Turkish banks faced a challenging year in 2015. Political uncertainty at home and ambiguous central bank policy abroad put pressure on banks' financial performance. This mainly comes from a weak Turkish lira, which has lost 26% of its value against the dollar this year according to Fitch Ratings, and slow lending growth. Some relief for banks share price materialized following the victory by the ruling AK party in the November 1, 2015, national elections. The Finans Asset Management Large-Cap Turkish Bank Index rose 10.5% the day after the election, but the sector still faces other challenges.
Turkish Lira Weakness
One of the main challenges facing Turkish banks is the high cost of domestic deposit funding. According to Bloomberg, Turkey has one of the lowest levels of household savings among the world’s 20 most industrialized nations (G-20). This means banks have to pay up to get people to make deposits. Additionally, those who do have bank savings tend to hold their savings in short maturity time deposits so that their money isn’t locked away for too long or at an uncompetitive interest rate. This forces banks to offer even higher interest rates on lira accounts to attract and retain deposits. It also means banks tend to offer higher interest rates on short-term deposits, driving up annualized borrowing costs.
Alternative Funding
The low level of domestic deposits forces Turkish banks to seek out alternative lending sources. Alternative lending mainly comes from short-term foreign currency borrowing. Turkish banks' high reliance on foreign currency funding makes them vulnerable to changes in foreign central bank policy. As explained in the bne IntelliNews’ 2015 Bank Survey, “The Turkish banking sector is highly dependent on external funds because of low saving rates in the country. Turkish lenders have not faced obvious problems in foreign borrowing yet, although the US Federal Reserve’s expected rate hike could curb capital flows to emerging markets, with Turkey seen as amongst the most vulnerable to that.” (For more information see, How a Strong US Dollar Can Hurt Emerging Markets.)
Slowing Loan Growth
In October, Moody’s, a credit rating company, drew a similar conclusion saying that Turkish banks may slow their lending in 2016 because foreign currency funding will likely become more expensive. Moody's says most foreign currency funding in Turkey is short-term and may become scarcer over the next 12 to 18 months as higher rates in the U.S. will likely result in weaker flows of international funds into emerging markets such as Turkey.
To some extent, this is already happening. Bloomberg reports that growth in consumer loans fell to about 13% year-on-year in September 2015, which is less than half the average pace since 2012. Data from the IMF shows Turkey’s annual average credit growth was around 26% from 2003 to 2012.
State Banks Better Positioned
Turkey has three banks that are either mostly or entirely state-owned (Ziraat Bankasi, Turkiye Halk Bankasi, and Turkiye Vakiflar Bankasi). These banks seem to be better protected from some of the challenges facing the wider banking sector. For example, according to Fitch Ratings, only state-owned commercial banks are eligible to receive savings deposits from certain state-owned companies. This means stable state-related deposits represent a high 30% of total deposits at Vakifbank and around 20% at Ziraat and 16% at Halk, according to Fitch. It also means these banks don’t face the same challenge of attracting and retaining domestic deposits that other Turkish banks do. This reduces their reliance on foreign funding.
Fitch also believes that there is “a high probability of support from the Turkish sovereign in case of need” for state-owned banks, according to a press release published when the three banks’ investment grade ratings were confirmed at the end of October. On the other hand, Moody’s has an overall negative outlook for Turkey’s banking system, citing “subdued economic growth and currency volatility that will reduce growth opportunities for banks and impair borrowers’ ability to service their loans.”
The Bottom Line
The victory of the ruling AK party in the November 1, election reduces political risk in Turkey, but the real challenges for the banking sector may come from the US Federal Reserve Bank’s interest rate policy. Turkish lending still exceeds banks’ capacity to fund that lending from customer deposits alone. This means Turkish banks remain vulnerable to rising foreign currency borrowing costs. A weak lira isn’t helping either and is pushing up domestic borrowing costs. State-owned banks are more insulated from some of these challenges but are still exposed to potentially rising foreign borrowing costs. Moody’s outlook for the Turkish banking sector has been negative for two years now, and it seems 2016 could be more of the same.
