Although the political climax in Turkey over the last 1 year caused reluctance in foreign investments, the Turkish financial sector is on the rise due to outstanding breakthrough of the financial indicators despite the volatility in the Turkish currency in the first quarter of 2017. The regulatory measures taken by the governmental authorities have a major role in the development and growth in the financial market.
Basel Compliance History of the Turkish Market
After the significant volatility in Turkish currency and foreign exchange markets during the late 1990s that led to profitability and liquidity issues, the Turkish banking sector has undergone various structural adjustments to strengthen the capital and liquidity adequacies in line with the international standards.
The Turkish banking system entered a new phase as of 1989 with the harmonization with the first Basel accords followed by the second Basel accord aiming to provide safeguards for the economic stability and solvency of banks by establishing risk and capital management requirements in the year 2012.
In order to further strengthen bank capital requirements through micro-prudential regulation and supervision and introduce more regulatory requirements on bank liquidity and bank leverage, adding a macro-prudential overlay that includes capital buffers, Turkish banking legislation has been brought in accordance with the Basel III requirements as of 20131 with the promulgation of (i) the Regulation on the Own Funds of Banks2 ("Regulation on Own Funds"); (ii) the Regulation on the Capital Maintenance and Cyclical Capital Buffer3; (iii) the Regulation on the Calculation of Banks' Liquidity Coverage Ratios4 and the amendment to the Regulation on the Measurement and Evaluation of the Capital Adequacy of Banks5 ("Capital Adequacy Regulation").
A Market with High Liquidity and Solid Capital Levels
The underleveraged Turkish banking sector, with its high liquidity, solid capitalization, asset quality, is the second largest in emerging Europe with a strong growth potential. Over time, the regulatory framework on risk-based capital and liquidity adequacy has been periodically updated to include Basel III requirements and standards and was further amended in August 2015 and January 2016.
The Basel compliant risk-based capital adequacy legislation framework entered into force in 2006; however, the minimum capital adequacy (including both Tier I and Tier II capital) standard ratio of banks is set as 8% since 1998 in Turkey. Parallel with the Basel compliance process, such minimum ratio found its way in great detail under the Capital Adequacy Regulation whilst the minimum equity capital (consists of Tier I Capital and Additional Tier I Capital) adequacy ratio is set as 6% and minimum Tier I capital ratio is set as 4,5%. The Banking Regulation and Supervision Agency ("BRSA") is authorised to increase such ratio taking into consideration internal systems, assets and financial conditions of the banks and to impose different minimum statutory capital adequacy ratios to different banks.
The BRSA announced a target capital adequacy ratio of 12% in 2006 and banks are expected to achieve and maintain a capital adequacy ratio that is higher than 12%. In addition, banks in Turkey are also required to implement an Internal Capital Adequacy Assessment Process ("ICAAP") which shall be used to internally calculate the capital adequate to cover current and future risks by banks. Specifically, the ICAAP for each bank shall assess its internal capital adequacy level and produce an internal capital requirement ratio based on that bank's risk profile and appetite and the volume and complexity of its transactions. In the calculation of such internal capital requirement ratio, banks shall include both internal capital requirements based on risks not captured by the statutory capital requirements and a capital planning buffer amount determined on the basis of stress tests and scenario analysis.
Thanks to the BRSA regulatory revolution over the years, the Turkish financial sector reached high capital adequacy levels as of March 2017, the capital adequacy ratio of the Turkish financial sector hit 16.1% consisting of high quality assets (85% qualifies as Tier I)6. Basel Committee on Banking Supervision Regulatory Consistency Assessment Programme ("RCAP") assessment team also determined and announced in its March 2016 report on assessment of Basel III risk-based capital regulations that Turkey is in compliance with the Basel risk-based capital standards with all underlying components following the last updates in the legislation took place in August and January 20167.
As in the risk-based capital adequacy legislation framework, the BRSA together with close cooperation and coordination with the Central Bank of the Republic of Turkey ("CB") conducted various revisions in 2015 and 2016 under the existing liquidity coverage ratio regulations in Turkey as well as enacted new ones in order to further strengthen the implementation of Basel III liquidity coverage ratio. As such, under the regulatory framework, two types of liquidity adequacy ratios are set forth that banks must comply with: overall liquidity adequacy ratio (100%) and foreign currency denominated liquidity adequacy ratio (80%) which are calculated for various maturity segments. The BRSA has a wide discretion to implement measures in cases where adequate levels of liquidity is not maintained by banks or not complied with the rules applicable to such ratios.
Furthermore, the CB provides an additional support on core liabilities of banks in the Turkish market in order to strengthen balanced growth and domestic savings where banks achieve core liability ratios higher than the average core liability ratio of the sector would benefit from higher interest rates applicable to deposits deposited at the CB as mandatory reserves8. The CB quarterly determines separate core liability ratios to be applied based on sectors, bank groups and banks and to be calculated taking into account of the aggregate of total deposits + own funds of banks as well as banks' total loans.
As a result of regulatory developments, the RCAP assessment team has also reported and announced that the final liquidity coverage ratio regulations in Turkey are in compliance with the minimum Basel liquidity coverage ratio standard and requirements as of 20 January 2016 with all graded components of the liquidity coverage ratio framework, including the high-quality liquid assets, the liquidity inflows and outflows and disclosure requirements9. It is determined the significant percentage of financing in the banking sector in Turkey comes from deposits (56% of the total assets in March 2017) in addition to having easy access to international funding sources. As such, banks in Turkey are capable of rolling-over their liabilities without encountering major problems and thus are operating with comfortable liquidity adequacy levels. It is announced that the total liquidity coverage ratio of the four main private Turkish banks is 110% as of March 2017, whilst the minimum required liquidity adequacy ratio for 2017 is determined 80%.
Use of Subordinated Loans and Debt Instruments in Capital Boost
The legal framework enacted by the BRSA also allows for one of the most well-known and preferred capital boosting methods utilized globally by the financial institutions: liability conversion into capital.
This method found its way in Turkish banking legislation under the Regulation of Own Funds with respect to unsecured and subordinated loans and debt instruments ("Subordinated Products"), the initial maturity of which should at least be five years amongst other requirements set by the BRSA. The Regulation on Own Funds stipulates that any such Subordinated Products which fulfil the criteria set forth thereunder will qualify for initial treatment as Tier II capital following the approval of the BRSA.
In order to support Tier II Capital for the purposes of meeting the minimum capital adequacy standard ratio of 8%, whilst paying regard to the minimum Tier I Capital ratio of 4.5%, a bank may obtain subordinated loans from the market or issue debt instruments complying with the conditions set forth by the BRSA. As a side benefit of capital boosting through the use of Subordinated Products, banks may also increase their lending limits by elevating their Tier II Capital to facilitate the lending activities and consequently, profit generation. Recent data on Turkish financial sector reveal that there is an increasing tendency in the use of Subordinated Products for these purposes.
In conclusion, the regulatory reforms undertaken by the BRSA throughout 2015 and early 2016 have significantly strengthened the Turkish banking market and substantially improved its compliance level with the Basel standards. Not only had these reforms enhanced the trust, stability and growth, they also enabled Turkish banks to maintain high profitability levels. Accordingly, Turkish banks' net profit hit $8.6 billion net profit in the first seven months of 2017, as declared by the BRSA.
- See the report of the Ministry for RU Affairs, available at http://www.ab.gov.tr/files/EMPB/web_dosyalari/bddk_basel_iii_internet_icerigi.pdf
- Published in the Official Gazette dated September 5, 2013.
- Published in the Official Gazette dated November 5, 2013.
- Published in the Official Gazette dated March 21, 2014.
- Published in the Official Gazette dated October 23, 2015, as amended.
- See the BRSA report, available at https://www.bddk.org.tr/WebSitesi/turkce/Raporlar/TBSGG/16031tbs_temel_gostergeler_raporu_mart_2017.pdf
- See the RCAP report, available at http://www.bis.org/bcbs/publ/d359.pdf?utm_source=BIS+-+All+categories+-+daily&utm_campaign=c60efcd5df-RSS_EMAIL_CAMPAIGN_RSS_ALL_CATEGORIES&utm_medium=email&utm_term=0_9691579743-c60efcd5df-93556757
- See the Circular of CB, available at http://www.tcmb.gov.tr/wps/wcm/connect/2658a7fd-007f-43f7-a846-cd3f0b7dd8fa/Teknik+Ayrintilar.pdf?MOD=AJPERES
- See the RCAP report, available at http://www.bis.org/bcbs/publ/d360.pdf?utm_source=BIS+-+All+categories+-+daily&utm_campaign=c60efcd5df-RSS_EMAIL_CAMPAIGN_RSS_ALL_CATEGORIES&utm_medium=email&utm_term=0_9691579743-c60efcd5df-93556757