IN GENERAL, ONE-THIRD of Turkish banks' assets are in government paper, one-third in loans and one-third is liquid, according to Fitch Ratings.
In no other country are bank assets distributed in this way. No properly run bank would keep a third of its assets liquid, meaning notes piled up in safety deposits. Nor would it invest so much in T-bills.
This bizarre allocation is dictated by Turkey's extraordinary circumstances. Governments traditionally rely on the Turkish banks to finance the public sector deficit. Funds from other sources are limited because the country is not deemed to be a very safe investment venue.
Turkish banks are not too unhappy about this situation because spreads on government paper are enormous. Last year, real return on government bonds was 33%. Of course there is always the danger that the government might default or, as happened in 2001, restructure part of the debt. Demirbank, a medium-size bank acquired by HSBC, crashed because it had invested virtually everything in T-bills. However, these risks do not seem so big or ominous to local bankers. Some banks have more than 40% of their assets in T-bills. In state banks the ratio is even higher.
It is prudent for banks to carry large amounts of cash because Turkey is a cash economy. People feel safer with cash than cheques, credit cards or other forms of liquidity. Demand for cash rises in difficult times. For example, there were large withdrawals from banks before and during the war in neighbouring Iraq although Turkey was not one of the belligerents.
Banks are reluctant to increase their loan portfolios. As one banker puts it: "Those companies you would want to lend to aren't borrowing. The companies that want to borrow are not those you would want to give loans to."
At the end of last year loans to the private sector constituted 34% of deposits compared with 135% in the eurozone.
Vertiginous volatility
How extreme volatility is in Turkey is vividly demonstrated by real GDP growth data. In 1999 growth was minus 5%. The following year this turned to plus 7.2%. In 2001 there was an almost symmetric reversal when the economy shrank by 7.6%. In 2002 GDP expanded by 6.5%. In the first quarter of this year Turkey was the fastest-growing economy after China, recording an 8.1% rise.
If the present momentum is maintained this year's 5% government growth target will probably be fulfilled. But the year end is the best part of four months away and for Turkey four months is a long time.
Interest rates provide yet another element of volatility. In March interest rates as measured by government borrowing shot up to nearly 70% when Turkey, up to then a most loyal ally of the US, surprised the world (and itself) by refusing to allow coalition troops to invade northern Iraq via Turkey. Banks began to calculate their losses.
In June after the US-led coalition had prevailed in Iraq, interest rates fell to about 40% and banks began to calculate their windfall profits, which could be as much as $5 billion to $6 billion for the whole sector.
"The margin in Turkey between failure and success is slim," says Nick Eisiner, Fitch Ratings' sovereign ratings director.
The banking sector nearly went bust in the 2001/02 crises. The government intervened through the BDDK (banking regulation and supervision board), which was created at the insistence of the IMF to introduce discipline to the banking sector. Using IMF funds the system was restructured at a cost of nearly $25 billion. The government took over more than 20 banks.
Largely as a result of the BDDK's work the system is healthier than it was two years ago but banks continue to be at the mercy of the government's ability to pay its debts. So far into the game the banks cannot stop bankrolling the government - they know very well that the government pays them back only because they lend it money to do so. The banks and the government are in the same boat. They sail or sink together.
One other negative effect of the government's unquenchable thirst for debt is that it has prevented bank consolidation. The smallest 30 banks, which constitute only 3% of the sector by assets, are ripe for merger and acquisitions. But for the time being they profit from the very high interest rates as much as the big banks and have no incentive to acquire or be acquired. Depositors are discouraged from seeking quality and safety by the government's nearly 10-year-old blanket guarantee of deposits.
Only if inflation drops, the economy stabilizes and the government's borrowing requirement falls, bringing down interest rates, will banks use funds now gobbled up by the state to finance credit expansion.
The scope is huge. Mortgages, household debt, insurance and mutual funds are just over 7% of GDP and there are relatively few loans to the private sector. An expansion of credit, and the privatization of state banks, could revive foreign banks' interest in investing in Turkey. The country has opened its doors completely. There is nothing to prevent 100% foreign ownership. All the banks seized by the government are on sale, as are the state banks.
Turkey has a very small foreign bank presence in view of the size of the market. Foreign banks make up 3% of the system by assets, the smallest share in emerging Europe.
This is not surprising since Turkey is not an important foreign investment destination. It receives less overseas investment than Azerbaijan and Bulgaria. Last year foreign investment dropped to $549 million, the lowest level since 1988.
Wary foreigners
Citigroup was among the first international banks to open a branch in Turkey and is currently the second biggest of the foreign players after HSBC. Its plans
for buying a medium-size local bank, TEB, were dropped in 2001 and the bank has focused on organic growth. Citigroup has opened 10 branches in the past two years, increasing its branch network to 24.
Three foreign banks have entered the Turkish market since the economic crisis, which bankrupted a large number of banks. HSBC and Banco Commercial Português (BCP) have bought two failed banks and Italy's UniCredito Italiano and Koçbank created a joint venture. Koçbank, owned by one of Turkey's largest industrial conglomerates, was forced into the merger because of capital inadequacy.
In September 2001, Italy's Intesa abruptly broke off negotiations to buy the majority shares of Garanti, the smallest of the big-four private banks. Garanti still hopes that negotiations may be resumed.
"There is a pool of banks for which Turkey is on the wait-and-see column," says a western banker who does not want to be identified. "But a lot of things have to change before foreign bank presence increases. There is no broad political consensus on many crucial matters from privatization to the role of the military. The list is long."