IFN.COM - Cover Story - 29-Aug-2011 - Volume8.Issue34
Forbidden fruit: Turkey’s tempting Islamic banking sector economic powerhouse
Turkey has been one of the few economic success stories emerging from the recession, with the highest economic growth rate in the world (11%) in Q1 2011. Despite a dip in 2008 with GDP contracting 14.6%, the economy rapidly returned to growth and GDP grew by 8% in 2010 with a 5% expansion predicted for 2011. Turkish banks were largely unaffected by the global financial crisis, with limited exposure to toxic securities and high retail deposit levels providing a liquidity buffer. The regulator maintains firm control with a focus on preventing excessive credit growth and a ban on foreign currency retail lending, meaning that banks have experienced little funding stress. Fitch Ratings recently changed Turkey’s ‘BB+’ sovereign rating outlook from stable to positive suggesting that a future upgrade could be on the cards, which will only enhance Turkey’s attractiveness to foreign investors. (source)
“No Islamic banking”
Strictly speaking there aren’t any Islamic banks in Turkey, as the country operates under a strictly secular system despite having a 98% Muslim population. Ali Ceylan, a senior partner at Turkish law firm Baspinar & Partners, explains that: “It is not possible to define [any] banks in Turkey as pure ‘Islamic banks’ since these banks are operating in a system which is different from Islamic understanding.” However, out of the 48 banks in Turkey four are classified as ‘participation’ banks providing financial services under interest-free and profit-sharing principles very similar to Islamic banking. Originally regulated by Turkey’s commercial code, in 1999 they were incorporated under the Banks Act and in 2000 came under the supervision of the Banking Regulation and Supervision Agency (BDDK). In 2005 they were fully integrated into the main regulatory framework under the Financial Services Act, and Gulcin Orgun, the senior director of financial institutions at Fitch Ratings in Istanbul, confirms that: “There are now no barriers for entry.”
Strictly speaking there aren’t any Islamic banks in Turkey, as the country operates under a strictly secular system despite having a 98% Muslim population. Ali Ceylan, a senior partner at Turkish law firm Baspinar & Partners, explains that: “It is not possible to define [any] banks in Turkey as pure ‘Islamic banks’ since these banks are operating in a system which is different from Islamic understanding.” However, out of the 48 banks in Turkey four are classified as ‘participation’ banks providing financial services under interest-free and profit-sharing principles very similar to Islamic banking. Originally regulated by Turkey’s commercial code, in 1999 they were incorporated under the Banks Act and in 2000 came under the supervision of the Banking Regulation and Supervision Agency (BDDK). In 2005 they were fully integrated into the main regulatory framework under the Financial Services Act, and Gulcin Orgun, the senior director of financial institutions at Fitch Ratings in Istanbul, confirms that: “There are now no barriers for entry.”
In fact, participation banks in Turkey have grown considerably faster than the rest of the banking system, reaching total assets of US$30 billion at the end of Q1 2011 from just US$7 billion in 2005. However, their market share remains low at just 4.3%, up from 2.5% in 2005, leaving ample room for growth. The largest participation player is Bank Asya with total assets of TL14.2 billion (US$8.1 billion) in 2010: an increase of 25% from 2009 and ranking it the 13th largest bank in Turkey. Clustered some way behind,Turkey Finance, Kuwait Turk and Albaraka Turk achieved total assets of TL10.7 billion (US$6.8 billion), TL9.59 billion (US$5.49 billion), and US$5.5 billion respectively.
Protected market
These four banks dominate the Islamic banking sector in Turkey, particularly on the retail side, and despite increasing foreign interest this situation is unlikely to change due to a highly protective government stance. The potential for growth in Turkey’s banking sector is considerable as the sector is relatively small compared to GDP, and in the conventional space M&A activity has already stepped up. In November 2010 Spanish Bank BBVA announced the acquisition of a 24.9% stake in Garanti Bank (Turkey’s second-largest private bank), while Credit Europe Bank (owned by Turkish Fiba Group) recently re-entered the domestic banking sector with the acquisition of Millenium Bank. However, although a growing number of Islamic institutions now have a presence in Turkey, their operations are restricted. Several Islamic banks including Dubai Islamic Bank and ABC Islamic Bank have representative offices, but do not have banking licenses. Some banks have expanded through acquisition: such as Dubai Bank’s strategic alliance with Daruma Corporate Finance to offer Islamic corporate finance and merchant banking, and Unicorn’s 2007 acquisition of asset management firm Inter Yatirim Menkul Değerler (now known as Unicorn Capital Turkey). However, these are regulated by the Capital Markets Board (CMB) rather than BDDK and are limited in scope. A few international players including HSBC, BNP Paribas and Citibank offer Islamic finance products, but have no participation banking license and are restricted to the corporate and commercial side.
These four banks dominate the Islamic banking sector in Turkey, particularly on the retail side, and despite increasing foreign interest this situation is unlikely to change due to a highly protective government stance. The potential for growth in Turkey’s banking sector is considerable as the sector is relatively small compared to GDP, and in the conventional space M&A activity has already stepped up. In November 2010 Spanish Bank BBVA announced the acquisition of a 24.9% stake in Garanti Bank (Turkey’s second-largest private bank), while Credit Europe Bank (owned by Turkish Fiba Group) recently re-entered the domestic banking sector with the acquisition of Millenium Bank. However, although a growing number of Islamic institutions now have a presence in Turkey, their operations are restricted. Several Islamic banks including Dubai Islamic Bank and ABC Islamic Bank have representative offices, but do not have banking licenses. Some banks have expanded through acquisition: such as Dubai Bank’s strategic alliance with Daruma Corporate Finance to offer Islamic corporate finance and merchant banking, and Unicorn’s 2007 acquisition of asset management firm Inter Yatirim Menkul Değerler (now known as Unicorn Capital Turkey). However, these are regulated by the Capital Markets Board (CMB) rather than BDDK and are limited in scope. A few international players including HSBC, BNP Paribas and Citibank offer Islamic finance products, but have no participation banking license and are restricted to the corporate and commercial side.
The Turkish government is notoriously reluctant to issue new banking licenses, meaning that despite the enticing opportunities, newcomers are unlikely to benefit. Cenk Karacaoglu (top), the vice president of financial institutions at Bank Asya, confirms that: “Turkey is issuing no new licenses for Islamic banks.” Although in the past there have been some attempts to obtain a license, none have been successful. In 2006 Kuwait-based The International Investor announced the acquisition of the embattled Adabank from the Turkish Savings and Deposit Insurance Fund, and applied for a participation license. However BDDK canceled the deal, claiming that the investment bank did not have the necessary capital to complete the purchase. It was eventually bought by G Capital, a subsidiary of Gulf Finance House, and remains licensed as a privately-owned deposit bank. Also in 2006 Dubai Islamic Bank tried to enter the market with the purchase of MNG Bank, but this again fell through. MNG was acquired by Arab Bank and now exists as Turkbank, with a conventional foreign-owned deposit bank license. Nor does the option of Islamic windows exist. Cenk reiterates that: “There is no possibility for Islamic windows in Turkey, by regulation.”
Although there are rumors in 2011 of two new applications from GCC entities for participation banking licenses, Cenk is adamant that this will not happen. The only other option is to merge with or acquire an existing bank. However, out of the four options three are already majority-owned by Middle East investors: Saudi National Commercial Bank (NCB) bought 60% of Turkey Finance in 2007, Kuwait Finance is 62%-owned by Kuwait Finance House (KFH), and Albaraka Turk is a subsidiary of Saudi Albaraka Banking Group and part-owned by the IDB. Bank Asya is the only Turkish majority-owned entity (over 50% publicly traded), and is already subject to takeover speculation with Qatar Islamic Bank reported to be bidding for a 25% stake.
However, there may exist one further window of opportunity. After the 2001 crash in Turkey some licenses controlled by now-defunct savings and deposits insurance funds became available. Cenk explains that if a foreign Islamic bank was able to get one of these licenses, it might be possible for them to enter the market. “There is an option for bidding by investors from both sides, both conventional and Islamic.” However, “for the foreseeable future, the current four banks will continue to dominate”.
Sukuk support
Regardless of ownership, Turkey’s participation banks have been seeing a surge in growth, driven by trade finance and SME loans. Cenk explains that: “There has been an especial increase in entrepreneurs exporting and importing in Turkey. Islamic banks focus on real trade, so demand is increasing compared to conventional banks.” However, the most exciting development has been the recent communiqué by CMB in April 2011 paving the way for Sukuk transactions. Turkey should be a natural market for Sukuk, which could attract valuable foreign investment into the domestic capital market. In 2010 Kuwait Turk launched the first issuance out of Turkey, a three-year US$100 million Wakalah Sukuk, and has plans for a further US$500 million issuance. Albaraka Turk is planning a US$250 million issuance this year. Bank Asya is also considering the prospect, but Cenk warns that: “It all depends on market conditions.” Corporates in Turkey already regularly access funding through Islamic structures. Earlier this year Bank Asya raised US$300 million through a syndicated Murabahah loan (increased from US$150 million due to high demand) in the largest facility ever extended to a Turkish bank.
Regardless of ownership, Turkey’s participation banks have been seeing a surge in growth, driven by trade finance and SME loans. Cenk explains that: “There has been an especial increase in entrepreneurs exporting and importing in Turkey. Islamic banks focus on real trade, so demand is increasing compared to conventional banks.” However, the most exciting development has been the recent communiqué by CMB in April 2011 paving the way for Sukuk transactions. Turkey should be a natural market for Sukuk, which could attract valuable foreign investment into the domestic capital market. In 2010 Kuwait Turk launched the first issuance out of Turkey, a three-year US$100 million Wakalah Sukuk, and has plans for a further US$500 million issuance. Albaraka Turk is planning a US$250 million issuance this year. Bank Asya is also considering the prospect, but Cenk warns that: “It all depends on market conditions.” Corporates in Turkey already regularly access funding through Islamic structures. Earlier this year Bank Asya raised US$300 million through a syndicated Murabahah loan (increased from US$150 million due to high demand) in the largest facility ever extended to a Turkish bank.
It is not all plain sailing, however. Gulcin Orgun, the senior director of financial institutions at Fitch Ratings in Istanbul, points out that: “At the present time the only Sukuk available [under the new legislation] is ljarah Sukuk,” which limits opportunity. The Turkish government also offers no support in terms of participation-based instruments for bank funding requirements, such as government certificates, MTNs, or Sukuk, and the governor of the central bank has announced that there are no future plans to issue any. And despite rumors of a debut sovereign Sukuk emerging as early as 2009, in reality this is unlikely to occur before the 2012 elections.
In addition, despite the positive outlook, significant issues still exist for Turkish participation banks. Assets are dominated by loans, which account for 74% of total assets – far higher than the conventional sector. In fact, their total loans share in 2010 was 6%, compared to just 4.3% market share. Participation banks are less exposed to retail clients and have a much higher relative share of the SME loan sector, which has strong growth potential but a concurrently higher risk. The Turkish central bank has also been steadily cutting interest rates – from 16.75% in October 2008 to 6.25% in January 2011, squeezing profit margins for the overall banking sector and pushing up competition.
Looking Gulfwards
Although Turkey sits in an enviable geographic position with opportunities in both directions, it is currently the MENA region that offers the most alluring prospects for its Islamic banks. Turkey’s direction of trade has reversed in the last decade and today 54% of trade goes to countries outside the EU, with Iraq, Iran, the UAE, Egypt, and Saudi Arabia all in its top 10 export partners. Trade flows between Turkey and the Arab world have grown on average by 18% per year since 2002, reaching US$24 billion in 2010. Over 2,000 Arab companies have around US$10.6 billion in direct investments in Turkey, most occurring since 2006, according to the National Bank of Kuwait. Unicorn Capital Turkey have also predicted that investors hit by the financial crisis and looking for alternatives to the US and Europe will pour into Turkey as soon as the government or a Turkish corporate issues a benchmark Sukuk to pave the way. Ali (top) reiterates that: “There is a great importance to cooperate with the other Islamic banks in the Middle East region to support this growth.”
Although Turkey sits in an enviable geographic position with opportunities in both directions, it is currently the MENA region that offers the most alluring prospects for its Islamic banks. Turkey’s direction of trade has reversed in the last decade and today 54% of trade goes to countries outside the EU, with Iraq, Iran, the UAE, Egypt, and Saudi Arabia all in its top 10 export partners. Trade flows between Turkey and the Arab world have grown on average by 18% per year since 2002, reaching US$24 billion in 2010. Over 2,000 Arab companies have around US$10.6 billion in direct investments in Turkey, most occurring since 2006, according to the National Bank of Kuwait. Unicorn Capital Turkey have also predicted that investors hit by the financial crisis and looking for alternatives to the US and Europe will pour into Turkey as soon as the government or a Turkish corporate issues a benchmark Sukuk to pave the way. Ali (top) reiterates that: “There is a great importance to cooperate with the other Islamic banks in the Middle East region to support this growth.”
However, there is still plenty to occupy the banks on the domestic front. Gulcun emphasizes that: “The total penetration of banking services is still relatively low in Turkey, with loans/GDP at around 50% levels compared with the developed and even many emerging countries, which provides strong potential for continued growth for participation banks.”
