Banking Regulation and Supervision Agency

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1 Banking Regulation and Supervision Agency TURKISH FINANCIAL SYSTEM: THE REVIEW OF 1 AND TRENDS 1 Strategy Development Department April, 1 Global economic outlook enters a relatively positive phase with the help of tapering short-term risks; nevertheless, global risks such as low growth, high unemployment and public finance fragilities persist in medium term. While the measures taken in the USA and EU contribute to the recovery in financial market conditions as of the last quarter of 1, the strong economic activity by emerging economies contributed a proportional recovery in global output. Nevertheless, in medium term, global risks such as low growth, high unemployment and public finance fragilities continue to persist. As a matter of fact, it has been entered into a stage that the feature of the problem of balancing of enduring fiscal consolidation requirement in developed economies with growth has acquired a structural nature for this period. Within this framework, fundamental fragilities in developed economies and the requirements for structural measures towards the mentioned fields are still justifiable. Together with the monetary expansion and the reduction of the pressure on financial markets, cross border banking activities increased. Within this scope, short and medium-term effects of the USA and EU-based monetary expansion on global capital flows needs to be monitored closely and macro financial policy conduct which was successfully carried out by emerging economies until now needs to be maintained with a medium-term view (Figure 1,,,). Contact: sgd@bddk.org.tr In Turkey, the implemented macro prudential policies enabled macro variables to maintain a sustainable balance in 1. The improved financial stability during 1 is mainly attributable to the measures towards increasing the fiscal discipline and national income, the policies towards stimulating domestic savings, flexible monetary policy and implementations limiting the strong loan demand. Along with the measures towards reducing the domestic demand, the balance between domestic and external demand improved which in turn increased the contribution of net exports to the GDP. Annual growth rate realized as.% by September 1 paving the way for the decoupling between annual growth rate and average global growth to decrease. The developments in deseasonalized production and capacity indicators as well as improving expectations in real sector and consumer sector indicates a stronger domestic demand in 1, compared to the previous year. Furthermore, despite the strong reserves, the continuation of global risks, short-term capital flows, upwards trend in real exchange rate level, requires the preservation of macro prudential approach in 1, as well. In this regard, the need for prudential approach for loan expansion elevates given the fact that the relative importance of domestic demand will increase while reaching at the % growth target foreseen in Medium-term Program for 1. The long term positive correlation between current account deficit and consumer loans put forward in studies with implementation implies that selective approaches in loan policies for 1 would be appropriate (Figure,,7,). 1 This report contains the analysis given in Financial Markets Report published by BRSA in 1 March 1. The full publication in Turkish can be downloaded at This report is for public information. The BRSA cannot be held accountable for any decisions taken based on the information and data provided therein. The report may be used upon proper citation.

2 The Risks of Household and corporate sectors are well within manageable levels. The ratio of household financial liabilities to financial assets increased to.% as of December 1 while the ratio of liabilities to GDP increased to 17.% (Figure ). Under the conduct of prudential policies, these ratios are expected to increase at a moderate rate. Although the share of short-term FX net open position to total net position in corporate sector is at a negligible level, the long-term FX open position remains flat. Thus while the ratio of FX assets to liabilities decreases, the exchange rate risk for corporate sector maintains its significance. Furthermore, the size of loans from abroad, with a maturity of less than one year, reached to USD. billion of which 9.% belongs to nonfinancial institutions (Figure 9,1). While asset growth and organizational expansion of financial sector continues, the diversity of financial products broadens and regulatory framework is improved regarding to market conditions. As global markets recover, Turkish financial sector with its good performance and growth potential, continued to attract the interest of foreign capital. While organizational expansion and employment increase sustained in financial sector, the customer network expansion is achieved by ameliorated technological infrastructure which is supported by operators providing applicable solutions to financial institutions. Issuance of new financial instruments in compliance with favorable market conditions and increased demand has helped the deepening of the markets. It is expected that the new regulations made by the CMB will encourage domestic borrowing markets and increase the interest of foreign investors (Figure 11,1,1,1,1,1). While banking sector grows by loans, the share of nondeposit resources continues to increase. Total assets of banking sector reached TL 1. trillion at the end of 1. Loans continued to be the most important item in banks' portfolio, increasing by 1.% last year. In order for the loan growth not to harm the financial stability, the close cooperation with collaborators will also be uninterrupted in the following period. Monetary policy of the CBRT along with the opportunity of holding legal reserves in the form of gold and/or FX resulted this item to be significant among assets (Figure 17). Banks policies towards diversifying the funding structure increased the share of nondeposit resources in liabilities (Figure 1). The abovementioned efforts had positive effects on lengthening the maturity structure and managing the operational costs. A relatively moderate growth was experienced in off-balance sheet transactions in 1. The revocable unused credit lines are the major factor for the increase in off-balance sheet transactions (Figure 19). The increase in net interest incomes amplified the period profit. Banking sector completed the year 1 with a profit of TL. billion. Net interest incomes, realized as TL. billion, were the main source of the profitability. The decline of interest rates which partially rebounded on deposit interests, had a positive impact on profits by limiting the sector s interest expenses. The fact that banks non-interest incomes are steadily increasing and that they put their operational costs under control is critically important for them to protect their competitive advantage and making their profitability sustainable (Figure ). In parallel with soft landing in economic activity, NPL ratio rose marginally in 1. The.% of total loans are composed of personal loans, while % thereof are SME loans and 1.% thereof are corporate and commercial loans. The share of large loans allocated by the banking sector within total loan amount is decreasing. This is considered to be positive in view of the decrease of risks which may arise from credit concentration. In 1, the sector s non-performing loans increased by.% to TL. billion. NPL ratio of loans (NPLR) is.% as of December 1. The increased asset written-offs by banks limited the increase of NPLR. When these writeoffs are considered, NPLR increases to.% (Figure ). These write-offs by banks, improved the NPLRs while reducing total profits. The fact that in the following quarter the ratio of non-performing loans amongst performing loans stock and the ratio of loans and receivables with limited collectibility to that with doubtful collectability raised indicates that there is a slight deterioration in the credit quality. On the other hand, this deterioration is considered to be temporary because the collection from non-performing loans in the following quarter has tended to increase after the first quarter of 1 (Figure ). In annual basis, the NPLR of personal loans decreased except for retail loans. Amongst personal loan types, the highest NPLR still belongs to credit cards. However, with also the effect of measures taken by the BRSA concerning credit cards, NPLR reduced both in quarterly and annual basis while the lowest ratios in recent years have been caught. Using credit cards consciously and in line with its true purpose will

3 contribute positively to the increase of credit quality in this area and to the decrease of the sector s credit risk in general (Figure,,,7). The sector s liquidity risk is at a manageable level. Liquidity ratios belonging to the first (-7 days) and second (-1 days) maturity tranches are significantly above the minimum limits (Figure ). In the period after the global crisis, the improvement of banking sector s asset quality, banks focus on sustainable profitability and the policies of the BRSA and CBRT have contributed banks to maintain a manageable liquidity risk level. Decisions taken in 1 concerning the increase of required reserves, coefficient changes of Reserve Option Mechanism (ROM) and the decrease of finance provided by repo have affected positively the sector s liquidity adequacy ratios. The sector s most important funding source is still deposits while the place and importance of security issuance in banks resource supply are increasing. Differentiation of legal reserves according to the maturity, has helped to increase the average maturity of deposits. The average maturity has elevated from days to its current level of 7 days in the last two years. The shortness of deposit s maturity and the fact that a little number of customers own the majority of total deposit are areas to be ameliorated bearing in mind their potentials to create liquidity risk (Figure )..In 1, total amount of securities issued by the sector increased by 1.% comparing to previous year and reached at TL 7.9 billion. About.% of the securities issued are composed of bonds,.% of bills and 1.% of asset-backed securities (Figure 1). As of December 1,.% of these securities are FXdenominated. The increased interest of foreign capital based on the confidence towards Turkish banking system along with income and liquidity advantages provided to the investors, particularly in tax area are the major factors making security issuance attractive. Debts granted from financial institutions abroad are contributing to the maturity structure of the liabilities and to the diminution of liquidity risk. As of December 1, the share of this type of debt is 1.% of total liabilities with average maturity of.7 years (Figure,,). Market risk is basically composed of general interest rate risk and exchange rate risk. Banking sector s market risk is basically composed of general interest rate risk and exchange rate risk. The risk originated from these two risk factors is composing.1% of total market risk (Figure ). Trading portfolio which is the main source of interest rate risk is mostly composed of government bonds and Eurobonds. Due to the decrease occurred in government bonds portfolio compared to previous trimester, the interest rate risk reduced. Exchange rate risk is generally composed of on-balance sheet USD and EUR open positions and increased by.% as to the previous period (Figure ). The change of interest rates may potentially create losses because of the general market risk as well as the maturity mismatch of banking accounts. Due to the decrease of interest rates and the shorter maturities of the liabilities, the sector s interest costs decreased faster than its funding rates. Thus, the interest margin slightly increased. The sector s interest rate gap (GAP) concentrates generally on maturity up to one month and maturity between one to three months (Figure 7). The sector mostly carries out derivative transactions based on foreign exchanges, 7% of which is composed of swap transactions. Derivative transactions are mostly fulfilled between banks and over-the-counter (OTC) markets. Derivative transactions carried out with natural persons are composing % of total derivative transactions. For dual currency deposit transactions made with natural persons, customers should be sufficiently informed about risks which may arise from these transactions. The 79% of derivative transactions are fulfilled with residents abroad, especially with that of England (Figure ). In the last quarter of 1, the growth rate of risk weighted assets realized below the growth rate of own funds as a result of macro-prudential measures. In parallel with the increase in risk appetite of the sector in 1 and 11, the growth rate of risk weighted assets is over the growth rate of own funds. On the other hand, macroprudential policies brought about a slow down of the growth rate of risk weighted assets to the levels below the growth rate of own funds (Figure 9). A large share (. %) of own funds is comprised of Tier 1 capital (Figure ). The sector s capital adequacy ratio is 17.9% as of December 1. The fact that the growth rate of risk weighted assets remained quite behind the growth rate of own funds created an increase by 1. points in CAR in the last quarter of year. In this period the growth rate of the amount subject to credit risk decreased when compared to previous quarters. Along with the fact that rating grade of Turkey increased to investable category in November 1, the fact that Eurobonds issued by

4 the Treasury subjected to % risk weight instead of 1% risk weight, has limited the increase in the amount subject to credit risk. The amount subject to market risk by the year-end decreased due to the fact that capital requirement calculated for interest rate risk decreased by the effect of the decrease in interest rates and the shrinking occurred in securities portfolio. The.% of own funds is comprised of Tier-I capital items which are accepted to have the highest level of loss compensation capacity. It is expected that the BRSA implementations that requires banks to leave the profit within the bank and limit the amount of profit to be distributed, shall increase the own fund quality further by creating a significant increase in reserve funds in the first quarter of 1. Income creation capacity of sector assets and return on assets and own funds increased comparing to the previous year. Turkish banking sector s net profit has reached the amount of TL. billion by the end of 1. Net profit improved by TL.7 billion comparing to the same period of the previous year. The upsurge in the net profit resulted basically from the increase in net interest margin. Maturity mismatches in the balance sheet has been influential in the increase of net interest incomes in an environment that interest rates fall. Besides, the fact that the sector created cost efficiency by incrementally using non-deposit liabilities has also been effective in the upsurge of net interest incomes. The change occurred in favor of expenses is distinctive in the non-interest income versus expense balance in the last quarter. Although growth of the operational expenses is the major factor behind that change, the general and special provision amounts in the last quarter have realized higher comparing to the previous quarters. Also the fact that the loss from capital market transactions reached to the level of TL. billion by the end-1, has negatively affected the profitability. However, the income creation capacity of the sector assets as well as ROA and ROE improved basically by the effect of expansion occurred in net interest margin (Figure 1,,,). It is estimated that capital adequacy shall remain upon the target ratio even as a result of assumptive shocks and macro crisis scenario, within the scope of stress test implementation a result of the shocks implemented to interest ratios, decrease by.7% and.% maximum occurs emanating from fixed interest government bond and Eurobond portfolios. Rate of exchange increase by % that occur on USD and EUR rate of exchanges would decrease CAR of the sector to 1% (Figure ). The shocks that may occur in interest rates may cause loss in TL positions in parallel with interest decreases in maturities other than up to one month on banking accounts due to maturity mismatches between TL, USD and EUR denominated assets and liabilities. The decrease in interest rates can cause profit in USD positions up to three months and in EUR positions in maturities up to one year (Figure 7). The development of macro economical variables was estimated in macro stress test realized for banking sector, by taking into account of crisis scenario depending on contraction assumption for two consecutive years besides the basis scenario. For the baseline scenario, GDP growth ratios forecasted in Medium Term Program (MTP) are used. For the crisis scenario, for first year two standard deviations (7.% contraction) are used; for the second year, Macro Scenario Model produced by Vector Autoregressive Model (VAR) in which one standard deviation (contraction by 1.%) shock was implemented. In both the crisis and the basis scenarios, loan expansion rate, NPL ratio and CAR were estimated. As a result of stress test results, in case that crisis scenario, the loan expansion, NPL ratio of loans and CAR shall realize by 1.%,.% and 1.% respectively (Figure,9,). Non-bank financial sector continues to expand. Total assets of non-bank financial sector increased by 17% in the last quarter of 1 as to the same period of the previous year. It is expected that the sector which achieved a stronger legal base by Financial Leasing, Factoring and Financing Companies Law entered into force in December 1, 1, shall carry out its activities more efficiently. When observed on sectoral basis, the increase in total assets is realized as % in asset management companies, 1% in financing companies, 1.1% in factoring companies and.7% in financial leasing companies as to the same period of the previous year (Figure 1,,,,,). Even losses by 1% and % probable to occur in loans in scenario analysis made for financial risks which the banking sector entertains would decrease the CAR of the sector by 1.7% and 1.19% levels respectively, it continues to remain above the target ratio by 1%. As

5 Q1 1Q 1Q Q1 Q Q Q 9Q1 9Q 9Q 9Q 1Q1 1Q 1Q 1Q 11Q1 11Q 11Q 11Q 1Q1 1Q 1Q 1Q P 1P 1P FIGURE 1: Global Growth Outlook 1 Growth FIGURE : TARGET Imbalances 1 Euro Billion Germany Finlandiya France Portugal TARGET Imbalances Holland Spain Italy World Trend (world) Advanced Trend (Adv.) Emerging Trend (Emer) FIGURE : Regional Capital Market Indices (pts) Capital Market Indices FIGURE : TRL Carry Trade Possibilities 1 Carry Trade Possibilities TRL long position 1. 1 MSCI_World MSCI_EM MSCI_EU (Right Axis) - -1 JPY EUR USD CNY FIGURE : Contributions to GDP Growth (pts) Net Exports Stock Chang. Investment Consumption GDP Growth (Right Axis) Unemployment (Right Axis) FIGURE : Current Account Balance and Components 1 USD Billion Annualized Data G-Bonds Equity - Other Sectoral Loans Banks Deposits Portolio FDI CAD - FIGURE 7: Developments in Consumer Loans 1 1 Consumer Loans Annual Growth of C. Loans (Right Axis) Annual Growth of Retail Crd. Cards(Right Axis) FIGURE : Household Balance Sheet HH Liab.s,,, HH Assets Liab./Assets(Right Axis) HH Liab./GDP (Right Axis) 1, 1, 1, 1, 1,9 17, 1 1

6 1Q1 1Q 1Q 1Q 11Q1 11Q 11Q 11Q 1Q1 1Q 1Q FIGURE 9: FX Position of Corporate Sector 1 USD Billion Long Term Net FX Pos. Short Term Net FX Pos. FX Assets /FX Liabs. (Right Axis, %) FIGURE 1: Corporate Sector Balance Sheet Financial Assets Financial Liabilities 1 Fin Liab. /Fin. Assets (Right Axis) FIGURE 11: Distribution of Employment by Financial Institutions Banks Faktoring Ins. Leasing Ins. Financing Ins. Asset Management Ins. 9 Intermediary Ins. Insurance Ins. Reinsurance Ins. FIGURE 1: Number of Customers: Banking Sector. Thousand Part.Bnk.Fund(Right) İnternet B.(Right) Mobile B.(Right) Deposit Credit Credit Card Bank Card FIGURE 1: Number of Customers: Capital Markets. Thousand... Private Pension System. Share Stock 1. Investment Fund 1. FIGURE 1: Distrubution of Investment Instruments: Residents 1% % % % % TL Deposit FXDA Precious Metal Acc. Part.Banks Funds GDS Eurobond Stock Investment Funds Bonds&Bills (Private) Repo % FIGURE 1: Distrubution of Investment Instruments: Non-Residents 1% % TL Deposit FXDA Precious Metal Acc. Part.Banks Funds GDS Eurobond Stock Investment Funds Bonds&Bills (Private) Repo FIGURE 1: The Asset Size of Financial Sector.. Other Financial Institutions Banks 1. ISE (Kapitalizasyon) CBRT 1. %

7 Q1 Q 7Q1 7Q Q1 Q 9Q1 9Q 1Q1 1Q 11Q1 11Q 1Q1 1Q FIGURE 17: Banking Sector Assets ,9 79, FIGURE 1: Banking Sector Liabilities 1 771, , 9,1 Cash& Rec.from Banks 7,9 7 Securuties Portfolio Loans 1, 99, Required Reserves Deposits 1, 1, Payables to Banks 7, 79,9 Funds from Repo 1, 11, Shareholders' Equity FIGURE 19: Off Balance Sheet FIGURE : Interest Incomes and Expenses Contingencies Commitments Off Balance Sh./Balance Sh.(Right axis) TL Billlion Int.Income Int.Expenses Non Int.Income Non Int.Expenses Profit (Right axis) 1 1 FIGURE 1: Outlook of NPL Uncollectible Loans and Receivables Loans and Receivables with Doubtful Collectibility 1 Loans and Receivables with Limited Collectibility Total NPL 1 FIGURE : Outlook of NPL Ratio NPLR 1 NPLR (including erased from assets) 1 FIGURE : Ratios Relating to NPL 1, 1, 1, 1,,,,,, Addition to NPL / Performing Loans Collection from NPL / NPL (Right Axis) FIGURE : Outlook of NPL Ratio by Loan Type 9 SME Retail Commercial 7 1 7

8 m m 9 m 1 m 1 m 1 m 1 m m 7 m m m m FIGURE : Outlook of NPL Ratio by Retail Loan Type 1 Housing Vehicle 9 Personal Finance Credit Cards FIGURE : Vintage Analysis of Retail Loans 7 Default Rate FIGURE 7: Sectoral Outlook of NPL Ratio Individual Services Agriculture Industry Other (Right Axis) 1 1 FIGURE : Outlook of Total Liquidity Adequacy Ratios TOTAL LAR First Maturity Tranche 7 Second Maturity Tranche Minimum Level FIGURE 9: Other Liquidity Ratios Liquid Assets / Short Term Liabilities Liquid Assets / Total Assets Fixed Assets / Total Assets (Right Axis) FIGURE : Maturity Structure of Deposits 1 At Call Up to 1 month 1- months - months -1 months Over 1 year Average Maturity (Right Axis) Day FIGURE 1: Development of Securities Issued by Turkish Banks ABS Bill Bond 1 1 FIGURE : Syndication and Securitization Loans $ Billion Securitization Syndication Total 1 1

9 7/Q1 7/Q 7/Q 7/Q /Q1 /Q /Q /Q 9/Q1 9/Q 9/Q 9/Q 1/Q1 1/Q 1/Q 1/Q 11/Q1 11/Q 11/Q 11/Q 1/Q1 1/Q 1/Q 1/Q FIGURE : Liabilities to Financial Institutions Abroad 1 1 $ Billion Other Subordinated Loans Repo Securitization Syndication Deposit Other Loans FIGURE : Maturity of Liabilities to Financial Institutions Abroad 1, 1, 1, 1, 1,, 11, 1 Share in Total Liabilities 1, 9 Average Maturity (Right Axis) 1,, 7, FIGURE : Market Risk Components Commodity Risk Equity Risk Exchange Risk General Interest Rate Risk 1 FIGURE : Trading Book Ingredients Others Stocks and Mutual Funds Eurobonds Gov. Bonds 1 FIGURE 7: Interest Margin and Its Components 1 Funding Rate (1) 11 Interest Cost () Interest Margin () FIGURE : Currency Based Financial Derivatives and IRSs TL Million Currency Swaps Currency Options Currency Forwards Total Currency Derivatives 1 IRS (right axis) FIGURE 9: Tier 1, Own Funds; RWA Quarterly Change Tier 1 Own Funds 1 Risk Weighted Assets 1 FIGURE : Own-funs, Tier 1 and Risk Weighted Assets Tier 1 Own funds Risk Weighted Assets 9

10 7/Q1 7Q 7/Q 7/Q /Q1 /Q /Q /Q 9/Q1 9/Q 9/Q 9/Q 1/Q1 1/Q 1/Q 1/Q 11/Q1 11/Q 11/Q 11/Q 1/Q1 1/Q 1/Q 1/Q FIGURE 1: Interest Income and Interest Expenditure 1 1 FIGURE : Non-Interest Income and Non-Interest Expenditure 1 1-1/Q1 1/Q 1/Q 1/Q -1 1/Q1 1/Q 1/Q 1/Q Non-Interest Income Non-Interest Expenditure Interest Income Interest Expenditure Net Interest Income Net Non-Interest Expenditure FIGURE : Income/Average Assets and Net Interest Margin FIGURE : ROA of the Banks Groups and the Sector,,, 1, 1, Income/Average Assets Net Interest Margin 1 Sector Deposit B. Participation B. Dev.&Inv.B. FIGURE : Credit Risk Sensitivity Analysis , 17, 1,7 1 1, 1 1 Basis Scenario %1 Loss % Loss 1 1,19 Target Ratio t-1 t t+1 FIGURE 7: Sensitivity Analysis on TRY Dominated Banking Book FIGURE : Sensitivity Analysis on Fixed Rate Gov. Bonds Portfolio,,,, 1, 1,,, -, -1, -1, -, -, -, -, Decrease in CAR FIGURE : Credit Growth Ratio Deposit Banks Investmet Banks Total bps. 1. TL Million % % 1,% 1. % M 1-M -M M-1Y % 1% 1% 1,1% 1,% 1,% 1,% 1,% Y-Y Y-Y Y-Y Y-Y Y-7Y 7Y-1Y 1Y-1Y 1Y-Y % % Adverse Scenario Baseline Scenario

11 FIGURE 9: NPL Ratio FIGURE : CAR of Banking Sector,%,%,%,%,%,%,%,% 1,% 1,%,%,%,7% Adverse Scenario,%,%,9%,9%,9% Baseline Scenario 19,% 1,% 17,% 1,% 1,% 1,% 1,% Adverse Scenario 17,% 17,9% 17,% 1,% 1,% Baseline Scenario,% ,% FIGURE 1: Percentage Share in Non-Bank Financial Sector % % 9% % FIGURE : Non-Bank Financial Sector Total Assets TL Million Financial Leasing Companies Factoring Companies Finance Companies Asset management Companies Total Assets 1 Financial Leasing Companies Finance Companies Factoring Companies Asset management Companies FIGURE : Selected B/S Accounts of Financial Leasing Companies 1 1 Receivables NPL Total Assets Loans received Own funds FIGURE : Selected B/S Accounts of Factoring Companies Receivables NPL Total Assets Loans received Own funds FIGURE : Selected B/S Accounts of Finance Companies 1 1 Receivables NPL 1 Total Assets Loans received Own funds FIGURE : Selected B/S Accounts of Asset Management Companies 1 TL Million 1 Loans Received 1 NPLs Received 1 Total Assets Loans received Own funds 11