Turkey: Domestic banking potential breeds foreign sceptics

Turkish banks have always been cautious about foreign expansion. They see too much opportunity at home to consider big investments overseas. But will the growth in Turkey’s international trade force them to broaden their horizons? Published in Euromoney, September 2012

Turkish banks are not a well-travelled group of companies, generally preferring the assured comforts of their home market to taking the risk of stepping out into the wider world. But as Turkey increasingly flexes its political and economic muscles on the world stage, and as domestic growth start to slow, could the country’s banks become more adventurous?

There are 44 banks in the country according to the Banks Association of Turkey. Between them they have more than 10,000 branches, but just 76 of these are abroad. On top of that a number of banks have international subsidiaries and representative offices in key overseas markets, but the figures nonetheless offer a clear indication of just how cautious Turkish banks have been.

It is not hard to see why. The Turkish banking market is profitable and has been growing at a healthy rate, so it makes sense for institutions to exploit the opportunities at home before taking the risk of moving into more unfamiliar surroundings.

According to Akbank, loans in the banking sector increased by about 26% a year from 2006 to 2011, and deposits grew by 18%. Figures from the banks association show that total assets have grown fivefold in the past nine years, from TL212.7 billion ($116.9 billion) in December 2002 to TL1.16 trillion by December 2011. But despite this enviable growth, the market remains underdeveloped.

"The Turkish banking sector has been a dynamic one and it is under-penetrated so there is still potential to grow domestically," says Gulcin Orgun, senior director for financial institutions at Fitch Ratings in Istanbul. "They have no urgent need to diversify their lending franchise outside Turkey."

According to Yapi Kredi, Turkey’s fourth-largest privately owned bank by assets, at the end of last year there were 132 bank branches in Turkey for every million inhabitants, compared with 462 branches per million in the EU. At the same time, the ratio of loans and deposits to GDP was just 104% in Turkey, compared with 246% in the EU.

The data suggest that the market has plenty of room to grow in both consumer and corporate lending. Corporate loans were 34% of GDP in 2011, and loans to households were 17% of GDP and mortgages just 5%. In comparison, the figures for the EU were 47% for corporate loans, 62% for household loans and 47% for mortgages.

It might seem inappropriate to compare Turkey with the more developed markets of the EU, but it also falls short when set alongside other eastern European countries such as Hungary and Poland, where both household loans and mortgages are higher as a percentage of GDP. Turkey has overtaken both countries when it comes to corporate loans over the past decade, but banks clearly feel there is much further to go.

"Turkey presents a challenging and exciting environment for banking," says Hakan Binbasgil, chief executive of Akbank. "The sector is poised for growth with significant prospects. While the middle class is weakening in other countries, the wealth of the Turkish middle class is rising. We have a young and tech-savvy population. And the relatively low penetration of most banking products implies opportunities. There is an unbanked population of 19 million people."

"We don’t see any growth potential bigger than we have in Turkey," adds Faik Acikalin, chief executive of Yapi Kredi. "The Turkish banking sector is a highly attractive market offering strong growth potential and profitability prospects in the medium term. Most Turkish banks, including us, are focused on exploiting growth opportunities in Turkey."

William Jackson, emerging markets economist at London-based Capital Economics, agrees that the prospects are good for Turkish banks in their home market. But he suggests another reason why their focus is likely to remain on their domestic market.

"There are a number of limitations on Turkish banks expanding abroad," he says. "First, Turkey is probably one of the most attractive countries for banks. It has a high long-run growth potential, good banking regulation and a relatively sound macroeconomic framework, so local banks may prefer to lend domestically rather than expand abroad.

"And second, it doesn’t look like Turkish banks have the foreign currency to spare to expand abroad. In fact Turkish banks have borrowed quite heavily from abroad to fund a domestic lending boom over the past few years."

The way that the growth in loans has been outpacing deposits in recent years means that the banks have had to seek alternative sources of finance to keep pace with demand for borrowing. The scale of the banks’ international borrowing has been clearly evident over recent months, with many of the country’s largest banks agreeing a mix of dollar and euro borrowing from a wide network of international institutions.

In April, for example, Yapi Kredi signed a term loan facility of €864.5 million and $264 million from 44 banks from 21 countries. Two months later, state-owned Türkiye Halk Bankası (Halkbank) signed a one-year syndicated loan for €558 million and $207.5 million with a consortium of 46 banks from 23 countries.

In August, Akbank finalized a €857 million and $450 million one-year loan, which it says will be used for general trade finance purposes. In the same month, Turk Ekonomi Bankasi (TEB) agreed a €250 million and $122 million syndicated loan to be used for the financing of international trade.

The ability of Turkish banks to secure substantial amounts of finance at favourable rates from international lenders points to the strength of both their own operations and their home market. Binbasgil says Akbank’s latest syndicated loan deal was 10 basis points lower, at Euribor and Libor plus 1.35%, than its previous facility agreed in March. "The growing number of lender banks, high roll-over rates and the decline in costs reflect investors’ positive expectations of the Turkish economy and the banking sector in general," he says. "Turkish banks have a very strong reputation in international markets. External debt roll-over ratios are over 100%."

However, there are a few reasons to suggest that Turkish banks could start to stretch their wings and become more adventurous.

Although the domestic market is certainly a vibrant one, it has been showing signs of slowing down. The Banks Association of Turkey says that the growth rate of total assets has been declining since the final quarter of 2011 and the growth of loans has also been easing off. There was an 18% increase in loans in the first half of 2012 compared with the same period last year, but that is down from 31% growth in the first half of 2011. Profits too have been suffering.

"In the past three to four years profit levels have been coming down," says a local industry analyst. "To some extent this is due to increased levels of competition but more fundamentally due to declining interest rates which resulted in lower net interest margins for the banks. Despite that, we haven’t seen any banks book any losses or report any huge collapse in their earnings. Structurally, the Turkish banking sector is still in the growth stage."

On a more positive note, as the syndicated loans recently raised by Akbank and TEB suggest, there is a great opportunity for banks to exploit the country’s ever more confident corporate sector as it breaks into new markets abroad.

Garanti Bank, the country’s second-largest privately owned bank, has also adapted to this trend. It has subsidiaries in Russia, the Netherlands and Romania, representative offices in Germany, the UK and China, and overseas branches in Luxembourg, Malta and North Cyprus. This gives it a more diverse international presence than many of its peers and the strategy behind its overseas expansion is clear.

"Our main attention is to markets with high growth potential, scalable population and strong trade relations with our home country," says Zekeriya Ozturk, the bank’s vice-general manager with responsibility for international business development. "Romania is the only market abroad where we are operating as a universal bank. It is one of the most attractive countries in eastern Europe for investment by foreign companies with its dynamic population of 19 million and openness to innovative new technologies. Furthermore it is an important trade partner for Turkey."

As a member of the EU since January 1 2007, Romania is in many ways a natural trade partner for Turkey. Indeed, Turkey’s trading relations have tended to be dominated by EU states and it has long held an ambition to become a member of the club itself. Ankara first applied for associate membership in what was then the European Economic Community in 1959 and asked for full membership in 1987. Negotiations have gone nowhere since then, however, not least because of differences over the northern third of Cyprus, which Turkey invaded in 1974 in response to a coup backed by the military regime in Athens.

With its EU membership application in limbo, Turkey has been pushing into other markets, both within its immediate neighbourhood of Europe and the Middle East and farther afield into Asia and Africa.

In a speech on July 10 this year, minister of finance Mehmet Simsek pointed out that the share of Turkey’s exports going to Europe had dropped from 56.6% in 2002 to 40.1% for the first five months of this year. Among the regions picking up the slack was the Middle East and North Africa (MENA), whose share of exports from Turkey grew from 12.1% to 30% between 2002 and the period from January to May this year. Asian exports, which include some MENA countries, grew from 14.5% in 2002 to 32.5% over the same period.

There are plenty of other signs of the increasing diversity of Turkish trade. In his speech, Simsek said that the number of countries to which Turkey exports more than $1 billion-worth of goods and services had increased from just five in 2000 to 30 in 2011. And the share of its largest five export markets fell from 46.5% of total exports in 2002 to 33.4% in 2011.

"Trade links between Turkey and many other countries have improved in the past five years," says Tamer Sengün, banking analyst at HSBC Securities Turkey. "The EU is still the largest trading partner but the ratio compared with total trade has come down, so this is creating opportunities from a trade finance perspective." "

There are some changes in Turkey’s relations in the region and in terms of its trading partners," adds Orgun. "Its international trade used to be dominated by Europe, but now there is increasing interaction with countries in places like the Middle East, the CIS [Commonwealth of Independent States] and northern Africa. There is more business to finance in the region and the banks are mainly aiming to serve the Turkish corporates that are doing business in those markets. They mainly can offer project finance loans or act as an intermediary in trade finance transactions and in some markets they also provide some retail banking products locally."

Alongside Garanti, the bank that has perhaps done most to explore the opportunities that the wider world has to offer is Isbank, the country’s largest. It opened its first overseas branches in 1932, in Alexandria and Hamburg, and currently has an international branch network that extends across Bahrain, Georgia, Iraq, North Cyprus and the UK, along with representative offices in China and Egypt and subsidiaries in Germany and Russia.

The last of these came about through the acquisition of the Moscow-based CJSC on 27 April, which was the banks’ first international purchase and gave it a 15-branch operation. Isbank’s latest international branch opening came on July 23 in the city of Batumi, on Georgia’s Black Sea coast, and it is now opening branches in Pristina, Kosovo, and in Baghdad.

Erdal Aral, the bank’s deputy chief executive, says its strategy is to become "a regional bank first, followed by being a global player".

But while it has been exploring the opportunities, it certainly has not exploited the full potential of these markets, keeping its activities to a fairly narrow range of banking services.

"Isbank structures its international presence in line with the globalization of the Turkish economy and of Turkish investors," says Aral. "We aim not only to expand in our core market but also to explore growth opportunities in the geographies where our clients are active. Turkish investors have started to concentrate their investments in neighbouring regions with dynamic demographics, growing consumption levels and strong economic potential. The economic, social and political conditions, the structure and the potential of the banking sector as well as economic relations are the major factors which we consider."

The expansion of Turkey’s trade links around the neighbouring regions of Europe, the Middle East and Asia has gone hand in hand with the more self-assured and prominent role that Turkey has been playing on the diplomatic stage under Recep Tayyip Erdogan, who has been prime minister since 2003.

The country’s mix of multiparty politics, a free-market economy and a majority Muslim population has led many commentators to suggest that the Turkish model could be usefully emulated by Egypt, Tunisia and other post-revolutionary societies. Adding weight to that, Turkey has played a prominent role in supporting some of the Arab Spring uprisings, most notably those in Libya and Syria.

Despite this, Turkish banks appear wary of many parts of the Middle East. They had largely ignored these markets in the past and still trail behind banks from the Gulf Cooperation Council countries when it comes to Libya and behind Lebanese banks in Syria. Among the few markets where they do seem to be making headway is the semi-autonomous Kurdistan region of northern Iraq where state-owned VakifBank and Ziraat Bank and privately owned Isbank and Garanti have all opened branches.

"Turkey has a lot of interests in the region," says Sengün. "Social unrest in the region creates risks for investments. If these problems are resolved and a more liberal political and economic climate is established, this area will be where Turkish banks will turn and invest for the medium to longer term. But Turkish banks are still quite slow. They are testing each and every market in the surrounding region."

The Turkish government has also tried at times to play a mediating role between Iran and the west over the former’s controversial nuclear programme. To date the attempts to bridge the gap between Tehran and Washington have not resulted in any diplomatic breakthroughs, but increasing amounts of trade have been passing through Turkey to Iran. Much of this is thought to be deals that have migrated from Dubai, where Iranian traders have come under heavy pressure from the local authorities to end their links with Tehran. Anecdotal evidence from Iranian businessmen in Dubai indicates that much of the trade has switched to go via Istanbul.

Beyond their Middle East hinterland, Turkish banks often appear to be more comfortable making forays into markets in eastern Europe and the former Soviet states that are now part of the CIS. Joining Garanti and Isbank in the CIS states is Yapi Kredi, which has subsidiaries in Russia and Azerbaijan. It says that revenues at its Baku-based division in the first quarter of 2012 were 37% up on the same period last year, helped by an increase in loan volumes and the opening of four new branches.

In most cases, however, the expansions are tentative rather than bold and Sengün expects that to continue. "Some banks are trying to focus their expansion projects in the Balkans, some in North Africa, others in the Middle East or the former Soviet republics," he says. "These moves are at the test phase. I haven’t seen any Turkish banks with a major expansion project in these countries, because the management teams still feel that their job in Turkey has not been completed and they need capital for Turkey rather than having some risky ventures in other countries. I don’t expect any Turkish banks to establish a real retail banking operation of a significant size anywhere outside Turkey in the next three to five years."

The lack of international exposure can be harmful to the banks. In July, Moody’s Investors Service downgraded a number of Turkish banks, citing among other things their low cross-border operational diversification and their high balance-sheet exposure to the debt of their domestic sovereign. "Banks’ revenue generation is primarily within Turkey and their balance sheets have a high direct exposure to the sovereign," the ratings agency said in its report.

The growing presence of international banks in Turkey will make the local market more competitive for the local institutions. That alone could prompt them to look for alternative growth opportunities abroad. It could also help them as they seek to expand overseas.

“Increased direct investments to Turkey will have a positive impact on the development of Turkey’s international business. Eventually that will also help Turkish banks to further develop their international business," says Akbank’s Binbasgil.

Ozturk agrees, saying it opens up new opportunities for Garanti Bank. "The Turkish banking sector has drawn a lot of attention in the past years," he says. "Numerous foreign investors have investments here and new ones are coming. We see this as a positive development for both the Turkish economy and the banking sector, with opportunities arising to develop joint projects benefiting from each other’s know-how."

International advice is also being sought by banks. In late July, Akbank announced that it had appointed three new heavyweight members to its international advisory board. They included Josef Ackermann, chairman of Zurich Insurance Group and former chairman of the management board of Deutsche Bank; Gao Jian, vice-governor of China Development Bank; and, Michael Klein, former chairman of the institutional clients group at Citi.

But even if they are looking more closely at what opportunities might lie beyond their borders, it seems unlikely that Turkish banks will implement any drastic change in their cautious strategies. Given a choice between a vibrant home market with plenty of potential and the uncertainty of overseas markets, they are likely to stick to what they know best.

"International expansion entails a long-term investment," says Ozturk. "A major challenge of Turkish banks may be the allocation of these resources between an attractive home market and a long-term investment."