turn by more prudent lending standards; and ii) an improved legal framework on personal-guarantees, as some banks are facing issues with defaulting borrowers. This has not been a major issue so far, as NPLs ratios have remained low: however, the recent deterioration of credit quality in most bank’s balance sheets, the ensuing increase in NPLs44 and the reduction of banks’ capital buffers (the core CAR – Tier 1 – declined by 77 bps to 13.26 percent in 2015, from 14.03 percent in 2014) have increased the need of loan restructuring. Banks are willing to provide the necessary resources for these restructurings, but they need BRSA support, especially on the legal side.

State banks’ competition and a slow BRSA stifle the performance of private banks and increase the probability of a banking crisis. So far, the banking sector supported[50] the country’s rising prosperity, but the growing role of state banks[51] weakened the private banks and – as a result – hampered private consumption. Furthermore, the BRSA is not proactive: the governance of state-owned banks is a raising concern[52], increasing the probability of a banking crisis.

We thank Mehmet N. Erten, Murat Dinç, Mutlu Akpara, Bashir Jaber, Elyas Nasser and Mert Yildiz for comments and suggestions, PulsarKC for data collection. All errors are ours.

[1] In 2015, as foreign investors liquidated 12.2 percent (USD 10bn) of their stocks and bonds holdings, total foreign investment declined to USD 72bn (USD 40bn in stocks and USD 32bn in bonds). Approximately 27 percent of foreign investors invest in stocks and government bonds.

[2] As of March 30th, 2016, TRY had appreciated 2.9 percent year-to-date (y-t-d) against USD to USD/TRY 2.836. This exchange rate is 195.2 percent above the pre-crisis (January 1998-June 2008) USD/TRY average (0.961), 7.3 percent below the post-crisis peak of September 14th, 2015 (3.058), and 103.1 percent above the post-crisis trough of November 4th, 2010 (1.396). TRY is expected to further depreciate against USD to USD/TRY 3.242 by 2020.

[3] During 2006–15, the GDP of Emerging and Developing Europe grew at an annual average of 3.2 percent.

[4] Data for 2015 have not been released yet.

[5] Tighter regulations on credit card payments and private consumer loans have not succeeded in bringing savings up to speed. IMF forecasts the savings to GDP ratio will reach 14.3 percent by year 2018.

[6] In 2014, the savings to GDP ratio in BRIC countries was: Brazil – 16 percent; Russia – 23; India – 31 ; and China – 50 (data for China as of 2013). The ratio for other EMs was: Mexico – 20; South Africa – 15.

[7] The c/a deficit is expected to marginally expand from 4.4 percent in 2015 to 4.8 percent in 2016 and then decrease to 4.5 percent in 2020 as the impact of lower crude prices is expected to be offset by a weaker TRY.

[8] In 2014, LTD was 115 percent.

[9] In 2014, Turkey’s banking sector issued bonds worth TRY 21.1bn, which is 24.0 percent higher compared to 2013; however, in 2015 it remained broadly stable at TRY 21.2bn – a 0.2 percent y-o-y growth.

[10] In December 2007, total banking assets in Turkey reached TRY 581.60bn.

[12] In December 2015, total banking sector assets in Turkey were TRY 2,357.45bn, up from TRY 1,994.33bn in December 2014. The total number of deposit banks in Turkey remained stable in 2015 at 32: 3 state-owned, 8 private, and 21 foreign-owned.

[13] In March 2016, the Economic Confidence Index – a composite index based on several surveys of business and consumer confidence published by the Turkish Statistical Institute (Turkstat) – increased to 78.3 points, up 9.5 percent from February 2016 level (71.5, the lowest value on record), but still down 22.3 percent from December 2015 level (100.8).

[14] In February 2016, inflation reached 8.8 percent y-o-y. In March 2016, inflation declined to 7.5 percent, 250 basis points (bps) above CBT’s target (5.0 percent since 2012). The target has been consistently missed since 2011, with actuals on average 310bps above target.

[15] Some of the most recent operations have seen European banks selling their participations in Turkey to Gulf Cooperation Council (GCC) investors. In December 2012, Burgan Bank bought Eurobank Tekfen from Eurobank EFG (Greece). In December 2015, Qatar National Bank agreed to buy a majority stake in Finansbank from National Bank of Greece. Other foreign investment in Turkey’s banking sector include DenizBank – 99.85 percent owned by Russian Sberbank since 2012 -, and Garanti – 39.9 percent owned by Spanish BBVA.

[16] For its fiscal year 2016, the World Bank considers upper-middle-income countries those with GNI per capita (calculated using the World Bank Atlas method) in 2014 of USD 4,125 – USD 12,746 in 2014 (in 2014, USD 10,830 for Turkey).

[17] MENA includes Qatar (159 percent), Bahrain (152), UAE (199), Saudi Arabia (93; Source: CEIC, 2016), Oman (122), Lebanon (342), Kuwait (162), Jordan (174), Tunisia (102; Source: CEIC, 2016), Algeria (72; Source: CEIC, 2016) and Iraq (2014: 87 percent).

[18] Source: Central Banks, International Monetary Fund (IMF), World Economic Outlook Database, 2016. Banking assets to GDP ratio for other upper-middle-income countries: Brazil (156 percent), China (262), Mexico (89).

[19] In 2015, the ‘return on equity’ (ROE) – net income divided by average shareholders’ equity – stood at its lowest post-crisis level, below both the pre-crisis (2003 – 2008) average (18.4 percent) and the post-crisis peak of 2009 (22.9). Forecast for 2017-2020 shows an average ROE level at 15.0 percent (Source: Bloomberg Consensus, 2016).

[20] Source: TBB, 2016. Risk Free return is measured as 10-year sovereign bond returns. Further average differentials: Middle East, 10.4 percent; Latin America, 10.0; North America, 9.7.

[21] NIM is calculated as ‘return on investment’(ROI) less interest expenses, divided by average earning assets.

[22] Source: CEIC, 2016.

[23] This figure is below pre-crisis (2003 – 2008) ROA average (2.3 percent) and post-crisis peak of 2009 (2.6).

[24] The decrease in profitability is mainly due to regulatory requirements and macroprudential policies to hold credit growth and household debt under control; forecasts say that NIM will decrease to 2.8 percent by 2018, at par with economies in transition.

[25] Despite a long-term declining trend, capital adequacy ratios (CARs) are currently above the 12.0 percent regulatory minima, and based on high-quality capital. In December 2015, the banking sector’s CAR was 15.6 percent, below both the pre-crisis (2002–2008) CAR average (23.8) and the post-crisis peak of 2009 (20.6) but above the post-crisis trough of 2013 (15.3). New regulations focus on inducing banks to increase retail loans and boost consumption, which will ultimately widen the c/a deficit; Turkey’s Banking Regulation and Supervision Agency (BRSA) is introducing Basel III rules, which will absorb more capital for the same amount of business and hence lower the returns on capital.

[26] The CET1 ratio or Tier 1 common capital ratio is a measurement of a bank’s core equity capital compared with its total risk-weighted assets (RWAs). This is the measure of a bank’s financial strength. The CET1 ratio excludes any preferred shares or non-controlling interests when determining the calculation.

[27] The “bank capital to assets” is the ratio of bank capital and reserves to total assets. Capital and reserves include funds contributed by owners, retained earnings, general and special reserves, provisions, and valuation adjustments. Capital includes tier 1 capital and total regulatory capital, which includes several specified types of subordinated debt instruments that need not be repaid if the funds are required to maintain minimum capital levels (tier 2 and tier 3 capital). Total assets include all financial and non-financial assets.

[28] Under the latest Basel III capital requirements to be implemented in Turkey from 2016, by 2019 banks will have to build up a common equity Tier 1 (CET1) capital conservation buffer equal to 2.5 percent of RWAs. They will also have to hold a buffer, with size dependent on systemic importance. This buffer will range from 1.0 percent to 3.0 percent of RWAs, but capped at 2.0 percent for the larger banks.

[29] Other changes to RWAs applicable to Turkish banks from March 2016: residential mortgage loans will attract a minimum 35 percent risk weight (currently 50 percent) and unsecured consumer portfolios will be weighted at 75 percent (currently 75 percent-250 percent).

[30] These changes apply to the banks’ internal systems, CARs, the liquidity coverage ratio, equity, as well as all disclosures related to credit risk reduction techniques and risk management.

[31] In April 2016, Moody’s stated in a report that “some Turkish banks will likely need to issue additional capital to prevent a shortfall before the full implementation of Basel III in 2019”. Banks’ capital level is “expected to fall over the next three to five years, with lending growth outpacing capital generation”. Given historically low levels of profitability of the banking sector, Moody’s estimated that the banking sector could only support a loan growth of around nine percent without depleting capital – assuming a 20 percent dividend payout ratio -, or 11-12 percent growth with full retention of earnings.

[32] According to Özlem Derici, Chief Economist at Deniz Invest, CBT has little power to defend the TRY in an emerging market crisis: foreign exchange reserves would not be sufficient, and currency could fall to USD/TRY 3.50.

[33] Russia has banned import of Turkish fruit and vegetables, poultry and salt, sale of charter holidays for Russians to Turkey and construction projects awarded to Turkish firms in Russia. Exports to Russia decreased by USD 2.4bn in 2015. Turkey risks losing USD 3.5bn annually in income from Russian tourists (second most popular destination for Russians in 2014, attracting about 3.3mn visitors), and another USD 4.5bn annually through the cancellation of construction projects.

[34] In 2016, according to Hürriyet daily, citing sector representatives, the revenue loss in the foreign tourism sector may reach USD 12bn. The economic think-thank TEPAV had previously estimated the cost of the Russian travel ban on Turkey at around USD 8bn this year, including direct and secondary impacts. In 2015, Turkey’s gross income from foreign tourism services reached USD 31.5bn.

[35] Exports to the Middle East dropped by 10.4 percent in 2015 compared to 2014 due to sharp losses in the Iraqi market.

[36] As of March 30, 2016, oil prices are at USD 39.26 per barrel (USD/bbl), 69 percent below the post-crisis peak level of April 8th, 2011 (126.65).

[37] In 2008, the TRY flirted with parity against the USD (USD/TRY 1.15 on January 10th, 2008), to decline to USD/TRY 3.05 on September 12th, 2015 and reach 2.84 on March 30th, 2016.

[38] As of March 30th, 2016, TRY had depreciated 1.4 percent y-t-d against EUR to EUR/TRY 3.216. This exchange rate is 135.0 percent above the pre-crisis (January 1998-June 2008) EUR/TRY average (1.368), 7.1 percent below the post-crisis peak of September 14th, 2015 (3.461) and 68.6 percent above the post-crisis trough of June 6th, 2010. EUR/TRY 1.907, registered on

[39] This is the Gross External Debt of Private Institutions, which includes both short-term and long-term debt. In 2015, private sector gross external debt stock amounted to 71.3 percent of total gross external debt stock of Turkey.

[40] According to Mr Timur Erk, head of Turkey’s Chemical Manufacturers Association, TRY depreciation outpaced the price drop in dollar-based commodity prices, and companies are holding on to a minimum stock. In 2015, import of commodities (excluding oil and gas) declined 13.6 percent y-o-y to USD 40.6bn vs USD 46.9bn in 2014.

[41] In 2015, NPLs stood at 3.1 percent, below both the pre-crisis (2004 – 2008, excluding outliers for 2002 & 2003) NPL average (4.3) and the post-crisis peak of 2009 (5.2) but above the post-crisis trough of 2011 (2.7). As of April 2016, Moody’s forecasts a 0.4-0.6 percentage points (pps) rise in the NPLs of the Turkey’s banking sector in 2016: the increase in bad loans would stem largely from the consumer and small-and-medium enterprises (SMEs) loan segments, whose stocks of problem loans have already grown significantly over 2015. Corporate loans have proven resilient so far, but they remain vulnerable to TRY depreciation and a likely increase in their borrowing costs.

[42] Bank NPL to gross loans ratio for emerging markets – Brazil (3.1 percent); Russia (7.4); India (4.2); China (1.7).

[43] The middle-income trap is a situation where a middle-income country (due to given advantages) will get stuck at a certain level as i) the increase in wages makes the country lose its competitive edge in the exportation of manufactured goods and ii) the country is unable to compete with more developed economies in the high-value-added market.

[44] Source: The Banks Association of Turkey (TBB), 2016.

[45] Over January-September 2015, total taxes on profits of corporates stood at TRY 24,486mn of which TRY 1,766mn were the total taxes paid by the banking sector. Taxes paid by banking sector as a percent of total corporate taxes on profits, are calculated assuming ‘taxes, duties, and charges’ on the income statement as percentage of total taxes on the profits of the corporates. Comparing this with CBT‘s reported nominal GDP of Turkey in September 2015 – TRY1,446bn; total corporate taxes amount to 1.7 percent of GDP and banking sector taxes amount of 0.1 percent of GDP.

[46] Excluding deposits/participation funds obtained from banks abroad.

[47] Demand, notice, up to (and including) 1 and 3-month maturity, 11.5 percent; up to (and including) 6-month maturity, 8.5 percent; up to 1-year maturity, 6.5 percent.

[48] Hedge accounting under the International Accounting Standards modifies the normal basis for recognizing gains and losses (or revenues and expenses) associated with a hedged item or a hedging instrument to enable gains and losses on the hedging instrument to be recognized in P&L in the same period as offsetting losses and gains on the hedged item.

[49] The banking system has a large structural maturity mismatch: assets (mostly long-term loans) are dominated by long-term maturities, while the large majority of liabilities (mostly short-term deposits) have maturities of less than 3 months. As of September 30, 2015, the net cumulative liquidity gap was USD 203.4bn in up-to-12 months’ bucket, i.e. the difference between assets and liabilities that have duration of 0-12 months.

[50] After the implementation of Banking Restructuring Program in 2001, Turkey registered high GDP growth rates with lower inflation rates than the previous decade. The strengthened financial system became the primary factor for the improvement in Turkey’s economic situation. During 1991-2001, the average GDP growth was 2.87 percent and average inflation was 74.67 percent, whereas during 2002-2008, the average GDP growth increased to 6.35 percent and average inflation decreased to 17.24 percent.

[51] The role of the state banks has increased as compared to the private banks as evidenced by the evolution of the size of their assets as percentage of total banking sector assets. Over 2007-2015, the proportion of total banking assets owned by state banks has increased from 30 to 32 percent, whereas it has decreased significantly – from 56 to 38 – for the private banks: for the same period, the proportion of total banking assets owned by foreign banks has increased steadily from 14 to 30 percent. Over 2007, in absolute figures, the total assets of state-owned banks have increased to USD 260bn in 2015 from USD 151bn in 2007, at a CAGR of 7.0 percent, whereas the total assets for the private banks have increased marginally to USD 308bn in 2015 from USD 280bn in 2007, at a CAGR of 1.2 percent: the total assets owned by foreign banks increased to USD 246bn in 2015 from USD 70bn in 2007 at a CAGR of 17.1 percent.

[52] There are raising concerns about the (mis)management of banks: in 2014, a raid uncovered USD 4.5mn hidden at the residence of Süleyman Aslan, CEO of state-owned Türkiye Halk Bankası; in a separate investigation, Hüseyin Aydın, CEO of TC Ziraat Bankası, the largest government-owned bank, could be heard on leaked recordings approving loans to businessmen who said they were under orders from Prime Minister Erdoğan to buy a media company.