From Crisis to Stability: Restructuring of the Turkish Banking Sector “Strong Banking Sector,...

From Crisis to Stability:From Crisis to Stability:Restructuring ofRestructuring of

the Turkish Banking Sectorthe Turkish Banking Sector

“ “Strong Banking Sector, Strong Strong Banking Sector, Strong Economy”Economy”

A. Teoman KermanA. Teoman Kerman

Vice PresidentVice President

2

““Strong Banking Sector, Strong Strong Banking Sector, Strong

EconomyEconomy””

OutlineOutline

Structural problemsStructural problems Impact of the crisisImpact of the crisis Restructuring strategyRestructuring strategy

Restructuring of the state banksRestructuring of the state banks Resolution of the SDIF banksResolution of the SDIF banks Strengthening of the private banksStrengthening of the private banks Improving the regulatory and supervisory Improving the regulatory and supervisory

frameworkframework Results of the restructuringResults of the restructuring Remaining challenges and BRSA agendaRemaining challenges and BRSA agenda Lessons learnedLessons learned

3



Pre-crisis structural problemsPre-crisis structural problems Small scale and segmented market Small scale and segmented market

structurestructure19198080 19199090 19991999 20002000

Commercial Commercial BanksBanks

3131 5454 6262 6161

State State 88 77 44 44

PrivatePrivate 1919 2525 3131 2828

ForeignForeign 44 2222 1919 1818

SDIFSDIF -- -- 88 1111

InvestInvest. &. & Dev Dev.. BanksBanks 66 1100 1919 1818

State State 44 33 33 33

PrivatePrivate 22 44 1313 1212

ForeignForeign -- 33 33 33

TOTALTOTAL 3737 6464 8181 7979

4



Licensing of banks 1980-1999 Licensing of banks 1980-1999 56 banks were licensed (42 deposit banks and 14 56 banks were licensed (42 deposit banks and 14

Development and Investment banks) Development and Investment banks) 15 of the 20 intervened banks were licensed in the 15 of the 20 intervened banks were licensed in the

post-1980 period; of these 13 were licensed in the post-1980 period; of these 13 were licensed in the 1990s.1990s.

Ownership details of intervened banks: Ownership details of intervened banks: 6 were media groups6 were media groups 12 were conglomerates12 were conglomerates Remaining 2 were cooperatives and pension fundsRemaining 2 were cooperatives and pension funds

Asset size of these banks were about 21 billion USD Asset size of these banks were about 21 billion USD while their liabilities were about 30 billion USD while their liabilities were about 30 billion USD (shareholders equity excluded)(shareholders equity excluded)

5



Asset growth 1980-2000Asset growth 1980-2000

Asset Size of Turkish Banking System and Asset Size / GNP

152535455565758595

105115125135145155

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Bill

ion

$

30

40

50

60

70

80

90

100

Per

cent

age

Asset Size (Left Axis)Asset Size/GNP (Right Axis)

6



Large FX open positions of Large FX open positions of private banksprivate banks

-10674

-8960

-2056-1487

-991

-1

-341 -454 -114

152

-954 -1049

140 110 321-86 -334 -394

252 122

-12000

-10000

-8000

-6000

-4000

-2000

0

2000N

ov. 0

0

Feb

. 01

June

01

Dec

. 01

Mar

ch 0

2

June

02

aug.

02

Dec

. 02

Jan.

03

Mar

ch 0

3

On-balance sheet positions Net Position

Crisis

7



Crowding out by Crowding out by governmentgovernment

Note: 2001 and 2002 data reflect the results of the three-stage audit process and are inflation-adjusted.

6,410,3 10,6

21,4

35,0

40,8

53,7

47,042,5

30,6

20,022,8

05

1015202530354045505560

1980 1990 1995 2000 2001 2002

Per

cent

age

Securities / T. Assets Loans / T.Assets

8



State banks: pre-crisis State banks: pre-crisis conditionsconditions

Liquidity problemsLiquidity problems State banks with over-night liabilities State banks with over-night liabilities

of $14 billionof $14 billion Low asset qualityLow asset quality Inadequate risk assessment and Inadequate risk assessment and

management systemsmanagement systems Lack of good corporate governanceLack of good corporate governance

9



Summing up: Pre-crisis Summing up: Pre-crisis conditionsconditions

BanksBanks Liquidity problemsLiquidity problems State banks with over-night liabilities of $14 State banks with over-night liabilities of $14

billionbillion Large open positions of the private banksLarge open positions of the private banks Significant share of holdings of government debtSignificant share of holdings of government debt Low asset qualityLow asset quality Inadequate risk assessment and management Inadequate risk assessment and management

systemssystems Lack of good corporate governanceLack of good corporate governance

Operating EnvironmentOperating Environment Major macroeconomic instabilityMajor macroeconomic instability High public sector deficitHigh public sector deficit Systemic distortions created by state and weak Systemic distortions created by state and weak

banksbanks

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November and February CrisesNovember and February Crises

Sharp Sharp increaseincrease in in

interest ratesinterest rates

Sharp depreciationSharp depreciation of of

the Turkish Lirathe Turkish Lira

ContractionContraction in economic in economic

activityactivity

Maturity mismatch Maturity mismatch funding lossesfunding losses

Decline in the value of Decline in the value of securities portfoliosecurities portfolio

Short-positionsShort-positionsFX FX losseslosses

Asset QualityAsset Quality Credit RiskCredit Risk

Result:Result:

Erosion in Capital BaseErosion in Capital Base

Macroeconomic Shocks Impact on the

Banking Sector

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The initial fiscal costs of the The initial fiscal costs of the Turkish Turkish

crisis have been highcrisis have been high

In addition, private banks In addition, private banks raised $2.4 billion raised $2.4 billion of capital from own resources.of capital from own resources.

Thus, there has been a significant burden-Thus, there has been a significant burden-sharing as $7.1 billion of the restructuring sharing as $7.1 billion of the restructuring costs were borne by the costs were borne by the private sector.private sector.

BillionUSBillionUSDD

Ratio to GDP Ratio to GDP (%)(%)

State Banks Duty LossesState Banks Duty Losses 19.019.0 12.812.8

Capital Support to State Capital Support to State BanksBanks

2.92.9 2.02.0

Resolution of SDIF Resolution of SDIF banksbanks

21.721.7 14.914.9

-Public Resources-Public Resources 17.017.0 11.711.7

-Private Resources-Private Resources 4.74.7 3.23.2

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Banking System Restructuring Banking System Restructuring ProgramProgram announced on May 15, announced on May 15, 20012001 Objective is to Objective is to eeliminate liminate distortions in distortions in the the financial sector financial sector and adopt regulations and adopt regulations to pto promotromotee an efficient, globally competitive an efficient, globally competitive and sound banking sectorand sound banking sector RRestructuring of the state banksestructuring of the state banks Resolution of Resolution of the the SDIF banksSDIF banks SStrengthening of trengthening of tthe private bankshe private banks Improving the Improving the regulatory regulatory and and supervisory supervisory frameworkframework

4 Main Pillars4 Main Pillars

But crises also provide But crises also provide opportunitiesopportunities

for major restructuring for major restructuring

Banking Sector

Restructuring Program

State Bank Reform

Strong Capital BaseCost Efficiency

•Structural Reform•Macroeconomic Stability•Decline in Public Deficit

Efficient Supervision

Market Discipline and Transparency

Sound Sound BankingBanking

Strong Strong Economy Economy

and and Sustainable Sustainable

Growth Growth EnvironmentEnvironment

Corporate Restructuring

Goal: Sound banking-strong Goal: Sound banking-strong economyeconomy

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Financial restructuring Financial restructuring of the state banksof the state banks

Liquidation of duty lossesLiquidation of duty losses ( $19 billion)( $19 billion)

Elimination of the over-night liabilities Elimination of the over-night liabilities ( From $14 billion in March 2001 to zero ( From $14 billion in March 2001 to zero

in 2002)in 2002) Strengthening of the capital baseStrengthening of the capital base

($2.9 billion)($2.9 billion) Appropriation in the budget for any Appropriation in the budget for any

subsidies provided through the state bankssubsidies provided through the state banks Determination of deposit rates uniformly Determination of deposit rates uniformly

with market rateswith market rates Efficient management of the loan portfolioEfficient management of the loan portfolio

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Appointment of a Joint Board of DirectorsAppointment of a Joint Board of Directors

Monitoring program for profitability, liquidity, Monitoring program for profitability, liquidity, and interest and interest marginsmargins

Establishment of internal control, financial Establishment of internal control, financial control and risk management unitscontrol and risk management units

Improved efficiency and productivity Improved efficiency and productivity As of December 2002, number of branches As of December 2002, number of branches

and personnel were reduced by 32% and and personnel were reduced by 32% and 51%, respectively, compared to December 51%, respectively, compared to December 2000.2000.

Operational restructuring of Operational restructuring of the the

state banksstate banks

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Intervention of the insolvent Intervention of the insolvent banks banks

by the SDIFby the SDIFNovember 2000

CrisisThe Government’s Declaration to The Government’s Declaration to

Expand the Scope of Expand the Scope of the Guarantee covering all liabilities of SDIF banksthe Guarantee covering all liabilities of SDIF banks

•Internal/external confidence loss to the financial system•Bank runs (Indonesian example)•Withdrawal of deposits from the banking system (Total deposit $75.5 billion)

Liquidation limited by the scope of the

existing deposit insurance

• $ 26 billion cash requirement instead of transferring funds in the form of Government Securities to the SDIF • Need for over-borrowing• Excessive pressure on interest rates• Impossibility of sustaining the debt service

Direct liquidation after takeover by the SDIF

•Legal process has been shortened compared to direct liquidation•Resolution process has been facilitated through deposit transfers •Some portion of employees were keptemployed through branch/bank sales

Resolution under the SDIF

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Rapid resolution of the Rapid resolution of the intervened banksintervened banks

20 banks were taken over by the SDIF20 banks were taken over by the SDIF1 bank in 19971 bank in 1997 Law Nr.3182Law Nr.3182

1 bank in 19981 bank in 1998 Law Nr.3182Law Nr.3182

6 banks in 19996 banks in 1999 Law Nr.3182 (1), 14.3 (1), Law Nr.3182 (1), 14.3 (1), 14.3/14.4 (4)14.3/14.4 (4)

3 banks in 20003 banks in 2000 14.3 (1), 14.3/14.4 (2)14.3 (1), 14.3/14.4 (2)

8 banks in 20018 banks in 2001 14.3 (3), 14.3/14.4 (5)14.3 (3), 14.3/14.4 (5)

1 bank in 20021 bank in 2002 14.3/14.414.3/14.4 The resolution of these banks through The resolution of these banks through

merger, transfer, sale or liquidation merger, transfer, sale or liquidation within 2 within 2 yearsyears

(As of today only 2 banks remain under SDIF)(As of today only 2 banks remain under SDIF)

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Resolution Process of the SDIF Resolution Process of the SDIF BanksBanks

Financial Restructuring;Financial Restructuring; Elimination of over-night liabilitiesElimination of over-night liabilities Reduction of FX open positionsReduction of FX open positions Determination of deposit rates uniformly with Determination of deposit rates uniformly with

market ratesmarket rates Auction of deposits of about $3bn to other Auction of deposits of about $3bn to other

banksbanks Transfer of liabilies to other banksTransfer of liabilies to other banks

With operational restructuring, significant With operational restructuring, significant reduction in the number of branches and reduction in the number of branches and personnelpersonnel

Excluding 2 remaining banks Excluding 2 remaining banks number of number of branches were reduced to 6, personnel to 583. branches were reduced to 6, personnel to 583.

With bank sales, a total of With bank sales, a total of 10,33710,337 jobs were jobs were kept. kept.

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Most of these funds were used for meeting the Most of these funds were used for meeting the deposit liabilities deposit liabilities (total $26 billion)(total $26 billion) of the of the SDIF banks through payments and/or transfer. SDIF banks through payments and/or transfer.

Initial costs of resolving the Initial costs of resolving the intervened banksintervened banks

Billion USDBillion USD

Public Funds (a-b)Public Funds (a-b) 1717.1.1 a.Bonds issued by Treasurya.Bonds issued by Treasury 1818..55

b.Bonds returned by the SDIFb.Bonds returned by the SDIF 11..55

Funds Provided from Private Sector Funds Provided from Private Sector (c+d)(c+d) 44.7.7

c.Deposit c.Deposit supportsupport fromfrom SD SDIIF revenuesF revenues 22.6.6

d.Capital d.Capital ssupport upport fromfrom SDIF revenues SDIF revenues 22.2.2

TOTALTOTAL 2121..77

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Legal obstacles to a rapid Legal obstacles to a rapid collection of assets of collection of assets of

intervened banksintervened banks

SDIF has collected a total of SDIF has collected a total of $$11..7 7 billion billion via direct collectionvia direct collection, , sale of sale of subsidiaries, tangible and intangible subsidiaries, tangible and intangible assets and bank sales.assets and bank sales.

Dragging legal porcedures and Dragging legal porcedures and lawsuits lawsuits are a major impediment to are a major impediment to rapid collection.rapid collection.

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Debt swap operationDebt swap operation: Private banks’ : Private banks’ FX open position to $1.5 bn in FX open position to $1.5 bn in December 2001 from $8.4 bn at end-December 2001 from $8.4 bn at end-20002000

Lower interest rate risksLower interest rate risks: Issuance of : Issuance of floating rate, FX indexed and FX floating rate, FX indexed and FX denominated government bonds denominated government bonds

Financial and Real Sector CouncilFinancial and Real Sector Council: to : to develop strategies to resolve NPLs and develop strategies to resolve NPLs and to restructure corporate debtsto restructure corporate debts

Özel BankalarÖzel BankalarStrengthening of the private Strengthening of the private

banksbanks

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Increase in potential credit riskIncrease in potential credit risk Deep-rooted structural problemsDeep-rooted structural problems Deeper than expected recession Deeper than expected recession Adverse international environmentAdverse international environment

Limited possibilities of liquidation of assets in Limited possibilities of liquidation of assets in current economic conditionscurrent economic conditions

Limited scope for raising new capital from Limited scope for raising new capital from domestic and foreign private investors domestic and foreign private investors

Vicious cycle of banking crisis-real sector crisisVicious cycle of banking crisis-real sector crisis

RationaleRationale

Recapitalization scheme for Recapitalization scheme for the private banksthe private banks

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To ensure transparency and enhance confidence in To ensure transparency and enhance confidence in banking sectorbanking sector

To maximize capital contributions by banks’ ownersTo maximize capital contributions by banks’ owners

To encourage mergers and acquisitionsTo encourage mergers and acquisitions

To enable banks to start extending credits to real To enable banks to start extending credits to real sectorsector

To facilitate corporate debt restructuringTo facilitate corporate debt restructuring

To restore market disciplineTo restore market discipline

Recapitalization scheme for Recapitalization scheme for the private banksthe private banks

ObjectivesObjectives

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Start of the procedure with the completion of the legal framework01.02.02

01.04.02

Finalization of

the first audit

15.05.02

Announcement of

BRSA’s final assessment results to the banks

30.06.02

Realization of

capital increase

s

AssessmenAssessmentt PhasePhase

AssessmenAssessmentt PhasePhase

BankBank RecapRecap..

PhasePhase

BankBank RecapRecap..

PhasePhase

StateState RecapRecap..

PhasePhase

StateState RecapRecap..

PhasePhase

Realization of the capital support

by Public

30.04.02

22.04.02

Completion of appropriatene

ss control (second audit)

Submission of

Merger&

Acquisition plans (where

relevant) to

BRSA

Meetings of

General Assembl

ies

Application to BRSA

for support

Recapitalisation Recapitalisation Program Program PhasesPhases

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The transparency of the banking sector has The transparency of the banking sector has increased.increased.

The ability of the public sector authority to The ability of the public sector authority to design and apply sound policies towards the design and apply sound policies towards the establishment of a healthy and efficient establishment of a healthy and efficient banking sector has been improved.banking sector has been improved.

Statistical Results:Statistical Results: The total capital needs of the 25 banks have been The total capital needs of the 25 banks have been

determined as 866 mil. $determined as 866 mil. $ After negotiations, 720 mil. $ of the capital needs After negotiations, 720 mil. $ of the capital needs

has been covered by banks and with other positive has been covered by banks and with other positive developments (e.i. decline in int.rates increased the developments (e.i. decline in int.rates increased the value of gov’t papers). Remaining capital needs was value of gov’t papers). Remaining capital needs was 146 mil.$.146 mil.$.

Özel BankalarÖzel BankalarResults of the Audit ProcessResults of the Audit Process

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Asset size of the recap banks decreased from Asset size of the recap banks decreased from 69 bil. $ to 66 bil. $ after auditing.69 bil. $ to 66 bil. $ after auditing.Important revisions in loans and NPL’s Important revisions in loans and NPL’s (loans decreased from 29,2 tril.TL to 24 tril. TL (loans decreased from 29,2 tril.TL to 24 tril. TL and NPL’s increased from 2,3 tril. TL to 7,8 tril. and NPL’s increased from 2,3 tril. TL to 7,8 tril. TLTLThe collaterals of loans have been examined The collaterals of loans have been examined and updated by experts and real estate and updated by experts and real estate valuaiton agencies. (declined from 35,8 tril. TL valuaiton agencies. (declined from 35,8 tril. TL to 30,4 tril. TL)to 30,4 tril. TL) Inflation Accounting: Inflation adjustments for Inflation Accounting: Inflation adjustments for the non-monetary assets realized.the non-monetary assets realized. After the auditing process the own funds After the auditing process the own funds increased and the risk weighted assetes increased and the risk weighted assetes decreased. As a result the sector’s average CAR decreased. As a result the sector’s average CAR realized as 14,8%.realized as 14,8%.

27



Banks realized capital increase of Banks realized capital increase of $2.4 $2.4 billionbillion from their own resources. from their own resources.

As a result of the three-stage audit, 3 As a result of the three-stage audit, 3 banks were found to be capital banks were found to be capital deficient.deficient. 1 bank applied for state support and 1 bank applied for state support and

received subordinated debt to reach 9% received subordinated debt to reach 9% capital adequacy ratio. capital adequacy ratio.

Another bank’s capital need was covered in Another bank’s capital need was covered in cash by shareholders. The capital increase cash by shareholders. The capital increase process was finalized as of September 2002.process was finalized as of September 2002.

Pamukbank, with a capital deficiency of Pamukbank, with a capital deficiency of about $2 billion, was transferred to the SDIFabout $2 billion, was transferred to the SDIF

Özel BankalarÖzel BankalarResults of the Recap SchemeResults of the Recap Scheme

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Moving towards international standardsMoving towards international standards Regulations on capitalRegulations on capital Regulations on risk managementRegulations on risk management RRegulations on credit and subsidiaries’ limits egulations on credit and subsidiaries’ limits

and loan loss provisioningand loan loss provisioning AAccounting standards and independent ccounting standards and independent

auditingauditing Regulations on facilitating mergers and Regulations on facilitating mergers and

acquisitions acquisitions Regulations on special finance housesRegulations on special finance houses MoUs with other countries supervisory MoUs with other countries supervisory

authoritiesauthorities

Yasal ve Kurumsal DüzenlemelerYasal ve Kurumsal Düzenlemeler Improving the regulatory and Improving the regulatory and supervisory frameworksupervisory framework

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Consolidation in the banking sector Consolidation in the banking sector Number of banks declined from 81 in 1990 Number of banks declined from 81 in 1990

to 53 as of April 2003to 53 as of April 2003 Decline in the share of the State and Decline in the share of the State and

the SDIF banksthe SDIF banksDuring 2000-2002 the share of these banks

in total loans and deposits from 34.2% to 18% and 53.3% to 39.3%, respectively.

Increase in mergers and acquisitions Increase in mergers and acquisitions Total asset size of the mergers and Total asset size of the mergers and

acquisitions that took place in the sector acquisitions that took place in the sector is around $26.5 billionis around $26.5 billion

Results of operational Results of operational rrestructuringestructuring

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Results of financial Results of financial rrestructuringestructuring

Reduction of financial risks to Reduction of financial risks to manageable levels.manageable levels.

Improved transparency Improved transparency Improved profitabilityImproved profitability

In 2002 private banks generated a profit of $1.5 billion, state banks generated a profit of $646 million

Strengthened capital structureStrengthened capital structureCAR rose to 27.1% in December 2002 from 9.3% in December 2000.

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Effects on the private sectorEffects on the private sector

Istanbul ApproachA total of $3.8 billion of loans of 135

firms were restructured. Increased credit extensionCredits rose to $29.4 billion in 2002

from 23.4 billion in 2001.

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Although certain risks have been Although certain risks have been

decreased to more manageable decreased to more manageable levels...levels...

Interest Rate RiskInterest Rate RiskIssuance of bonds with variable interest rates Issuance of bonds with variable interest rates Distortions created by state banks and insolvent banks Distortions created by state banks and insolvent banks

eliminatedeliminated

Credit RiskCredit RiskAdequate classification of NPLs Adequate classification of NPLs after the after the 33-stage audit-stage auditRealistic assessment of cRealistic assessment of collateral ollateral Necessary provisions have been set asideNecessary provisions have been set aside

FX RiskFX RiskIssuance of FX-indexed bonds Issuance of FX-indexed bonds Implementation of floating rate regime Implementation of floating rate regime Improvements in risk management Improvements in risk management

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...some risks still remain...some risks still remain Despite Istanbul Approach share of NPLs are still Despite Istanbul Approach share of NPLs are still

high high Total sector Loan Loss Ratio = 17.8%Total sector Loan Loss Ratio = 17.8%For 25 Re-cap banks this ratio is 10.1% in 2002 For 25 Re-cap banks this ratio is 10.1% in 2002 compared to 24.7% in 2001compared to 24.7% in 2001

Short-term maturity structure of depositsShort-term maturity structure of deposits

More than 90% of the deposits have a maturity of More than 90% of the deposits have a maturity of less than 3 monthsless than 3 months

57% of the deposits are in FX57% of the deposits are in FX High share of Government bonds in the balance High share of Government bonds in the balance

sheetsheetFor Private Banks in 2002For Private Banks in 2002Securities /Total Assest= 33.3%Securities /Total Assest= 33.3%

Low level of free capital Low level of free capital High level of operational costsHigh level of operational costs

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BRSA’s agendaBRSA’s agenda

Rationalization of intermediation costsRationalization of intermediation costs

Establishment of financial holding companiesEstablishment of financial holding companies

Providing a level playing field in the sectorProviding a level playing field in the sector

Establishment of secondary markets for Establishment of secondary markets for

distressed debtdistressed debt

Incentives for rapid resolution of NPLsIncentives for rapid resolution of NPLs

Compliance with BASEL-II AccordCompliance with BASEL-II Accord

Risk based supervisionRisk based supervision

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Challenges faced Challenges faced by the BRSAby the BRSA

Legal obstaclesLegal obstacles Lack of political backing and consensus Lack of political backing and consensus Intense lobbying by pressure groupsIntense lobbying by pressure groups

Relationships between media and bank Relationships between media and bank groupsgroups

Public awarenessPublic awareness Institutional draw-backs Institutional draw-backs

BRSA - SDIF relationshipsBRSA - SDIF relationships Institutional development of BRSAInstitutional development of BRSA

Lack of secondary markets for distressed Lack of secondary markets for distressed debtdebt

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Key Lessons: Restructuring Key Lessons: Restructuring instruments instruments

utilized by the BRSAutilized by the BRSA Introduction of blanket guaranteeIntroduction of blanket guarantee Voluntary debt swap (TL to FX indexed)Voluntary debt swap (TL to FX indexed) Tax incentives for merger and acquisitionsTax incentives for merger and acquisitions Tax incentives to lengthen maturity of depositsTax incentives to lengthen maturity of deposits Merge then resolve (sell or liquidate) strategyMerge then resolve (sell or liquidate) strategy Superpowers granted to the SDIF to accelerate Superpowers granted to the SDIF to accelerate

collectioncollection SDIF deposit auctionsSDIF deposit auctions Re-capitalization scheme and provision of Tier-II Re-capitalization scheme and provision of Tier-II

capital capital Agree on protocols to accelerate collection process Agree on protocols to accelerate collection process

and to minimise costsand to minimise costs Voluntary corporate debt restructuring (Istanbul Voluntary corporate debt restructuring (Istanbul

Approach) Approach)

From Crisis to Stability: Restructuring of the Turkish Banking Sector “Strong Banking Sector,...

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