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

161608Z Mar 04

UNCLAS SECTION 01 OF 04 ANKARA 001578 
 
SIPDIS 
 
 
SENSITIVE 
 
 
STATE FOR E, EB/IFD, AND EUR/SE 
TREASURY FOR OASIA - JLEICHTER AND MMILLS 
NSC FOR MBRYZA AND TMCKIBBEN 
 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV TU
SUBJECT: MIXED SIGNALS--OR WORSE--ON STATE BANK 
PRIVATIZATION 
 
 
REF: A. ANKARA 1319 
     ¶B. ANKARA 1437 
     ¶C. ANKARA 851 
 
 
 ¶1. (Sbu) Summary: According to World Bank and IMF officials, 
GOT officials up through Economy Minister Babacan have agreed 
on a strategy to privatize the state-owned Banks.  The 
government will withdraw some state bank capital and 
gradually shrink the deposit base and government securities 
portfolio, facilitating Halk Bank's privatization by June 
2005 and Ziraat Bank's by December 2005.  However, 
state-owned bank executives have yet to show any signs of 
preparing to shrink their banks to prepare for privatization, 
and have taken actions to expand both deposits and loans. 
The IMF has incorporated the first steps towards downsizing 
the state banks in its Seventh Review.  End Summary. 
 
 
World Bank Team Engages on a New Strategy: 
----------------------------------------- 
 
 
¶2. (U) A World Bank team has been in Turkey over the past few 
weeks, working with a GOT interagency committee to analyze 
how to revive the stalled program of state bank 
privatization.  In the wake of the 2000-2001 crisis, the GOT 
had to recapitalize the state banks at a cost of 16 percent 
of GDP.  Turkey's post-crisis program with the IFI's called 
for a shrinkage of the state banks to prepare for their 
privatization.  Over the past year or so, the process has 
completely stalled.  The GOT recently agreed to re-open a 
dialogue with the World Bank on state bank privatization, as 
part of its recent re-engagement on a broader array of issues 
(ref C). 
 
 
¶3. (Sbu) In a March 10 meeting with econoffs, World Bank 
Financial Economist Rodrigo Chavez called the state banks the 
"Achilles Heel" of the economy that stand in the way of the 
Structural Adjustment Program.  He said that the World Bank 
had come to accept that its initial strategy for privatizing 
the state banks would not work.  Ziraat and Halk Bank hold 
about thirty percent of government securities, and with their 
huge balance sheets are unlikely to be marketable in their 
current form.  Moreover, the idea of merging Ziraat and 
Halk--which do not appear to have complementarities--would 
probably make it even harder to sell these banks.  According 
to Chavez, the World Bank therefore "took a step backward" 
and is working on a new action plan or road map. 
 
 
A New "Road Map": 
--------------- 
 
 
¶4. (Sbu) The new plan would entail privatizing Halk by June 
2005 and Ziraat by December 2005.  To reach the point at 
which these banks could be ready for privatization, a number 
of actions would be taken to shrink the banks' balance 
sheets.  First and foremost, the state banks would reduce 
their deposit base by offering lower interest rates and 
ending their aggressive bidding for deposits.  With a 
recently-adopted law limiting the state's insurance guarantee 
on all bank deposits over TL 50 billion (about $38,000) in 
July, the state Banks should offer rates that are lower than 
their private sector counterparts on a risk-adjusted basis. 
Chavez agreed with econoff that there was a danger depositors 
would assign a lower risk to the state-owned banks' implied 
government backing--hence the need for a risk-adjusted 
interest rate.  In a March 16 meeting, IMF Deputy Resrep 
Christoph Klingen said the Fund had secured a commitment from 
the GOT--as part of the Seventh Review--not to allow state 
banks to offer either deposit interest rates as high as 
private banks or loan rates lower than private banks' rates. 
 
 
¶5. (Sbu) As they run down their deposit base on the liability 
side, Ziraat and Halk would be able to reduce their outsized 
government securities portfolio on the asset side by not 
rolling over securities as they come due.  The government 
securities portfolios would be further reduced as repayment 
to the Treasury via a withdrawal of a portion of the capital 
it contributed in 2001 to save the banks.  Chavez said the 
write-down would be for 6 Quadrillion TL ($4.6 billion) at 
Ziraat and 2 Quadrillion ($1.5 billion) at Halk.  Klingen 
later told econoffs that the GOT had committed to a $3 
billion write-down of Ziraat's capital and would write down 
Halk Bank's capital by $1 billion if the Halk-Pamuk merger 
was not structured in such a way that Halk "eats" Pamuk's 
negative net worth. Note: It's not clear why Klingen and 
Chavez were citing different numbers. End Note. Klingen also 
pointed out that the overcapitalization of the two banks 
creates room for expansionary activities that run counter to 
the shrink-to-privatize strategy. 
 
 
¶6. (Sbu) Chavez said that the State Banks have been taking 
substantial interest rate risk, through asset-liability 
maturity mismatches.  With a strong trend of declining 
interest rates, the banks have borrowed short-term and bought 
one-to-two year government paper.  Though this has frequently 
meant a negative short-term carry, the banks have made 
profits from the capital gain at the time of sale.  Chavez 
said that Ziraat Bank's $556 million 2003 profits might have 
been a small loss were it not for these bets on interest 
rates.  If interest rates come back up, Ziraat and Halk will 
be badly hurt. 
¶7. (Sbu) The road map would also call for the state banks to 
sharply reduce their lending activities during the transition 
period, and there would be a detailed analysis of the branch 
network. Chavez said that, surprisingly, many of the 
small-town and rural branches of Ziraat and Halk are highly 
profitable.  Since the state banks have little competition in 
these remote locations, the branches tend to do well from 
sight deposits and fee income.  By contrast, Ziraat's urban 
branches tend to lose money. 
 
 
¶8. (Sbu) Chavez confirmed that the GOT and BRSA/SDIF had made 
a firm decision to integratemerge SDIF-intervened Pamuk Bank 
with Halk Bank.  Instead of having to recapitalize Pamuk 
Bank, which has a negative net worth, the SDIF would give 
Pamuk to Halk. Halk would take the useful assets of Pamuk 
Bank and dispose of the residual, as the SDIF would have had 
to do anyway.  In this way Halk would in effect pay for the 
Pamuk recapitalization, which it can afford because of its 
large capital base.  The synergies would also help Halk 
prepare for privatization.  Note: Though, on its face, this 
might appear to work against the strategy, in that the merger 
would expand Halk Bank's balance sheet, a variety of 
contacts--Chavez, the IMF's Odd Per Brekk, BRSA V.P. Ercan 
Turkan, and former BRSA Chairman Engin Akcakoca--have all 
told econoffs that the deal makes sense because of the 
synergies between the two banks.  According to these 
contacts, Pamuk Bank's better quality staff and systems would 
improve Halk Bank.  End Note. 
 
 
IFI-GOT Negotiations: 
-------------------- 
 
 
¶9. (Sbu) According to Chavez and the IMF's Klingen, Economy 
Minister Babacan and the interagency GOT committee insist 
they are committed to privatization.  Given past missteps, 
such as the failure of the Vakif Bank privatization (see 
below), and the interrelationship between state bank 
privatization and the Treasury's domestic borrowing program, 
these GOT officials say they want to be very careful to avoid 
mistakes in the process of privatizing the state banks. 
 
 
¶10. (Sbu) Chavez explained that the component of the strategy 
that most worries their GOT counterparts is the impact on 
Treasury's borrowing program.  Though the write-down of 
capital (via return of government securities to Treasury) 
would reduce Treasury's debt, the shrinkage beyond the 
capital reduction would oblige Treasury to replace state 
bank-held government securities with securities held by the 
private sector investors (mainly banks) at shorter 
maturities.   Chavez said the World Bank believes that the 
market could absorb this additional supply of government 
securities under current conditions: there is strong demand 
for government paper and the market will gain extra liquidity 
from the drawdown of Ziraat and Halk time deposits.  Chavez 
asserted that the markets would view government paper as a 
close substitute for these deposits. 
 
 
¶11. (Sbu) According to Chavez, the GOT officials want to 
bring in a third party as a kind of insurance policy that the 
World Bank knows what it is doing.  The Bank is willing to 
accommodate the GOT by agreeing to bring in an investment 
bank, provided the terms-of-reference are carefully 
structured and the investment bank has responsibility to see 
the privatization through to conclusion.  Chavez is preparing 
a World Bank response for his management's approval along 
these lines. He is hoping the World Bank and GOT will reach 
agremeent on the terms of reference this spring and conduct a 
tender to select the investment bank.  Given the GOT's track 
record on privatization and SDIF asset sales, econoff warned 
of the dangers of the investment bank setting a valuation 
that would kill the privatization.  Chavez and Arslan agreed 
and claimed the key will be how the terms of reference are 
structured. 
 
 
¶12. (Sbu) Perhaps because of the disconnect between GOT 
actions and words (see below), the IMF has included the first 
steps towards state bank privatization in its Seventh Review 
requirements.  In a meeting March 16, IMF Deputy Resident 
Represent Christoph Klingen told econoffs that the GOT had 
reached agreement with Fund staff on a draft Letter of Intent 
which included commitment to progress on state bank 
privatization.  In the Letter of Intent itself, Klingen said 
there is a structural benchmark that the GOT will come up 
with a State bank privatization strategy , the key elements 
of which will be publicly announced by mid-June.  The Fund is 
also requiring completion of the Halk-Pamuk merger. 
 
 
Disconnect with State Bank Managers: 
----------------------------------- 
 
 
¶13. (Sbu) Meanwhile, the statements and actions of state bank 
executives, suggest that either they have not yet been reined 
in by Babacan and the interagency committee or are openly 
defying the World Bank strategy.  In a February 24 meeting 
with Econoffs, State Bank Board Chairman Zeki Sayin was 
careful to accept that Halk and Ziraat would eventually be 
privatized but was otherwise completely out of sync with the 
shrinkage strategy.  By referring to the state banks 
competing with private banks for deposits and loans, he 
implied a strategy of growth rather than shrinkage.  He 
emphasizing the banks' "autonomy" from the Government, and 
claimed the Government was not interfering in the Banks' 
"restructuring."  Sayin said the banks are run by 
"professionals" whose prerogative includes decisions on 
interest rates, but claimed these rates were not below the 
banks' cost of funds.  According to Sayin, though the banks 
were not increasing the number of employees or branches, 
management was trying to run the banks effectively and 
profitably so the banks would not be a burden on the state. 
 
 
¶14. (Sbu) The CEO's of Halk and Ziraat have also made public 
statements that seem contrary to the IFI strategy. These 
managers have announced low-interest loan programs for 
farmers and small businesses in recent months, and talk about 
their vision for the banks for the year.  One private 
Istanbul analyst reports that a government official told him 
the GOT strategy for 2004 was for the State Banks to grow 
their loan portfolios, because the government fears that the 
State Banks would become unprofitable in this year's 
lower-interest rate environment.  BRSA V.P. Turkan told 
econoffs Ziraat was offering 1.9 percent monthly interest on 
consumer loans, undercutting the private banks' 2 percent 
rate. 
 
 
¶15. (Sbu) In a series of meetings in Istanbul March 3, 
several private sector observers told Econcouns that the 
State Banks have reversed course, and seemed to be trying to 
grow rather than shrink.  They saw the State Banks competing 
on deposits as well as loans, and attributed at least part of 
the motivation to Government populism.  Baturalp Candemir of 
HC Istanbul feared the aggressive lending would lead to 
non-performing loans and said that BRSA Chairman Bilgin had 
told him that Halk bank had to grow becaus of its important 
role in the economy.  Huseyin Kelezoglu, also of HC Istanbul, 
said State Bank growth would: a) discourage foreign 
investment in the banking sector; b) increase State Bank 
vulnerability to political pressure; and c) hinder the 
development of the private banks.  Former State Bank Board 
Chairman Vural Akisik also agreed the state banks had 
reversed strategy.  He had heard that Vakif Bank leadership 
was now saying the bank could not be privatized.  Akisik also 
said the GOT was pressuring the Bankers Association to 
reverse an Akisik-era reform, which was to shift chairmanship 
of the Association from Ziraat to one of the private bank 
executives. 
 
 
¶16. (Sbu) In subsequent meetings with Istanbul Econoff the 
week of March 8, a number of Turkish bankers echoed 
Kelezoglu's concerns and reported additional evidence of 
Government support for the expansion of State Banks.  Huseyin 
Imece, Executive Vice President at Yapi Kredi, noted that he 
has heard that state agencies have been directed to shift 
their deposits from private banks to either Ziraat or Vakif 
Bank by August.  In Yapi's direct experience, Imece said one 
unnamed state agency recently cancelled its five-year 
contract with the bank to make the shift. This shift will 
provide interest-free demand deposits to the State Banks. 
Imece and others, including Koc Bank CEO Kemal Kaya, noted 
that the roll-back of the deposit guarantee to cover only 
accounts up to 50 billion TL will enhance state banks' 
competitive advantage, given the perception of continued 
state backing.  (While 99 percent of Turkish accounts will be 
covered under the new policy, in volume terms well over half 
of Turkish accounts will reportedly not be covered.)  In sum, 
Istanbul's privately-owned banks see the state bank policy 
shift as an added and unwelcome challenge just as they adjust 
to a more difficult, low-interest rate environment without 
easy profits from government securities. 
 
 
¶17. (Sbu) In the meeting with Chavez, econoff raised the 
problematic behavior of the state bank managers.  Arslan 
pointed out that this was typical behavior for the managers 
of State-owned enterprises on the verge of privatization and 
Arslan attached greater importance to what the World Bank's 
counterpart technocrats were saying.  These executives have a 
conflict of interest, in that they will lose their jobs from 
the privatization.  While admitting the state bank 
executives' actions was counterproductive, Chavez said his 
understanding is that Babacan and the Prime Minister will 
make the decision on state bank privatization. 
 
 
The Strange Case of Vakif Bank: 
------------------------------ 
 
 
¶18. (Sbu) Chavez saw far greater challenges in moving forward 
on the privatization of Vakif Bank.  An earlier privatization 
decision on Vakif was overturned by the Constitutional Court, 
bringing the process to a halt.  Chavez said the World Bank 
team had come to the conclusion that for now, at least, Vakif 
was not privatizable.  He said there were market reasons 
relating to the structure of the balance sheet but there was 
also a lack of clarity in the ownership structure.  Though it 
is by law a private bank, owned by a grouping of foundations 
and by its employee pension fund, Vakif is de facto 
controlled by the state.  Chavez said the key question is how 
to reduce state control, and believes it could be done 
through dilution of the existing owners' share in the 
capital.  Chavez said that Vakif CEO Kacar agreed in 
principle to some dilution, but wanted to keep the 
foundations' and pension fund's combined share at least at 55 
percent.  This is unacceptable for the World Bank since it 
will render any share sale unattractive.  According to 
Chavez, it is not clear whether Kacar really speaks for the 
GOT on this issue and the World Bank wants Treasury to seek 
GOT views.  Chavez also noted that a Vakif privatization 
would require the approval of a broader array of actors than 
for Ziraat and Halk: In addition to Babacan, Deputy Prime 
Minister Sahin (also Labor Minister) would have to sign, 
representing the owners.  The SDIF would also have to 
approve, under the conditions of a subordinated loan SDIF 
granted Vakif.  Finally, the pension fund would have a say 
since it has a 25 percent blocking minority. 
 
 
 
 
¶19. (Sbu) Klingen said the IMF Letter of Intent is also 
committing to the completion of due diligence on Vakif Bank 
by June 30, to be followed by a decision on how to dilute 
Vakif's capital. 
 
 
Comment: 
------- 
 
 
¶20. (Sbu) Comment: Though the World Bank's strategy seems 
reasonable, and the renewed GOT engagement an improvement 
from the previous stalemate, the disconnect between state 
bank management actions and the World Bank's dialogue is 
troubling.  Part of the problem may be that, until now, the 
state bank managers simply had not received the word yet, and 
will soon be reined in by their ministerial overlords.  It is 
also possible, however, that the state bank managers have 
some ministerial support for their actions, i.e. that Babacan 
has not yet built broader support for the privatization. End 
Comment. 
 
 
EDELMAN