This record is a partial extract of the original cable. The full text of the original cable is not available.

UNCLAS SECTION 01 OF 03 ISTANBUL 000635 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE FOR E, EUR AND EB 
TREASURY FOR U/S TAYLOR AND OASIA - MILLS 
NSC FOR QUANRUD AND BRYZA 
 
 
E.O. 12958: N/A 
TAGS: EFIN ECON TU
SUBJECT: TURKEY'S BANKING SECTOR: ON FIRMER GROUND, BUT NOT 
OUT OF THE WOODS 
 
 
This is a joint Ankara-Istanbul cable.  Sensitive but 
Unclassified - not for internet distribution. 
 
SIPDIS 
 
 
¶1. (SBU)  Summary: Industry and government contacts in 
Istanbul and Ankara concur that Turkey's banking sector has 
improved considerably since the 2001 crisis.  Government 
moves to impose effective and independent oversight through 
the creation of the Banking Regulatory and Supervision Agency 
(BRSA) in September 2000 increased transparency and public 
confidence.  The takeover and resolution of 19 insolvent 
banks, and partial restructuring of public banks, have 
eliminated unfair competition and eliminated the worst 
performers.  Most concur, however, that serious problems 
remain, and that the sector remains extremely fragile, with 
bank exposure not just to individual balance sheet problems, 
but also to systemic risk as a result of Turkey's tenuous 
macroeconomic fundamentals.  Turkish banks operate more as 
hedge funds than commercial lenders, with government 
securities making up a higher percentage (an average of 40 
percent) of their assets than loans.  Having gotten into the 
government securities game, however, the banks have no easy 
exit, other than through a long-range strategy of increasing 
their capital and growing out of the problem.  However, the 
quick end to war in Iraq, and declining interest rates have 
given the sector some breathing room, providing profits in 
place of the heavy paper losses that March's high rates 
caused.  In the medium term, the sector needs increased 
capitalization, either through foreign direct investment or 
public offerings.  Either solution involves diluting 
ownership of family-owned businesses, however, which will 
face traditional barriers.  End Summary. 
 
 
¶2. (SBU) Snapshot of the Sector: Turkey's banking sector is 
small by world standards, with total assets at the end of 
2001 of only USD 122 billion.  Forty percent of that total is 
accounted for by three state banks: Ziraat, Halk and Vakif 
Banks (the first two being Turkey's largest banks).  On the 
private side of the sector there are the big four-- Akbank 
(the market leader), Isbank, Garanti Bank and Yapi Kredi (the 
last being managed by the BRSA with a view towards its sale 
in the medium term).  There are also six significant 
medium-sized banks (by Turkey's standards)-- Kocbank, 
Denizbank, Finansbank and TEB are the leaders in this 
category.  In addition to small traditional banks, there are 
also a number of "Special Finance Houses" (in Turkish legal 
parlance) which follow Islamic banking principles.  Though 
they account for only 4 percent of total banking sector 
assets, they are politically important to the AK party, as 
several ministers (including Finance Minister Unakitan) and 
senior officials rose through their ranks.  Foreign 
participation in the sector is extremely limited.  While a 
number of foreign commercial and investment banks have 
correspondent offices in Turkey, only two commercial banks 
have entered the market recently-- HSBC through the purchase 
of the bankrupt Demir Bank and Unicredito (Italy) through a 
50/50 partnership with Koc Bank.  Analysts note that overall 
the market is thin and undercapitalized, as is evident in the 
fact that the "big four's" total assets barely equal those of 
the National Bank of Greece (at around USD 40 billion). 
 
 
¶3. (SBU) Improvements Since the Crisis: If challenges remain 
in the sector, all agree that the specific problems that 
contributed to the 2001 crisis have been partially addressed 
by post-crisis reforms.  BRSA Vice President Ceyla 
Pazarbasioglu, in an April 17 meeting, pointed specifically 
to the system's enormous short foreign exchange position 
(addressed through a debt swap, and subsequent bank attempts 
to avoid overexposure to exchange risk); high levels of group 
lending (being brought down over four years to an 
internationally accepted level-- Finansbank Chairman Husnu 
Ozyegin noted to us on April 29 that whereas his FIBA group 
was once his bank's number one customer, it is now only 
number 7); and the sector's high level of non-performing 
loans (being addressed by debt restructuring, as through the 
Istanbul approach, and other steps).  In addition, we would 
mention two big improvements: BRSA's intervention and 
resolution of 19 private banks, which took out the sector's 
worst performers; and the GOT's recapitalization of Halk and 
Ziraat Banks (at a cost of about USD 25 billion). 
 
 
¶4. (SBU) But problems remain: Those we canvassed in recent 
weeks agree, however, that the sector is not by any means out 
of the woods.  Key remaining issues include the lack of free 
capital and the sector's overall need for increased 
capitalization, maturity mismatches between assets and 
liabilities, overexposure to government securities and 
resultant "systemic" risk, and lack of other profitable 
assets.  Though a range of banks have recently trumpeted 
advantageous loan programs for members of such business 
associations as the Istanbul Chamber of Commerce, TEB General 
Manager Akin Akbaygil notes that overall there is no 
significant loan demand by local clients, given prevailing 
high interest rates and transaction costs.  That lack of 
demand has led banks to shift more of their resources into 
the government bond market, an area that Akbaygil quipped is 
a little like "hell," in that it is easy to get into and very 
hard to escape.  Indeed most analysts believe that 
notwithstanding the fact that ownership of bonds by 
individuals is at its highest level ever, the banks are now 
trapped in a "pyramid scheme" from which they cannot escape. 
The banks are clearly aware of the treadmill on which they 
find themselves: Koc Bank General Manager Kemal Kaya 
confirmed rumors that the big four have been exploring the 
possibility of a government debt restructuring with the 
government in Ankara, perhaps to be accompanied by a change 
in reserve requirements.  Kaya indicated that then Treasury 
U/S Oztrak had not responded to the proposal when he received 
it in late March. 
 
 
¶5. (SBU) Systemic Risk: Pressure from the banks for 
restructuring has likely eased in recent weeks, as the 
overall market mood has lightened with the end of the war. 
While banks were worried about heavy losses at the end of the 
first quarter, as a result of high interest rates, they are 
now enjoying windfall profits, given those rates decline. 
However the long-term problem of their overexposure to 
government debt remains, as does the maturity mismatch that 
accompanies it.  While most deposits held by banks are one or 
at most three month terms, government bond maturities have 
increasingly been extended, and now average just over 14 
months.  Given that most bank-held bonds have a floating rate 
or are denominated in foreign currencies, the banks no longer 
face a large foreign exchange risk (it has effectively been 
shifted to the government, which has been managing it well), 
but the overall credit risk remains, and in the view of some 
outside analysts should be provisioned against (though 
currently government bonds are treated as no risk for 
accounting purposes).  Akbaygil also alerted us to another 
looming risk that has attracted little attention to date: the 
banks' exposure to the liabilities of the Turkish insurance 
industry, which it largely controls through wholly-owned 
subsidiaries.  Like the banks themselves the sector is 
undercapitalized. 
 
 
¶6. (SBU) Structural Problems: Beyond the difficult 
macroeconomic environment in which they work, banks also face 
a tough operating environment.  Akbank CEO Zafer Kurtal noted 
that in addition to high interest rates, intermediation taxes 
and fees can easily add another fifteen percent to the cost 
of a loan, even before any bank margin is considered.  Banks' 
problems are compounded by the continued lack of inflation 
accounting (though the government has promised to introduce 
it for the sector this year), which results in situations 
like that faced by industry leader Akbank in the first three 
months of this year, when it paid an effective 80 percent tax 
rate on its profits.  The larger banks (especially Is and 
Garanti) hold large real estate portfolios and other fixed 
assets which cannot be easily liquidated in the present 
economic environment.  Isbank, given its extensive industrial 
subsidiaries, has faced extensive group losses which have 
dragged down its bottom line.  Bender Securities analyst 
Murat Gulkan notes that as a result the banks' position is a 
bit deceiving, in that they are not as solvent as their 
current liquidity would otherwise indicate. 
 
 
¶7. (SBU) The Lethal Bank/Media Mix: At least three of 
Turkey's biggest banks are owned by groups with large media 
holdings (YPK, Disbank, and Garanti).  The media subsidiaries 
often slant "news" stories to promote their holding and bank 
interests.  Thus Dogan's (Dis' parent) recent series on the 
BRSA's failure to collect from bankrupt banks' former owners 
also coincided with Dis' attempt to acquire assets from the 
BRSA.  Even so, there is legitimate public concern with the 
failure to date to collect from former bank owners.  The 
BRSA's inability to agressively pursue these debtors has been 
the one black mark on an otherwise strong record. 
 
 
¶8. (SBU) Comment: As TEB CEO Akbaygil noted to us, banking is 
the superstructure of the overall economy, and consequently 
will prosper or suffer in line with the economy's health and 
the government's effectiveness in implementing the economic 
reform program.  If reform implementation continues, analysts 
see a strong upside-- a view that led one brokerage to 
upgrade both Akbank and Isbank late last year.  Improvement 
of the macroeconomic climate alone will not be enough, 
however.  In the medium term, more capital is needed.  The 
two most likely sources of this capital are direct foreign 
investment or selling off more equity on the Istanbul Stock 
Exchange.  Either choice will result in dilution of 
family-owned bank businesses.  While some CEO's like 
Finansbank's Husnu Ozyegin tell us they are prepared to 
accept this (in the expectation that they will be able to 
retain effective control even with a 25-30 percent share), 
traditional attitudes on protecting the family "jewels" will 
doubtless prove a barrier.  End Comment. 
QUINN