By 2023, the centenary of the founding of the Republic of Turkey, the government of Recep Tayyip Erdogan wants to establish Istanbul as one of the world’s top 10 financial centres, with a $2.6bn complex housing the country’s regulatory bodies as well as national and foreign banks.

But, while the Istanbul International Financial Centre’s promotional materials glitter with computer-generated images of golden skyscrapers, the Turkish banking sector has lost some of its lustre.

After the US Federal Reserve announced in mid-May it would start winding down its $85bn monthly bond buying, prompting an outflow of funds from emerging markets, Turkish bank stocks took a beating.

According to data compiled by Muge Dagistan, an analyst at FinansInvest, Turkish banks’ share prices fell 26 per cent in absolute terms between May 17 and mid-September, or 9 percentage points more than the whole stock market.

As the lira slipped to record lows against the dollar, concerns also mounted that, with an election next year, the central bank had become too wedded to the country’s growth targets to tighten monetary policy. Market participants’ anxiety increased further after the bank, having raised overnight lending rates in July and August, pledged not to do so again until 2014.

Meanwhile, Mr Erdogan’s reaction to protests that engulfed several Turkish cities in June – when he attacked a cryptic “interest rate lobby” and the authorities launched investigations into brokerages and foreign exchange transactions – saw investors and bankers scratching their heads in disbelief.

But, more recently, the banks, many of which enjoy investment-grade status from credit-ratings agencies, have been able to heave a sigh of relief.

After the Fed announced in September that it would continue bond purchases for the time being, bank stocks recovered some of their losses.

Data released in November by Turkey’s bank watchdog, the Banking Regulation and Supervisory Agency (BDDK), revealed that their total assets had increased by 20.3 per cent in the first nine months of 2013, reaching 1,649bn lira ($808bn). Profits rose to 19.9bn lira ($9.8bn), a 16.2 per cent leap from the same period last year.

Although deposit costs, which have been rising since May, ate into banks’ margins, and profits fell significantly in the third quarter, analysts expected a rebound by the end of the year.

That the banks were able to ride out the summertime turbulence in the markets did not come as a surprise.

Ever since a calamitous February 2001 crisis forced Turkey to spend a third of GDP refinancing its banking sector, the BDDK has run a tight ship, imposing strict accounting standards, reserve requirements, and capital adequacy ratios.

Until 2011, when it allowed the Lebanese bank Audi to set up shop, the watchdog had not granted a single licence in more than a decade. It has since issued three more, to the Bank of Tokyo-Mitsubishi UFJ, Italy’s Intesa Sanpaolo and Rabobank, a Dutch bank.

Turkey has also become a hot destination for Islamic finance. “Participation banks”, the religiously neutral name that the government has coined for Islamic banks, reached a combined 90.8bn lira ($44bn) in assets in September, an increase of 29 per cent from 2012, growing 10 percentage points more than conventional banks.

A field that has hitherto included just four players – Turkiye Finans, Bank Asya, Kuveyt Turk, and Albaraka Turk – is about to get bigger. State-run Ziraat and Halkbank plan their own sharia-compliant units.

However, averse to fresh interest rate rises, the government has attempted to temper a credit boom by way of more regulations on banks. With rates low, loans have risen by roughly 30 per cent over the past year, to more than 1tn lira, double the central bank’s 15 per cent target.

Asset quality shows visible signs of deterioration. Non-performing loan (NPL) ratios are still some of the lowest in Europe, but the volume of NPLs is rising fast – up 53 per cent since the end of 2011 to 28.6bn lira.

The savings rate, meanwhile, has dipped to a new low of 12.6 per cent of GDP.

This year, Mr Erdogan, seemingly out of the blue, warned Turks of the risks of credit card loans – up by some 86 per cent since 2010, according to Moody’s Investors Service.

“Those credit cards; don’t have them,” he said. “If everybody spends as much as [banks] want them to, they won’t even be able to earn that income.”

Yet, any illusion that the prime minister’s remarks had been a mere flight of fancy was put to rest in October, when the BDDK introduced new caps on credit card borrowing and spending limits, and increased the minimum threshold for monthly payments.

The new rules are expected to cut into banks’ profits by several percentage points.

With a nod to Turkey’s gaping current account deficit, Ali Babacan, deputy prime minister, recently made clear that more regulation was in the pipeline.

“If loans are issued to increase exports, production and investment, and to support small and medium-size enterprises, we will say ‘yes’,” he said.

“However, we will say ‘no’ to loans that are issued for the sole purpose of increasing consumption, as the exhaustion of such a measure will only harm our economy.”

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