## cr1735

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**Canonical URL:** [cr1735](https://www.imf.org/-/media/files/publications/cr/2017/cr1735.pdf)

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---

### Team, scope, and documentation
- Team led by Nigel Jenkinson, International Monetary Fund (IMF) and Mario Guadamillas, World Bank (WB).
- Deputy Mission Chiefs: Jay Surti (IMF) and Anderson Silva (WB).
- IMF team members: Jefferson Alvares; Jana Bricco; Ryan Davis; Kelly Eckhold; Caio Ferreira; Gregorio Impavido; Richard Lalonde; Jonathan Pampolina; Narayan Suryakumar; Nico Valckx.
- WB team members: Laura Ard; Subika Farazi; Jose Antonio Gragnani; Michael Grist; Zamir Iqbal; Damodaran Krishnamurti; Harish Natarajan; Kevin Mark Stephenson.
- IMF experts: Geof Mortlock and Anand Sinha.
- Principal interlocutors: Undersecretary of the Treasury (UoT), Governor of the Central Bank of the Republic of Turkey (CBRT), Chair of the Banking Regulation and Supervision Agency (BRSA), Chair of the Capital Markets Board (CMB), Chair of the Savings and Deposit Insurance Fund (SDIF), Head of the Financial Crimes Investigation Board (MASAK), other official agencies, financial sector, and stakeholders.
- Report prepared by Nigel Jenkinson and Jay Surti with contributions from the FSAP team; draws on Technical Notes and Detailed Assessment Reports on Basel Core Principles for Effective Banking Supervision (BCP), Insurance Core Principles (ICP), and Principles for Financial Market Infrastructure (PFMI).
- Date: December 20, 2016.

### Purpose and focus of the FSAP
- FSAPs assess the stability of the financial system as a whole, not individual institutions.
- Objective: identify key sources of systemic risk and implement policies to enhance resilience to shocks and contagion.
- Certain risk categories excluded: operational risk, legal risk, fraud-related risk.
- Turkey deemed by the Fund to have a systemically important financial sector; assessment forms part of Article IV Consultation bilateral surveillance.

### Executive summary — key findings and risks
- Fundamental stability challenges:
  - Reduce dependence on external and foreign currency financing.
  - Increase maturity and diversity of funding instruments for banks and firms.
  - Long-standing shortfall of national savings to finance domestic investment.
  - Persistent elevated inflation and bouts of exchange rate volatility.
  - Households and firms have incentives to hold short-term deposits and foreign currency.
- Heightened financial stability risks stem from:
  - Tighter or more volatile global funding conditions.
  - Weaker euro area growth.
  - Geopolitical tensions.
  - Loss of market confidence in domestic policies.
- Balance-sheet fragilities amplify risks:
  - Increases in corporate leverage in recent years, particularly in foreign currency.
  - Severe stress could significantly strain companies’ debt servicing capacity.
  - Banks face pressured asset quality and returns that appear below their cost of equity.
  - Banks would likely absorb significant spillovers from corporate distress.
  - Capital buffers may be sufficient for a severe short-duration shock; a protracted recession would generate large capital shortfalls over the medium term.
- Policy priorities:
  - Lower vulnerabilities from banks’ wholesale FX financing and high corporate leverage in FX.
  - Raise official net FX reserves to provide a stronger national-level buttress.
- Institutional and supervisory progress:
  - Financial Stability Committee (FSC) regularly convenes heads of financial regulatory agencies and applied macroprudential tools with positive results.
  - Strengthened financial regulation and supervisory processes for banks and other intermediaries.
- Remaining priorities:
  - Raise effectiveness of financial supervision and governance.
  - Strengthen systemic risk identification and coordination of macroprudential policies.
  - Lower systemic liquidity risks and address gaps in crisis management arrangements.
- International standards assessments indicated need to enhance:
  - Supervisory processes for banks (risk-assessment focus, supervisory evaluation and enforcement of credit risk and corporate governance).
  - Insurance supervision (governance, independence, accountability, integration of functions).
  - FMIs (concentration of intraday liquidity at end of day; institute risk management for interdependencies among FMIs).

### Key recommendations to enhance resilience (selected, with timing)
- Timing codes: I = immediate, ST = short-term (within one year), MT = medium-term (beyond one year).
- Banking supervision:
  - Revise legislation to further strengthen BRSA independence (#21). MT
  - Deepen and broaden the risk assessment nature of banking inspections and follow up (#22). MT
  - Strengthen corporate governance rules and enforcement (#21). MT
  - Evaluate and revise the definition of credit classifications and strengthen enforcement (#24). ST
- Insurance supervision:
  - Improve independence, governance and accountability of supervisor; increase resources for internal control functions; integrate offsite, onsite and enforcement activities; develop risk-based, group supervision (#26). ST/MT
- Systemic risk oversight:
  - Strengthen macroprudential measures to lower foreign exchange risk in the economy (#35). I
  - Strengthen FSC’s governance and powers, provide explicit financial stability objective to all members, and limit CoM role (#31). ST
  - Develop procedures for improved systemic risk assessment and coordination of macroprudential policies; table policy proposals for ex ante FSC discussion and request formal responses to recommendations (#31). ST/MT
  - Base choice of policy tools on integrated assessment of systemic risk and cost-benefit analysis of alternative options (#36). ST
  - Strengthen transparency (including publishing an Annual Report) (#31). ST
- Managing systemic liquidity:
  - Orient liquidity provision towards a single key policy rate (#38). I
  - Increase net reserves such that gross reserves are within the range of 100-150 percent of the Assessment of Reserves Adequacy (ARA) metric (#39). MT
  - Improve ELA capacity; redefine CBRT FX lending facility as ELA and increase conditionality (#40). ST
- Financial crisis management:
  - Strengthen recovery and resolution planning and enhance resolution powers by: (i) Strengthening the Banking Law; (ii) Developing guidance (#43). MT
  - Strengthen domestic and cross-border coordination arrangements (#45, #47). ST
- AML/CFT:
  - Determine reason for low money laundering (ML) conviction rates and plan to address them (#50). MT
  - Introduce customer due diligence requirements for politically exposed persons (#50). ST
  - Ensure compliance with requirements of the United Nations Security Council Resolution (UNSCRs), and strengthen border controls on currency transportation (#50). MT

### External vulnerabilities and immediate risks
- Current account deficit projected to deteriorate to 4.5 percent of GDP in 2016.
- External debt burden at 60 percent of GDP.
- Gross annual financing needs exceed one quarter of GDP.
- FX reserves low compared to external debt and the foreign currency refinancing needs of banks and nonfinancial corporates (NFC).
- Gross international reserves (GIR) are below the IMF ARA metric.
- Downside risks tilted to the downside due to:
  - Large annual external financing need against low net international reserves (NIR).
  - Heightened global and regional uncertainties and tepid growth in key export markets.
  - Sovereign credit rating lowered below investment grade.
  - Risk of a large and protracted capital flow reversal given weaknesses in banks’ and NFCs’ balance-sheets.
  - Heightened economic and political uncertainty after July.

### Financial system structure and banking sector vulnerabilities
- Banks constitute over 90 percent of the financial system by assets.
- Financial system assets at 118 percent of 2015 GDP.
- Banking business model convergence among the 10 largest banks increases systemic exposure to common shocks.
- Asset-side developments:
  - Credit growth averaged over 20 percent per year over the last five years.
  - Since 2012, credit growth shifted from households towards corporate and SMEs; this segment now constitutes over 75 percent of the loan book.
  - Lending in FX has risen strongly though two-thirds of credit exposures remain in TRY.
- Funding-side developments:
  - Most funding raised at very short maturities and more than half in FX.
  - Deposits of over 12-month maturity are negligible.
  - Average maturity: 2½ months for TRY deposits and 3½ months for FX deposits.
  - Wholesale funding increased by more than 10 percentage points to over 40 percent of nonequity financing as of end-2015.
  - Over 60 percent of wholesale financing is in FX compared to an FX share of just over 40 percent of the deposit base.
- Returns, asset quality, and capital buffers:
  - Reported NPLs between 2½ and 3 percent of gross lending since end-2011.
  - Restructured credits rose from around 1 percent to 3 percent of gross loans between 2011 and 2015.
  - Applications for bankruptcy protection reportedly doubled since 2012.
  - Rising share of NPLs purchased by asset management companies reached 34 percent by 2014, with average recovery rates quoted by banks between 17-to-20 percent of outstanding value.
  - Banks’ capital buffers remain high but have been falling over the medium term.
  - Bank returns have been lower than estimated costs of equity consistently over the last five years.

### Corporate sector vulnerabilities (NFCs)
- NFC liabilities grew from 30 percent of GDP in 2007 to over 60 percent in 2015.
- 45 percent of NFC financial debt is in FX.
- Some 83 percent of financial debt is from Turkish banks.
- NFC FX assets cover less than 40 percent of FX liabilities.
- NFCs’ negative net FX position of USD 188 billion as of March 2016 (short-term FX position closed).
- Gross FX liabilities for the overall sector stood at USD 300 billion in 2016Q1, with short-term liabilities at 27 percent of the total.
- Sample of 396 publicly listed companies:
  - Debt-to-equity ratios doubled since 2007 to around 56 percent.
  - Interest expenses as a share of earnings rose to 80 percent for the weakest quartile of firms.
- Exporters’ revenues have not risen with TRY depreciation due to weak external demand; exposure to FX composition mismatch noted (earnings in euros, debt in U.S. dollars).

### SMEs, SOEs, and contingent liabilities
- Unlisted SMEs: rising leverage since 2009 including in FX, and declining profitability since 2011.
- SOEs’ return on assets at - 2 percent in 2014; resulted in heavy borrowing from banks.
- Direct and indirect contingent fiscal liabilities linked to guarantees for PPP projects appear to be growing steadily.
- Public sector banks’ role in funding PPPs may further raise contingent liabilities.

### Stress tests: design and key outcomes
- Scenarios analyzed:
  - Baseline: stable GDP growth of around 3½ percent with a zero output gap, high credit growth, FX depreciation, and persistently high current account deficits.
  - Adverse scenario: short period of sharp contraction in output with loss of access to international capital markets of the order experienced in 2008-09; results in high inflation, capital outflows, higher interest rates, stronger FX depreciation, prompting moderate balance-sheet strains for banks and NFCs.
  - Severely adverse scenario: prolonged loss of market access, deep recession with significantly larger cumulative and persistent GDP decline, higher capital outflows, and more severe and protracted market and credit disruptions.
- Resilience to stress — banks:
  - Adverse scenario:
    - Average CAR of the 10 largest banks remains above the regulatory floor of 8 percent in the first year.
    - Aggregate capital shortfall limited to under TRY 10 billion (one third of a percent of 2015 GDP).
    - Rapid economic recovery thereafter pulls undercapitalized banks’ CARs above 8 percent by end of second year.
  - Severely adverse scenario:
    - Aggregate capital needs can range up to TRY 100 billion, equivalent to 3½ percent of GDP after four years, under full recognition of credit risk.
    - Half of the 10 largest banks remain undercapitalized at the end of five years despite outer-years recovery assumptions.
- Interaction of liquidity and solvency:
  - Severe liquidity stress could lower liquidity coverage capacity by half (TRY) or more (FX) over 12 months in the adverse scenario.
  - Capital needs could be up to 2½ to 3½ times higher (some one percent of 2015 GDP) when liquidity and solvency interact.
  - In the severely adverse scenario, persistent loan losses and capital shortfalls could extend liquidity pressures to retail deposits with higher knock-on solvency impact.
- Resilience to stress — NFCs:
  - Median interest coverage ratio (ICR) for publicly-listed NFC sample falls below the critical threshold of two over the stress horizon.
  - Medium-sized firms (top 50–100 by asset size) show noticeably weaker performance.

### Policy recommendations to enhance resilience (regulatory, supervisory, macroprudential)
- Regulatory and supervisory framework:
  - Banking Law provides a broadly appropriate supervision framework with clear responsibilities and necessary supervisory powers.
  - Need to reinforce implementation: deepen risk-assessment focus of inspections, strengthen supervisory evaluation and enforcement of credit risk and corporate governance.
- Macroprudential application and FX risk options:
  - Decrease the spread between borrowing in lira and FX.
  - Impose restrictions on the structure of liabilities.
  - Apply higher risk weights or provisioning on lending to NFCs in FX.
  - Choice of policy tools should be based on integrated assessment of systemic risk and cost-benefit analysis; macroprudential tools are not a substitute for macroeconomic policy adjustment.
- Managing systemic liquidity — CBRT:
  - Focus interest rate tools on inflation, apply them more transparently and predictably, and make liquidity available at the key policy rate.
  - Transparently target a single key policy rate and provide most liquidity at that rate to encourage two-way markets.
  - Increase CBRT haircuts on FX collateral relative to Lira denominated securities to incentivize ownership of TRY securities as collateral.
  - Rebuild net FX reserves so CBRT FX reserves are within the standard ARA metric range; eliminate regular FX auctions and sales to increase flexibility.
  - ROM useful though may not fully substitute for CBRT net reserves if capital outflows concentrated outside banking system.
- Emergency Liquidity Assistance (ELA):
  - Treat FX lending facility as ELA and remove its committed nature to increase CBRT flexibility and strengthen bank incentives to self-insure against FX liquidity risks.
  - Enhance horizon scanning for ELA needs and perform regular procedure tests.
  - Include other relevant agencies in ELA processes, potentially coordinated by the FSC.
  - Introduce and preposition an expanded range of ELA collateral (including accepting bank loans).
  - Put processes in place to obtain government indemnities for significant financial risks of ELA.
- Crisis management and resolution:
  - Strengthen recovery and resolution planning and enhance resolution powers (expand SDIF powers: business transfer, establish/capitalize bridge banks, bail-in).
  - Establish a standing crisis management working group under the FSC and an inter-agency MOU at FSC level.
  - Develop cross-border coordination arrangements and capacity-building initiatives.
  - Strengthen purchase and assumption implementation arrangements and develop capacity to complete deposit insurance payments within a target period of 7 days.
- AML/CFT:
  - Determine reasons for low ML conviction rates and address them.
  - Introduce CDD requirements for politically exposed persons.
  - Ensure compliance with UNSCRs and strengthen border controls on currency transportation.

### Institutional and supervisory findings — BRSA, insurance, FSC
- BRSA independence and mandate:
  - BL establishes BRSA’s general independence and clear mandate, but legal parameters and arrangements can compromise independence (appointments process, ministerial actions against BRSA).
  - Recommendation: assign financial stability the primary role over development objective.
- Supervisory process and CAMELS:
  - CAMELS redesigned to capture underlying risk more granularly, but process stops short of firm, forward-looking, actionable results; skewed towards compliance validation.
  - Recommendation: BRSA to form well-founded qualitative conclusions leading to proportionate supervisory responses and corrective actions.
- Risk management and ICAAP:
  - ICAAP recently introduced; banks and supervisors are still developing approaches and systems.
  - Recommendation: further develop ICAAP implementation, reporting quality, and supervisory scrutiny before wider reliance on ICAAP outputs.
- Credit classification and provisioning:
  - Definitions in special mention and substandard categories are loose and overlapping.
  - Recommendation: strengthen asset classification definitions and refocus supervisory credit review to assess bank-wide implications.
- Insurance supervision:
  - Regulation and supervision enhanced (reporting, monitoring, solvency, reserving and investment practices), but gaps remain relative to international standards.
  - Recommendations: improve independence, governance and accountability; integrate offsite/onsite/enforcement activities; develop risk-based, group supervision; strengthen corporate governance and internal control independence and resources.
- Financial Stability Committee (FSC):
  - Established in 2011 by Decree Law 637; chaired by the Minister in charge of the Undersecretariat of the Treasury, currently the Deputy Prime Minister (DPM).
  - Members: Undersecretary of Treasury, Governor of CBRT, Chairman of BRSA, Chairman of CMB, Chairman of SDIF.
  - FSC duties: determine and monitor systemic risks; warn institutions; evaluate systemic risk management plans; coordinate systemic risk management; collect data and coordinate policies.
  - Systemic Risk Assessment Group (SRAG) established October 2012 supports analytical capacity.
  - Recommendations to strengthen FSC: enhance governance, provide all member agencies explicit financial stability mandate, institutionalize operational arrangements to table policy proposals and require follow-up responses, strengthen SRAG/Secretariat, increase transparency (publish an annual report), and limit Council of Ministers (CoM) role to crisis resolution beyond member agencies’ mandates.
- Systemic risk assessment improvements:
  - SRAG developed first version of a heat map.
  - Further steps: strengthen indicator mapping to sources of systemic risk; conduct periodic integrated/joint stress testing once or twice a year; integrate stress testing outputs into systemic risk assessments; monitor D-SIFIs, FMIs, and entities beyond regulatory perimeter; assemble database of FX exposures for unlisted NFCs.

### Financial Market Infrastructures (FMIs), CBRT-operated payment and SSS (EFT, RPS, ESTS) — key findings
- CBRT operates an integrated payment and SSS comprising EFT (RTGS), RPS, and ESTS (CSD-cum-SSS for government securities and CBRT bills).
- Total participants: 54 (all banks except MKK).
- Takasbank functions: SSS for secondary market transactions/repos on government securities on BIST; SSS for equities and corporate bonds traded on BIST; CCP for derivatives traded on BIST and on SLB platform; money market platform; collateralized cash credit facility; Legal Entity Identifier Operating Unit (LOU).
- Assessment against CPMI-IOSCO PFMIs:
  - EFT and ESTS broadly observe risk management, liquidity risk management, default management and operational risk management principles; partly observe tiered participation principle.
  - PSD risk management framework internally focused; does not fully account for external FMIs linkages and dependencies.
  - Participant exposure to liquidity risk due to transaction concentration closer to end of day.
  - Default management procedure developed but not comprehensively tested.
  - Legal ambiguity regarding Takasbank sub-account structure in ESTS and protection of securities in sub-accounts.
- Key recommendations for FMIs (selected, with priority where provided):
  - Review legal certainty for collateralized liquidity support involving securities held in ICSDs. Priority: Low.
  - Review and address ambiguity on legal protection of securities holdings in sub-accounts held by Takasbank at ESTS. Priority: High.
  - Expand PSD/CBRT risk management framework to include dependencies on other FMIs and risks posed to other FMIs. Priority: High.
  - Test the default management procedure comprehensively and include participants. Priority: Low.
  - Strengthen business continuity procedures to cover operational risks arising from other FMIs and develop complex scenarios. Priority: High.
  - Institute mechanisms to collect information about entities accessing EFT through tiered arrangements. Priority: Medium.
  - Address inefficiencies in government securities secondary market settlement by introducing new interfaces between MKK, ESTS and Takasbank. Priority: Medium.
  - Consider instituting explicit stress testing for liquidity and joint liquidity analysis between PSD and Markets departments. Priority: High.
- Business continuity:
  - Well-laid out BCP with governance arrangement, but BCP scenarios historically focused on CBRT infrastructure; plans underway to include complex scenarios and critical participants (including Takasbank and MKK).
- Authorities’ response:
  - CBRT and CMB broadly agree with findings; CBRT has revised RMF to include interlinked FMIs and identified two critical FMIs; CMB progressing on TR regulation and oversight resourcing.

### Insurance sector: structure, staffing, main findings, and ICP observance (select)
- Regulatory responsibilities vested in Undersecretary of the Treasury (UoT) split between General Directorate of Insurance (GDI) and Insurance Supervision Board (ISB).
- Combined staff: 172 (ISB: 66; GDI: 106).
- Industry size and trends:
  - In 2015, insurance sector comprised less than 3 percent of all financial services sector assets.
  - From 2006–2015, gross premiums written grew at an average annual rate of approximately 22 percent (7.4 percent at constant prices).
  - Insurance penetration remains low relative to peers.
- Key supervisory challenges and recommendations:
  - Clarify primary objectives (policyholder protection suggested as principal objective) and improve operational independence, governance and accountability of supervisor.
  - Map controlling beneficiaries of insurers and ensure ongoing suitability requirements.
  - Strengthen corporate governance, internal control, ERM, actuarial and audit requirements (require actuaries to opine on pricing; require external auditors to opine on risk management/internal controls).
  - Integrate offsite, onsite, and enforcement activities within a single supervisory organization or improve coordination.
  - Transition towards Solvency II Pillar One capital requirements and establish clear solvency control level below which insurer cannot continue.
  - Improve oversight of intermediaries, conduct of business, disclosure, and complaint handling.

### Selected economic and financial statistics (as presented)
- Population (2015): 78.2 million
- Per capita GDP (2015): US$9,182
- Quota (2015): SDR 1,455.8 million
- Real GDP growth rate series presented: 3.0 4.0 2.7 2.9 3.3 3.6 4.0 3.9
- Contributions to real GDP growth — Private domestic demand 1/: 0.9 3.2 2.5 1.5 2.8 3.0 3.4 3.6
- GDP deflator growth rate series: 8.3 7.4 7.4 7.4 7.4 7.5 7.3 7.0
- Nominal GDP growth rate series: 11.5 11.7 10.2 10.5 10.9 11.4 11.6 11.2
- CPI inflation (12-month; period-average) series: 8.9 7.7 7.7 8.0 7.9 7.4 7.3 7.0
- Unemployment rate series: 9.9 10.3 10.5 11.0 11.0 10.5 10.0 10.1
- Nonfinancial public sector — Primary balance series: 0.6 0.7 -0.6 -1.3 -0.7 0.5 0.8 0.9
- Net interest payments series: 2.2 2.1 2.1 2.0 1.8 1.8 1.8 1.8
- Overall balance series: -1.6 -1.5 -2.6 -3.4 -2.5 -1.3 -1.0 -0.9
- General government gross debt (EU definition) series: 33.5 32.9 34.6 35.8 36.6 35.8 35.2 34.8
- Current account balance series: -5.5 -4.5 -4.5 -5.3 -5.5 -5.0 -4.7 -5.0
- Gross financing requirement series: 26.5 27.9 27.2 30.7 31.5 30.9 29.6 29.2
- Foreign direct investment (net) series: 0.7 1.7 1.1 1.2 1.3 1.4 1.5 1.6
- Gross external debt series: 50.4 55.4 59.6 67.1 67.8 66.6 64.9 63.5
- Net external debt series: 30.8 35.7 38.7 44.6 45.9 45.8 45.1 44.6
- Short-term external debt (by remaining maturity) series: 21.0 22.6 23.8 27.1 27.4 26.6 25.7 24.4
- TL/US$, EOP series: 1.5 1.9 1.8 2.1 2.3 2.9 2.8 2.9 3.0
- Financial soundness indicators (selected banking sector figures):
  - Total Assets (percent of sector or index as reported): 91.6 93.8 96.7 110.5 114.1 120.7 111.9 115.1 117.7
  - o/w Gross Loans: 47.9 52.6 56.1 66.8 71.0 76.0 70.2 73.0 74.8
  - Deposits (o/w Deposits): 56.2 53.6 54.5 60.3 60.2 63.8 59.2 60.9 62.3
  - NPLs / Gross Loans: 3.7 2.7 2.9 2.8 2.9 3.1 3.3 3.3 3.3
  - Provisions / Gross NPLs: 83.8 79.4 75.2 76.3 73.9 74.6 75.2 76.2 76.4
  - Credit Growth (YoY) 7/: 33.9 29.9 16.4 31.8 18.5 19.7 14.2 12.3 8.6
  - ROAA 2/ 8/: 2.5 1.7 1.8 1.6 1.3 1.2 1.2 1.3 1.5
  - CAR: 19.0 16.6 17.9 15.3 16.3 15.6 15.5 15.8 16.0
  - CT1R: 17.0 14.9 15.1 13.0 13.9 13.2 13.3 13.5 13.7
  - Liquid Assets / Assets 11/: 28.2 26.2 26.0 24.3 23.3 21.6 21.9 21.5 21.2
  - Loan-to-Deposit ratio: 85.2 98.2 102.9 110.7 117.9 119.2 118.6 119.7 120.1
  - Non-Core / Core Liabilities 4/: 33.9 44.9 43.7 52.0 55.2 56.4 55.6 55.2 55.1

### Risk Assessment Matrix (RAM) — selected global and domestic risks and policy responses
- Global — Tighter or more volatile global financial conditions:
  - Likelihood: Medium; Time Horizon: Short Term; Impact: High.
  - Policy response: strengthen bank and NFC balance-sheets (restrictions on liability structure; higher risk weights/provisioning on FX lending to NFCs); tighten monetary policy; use FX reserves to smooth volatility to extent NIR allows; if recession ensues consider loosening fiscal stance.
- Domestic — Loose domestic policies leading to high inflation and deteriorating fiscal position:
  - Likelihood: Medium; Time Horizon: Short to Medium Term; Impact: High.
  - Policy response: Short-run tighten monetary policy and normalize framework; Medium term tighten fiscal policy and prioritize expenditure compression.

### Follow-up and progress on 2011 FSAP recommendations (selected)
- Micro-prudential regulation and supervision — banking:
  - Review and revise supervisory and regulatory framework to align with Basel framework — Implemented.
  - Revise the Banking Law to enhance operational and organizational autonomy of the BRSA — Not implemented.
- Micro-prudential regulation and supervision — insurance:
  - Reform insurance regulation and supervision processes to be more transparent, consultative, accountable — Partly implemented.
  - Transfer responsibilities for insurance regulation and supervision to an independent integrated insurance supervisory body — Not implemented.
- AML/CFT regime:
  - Adopt a new Law on CFT — Implemented.
  - Establish a definition for Politically Exposed Persons (PEP) and requirements for reporting entities in line with FATF — Not implemented.

*Prepared by Nigel Jenkinson and Jay Surti; December 20, 2016.*

### 2016. More information on the FSAP may be

### cr1735 - 2016. More information on the FSAP may be

### Team, Scope, and Documentation
- Team led by Nigel Jenkinson, International Monetary Fund (IMF) and Mario Guadamillas, World Bank (WB).
- Deputy Mission Chiefs: Jay Surti (IMF) and Anderson Silva (WB).
- Team members (IMF): Jefferson Alvares, Jana Bricco, Ryan Davis, Kelly Eckhold, Caio Ferreira, Gregorio Impavido, Richard Lalonde, Jonathan Pampolina, Narayan Suryakumar, Nico Valckx.
- Team members (WB): Laura Ard, Subika Farazi, Jose Antonio Gragnani, Michael Grist, Zamir Iqbal, Damodaran Krishnamurti, Harish Natarajan, Kevin Mark Stephenson.
- IMF experts: Geof Mortlock and Anand Sinha.
- Principal interlocutors: Undersecretary of the Treasury (UoT), Governor of the Central Bank of the Republic of Turkey (CBRT), Chair of the Banking Regulation and Supervision Agency (BRSA), Chair of the Capital Markets Board (CMB), Chair of the Savings and Deposit Insurance Fund (SDIF), Head of the Financial Crimes Investigation Board (MASAK), other official agencies, financial sector, and stakeholders.
- Report prepared by Nigel Jenkinson and Jay Surti with contributions from the FSAP team; draws on Technical Notes and Detailed Assessment Reports on Basel Core Principles for Effective Banking Supervision (BCP), Insurance Core Principles (ICP), and Principles for Financial Market Infrastructure (PFMI).
- Date: December 20, 2016.

### Purpose and Focus of the FSAP
- FSAPs assess the stability of the financial system as a whole and not that of individual institutions.
- Intended to help countries identify key sources of systemic risk and implement policies to enhance resilience to shocks and contagion.
- Certain risk categories excluded: operational risk, legal risk, fraud-related risk.
- Turkey deemed by the Fund to have a systemically important financial sector; stability assessment under this FSAP is part of bilateral surveillance under Article IV Consultation of the Fund’s Articles of Agreement.

### Executive Summary — Key Findings and Risks
- Fundamental stability challenges:
  - Reduce dependence on external and foreign currency financing.
  - Increase maturity and diversity of funding instruments for banks and firms.
  - Long-standing shortfall of national savings to finance domestic investment.
  - Persistent elevated inflation and bouts of exchange rate volatility.
  - Households and firms have incentives to hold short-term deposits and foreign currency.
- Heightened financial stability risks stem from:
  - Tighter or more volatile global funding conditions.
  - Weaker euro area growth.
  - Geopolitical tensions.
  - Loss of market confidence in domestic policies.
- Balance-sheet fragilities amplify risks:
  - Increases in corporate leverage in recent years, particularly in foreign currency.
  - Severe stress could significantly strain companies’ debt servicing capacity.
  - Banks face pressured asset quality and returns that appear below their cost of equity.
  - Banks would likely absorb significant spillovers from corporate distress.
  - Capital buffers may be sufficient for a severe short-duration shock; a protracted recession would generate large capital shortfalls over the medium term.
- Policy priorities:
  - Lower vulnerabilities from banks’ wholesale foreign exchange (FX) financing and high corporate leverage in FX.
  - Raise official net FX reserves to provide a stronger national-level buttress.
- Institutional and supervisory progress:
  - Financial Stability Committee (FSC) regularly convenes heads of financial regulatory agencies and applied macroprudential tools with positive results.
  - Strengthened financial regulation and supervisory processes for banks and other intermediaries.
- Remaining priorities for improvement:
  - Raise effectiveness of financial supervision.
  - Enhance governance arrangements.
  - Strengthen systemic risk identification and coordination of macroprudential policies.
  - Lower systemic liquidity risks.
  - Address gaps in crisis management arrangements.
- Assessments against international standards identified enhancements needed in:
  - Supervisory processes for banks: deepen risk-assessment focus of inspections, strengthen supervisory evaluation and enforcement of credit risk and corporate governance.
  - Insurance supervision: improve governance, independence, accountability, integration of functions, focus on corporate governance and internal controls.
  - Financial Market Infrastructures (FMIs): address concentration of intraday liquidity at end of day and institute risk management for interdependencies among FMIs.
- Strengthening the FSC:
  - Provide additional clarity on roles and responsibilities of FSC, Council of Ministers (CoM), and FSC member authorities.
  - Provide all member agencies an explicit objective for financial stability.
  - Change procedures to support integrated risk identification and ex ante assessment of alternative policy options.
  - Commit member agencies to consider and respond to FSC recommendations before taking policy decisions.
  - Increase transparency and disclosure, including publishing an FSC Annual Report.
- Market development:
  - Deeper Turkish lira money and capital markets would lower systemic risks.
  - Focus interest rate tools on inflation, apply tools transparently and predictably, make liquidity available at the key policy rate.
  - Develop derivatives markets and improve issuance regulations, disclosure, and governance standards for capital market products.
- Crisis management and resolution:
  - Work underway to address weaknesses in crisis management planning and bank resolution powers; completing improvements is a priority.
  - Strengthen legal framework and procedures to expand resolution tools, support recovery and resolution planning, develop early warning and systemic impact assessments, and enhance Emergency Liquidity Assistance (ELA) framework.
  - Create a crisis management working group reporting to the FSC and underpinned by an inter-agency Memorandum of Understanding (MOU) at the FSC level.
  - Develop cross-border coordination arrangements and capacity-building initiatives.
- Contextual note:
  - FSAP recommendations finalized on completion of missions in June 2016.
  - Article IV Consultation report notes increased political and economic uncertainty following the failed coup attempt in July, raising importance of strong framework to protect financial stability.
  - Maintaining institutional capacity, staffing, and independence of public agencies is key to implementing FSAP recommendations.

### Key Recommendations to Enhance Resilience (selected, with timing)
- Timing codes: I = immediate, ST = short-term (within one year), MT = medium-term (beyond one year).
- Banking Supervision:
  - Revise legislation to further strengthen BRSA independence (#21). MT
  - Deepen and broaden the risk assessment nature of banking inspections and follow up (#22). MT
  - Strengthen corporate governance rules and enforcement (#21). MT
  - Evaluate and revise the definition of credit classifications and strengthen enforcement (#24). ST
- Insurance Supervision:
  - Improve independence, governance and accountability of supervisor; increase resources for internal control functions; integrate offsite, onsite and enforcement activities; develop risk-based, group supervision (#26). ST/MT
- Systemic Risk Oversight:
  - Strengthen macroprudential measures to lower foreign exchange risk in the economy (#35). I
  - Strengthen FSC’s governance and powers, provide explicit financial stability objective to all members, and limit CoM role (#31). ST
  - Develop procedures for improved systemic risk assessment and coordination of macroprudential policies: agree to table policy proposals for ex ante FSC discussion and request formal responses to recommendations (#31). ST/MT
  - Base choice of policy tools on integrated assessment of systemic risk and cost-benefit analysis of alternative options (#36). ST
  - Strengthen transparency (including publishing an Annual Report) (#31). ST
- Managing Systemic Liquidity:
  - Orient liquidity provision towards a single key policy rate (#38). I
  - Increase net reserves such that gross reserves are within the range of 100-150 percent of the Assessment of Reserves Adequacy (ARA) metric (#39). MT
  - Improve ELA capacity; redefine CBRT FX lending facility as ELA and increase conditionality (#40). ST
- Financial Crisis Management:
  - Strengthen recovery and resolution planning and enhance resolution powers by: (i) Strengthening the Banking Law; (ii) Developing guidance (#43). MT
  - Strengthen domestic and cross-border coordination arrangements (#45, #47). ST
- AML/CFT:
  - Determine reason for low money laundering (ML) conviction rates and plan to address them (#50). MT
  - Introduce customer due diligence requirements for politically exposed persons (#50). ST
  - Ensure compliance with requirements of the United Nations Security Council Resolution (UNSCRs), and strengthen border controls on currency transportation (#50). MT

### Macrofinancial Setting — Short summary
- The Turkish economy slowed following strong performance in 2015.
- Domestic and external shocks, increasing private indebtedness, weaker business confidence, lower private investment demand and tourism revenues, and tightening of credit standards contributed to the slowdown.
- Economic growth is projected to decline to 2.7 percent this year.
- In the medium-term economic growth is expected to increase gradually.

*Prepared by Nigel Jenkinson and Jay Surti; December 20, 2016.*

### 2.      External vulnerabilities remain elevated. Notwithstanding a favorable external financing

### 2.      External vulnerabilities remain elevated. Notwithstanding a favorable external financing

### External position and immediate risks
- Current account deficit projected to deteriorate to 4.5 percent of GDP in 2016.
- External debt burden at 60 percent of GDP.
- Gross annual financing needs exceed one quarter of GDP.
- FX reserves low compared to external debt and the foreign currency refinancing needs of banks and nonfinancial corporates (NFC).
- Gross international reserves (GIR) are below the IMF ARA metric.
- Downside risks are tilted to the downside due to:
  - Large annual external financing need against low net international reserves (NIR).
  - Heightened global and regional uncertainties and tepid growth in key export markets.
  - Sovereign credit rating lowered below investment grade, increasing vulnerability in global funding markets.
  - Risk of a large and protracted capital flow reversal given weaknesses in banks’ and NFCs’ balance-sheets.
  - Heightened economic and political uncertainty after July.

### Assessment of financial system vulnerabilities (overview)
- Structural factors increasing vulnerability:
  - High proportion of savings and debt held in foreign currency and at short maturities.
  - Dependence on cross-border financing.
  - Convergence in major banks’ business models.
- Cyclical factors increasing vulnerability:
  - Growing corporate leverage.
  - An underbelly of mid-sized companies below the largest firms.
  - Rising corporate-bank and (contingent) corporate-sovereign exposures.
  - Deterioration in banks’ asset quality at a time when returns are below the cost of equity.

### Financial system structure and banking sector importance
- Banks constitute over 90 percent of the financial system by assets.
- Financial system assets at 118 percent of 2015 GDP.
- Banking system size is average relative to peer emerging markets, but:
  - Proportion of credit financed by nondeposit channels is larger.
  - Concentration is not significant; market share distributed among private domestic, foreign-owned, and state-owned banks.
  - Foreign bank asset ownership share increased via acquisition-based entry.

### Banking business models, risks, and vulnerabilities
- Convergence of the 10 largest banks’ business models over the last five years increases systemic exposure to common shocks.

Asset-side developments
- Banks have shifted from securities into lending with increasing FX and NFC exposures.
- Credit growth averaged over 20 percent per year over the last five years.
- Since 2012, credit growth has shifted from households towards corporate and SMEs; this segment now constitutes over 75 percent of the loan book.
- Lending in FX has risen strongly though two-thirds of credit exposures remain in TRY.

Funding-side developments
- Most funding raised at very short maturities and more than half in FX.
- Deposits of over 12-month maturity are negligible.
- Average maturity: 2½ months for TRY deposits and 3½ months for FX deposits.
- Wholesale funding increased by more than 10 percentage points to over 40 percent of nonequity financing as of end-2015.
- Over 60 percent of wholesale financing is in FX compared to an FX share of just over 40 percent of the deposit base.

Systemic risk
- Systemic risk measures show elevated common vulnerability of banks during episodes of global market disruption and geopolitical uncertainty due to business model convergence.

### FX exposures and hedging
- Large FX positions from banks’ funding strategy are closed through derivatives with foreign counterparties.
- Short on-balance-sheet position at 20 percent of regulatory capital, mitigated by hedging via plain vanilla cross-currency and interest rate swaps with international banks.

### Liquidity risk and maturity transformation
- Liquidity risk management has become more challenging due to:
  - Rising maturity transformation as banks moved out of government securities into private credit.
  - Growth in FX wholesale funding increasing refinancing risk.
- While share of wholesale external funding in medium-term buckets increased, a significant proportion remains sourced at short maturities.
- Footnote: Some overstatement of medium-to-long term wholesale funding may exist as banks nominally extended syndicated loan maturities by a few days to just beyond 365 days.

### Returns, asset quality, and capital buffers
- Reported NPLs between 2½ and 3 percent of gross lending since end-2011.
- Returns have deteriorated due to rapid balance-sheet expansion and reorientation towards lower margin corporate lending and policy-induced squeeze on retail credit margins.
- Bank returns have been lower than estimated costs of equity consistently over the last five years; the gap widened over time.
- Restructured credits rose from around 1 percent to 3 percent of gross loans between 2011 and 2015.
- Applications for bankruptcy protection reportedly doubled since 2012 (example cited in text).
- Rising share of NPLs purchased by asset management companies reached 34 percent by 2014, with average recovery rates quoted by banks between 17-to-20 percent of outstanding value.
- Banks’ capital buffers remain high but have been falling over the medium term.
- Estimated cost of equity demanded by investors higher than bank returns, implying potential difficulty raising capital if required.

### Corporate sector (NFCs) vulnerabilities
- NFC liabilities grew from 30 percent of GDP in 2007 to over 60 percent in 2015.
- 45 percent of NFC financial debt is in FX.
- Some 83 percent of financial debt is from Turkish banks.
- NFC FX assets cover less than 40 percent of FX liabilities.
- NFCs’ negative net FX position of USD 188 billion as of March 2016 (short-term FX position closed).
- Gross FX liabilities for the overall sector stood at USD 300 billion in 2016Q1, with short-term liabilities at 27 percent of the total.
- From a sample of 396 publicly listed companies:
  - Debt-to-equity ratios doubled since 2007 to around 56 percent.
  - Interest expenses as a share of earnings rose to 80 percent for the weakest quartile of firms.
- Exporters’ revenues have not risen with TRY depreciation due to weak external demand.
- A stronger U.S. dollar and tightening dollar funding could add pressure on profits because exporters tend to earn in euros while much debt is in U.S. dollars.

### SMEs, SOEs, contingent liabilities
- Unlisted SMEs exhibit similar risk profiles: rising leverage since 2009 including in FX, and declining profitability since 2011.
- Absence of information prevents assessment of hedging for these SMEs.
- SOEs’ profitability weakened (return on assets at - 2 percent in 2014), resulting in heavy borrowing from banks.
- Direct and indirect contingent fiscal liabilities linked to guarantees for PPP projects appear to be growing steadily.
- Public sector banks’ role in funding PPPs may further raise contingent liabilities.

### Bankruptcy and sectoral contagion risk
- Implied ratings for publicly-listed firms show over 70 percent rated either B or lower in the NFC stress testing exercise.
- Around 25 percent of firms’ liabilities are to other firms, heightening risk of rapid cascading deterioration in credit quality in the event of shocks.

### Household sector
- Household credit remains important; restrictions prevent lending to households in FX.
- Some exuberance in the housing market present; household debt-to-GDP and financial net worth have held steady.
- Debt-to-disposable income was rising until recently.
- Loan losses on retail (mainly credit card) loans were higher by over 40 percent in 2015 relative to 2011.
- Authorities’ recent easing of macroprudential policies on household lending to support demand occurs when financial stability risks are elevated.

### Stress tests: design and key outcomes
- Large existing capital buffers render banks resilient to a severe, adverse economic shock if it is sufficiently short in duration; a protracted recession would generate large capital shortfalls.
- Under stress scenarios, liquidity risks may add significantly to solvency pressure, increasing capital needs.
- Mid-to-large sized NFCs face significant difficulties servicing debt under stress due to higher interest expenses from rising cost of funds, TRY depreciation, and recession-induced earnings declines.

Scenarios analyzed
- Baseline: stable GDP growth of around 3½ percent with a zero output gap, high credit growth, FX depreciation, and persistently high current account deficits.
- Adverse scenario: short period of sharp contraction in output with loss of access to international capital markets of the order experienced in 2008-09; results in high inflation, capital outflows, higher interest rates, stronger FX depreciation, prompting moderate balance-sheet strains for banks and NFCs.
- Severely adverse scenario: prolonged loss of market access, deep recession with significantly larger cumulative and persistent GDP decline, higher capital outflows, and more severe and protracted market and credit disruptions.

Resilience to stress — banks
- Adverse scenario:
  - Despite large deterioration, the average capital adequacy ratio (CAR) of the 10 largest banks remains above the regulatory floor of 8 percent in the first year.
  - Aggregate capital shortfall limited to under TRY 10 billion (one third of a percent of 2015 GDP).
  - Rapid economic recovery thereafter pulls undercapitalized banks’ CARs above 8 percent by end of second year.
- Severely adverse scenario:
  - Aggregate capital needs can range up to TRY 100 billion, equivalent to 3½ percent of GDP after four years, under full recognition of credit risk.
  - Half of the 10 largest banks remain undercapitalized at the end of five years despite outer-years recovery assumptions.

Interaction of liquidity and solvency
- Severe liquidity stress could lower liquidity coverage capacity by half (TRY) or more (FX) over 12 months in the adverse scenario.
- Liquidity stress could force banks to cut credit lines, amplifying pressures on NFCs and households, raising NPLs and loan losses beyond solvency stress test levels.
- Capital needs could be up to 2½ to 3½ times higher (some one percent of 2015 GDP) when liquidity and solvency interact.
- In the severely adverse scenario, persistent loan losses and capital shortfalls could extend liquidity pressures to retail deposits with higher knock-on solvency impact.

Resilience to stress — NFCs
- NFCs particularly vulnerable to interest rate and FX shocks in both scenarios.
- Median interest coverage ratio (ICR) for publicly-listed NFC sample falls below the critical threshold of two over the stress horizon, indicating higher default risk.
- Larger firms more resilient due to higher FX asset stock; medium-sized firms (top 50–100 by asset size) show noticeably weaker performance.

### Policy recommendations to enhance resilience
Regulatory and supervisory framework
- Since the 2011 FSAP, authorities made significant efforts to strengthen banking regulation and supervision.
- The Banking Law (BL) provides a broadly appropriate supervision framework with clear responsibilities and necessary supervisory powers.
- The established methodology for banking supervision is comprehensive and grounded on extensive databases and regulation largely in compliance with international standards.
- The BCP assessment highlights strengthening of the framework but emphasizes the need to reinforce implementation.

*Source: IMF staff assessment contained in the provided chapter text.*

### 21.      Several important elements of the framework potentially limit the BRSA’s operational

### cr1735 - 21.      Several important elements of the framework potentially limit the BRSA’s operational

### BRSA independence and mandate
- Findings:
  - The BL establishes the BRSA’s general independence and a clear mandate.
  - Legal parameters and other arrangements can compromise independence, including issues within the BRSA board appointments process and the ability of the relevant minister to take action against the BRSA.
  - The BRSA’s twin objectives of financial sector stability and financial sector development require prioritization to prevent potential conflict.
- Recommendation:
  - Financial stability should be assigned the primary role.

### Supervisory process and CAMELS
- Findings:
  - The CAMELS rating system has been redesigned to capture underlying risk at a more granular level.
  - The process stops short of generating firm, forward-looking, and actionable results.
  - The current process is skewed towards validation of compliance processes and constrains active, more forceful supervisory judgments and decisions.
- Recommendation:
  - BRSA should form well founded, qualitative conclusions about the condition, operations, and governance of banks which lead to proportionate supervisory responses and corrective actions.

### Risk management and ICAAP
- Findings:
  - The risk management framework is centered in the Internal Capital Adequacy Assessment Process (ICAAP).
  - ICAAP was introduced relatively recently; banks are still developing their approaches and systems.
  - The quality of banks’ reports and the scrutiny by supervisors will need to develop further before the results can be more reliably and extensively used.
- Recommendation:
  - Further develop ICAAP implementation, reporting quality, and supervisory scrutiny before wider reliance on ICAAP outputs.

### Credit classification and provisioning
- Findings:
  - Regulatory asset classification definitions, particularly in the special mention and substandard categories, are loose and substantially overlapping.
  - The supervisory credit review process requires strengthening.
  - Examination conclusions focus more on internal control issues rather than on the implications for management acumen, the condition of the subject credit portfolio and the bank in general, and the effectiveness of risk management and governance.
- Recommendation:
  - Strengthen asset classification definitions and refocus supervisory credit review to assess higher-level implications and bank-wide risk management effectiveness.

### Insurance regulation and supervision
- Findings:
  - Regulation and supervision of insurance have been significantly enhanced during the past five years: information reporting, insurer monitoring and supervision efficiency increased; solvency ratios strengthened; reserving and investment practices improved.
  - Much work remains to close the gap between current practices and international standards.
- Recommendations:
  - Explore options to improve the independence, governance and accountability of the insurance supervision authority.
  - Integrate offsite, onsite, and enforcement activities within a single supervisory organization.
  - Complete development of a risk-based approach and a group-wide supervisory framework.
  - Strengthen corporate governance requirements and ensure key internal control functions have appropriate independence and resources.

### National Payment System (NPS)
- Findings:
  - The NPS in Turkey is well developed, safe and efficient.
  - Legal framework has been significantly enhanced in recent years; institutional arrangements are clear and well organized.
  - Authorities’ scope and powers related to regulation, supervision and oversight of the NPS are adequate.
- Improvement opportunities:
  - Address risk management in a more integral way considering risks among FMIs.
  - Explore and implement liquidity mechanisms to address end-of-day payment concentration risks.

### Oversight and management of systemic risks — FSC arrangements
- Findings:
  - Turkey has made significant progress in developing a macroprudential policy framework.
  - The Financial Stability Committee (FSC) brings together heads of five agencies with financial sector oversight responsibilities to support identification and management of systemic risks.
  - The FSC is primarily an oversight and discussion body; operational responsibilities remain with member agencies.
- FSC composition and mandate (as described):
  - Established in 2011 by Decree Law 637.
  - Chaired by the Minister in charge of the Undersecretariat of the Treasury, currently the Deputy Prime Minister (DPM).
  - Members: Undersecretary of Treasury (Treasury), Governor of the CBRT, Chairman of the BRSA, Chairman of the CMB, Chairman of Savings Deposit Insurance Fund (SDIF).
  - Duties include determining and monitoring systemic risks; warning related institutions; evaluating systemic risk management plans; coordinating systemic risk management; collecting data and coordinating policies; making decisions within the framework of the law.
  - Treasury provides secretarial support; members provide analytical support.
  - The Systemic Risk Assessment Group (SRAG), established by protocol in October 2012, supports analytical and decision making capacity; key SRAG priorities include development of additional risk assessment tools and closure of data gaps.
- Benefits and limitations:
  - Current arrangements supported information sharing and improved focus on systemic risks.
  - FSC often used as a platform for sharing agencies’ own assessments rather than as a forum for ex ante policy formulation and option evaluation.
  - Consensus is needed to reach recommendations; little transparency and information disclosure by the Committee.
- Recommendations to strengthen FSC:
  - Enhance governance, including restricting role of the CoM to crisis resolution beyond member agencies’ mandates.
  - Provide all member agencies with an explicit mandate for promotion of financial stability to support FSC work.
  - Institutionalize stronger operational arrangements: commit members to table policy proposals at formulation stage and require follow-up responses on recommendations.
  - Strengthen analytical support and SRAG via an integrated and enhanced Secretariat.
  - Implement a more structured communication strategy, including publishing periodical information (e.g., an annual report) and a published protocol or charter on responsibilities and organizational practices.

### Systemic risk assessment improvements
- Recent progress:
  - SRAG developed the first version of a heat map as a collaborative tool to support systemic risk assessment.
- Further steps recommended:
  - Strengthen mapping of indicators to potential sources of systemic risk to provide a forward looking perspective.
  - Conduct periodic integrated or joint stress testing (top down and bottom up) once or twice a year.
  - Integrate stress testing outputs into systemic risk assessments.
  - Monitor and assess domestic systemically important financial institutions (D-SIFIs), financial market infrastructures, and risks beyond the regulatory perimeter.
  - Undertake ex post assessment of the effectiveness of policy measures.
- Note:
  - It is recommended that authorities assemble a database of FX exposures for unlisted NFCs (including SMEs and SoEs) along the lines of their database on publicly listed companies to assess risks to financial stability.

### Macroprudential policy application and remaining vulnerabilities
- Findings:
  - A wide range of macroprudential tools applied in the past five years to contain cyclical risks and strengthen structural resilience.
  - Measures in 2011 and 2013 to contain cyclical consumer credit risk contributed to a subsequent slowdown in loan growth.
  - Policies to strengthen bank funding supported extension of maturities of non-core (wholesale) liabilities in FX and provided flexibility to manage short-term FX liquidity pressures.
- Remaining vulnerabilities:
  - High dependence on short term FX funding by banks and NFCs.
  - High leverage of NFCs, including in FX.
- Policy options recommended to lower FX risk:
  - Decrease the spread between borrowing in lira and FX.
  - Impose restrictions on the structure of liabilities.
  - Apply higher risk weights or provisioning on lending to NFCs in FX.
- Caution:
  - Recent easing of macroprudential measures on the retail side is not clearly supported by systemic risk considerations.
  - Choice of policy tools should be better informed by integrated assessment of systemic risk and cost-benefit considerations; some tools combine monetary policy and macroprudential objectives, raising appropriateness questions.
  - Macroprudential tools should target systemic risk and are not a substitute for macroeconomic policy adjustment.
  - A systematic review of costs and benefits of potential options by the FSC at the risk identification and policy formulation stage is recommended.

### Managing systemic liquidity — CBRT liquidity and FX capacity
- Key questions raised:
  - To what extent does the CBRT’s monetary policy implementation framework support development of domestic money and capital markets to reduce reliance on FX funding?
  - How robust is the CBRT’s capacity to manage FX liquidity risks in the system?
  - Is the CBRT’s ELA framework sufficiently robust to buffer the system in a systemic crisis?
- Recommendations to support Lira markets:
  - Focus interest rate tools on inflation, apply them more transparently and predictably, and make liquidity more readily available at its key policy rate.
  - Transparently target a single key policy rate and provide most liquidity at that rate to encourage two-way markets.
  - Increase CBRT haircuts on FX collateral relative to Lira denominated securities to incentivize ownership of TRY securities as collateral.
  - These recommendations are consistent with the CBRT’s reform plans announced in its 2015 “Roadmap”.
- FX reserve capacity findings and recommendations:
  - Net FX reserves are relatively low and need to be rebuilt such that CBRT FX reserves are within the standard ARA metric range.
  - Much of the CBRT’s gross reserves are funded by reserve requirements of banks which may need access in stress.
  - Other contingent claims on reserves (FX auctions, FX sales to the state energy company, large FX lending facility) limit flexibility to respond to a systemic crisis.
  - Eliminating regular FX auctions and sales would increase flexibility and foster FX market development and liquidity.
  - The Reserves Option Mechanism (ROM), allowing banks to substitute TRY required reserves with FX reserves and vice versa, has proved useful though not severely tested; ROM may not fully substitute for CBRT net reserves if capital outflows are concentrated outside the banking system.
  - Note: The CBRT has not offered to sell any FX via auction since 27 April 2016 but has not formally cancelled daily auctions.

### Emergency Liquidity Assistance (ELA)
- Findings and concerns:
  - The ELA function is established and procedures exist, but the CBRT views ELA as a remote event and does not perform regular tests of procedures.
  - Some current operations (e.g., the FX lending facility) should be considered ELA and separated from standard operations.
- Recommendations:
  - Remove the committed nature of the FX lending facility to increase CBRT flexibility and strengthen bank incentives to self-insure against FX liquidity risks.
  - Enhance horizon scanning for potential ELA needs and perform regular procedure tests.
  - Include other relevant agencies in ELA processes, potentially coordinated by the FSC.
  - Introduce and preposition an expanded range of ELA collateral (including accepting bank loans).
  - Put processes in place to obtain government indemnities for significant financial risks of ELA.

### Financial safety nets, bank resolution, and crisis management
- Findings:
  - Turkey has several elements for effective financial safety nets, recovery and resolution frameworks, and crisis management arrangements.
  - There is a reasonably clear institutional framework with tasks allocated to supervisory agency, resolution authority, central bank and the Treasury, and structures to facilitate domestic coordination.
  - Laws applicable to bank recovery and resolution contain many essential provisions: corrective action powers, triggers for entry into resolution, and a broad range of resolution powers.
  - The assessment highlighted gaps and scope for strengthening recovery, resolution policy, and preparedness.
- Deposit insurance specifics:
  - SDIF has many of the powers required to make payouts to insured depositors and has developed systems and controls to achieve this in a relatively short period.
  - The deposit insurance limit is TRY 100,000 per depositor per bank and provides full coverage to over 95 percent of natural person depositors.
  - The deposit insurance fund is financed on an ex ante basis and as of June 2016 represented over six percent of insured deposits.
- Recommendation:
  - Strengthen purchase and assumption implementation arrangements and develop capacity to complete deposit insurance payments within, ultimately, a target period of 7 days.

*IMF staff report text as provided in the source content.*

### 43.      As the authorities have recognized, there are still many shortcomings in the financial

### cr1735 - 43.      As the authorities have recognized, there are still many shortcomings in the financial

### Financial safety net, recovery, and resolution
- Authorities recognize many shortcomings in financial safety net arrangements relative to new international standards for recovery and resolution.
- Ongoing reforms initiated to address shortcomings, including proposals for strengthening the BL and developing policy on:
  - recovery planning,
  - resolvability assessments,
  - resolution planning.
- Important priorities for legal reform (as highlighted in the assessment):
  - equip BRSA with effective recovery planning powers, empower SDIF to undertake resolvability assessments and resolution planning, and empower both agencies to require banks to undertake necessary changes to make plans implementable;
  - introduce new resolution tools for the SDIF, including powers for more comprehensive business transfer, for establishing and capitalizing bridge banks, and for implementing bail-in when judged appropriate;
  - facilitate international bank data sharing by SDIF.
- Amendments to the BL should provide appropriate legal safeguards to support effective resolution, particularly regarding the ‘no creditor/shareholder worse off’ principle, and associated compensation provisions.

### Institutional arrangements and crisis management responsibilities
- Legal changes should be accompanied by strengthening institutional arrangements for crisis management.
- Additional clarification of objectives for each agency would be beneficial to ensure each supports effective crisis management and financial stability.
- Proposed delineation of roles in line with international practice:
  - BRSA should retain responsibility for determining whether the triggers for resolution have been breached, in consultation with SDIF;
  - following that determination, control of the bank should immediately pass to SDIF, with SDIF taking full responsibility for determining the form of resolution to be applied.

### Coordination mechanisms and operational preparedness
- Coordination mechanisms among agencies should be enhanced.
- Recommendation to establish a standing working group under the FSC, comprising all member agencies, tasked to coordinate development of crisis management strategies and options, including policies on recovery planning, resolvability assessments and resolution planning.
- Development of a published FSC crisis management MOU is recommended setting out objectives and principles of bank resolution, responsibilities of each agency, and processes for crisis management coordination.

### Resolution funding and cross-border arrangements
- Consideration should be given to establishing a new systemic resolution funding mechanism.
  - Authorities should consider a range of resolution funding mechanisms, and the costs and benefits of each, as well as providing legal clarity on the application of the mechanism.
- Cross-border recovery and resolution arrangements need bolstering:
  - currently there are no crisis management MOUs between SDIF and foreign counterparts;
  - SDIF is not involved in any CMGs and has not established CMGs for systemically important banks domiciled in Turkey;
  - suggested that agencies establish crisis management MOUs with foreign authorities (home and host) of systemic importance to Turkey and establish or seek involvement in CMGs where practicable.

### AML/CFT: risks, reforms, and priorities
- Assessment of ML/TF environment:
  - Turkey faces significant money laundering/terrorism financing (ML/TF) risks from criminal and terrorist organizations (e.g., Islamic State of Iraq and the Levant (ISIL)) as well as corruption.
  - ML convictions are low.
  - Criminal organizations, foreign terrorist fighters, and separatists exploit the informal economy and vulnerabilities in controls of transportation of currencies across borders.
- Steps taken:
  - legal framework amended to more fully criminalize ML and establish mechanisms to freeze terrorist assets;
  - a national risk assessment (NRA) is underway and expected to be completed before Turkey’s next mutual evaluation by the Financial Action Task Force (FATF) in 2019.
- Recommended priorities to strengthen implementation:
  - determine reasons for relatively low ML conviction rate and develop strategies to address shortcomings, including ensuring the ML offense is in line with the international standard;
  - promptly complete the NRA to inform risk-based responses and prioritize resolution of vulnerabilities;
  - align the legal framework with international standards, including customer due diligence requirements for politically exposed persons, criminalization of the financing of FTFs, and the evidentiary standard for domestic designations;
  - enhance controls over cross-border transportation of currency (including by increasing fines and sanctions);
  - ensure freezing of assets of designated persons and organizations is conducted without delay.

### Broadening markets and services: capital markets and financial inclusion
- Developing Turkish capital markets can help alleviate duration mismatches of banks and corporates, reduce reliance on foreign currency, and support growth, given vulnerabilities from short-term funding in lira and foreign currency and high dependence on bank finance.
- Policy options and measures:
  - support consolidation of an interest rate derivatives market and stimulate liquidity in government and corporate bond markets to facilitate hedging and enhance demand for capital market products;
  - improve issuance regulations, disclosure and governance standards to strengthen investor confidence;
  - stimulate savings and assess limitations on more effective allocation of capital by different types of investors.
- Financial inclusion:
  - Turkey compares favorably with peers in bank account penetration, supported by an innovative retail payments system;
  - inclusion challenges: gender gap, lack of savings, limited access to finance in under-served regions;
  - Islamic finance is emerging and could catalyze inclusion but regulatory/governance, capacity, and financial literacy issues need addressing;
  - further inclusion measures: better targeting under-served segments, strengthen public/private coordination, enhance Monitoring and Evaluation framework, ensure level playing field between banks and nonbanks, fine-tune payment mechanisms for government payments.

### Selected economic and financial statistics (as presented)
- Population (2015): 78.2 million
- Per capita GDP (2015): US$9,182
- Quota (2015): SDR 1,455.8 million
- Real GDP growth rate: 3.0 4.0 2.7 2.9 3.3 3.6 4.0 3.9
- Contributions to real GDP growth — Private domestic demand 1/: 0.9 3.2 2.5 1.5 2.8 3.0 3.4 3.6
- GDP deflator growth rate: 8.3 7.4 7.4 7.4 7.4 7.5 7.3 7.0
- Nominal GDP growth rate: 11.5 11.7 10.2 10.5 10.9 11.4 11.6 11.2
- CPI inflation (12-month; period-average): 8.9 7.7 7.7 8.0 7.9 7.4 7.3 7.0
- Unemployment rate: 9.9 10.3 10.5 11.0 11.0 10.5 10.0 10.1
- Nonfinancial public sector — Primary balance: 0.6 0.7 -0.6 -1.3 -0.7 0.5 0.8 0.9
- Net interest payments: 2.2 2.1 2.1 2.0 1.8 1.8 1.8 1.8
- Overall balance: -1.6 -1.5 -2.6 -3.4 -2.5 -1.3 -1.0 -0.9
- General government gross debt (EU definition): 33.5 32.9 34.6 35.8 36.6 35.8 35.2 34.8
- Current account balance: -5.5 -4.5 -4.5 -5.3 -5.5 -5.0 -4.7 -5.0
- o/w Nonfuel current account balance: 0.7 0.2 -1.3 -1.4 -1.5 -1.0 -0.8 -1.1
- Gross financing requirement: 26.5 27.9 27.2 30.7 31.5 30.9 29.6 29.2
- Foreign direct investment (net): 0.7 1.7 1.1 1.2 1.3 1.4 1.5 1.6
- Gross external debt 3/: 50.4 55.4 59.6 67.1 67.8 66.6 64.9 63.5
- Net external debt: 30.8 35.7 38.7 44.6 45.9 45.8 45.1 44.6
- Short-term external debt (by remaining maturity): 21.0 22.6 23.8 27.1 27.4 26.6 25.7 24.4
- TL/US$, EOP: 1.5 1.9 1.8 2.1 2.3 2.9 2.8 2.9 3.0

### Financial soundness indicators (selected banking sector figures)
- Total Assets (percent of sector or index as reported): 91.6 93.8 96.7 110.5 114.1 120.7 111.9 115.1 117.7
- o/w Gross Loans: 47.9 52.6 56.1 66.8 71.0 76.0 70.2 73.0 74.8
- Deposits (o/w Deposits): 56.2 53.6 54.5 60.3 60.2 63.8 59.2 60.9 62.3
- NPLs / Gross Loans: 3.7 2.7 2.9 2.8 2.9 3.1 3.3 3.3 3.3
- Provisions / Gross NPLs: 83.8 79.4 75.2 76.3 73.9 74.6 75.2 76.2 76.4
- Credit Growth (YoY) 7/: 33.9 29.9 16.4 31.8 18.5 19.7 14.2 12.3 8.6
- ROAA 2/ 8/: 2.5 1.7 1.8 1.6 1.3 1.2 1.2 1.3 1.5
- CAR: 19.0 16.6 17.9 15.3 16.3 15.6 15.5 15.8 16.0
- CT1R: 17.0 14.9 15.1 13.0 13.9 13.2 13.3 13.5 13.7
- Liquid Assets / Assets 11/: 28.2 26.2 26.0 24.3 23.3 21.6 21.9 21.5 21.2
- Loan-to-Deposit ratio: 85.2 98.2 102.9 110.7 117.9 119.2 118.6 119.7 120.1
- Non-Core / Core Liabilities 4/: 33.9 44.9 43.7 52.0 55.2 56.4 55.6 55.2 55.1
- TL/US$, EOP: 1.5 1.9 1.8 2.1 2.3 2.9 2.8 2.9 3.0

*International Monetary Fund — Turkey: selected chapters and statistical tables (as presented in the source PDF).*

### 1.  SRISK  Capital Shortfall of  Listed Banks and Insurers

### 1.  SRISK  Capital Shortfall of Listed Banks and Insurers

### Banks’ FX and Liquidity Risks
- Charts show On-Balance Sheet FX Net Open Position and Off-Balance Sheet FX Net Open Position in "In $ billion" series for 2011–2016 with axes labeled (examples visible: -90 to 500 on one chart; 0 to 150 and 0 to 600 on others).
- Deposits by Maturity are shown "In percent of total deposits" with maturity buckets including <=7, <=1 month, <=3 months, <=12 months, rest.
- Maturity gaps presented "In $ billion, weighted average" and bank external liabilities series show "Short-term debt", "Long-term", "Total (rhs)" with axes spanning 40 to 200 and 0 to 140 respectively.
- Bank External Liabilities charts present "Short-term debt" and "Short-term debt (remaining maturities)" in "In $ billion" (axes include 20 to 120).

Sources: CBRT, BBSA, and Fund staff estimates.
Notes: NOP = net open position; short-term liability = of (residual) maturity less than 12 months; medium-to-long term liability = of (residual) maturity greater than 12 months.

### Banks’ Returns, Asset Quality, and Solvency
- Bank Profitability (In percent) series for 2010–2016 show ROA and ROE (axes labeled 0 to 23).
- Bank Capital Adequacy (In percent) series include CAR and Core CAR for 2011–2016 (axes labeled 10 to 19).
- Bank Problem Assets (In percent of total loans) series show NPLs and Restructured Loans with values around 0 to 8 on axis.
- NPL to Tangible Equity and Provisions presented "In percent, weighted average" for ownership types: State-owned, Domestically-owned, Foreign-owned (dates include 2011Q4, 2013Q2, 2014Q4, 2016Q2).
- Banks' Returns and Cost of Capital (In percent) series show ROAE and Cost of capital for 2012–2016 (axes labeled 5 to 25).

Sources: BRSA, The Banks Association of Turkey (BAT), PDP, and Fund staff estimates.
Notes: CAR = capital adequacy ratio; Core CAR = total core CAR; Hotels = hotels and restaurants; Finance = financial intermediation; Trade = wholesale and retail trade; Households = individual credit; NPL = non performing loans.

### Corporate Sector Risks and Vulnerabilities
- Turkish Firms: Debt to Equity series for 2003–2015 with Median and Median Top firm groups (axis 0 to 80).
- Corporate Earnings show ROA and ROE (2003–2015) with axis ranges 2.0 to 5.0 for ROA and 2.5 to 5.0 for ROE.
- Corporate Sector FX Liabilities presented in "Billion, USD" with categories: Import Payables, LT External Loans, ST External Loans, Non bank financial companies, LT FX Indexed Loans, ST FX Indexed Loans, LT Domestic Bank Loans, ST Domestic Bank Loans (axes up to 350).
- Net Foreign Exchange Position of Corporate Sector shown in "Billion, USD" with net and short-term net positions (axis -200 to 50).
- Nonfinancial Corporate Ratings distribution (EDF9 Implied Rating Distribution) across Aaa-Aa, A, Baa, Ba, B, Caa-C.
- SMEs Profitability and Leverage: Net Sales percentage of Assets and Debt percentage of Assets with axis ranges Net Sales 52–66, Debt 40–140 (2006–2014).

Sources: IMF Staff Estimates and S&P Capital IQ; CBRT; Moody's; Turkish Treasury.

### Summary Results of Solvency Stress Tests of Major Banks (Figure 9)
- Source: BRSA supervisory data, IMF Staff Computations.
- Note: Stress impact estimates show the median of the range of impact estimates under different methodologies and risk factor inputs. ERB = Economic Risk-Based Approach, STA = Standardized approach under Basel II capital regulation. V-scenario = Adverse Scenario. L-scenario = Severely Adverse Scenario.
- Panels and series shown (2015–2020 or 2016–2020 depending on panel):
  - A. Capital Adequacy Ratio (In percent) with series ERB, STA, Baseline, V-scenario, L-scenario (axis 0 to 18).
  - B. Return on Assets (In percent) with ERB, STA, Baseline, V-scenario, L-scenario (axis -1 to 2).
  - C. Loan Loss Provisions Ratio (Relative to total assets, in basis points) with Baseline, V-scenario, L-scenario (axis 0 to 250).
  - D. Risk-Weighted Assets (Index, 2015=100) with Baseline, V-scenario, L-scenario (axis 0 to 250).
  - E. Number of Banks with Capital Shortfall with ERB, STA, V-scenario, L-scenario (axis 0 to 9 in some panels; and 0 to 60 in others).
  - F. Capital Shortfall (In billion TRL) with ERB, STA, V-scenario, L-scenario (axis 0 to 60).

### Results of the Liquidity Stress Tests of Major Banks (Figure 10)
- Source: BRSA and FSAP Calculations.
- Note: Stressed liquidity coverage ratios are derived after imposing stress on cash outflows (Moderate stress: 10/20 percent on retail deposits for large/other banks, 10 percent on corporates; Severe stress: 10/30 percent on retail deposits for large/other banks, 15 percent on corporates; Very severe stress: 15/30 percent on retail deposits for large/other banks, 20 percent on corporates), discounting high quality liquid assets by 5 percent, and assuming zero inflows from the central bank or the interbank market. In the Extreme stress scenario, both outflows and inflows are stressed to a higher degree. In the right-hand figure, counterbalancing capacity refers to all assets that can be liquidated and used to counterbalance funding gaps.
- Current and Stressed Liquidity Coverage Ratio (In percent) panels: Total and FX for Dec. 2015 and scenarios Moderate stress, Severe, Very severe, Extreme (axis 0 to 250).
- Maturity Profile of Cash Flow Liquidity in TL and FX (In billion TL) shows cumulative net liquidity after counterbalancing across buckets Daily, 1-7d, <1m, 1-3m, 3-6m, 6-9m, 9-12m, 1-2yr, 2-5yr.

### Funding Liquidity–Solvency Feedback in Solvency Stress Tests (Figure 11)
- Liquidity stress can add to solvency pressure, adversely affects banks’ profitability for some time, the impact is persistent and significant relative to GDP in 2016.
- Source: FSAP calculations, based on BRSA supervisory banking data.
- Note: Specific refers to funding shocks (interest rate shocks to liabilities) imposed on the three weakest banks in 2016, and spilling over to the three most connected banks, based on the results from the spillover analysis. Market-wide refers to a generalized funding shock affecting all banks in 2016 and 2017. Results shown are for the economic risk based approach to solvency stress testing.
- Impact series (V-scenario, Specific, Market-wide) shown for:
  - Impact Funding Shocks on CAR in V-scenario (In percent) (axis 0 to 16 for 2015–2020).
  - Impact Funding Shocks on ROA in V-scenario (In percent) (axis -2 to 2 for 2015–2020).
  - Impact Funding Shocks on Bank Capital Needs — Number of banks with capital shortfall (axis 0 to 10 for 2016–2020).
  - Impact Funding Shocks on Bank Capital Needs — Recapitalization need, in billion TRL (axis 0 to 35 for 2016–2020).

### Corporate Sector Stress Test Analysis (Figure 12)
- FX Sensitivity Analysis: Stressed ICR 2016 for unhedged firms and hedge ratios 20%, 50%, 80% with FX assets hedge and median/top firm groups (scale -1.0 to 6.0).
- Solvency Risk: Sensitivity Analysis ICR (2015) and stressed ICRs for INT EXP 1 S.D, EBITDA 1 S.D, ICR 1 S.D (scale -2.0 to 12.0).
- Adverse Scenario Forecast: Median EBITDA and INT EXP with ICR (RHS) (axes 0.0 to 6.0 and 0 to 25).
- FX Risk: Adverse Scenario ICR across years 2015–2020 with percentiles and median/top firm groups.
- Severely Adverse Forecast: Median EBITDA, INT EXP, ICR (RHS).
- Debt At Risk (Percent of Total Debt) for sample of publicly-listed firms shown by ICR buckets ICR<1, ICR<2, ICR<3, ICR<4, ICR<5, Above 5 for Pre-Stress, Adverse Scenario, Severely Adverse.

Note: 1. List of firms excludes conglomerates, firms with a FX functional currency and leasing firms.
Source: IMF Staff Estimates and S&P Capital IQ.

### Risk Assessment Matrix (RAM) — Selected Risks, Likelihood, Impact, Policy Response (Annex I)
- Global risks highlighted:
  - Economic fallout from political fragmentation: Likelihood High; Time Horizon Short to Medium Term; Impact Low/Medium/Medium (varied across sub-items). Policy response:
    - Preemptively increase FX reserves through sterilized intervention.
    - Medium term: Improve competitiveness through structural reform.
    - Reduce energy dependence by developing additional domestic generation capacity.
  - Tighter or more volatile global financial conditions: Likelihood Medium; Time Horizon Short Term; Impact High. Policy response:
    - Preemptively strengthen bank and NFC balance-sheets through restrictions on the structure of liabilities and higher risk weights or provisioning on lending to NFCs in FX.
    - Tighten monetary policy.
    - Use FX reserves to smooth volatility in disorderly market conditions to the extent the NIR level allows.
    - In case a recession ensues, consider loosening the fiscal stance.
  - Weaker-than-expected global growth: Likelihood Low/Medium; Time Horizon Short to Medium Term; Impact Medium/High/Medium. Policy response:
    - Preemptively strengthen bank and NFC balance-sheets through restrictions on the structure of liabilities and higher risk weights or provisioning on lending to NFCs in FX.
    - Medium term: Diversify export destinations, increase high value-added exports, and improve competitiveness.
    - Structural reforms should be promptly implemented.
    - Medium term: Tighten fiscal policy to bring it back into line with the reduced growth potential.
- Domestic risks highlighted:
  - Loose domestic policies leading to high inflation and deteriorating fiscal position: Likelihood Medium; Time Horizon Short to Medium Term; Impact High. Policy response:
    - Short-run: Tighten monetary policy and normalize the framework.
    - Medium term: Tighten fiscal policy to bring it back into line with the medium-term program. Prioritize expenditure compression.
  - Private debt overhang weighing on domestic demand: Likelihood Medium; Time Horizon Short to Medium Term; Impact High. Policy response:
    - Preemptively strengthen bank and NFC balance-sheets through restrictions on the structure of liabilities and higher risk weights or provisioning on lending to NFCs in FX.
    - Short-run: Use some additional fiscal space and assign a bigger weight to the output gap in monetary policy consistent with orderly FX market conditions.
    - Medium term: Put in place a robust debt-restructuring framework.

Note: The RAM shows events that could materially alter the baseline path. The relative likelihoods are staff subjective assessments: "low" indicates probability below 10 percent, "medium" between 10 and 30 percent, "high" between 30 and 50 percent. "Short term" indicates within 1 year and "medium term" within 3 years.

### Report on the Observance of Standards and Codes (ROSC) — Summary Assessments of BCP (Annex II)
- Assessment context:
  - The assessment was completed as part of an FSAP undertaken by the IMF and the WB during 2016 and reflects the regulatory and supervisory framework in place as of completion in April 2016.
  - The assessment uses the revised BCP assessment methodology approved by the Basel Committee, rating against Essential Criteria (EC).
  - Assessment sources: (i) legal and documentary evidence; (ii) the work of the supervisory authority; (iii) implementation in the banking sector.
  - The mission reviewed BRSA documentation, BCP self-assessment by BRSA, responses to supervisory questionnaires, laws including the BL, regulations, inspection reports, and held meetings with BRSA staff, local banks, an external auditing firm, a credit rating agency, and the Turkish Treasury.
- Main findings:
  - Since the Basel Core Principle assessment in 2011, significant effort undertaken to strengthen banking regulation and supervisory process.
  - Progress: development of macroprudential policy framework; establishment of the Financial Stability Committee (FSC) to promote information sharing and coordinate policy measures; updates to regulatory framework; upgrade of supervisory approach.
  - Assessment emphasizes:
    - Significant strengthening of regulatory framework and revisions to supervisory approach.
    - Need to strengthen implementation of the framework.
    - Continued need for BRSA to form well-founded, qualitative conclusions about bank operations and oversight and to take corresponding, proportionate supervisory responses.
- Section heading referenced: Responsibility, Objectives, Powers, Independence, Accountability (CPs 1–2).

Sources: BRSA supervisory data, IMF Staff computations, FSAP calculations, CBRT, BBSA, BAT, PDP, S&P Capital IQ, Moody’s, Turkish Treasury, IMF Staff Estimates.

*Source: cr1735 - 1. SRISK Capital Shortfall of Listed Banks and Insurers (IMF PDF chapter).*

### 7.      Similar to the 2011 assessment, some important elements of the regulatory and

### 7.      Similar to the 2011 assessment, some important elements of the regulatory and supervisory framework persist and potentially limit the BRSA’s objectives and operational and organizational independence.

### Independence and Governance
- The BL provides a broadly appropriate framework and establishes the BRSA’s general independence and a clear mandate.
- The enumerated regulatory and supervisory objectives of financial sector stability and development require prioritization and could present potential conflicts when the BRSA carries out its mandate.
- Outstanding issues that can compromise independence include:
  - i) the appointments of the BRSA Chair and Board members are made by the CoM without any confirmation process by any other independent body,
  - ii) the requirement that the supervisor shall consult the Ministry and the State Planning Organization before putting regulations into force;
  - iii) the relevant minister may permit lawsuit(s) against Board members,
  - iv) the related Ministry may file a lawsuit for the cancellation of the BRSA Board’s regulatory decisions; and
  - v) the Prime Minister can remove members of the Board, if conditions in the BL are met, without publicly disclosing the reasons.
- In relation to resourcing, entry conditions to the BRSA are not attractive for the hiring of mid-career professionals and provide practical constraints in the event of a shortfall in experience levels.

### Ownership, Licensing, and Structure (CPs 4–7)
- The BL provides clear definitions of activities permitted only to registered banks, including taking deposits from the public.
- Law, regulation, and procedures provide the BRSA authority to control and oversee significant bank ownership and controlling companies.
- Major acquisitions and investments by banks and controlling companies are subject to prior approval by the BRSA.
- The licensing framework and BRSA processes provide a comprehensive framework to assess adequacy of new bank registrations, including foreign bank branches.
- Recommendations:
  - Consider explicitly requiring that banks’ boards have, on a collective basis, sound knowledge of their banks’ material activities and planned activities.
  - More explicitly determine whether relevant home supervisors practice global consolidated supervision on cross-border activities and consider more extensively the effectiveness of supervision in host countries.

### Methods of Ongoing Supervision (CPs 8–10)
- The BRSA has enhanced its supervisory approach since 2011; methodology is comprehensive and documented in manuals.
- It leverages substantial databases and has authority to require periodic information from banks and controlling companies for offsite and onsite processes.
- The CAMELS rating system was redesigned to capture underlying risk on a more granular level and added qualitative and quantitative assessment criteria.
- Shortcomings in practical implementation:
  - The onsite supervisory process focuses on generating the CAMELS rating but is not sufficient to produce firm, forward-looking, and actionable conclusions.
  - Special examinations concentrate heavily on compliance and do not clearly identify needs for broader supervisory action.
  - Results of the ICAAP need more thorough analysis and discussion with banks; stress test results should play a larger role.
  - Banks, particularly systemically important financial institutions (SIFs), should be required to develop recovery plans and the BRSA should assess their resolvability.
  - Consider setting policies establishing at least one annual meeting between supervisors and the board of the bank.
- Organizational issues:
  - Onsite and offsite functions are relevant and well developed, but work is conducted in parallel with little coordination or cross-departmental communication.
  - Supervisors do not exchange views beyond written reports.
  - Recommendations: develop a process to assess internal effectiveness and increase rotation between on- and off-site supervisors.

### Corrective and Sanctioning Powers of Supervisors (CP 11)
- The BRSA has an appropriate range of supervisory tools for noncompliance or systemic risk.
- In practice, remedial and corrective legal actions are rarely used; the BRSA relies more on administrative fines whose scope is more clearly defined in the BL.
- The process is relatively skewed towards validation of compliance processes and constrains active supervisory judgments and decisions.

### Cooperation, Consolidated, and Cross-Border Banking Supervision (CPs 3–12–13)
- The regulatory and reporting framework is broadly appropriate for monitoring risks from nonbanking and foreign banking operations in groups.
- Given limitations of the CAMELS rating and ICAAP, the BRSA should make further efforts to monitor and manage risks from nonbanking and foreign activities or parent entities.
- Recommendations:
  - Deepen analyses and strengthen techniques such as group-wide stress testing.
  - Further improve recovery and resolution planning of large banking groups, including scenarios where shocks originate from nonbanking entities or parent groups.
- Legal provisions and operational frameworks for cooperation with domestic and foreign authorities are in place; BRSA has improved home-host relationships but should further develop cross-border crisis coordination and resolution plans.

### Corporate Governance (CP 14)
- The legal framework is extensive but heavily focused on board responsibilities regarding internal systems (risk management, internal control, internal audit).
- Supervisory validation of internal systems operation and overall governance is not well supported; no holistic cross-cutting assessment of corporate governance exists.
- Recommendations:
  - Develop a more comprehensive corporate governance regulation completing elements already in guidelines and regulation.
- Specific governance shortcomings:
  - Neither the BL nor subsidiary legislation requires the board to act, on a collective basis, in an independent and objective manner and apart from third-party influence.
  - No requirement for the majority of the board to be composed of nonexecutive or independent members.
  - The BL requires Board audit committees to have a minimum of two independent members, which is considered too few to execute duties robustly, given the audit committee’s role in internal systems oversight including risk management.

### Prudential Requirements, Regulatory Framework, Accounting and Disclosure (CPs 15–29)
- The BRSA has adopted Basel II, 2.5 and III components according to the Basel Committee framework.
- Capital is calculated on a consolidated and solo basis; BRSA can impose additional capital requirements on individual banks.
- The BRSA applies the three Basel ratios (common equity tier 1, tier 1 and total capital) as well as countercyclical capital requirements, systemically important bank capital add-ons and a “capital planning buffer” that provides a forward looking nature to capital regulation.
- Recommendation: as BRSA gains experience with the ICAAP, consider simplifications to improve enforceability and reduce compliance burden, particularly for non-systemically important banks.
- The overarching risk framework is embodied in the RICAAP (Regulation on Internal Systems and Internal Capital Adequacy Assessment Process of Banks); banks are still developing approaches and systems.
- Quality of banks’ reports and supervisory scrutiny need further development before results can be reliably and extensively used; overall risk management framework requires increased independence and development.

### Credit Risk, Classification, and Provisioning
- Legal framework for credit risk is generally comprehensive, but several issues compromise effectiveness and application:
  - Framework does not require ongoing, independent (from the business line) credit risk monitoring of large individual exposures or homogeneous portfolios and verification of process integrity.
  - Information from this line function is source data used by risk management functions, audit committee, board reporting, and likely reported to the BRSA.
- Credit classification and provisioning framework is generally adequate, but:
  - Credit classification definitions, particularly in special mention and substandard categories, are loose and substantially overlapping.
  - Accuracy of asset classification, provisioning, and reporting to boards and the BRSA is called into question given reclassifications assigned by onsite examiners.
  - Examination conclusions focus more on internal control issues rather than higher-level implications for portfolio condition, management, and governance.
- Historical and statistical support for standard (general) and special mention loan categories is not substantiated by accumulated loss experience.
  - It is not clear if appraised values, within a range, are being realized upon sale of properties or if provisioned amounts are adequately covering loss experience on classified loans.
  - Recommendation: establish clear parameters for periodic valuation of underlying collateral on NPL exposures.

### Concentration, Country, Market, and Liquidity Risk
- Legal framework for concentration risk and large exposures limits is generally in line with international standards; definition of connected parties is comprehensive.
- BRSA examines and monitors exposures including large exposures, concentrations by sector, product, customer, and risk group.
- BRSA guidance adequately captures country and transfer risk; banks expected to establish country risk parameters and monitoring systems, including indirect foreign-exchange and indirect country risk.
- Market risk and interest rate risk (in the banking book) regulation is comprehensive, including parameters for valuation, stress testing, and model use.
  - Specialist expertise is not deployed to evaluate stress testing scenarios or calculation details.
  - Recommendation: use specialized expertise to evaluate scenarios and assumptions for complex stress testing and review model validations during onsite or offsite exercises; develop specialized examination processes for more frequent and deeper assessments.
- Liquidity:
  - BRSA has a comprehensive framework for liquidity regulation, monitoring, and assignment of bank responsibilities; regulation is in some cases more rigorous than international benchmarks.
  - BRSA received a “compliant” rating in a Regulatory Consistency Assessment of its Basel III liquidity coverage ratio (LCR) regulations.
  - The CBRT has taken steps to strengthen foreign currency funding.
  - Opportunity: strengthen liaison between the BRSA and the CBRT on monitoring and management of foreign liquidity risk.
  - Given potential foreign exchange roll over risk, consideration could be given to increasing the ultimate target for the FX LCR from 80 percent to 100 percent.
  - Onsite liquidity reviews should further analyze impacts of liquidity operations on other balance sheet areas, growth trends, asset quality, and management processes.

### Related Parties, Internal Control, and Audit
- Legal and regulatory framework for related parties is comprehensive; offsite department monitors reporting and onsite review process is well structured.
- Gaps:
  - No explicit legal provision requiring prior approval of related party transactions by the bank’s board.
  - No explicit provision requiring approval (prior or post) of write-off of related party transactions.
  - Legislation addresses credit transactions with related parties but is silent on other non-credit transactions.
  - Recommendation: expand legislation to explicitly capture all transactions within parameters of related party limits and requirements.
- Internal control and internal audit frameworks are comprehensive; targeted or specialized examinations of internal audit leveraging other supervisory observations could enhance validation of this function and the BRSA’s confidence in audit outputs as early warning indicators.

### Financial Reporting, External Audit, and AML
- Procedures for financial reporting and external audit are well established; accounting standards closely follow IFRS and provisioning standards dovetail with IFRS 9 implementation.
- Valuation procedures for financial assets are comprehensive; banks must disclose financial statements according to TFRS and TAS on both solo and consolidated bases.
- Disclosure requirements for nonfinancial information are adequate; BRSA regularly evaluates timeliness and content of external audit/annual reports for compliance.
- AML framework includes customer due diligence (CDD) rules and suspicious transaction reporting procedures but has shortcomings:
  - CDD requirements should include a customer acceptance policy identifying business relationships the bank will not accept based on identified risks and enhanced due diligence on politically exposed persons.
  - Framework should require banks to report to the BRSA suspicious activities and incidents of fraud when such activities/incidents are material to the safety and soundness or reputation of the bank.

### Summary Compliance Highlights (extracts from Table 1)
- Core Principle 1 (Responsibilities, objectives and powers): BL provides a broadly appropriate framework and clear responsibilities and adequate powers to the BRSA; lack of defined hierarchy between financial stability and development objectives may cause conflicts and be harmful to safety and soundness of banks. Recommendation: explicitly subordinate the objective of development of the financial sector to financial stability in the BL.
- Core Principle 2 (Independence, accountability, resourcing and legal protection for supervisors):
  - Legal protection of the supervisor is broadly adequate but institutional shortcomings should be improved.
  - BL establishes BRSA as independent but contains provisions that might undermine independence in practice via several channels of government interaction (appointments by CoM without confirmation, consultation requirement with related Ministry before regulations, Prime Minister removal powers without publishing reasons, minister may permit lawsuits against board members, ministry may file lawsuit to cancel Board regulatory decisions).
  - These channels of potential political influence, and the large role of state-owned banks, might cause conflicts of interest undermining financial stability.
  - Accountability framework could be improved; assessors did not see evidence of a third party ensuring BRSA powers are exercised appropriately and operations are effective and aligned with mandate.
  - Resourcing: entry conditions are not attractive for hiring mid-career professionals and constrain response to experience shortfalls.

*International Monetary Fund — assessment excerpt*

### 3. Cooperation and

### 3. Cooperation and

### Cooperation and collaboration
- Legal provisions as well as operational frameworks for cooperation and collaboration with domestic and foreign authorities are in place.
- Protections on confidentiality appear appropriate.
- Regarding the lack of processes for recovery and resolution planning, the assessors do not see their absence as reflecting a lack of collaboration between authorities.
- See also CP9.

### Permissible activities
- The BL provides clear definitions of activities that are only permitted to be conducted by registered banks, including taking deposits from the public.

### Licensing criteria
- Provisions in the laws and regulations related to licensing and the process followed by the BRSA provide a comprehensive framework to assess the adequacy of new registrations for banks, including foreign bank branches.
- The BRSA seems to have a broadly sound process to assess applications in practice.
- Additional needs:
  - i) impose requirements and assess if the bank’s board has a collectively sound knowledge of the material activities the bank intends to pursue; and
  - ii) for cross-border banking operations, determine whether the home supervisor practices global consolidated supervision.

### Transfer of significant ownership
- The power given to the supervisor by laws and regulations as well as the current procedures provide broadly sound control and oversight regarding significant ownership of a bank and a controlling company.

### Major acquisitions
- The regulatory framework subjects major acquisitions and investments by banks and controlling companies to prior approval by the BRSA.
- The BRSA has well established supervisory practices to limit and monitor risks arising from such activities.
- Going forward, supervisors should consider more extensively and formally the effectiveness of supervision in host countries.

### Supervisory approach
- The BRSA has an established and comprehensive methodology to supervise banks, documented in a number of manuals and leveraging comprehensive databases and a broadly appropriate regulatory framework.
- Practical implementation shortcomings to address:
  - The inspections need to develop a more profound and forward-looking risk assessment nature, producing a clear view of the risks faced by and posed by the bank. Current conclusions tend to focus mostly on compliance issues and do not identify and make clear if there is need for broader and more forceful supervisory action. Supervisors also need to derive and highlight the implications of the specific findings for the broader risk assessment of the bank.
  - The BRSA should not take excessive comfort from the fact that issues are analyzed during the ratings process. By its own nature, and as currently applied by the BRSA, the ratings process is not deep enough to generate firm and actionable conclusions. From time to time, the scope of special inspections needs to encompass issues that are currently addressed only during the ratings phase.
  - The BRSA needs to enhance the forward-looking components of its assessments. Results of the ICAAP need to be more thoroughly analyzed and discussed with banks. Stress tests results should play a larger role in the assessment framework. In addition, the ratings methodology could explicitly incorporate the expected trend for each component.
  - Banks, particularly the systemically important ones, should be required to develop recovery plans and the BRSA should assess their resolvability.

### Supervisory techniques and tools
- The BRSA employs an array of tools and techniques to carry out its supervisory responsibilities. On-site and off-site functions are relevant and well developed.
- Coordination and integration issues:
  - Different departments share findings with each other, but their work seems to be conducted in parallel with little coordination. The departments do not seem to have joint projects and supervisors do not exchange views beyond written reports.
  - As required by EC1, it is important for the BRSA to develop policies and processes to assess the effectiveness and integration of on-site and off-site functions, and to address any weaknesses that are identified.
  - Increasing the rotation between on- and off-site supervisors could help integration.
- Communication with banks could be improved:
  - The BRSA should consider setting policies establishing at least one annual meeting between supervisors and the board of the bank.
  - The end of the CAMELS rating process might be an appropriate occasion to explain to the board the views and concerns of the BRSA. The assessors understand that this is frequently done, but not systematically with all banks.
  - Important analyses, such as stress testing exercises, could be more clearly discussed with banks.

### Supervisory reporting
- The regulatory framework requires banks and controlling companies to periodically submit a broad range of information.
- Regulatory and supervisory processes exist to ensure accuracy and comparability of submitted returns.
- Developed procedures for analyzing collected information and feeding into supervisory activities are in place.

### Corrective and sanctioning powers of supervisors
- The BRSA has available an appropriate range of supervisory tools to use when, in the supervisor’s judgment, a bank is not complying with the regulations or represents a risk for the financial sector.
- In practice, remedial and corrective actions provided for in the law are rarely used at an early stage as a preventative measure.
- The BRSA seems to rely more heavily on administrative fines whose scope of application is more clearly defined in the BL than on taking actions at an early stage to address unsafe and unsound practices that require supervisory judgment.
- Evidence and limitations:
  - Evidence was presented of BRSA actions requiring banks to make adjustments to practices and processes, but such action had a scope limited to specific issues such as the classification of particular loan operations.
  - Evidence was not observed of supervisors addressing broader concerns about the risks posed and faced by banks from a deepening and expansion of the initial review.
- The supervisory review process within the BRSA seems to play a role towards limiting the issues that supervisors raise with banks; the current process seems relatively skewed towards validation of compliance processes and thus constrains active supervisory judgments and decisions.
- Consideration could be given to integration of supervision and enforcement, particularly in terms of communication with financial institutions, to support a more risk focused and less compliance based supervisory approach.

### Consolidated supervision
- The regulatory and reporting framework provides a broadly appropriate structure for monitoring and assessing risks to banks from nonbanking and foreign banking operations in banking groups.
- Limitations and recommended enhancements:
  - The current limitations of the CAMELS rating and ICAAP process mean the BRSA should make further effort to monitor and manage risks arising from nonbanking and foreign activities or parent entities of a financial group.
  - The BRSA should deepen the analyses and strengthen techniques, such as group-wide stress testing, to monitor and assess these risks.
  - It is important to further improve the group-wide strategic view of the banking group operations and risks.
  - Authorities should further improve the recovery and resolution planning of large banking groups particularly once the necessary power is given to the supervisor by the expected new legislation. Such planning should also consider scenarios where shocks originate from nonbanking entities or parent groups.

### Home-host relationships
- The BRSA has made vast efforts to improve home-host relationships during the last few years:
  - The agency has started organizing colleges, signed a number of important MoUs, and removed obstacles that weakened the supervision of Turkish banks’ operations in several countries.
- Remaining needs:
  - Considering that some Turkish banks hold material operations abroad, it is important to improve the relationship even further.
  - It is essential to develop a framework for cross-border crisis coordination with relevant host authorities and the development of resolution plans that pay special attention to cross border issues.

### Corporate governance
- The legal framework surrounding the corporate governance framework for banks is extensive, but very heavily focused on board responsibilities regarding internal systems (risk management, internal control, internal audit).
- Examination processes (General Assessment Report (GAR) and specialized examinations) have required steps to check board approvals, internal structures, and processes which reflect on the governance function. The BRSA approves board and senior management appointments and reviews the appointments process of the bank.
- Shortcomings in supervisory outputs:
  - Results of special examinations and supervisory processes consistently stop short of drawing conclusions, in analytical, narrative form, on the implications the findings have for critical areas directly linked to the examined area (management oversight of business areas, adequacy of risk management and internal audit’s role, integrity of MIS up to the board level, and ultimately, board oversight).
  - Supervisory observations are not easily collected to form a cross-cutting, substantiated view on corporate governance and the adequacy of internal systems. This impacts the degree to which the BRSA should place confidence in the systems that inform the board and itself, as well as the systems’ ability to generate early warning indicators of deterioration.
- Board composition and committees:
  - There is no requirement for the majority of the board to be composed of nonexecutive members. Practically speaking, 10 out of 53 banks are listed and must fall under the CMB Communique on governance which requires a majority of independent directors.
  - Consideration should be given to upgrading legislation requiring the board to be composed of a majority of nonexecutive members, and ideally, with a certain minimum of independent individuals. (The definition of “independent” should be consistent with that used by the CMB in its Communiqué on Corporate Governance.)
  - Audit committee membership should be expanded. A minimum of two members is considered too few to execute assigned duties in a robust and effective manner.
  - In some banks the chair of the audit committee is also the chairman of the board which does not reflect best practice and potentially represents a conflict of interest.
  - The audit committee should be expanded and composed of all independent directors. Legislation directs that audit committees have oversight responsibility for internal systems which includes risk management. Under current audit committee structures, proper oversight of both critical areas is difficult.
  - Risk management oversight responsibility should be separated from the audit committee, particularly in the more complex institutions.
- Reviews and examinations:
  - While three special examinations of governance elements have been conducted, there is a need to more regularly conduct cross-cutting assessments of corporate governance in a holistic manner leveraging recent examination results, relevant offsite information, and information generated from any enforcement actions.

### Risk management process
- The RICAAP forms a part of the core of the BRSA’s regulatory framework for risk management.
- Given that the ICAAP is a relatively recent requirement, banks are still developing their approach and implementing important systems. Banks and supervisors are in a learning phase.
- The quality of banks reports and the scrutiny of the reports by supervisors will need to develop further before the results can be more reliably and more extensively used.
- Requirements and recommendations:
  - Commensurate with their size and complexity of operations, banks should be specifically required to have qualified CROs with sufficient stature, position and authority within the organization to oversee risk management activities. The level of senior manager may not provide the necessary stature necessary to challenge high level risk decisions and processes.
  - While there are comprehensive requirements for the evaluation of new products, parameters should be expanded to explicitly address material modifications to existing products and major acquisitions. It should also direct banks to restrict such products or activities if they do not have the necessary controls, management, and resources to manage related risks.

### Capital adequacy
- The BRSA has adopted the various components of Basel II, 2.5 and III according to the framework established by the Basel Committee.
- Capital is calculated on a consolidated and solo basis for all banks and the BRSA has the authority to impose additional capital requirements on individual banks, as deemed necessary.
- The BRSA has applied the three Basel ratios (common equity tier 1, tier 1 and total capital) as well as countercyclical capital requirements, systemically important bank capital add-ons and a “capital planning buffer” that provides a forward looking nature to the capital regulation.

### Credit risk
- The legal framework for credit risk is generally comprehensive. It establishes the responsibility of the board in this area, requires a framework for the credit business of banks, as well as prescribes a properly controlled credit risk environment.
- Issues compromising effectiveness and application:
  - The framework design does not require ongoing, independent (from the business line) credit risk monitoring of large individual exposures or homogeneous portfolios. Important source data (e.g., identification of deteriorating credits, level of (accurately) classified assets, status of restructured credits, etc.) is generated by a line management function (credit monitoring) without independent verification that 1) management identification processes are accurate and timely, 2) that management, itself, is well informed of the risk and that it is running and is upholding board prescribed underwriting standards, and therefore, accurately conveying its business risk, and that 3) timely borrower intervention is activated.
  - This (unverified) information generated by the line function is source data used by the risk management functions for audit committee and board reporting and is also likely the information also reported to the BRSA for monitoring and examination purposes.
  - The internal audit function, while important, is not designed to play an ongoing surveillance role such as an independent credit risk management unit and cannot replace the need to have such a function within the bank(s).
- Examination findings and classification issues:
  - Examiners have identified important, clearly inaccurate classifications of credit that could indicate the issues above. However, the significance of these inaccurate classifications was not clear from the examination samples reviewed. There was no indication of the size of the sample of reviewed credits, how significant the aggregate, inaccurately classified credit was to the total portfolio, and if such findings could be extrapolated to the entire portfolio.
  - Credit classification definitions, particularly in the special mention and substandard categories, are overlapping. Evidence demonstrates that both examiners and bankers fluidly move credits among these categories which compromises the picture of the bank’s risk profile.
  - Such movement and less rigorous classification impacts provisioning levels and the accuracy of the bank’s financial statement.
  - The REPL (Regulation on the Procedures and Principles for the Evaluation of Loans and other Receivables and Provisions) explicitly allows restructuring of loss credit which is considered in many systems to be imprudent activity as such loans are, by definition, permanently impaired and considered “nonbankable” assets. In some systems, such credits are prohibited from being restructured. The draft REPL is silent on this issue but theoretically would allow this practice. This practice should be explicitly addressed (disallowed).
  - The manner in which examiners present and write up the credits they review during special examination does not clearly depict the nature and volume of other related exposures in the given bank which, if presented, would help put the overall borrower relationship in context.

### Problem assets, provisions, and reserves
- The framework for credit classification and provisioning is generally adequate.
- Concerns:
  - The accuracy of asset classification by banks, and therefore the integrity of reporting to boards and the BRSA, is called into question given the nature of reclassifications assigned by onsite examiners and the lack of documentation therein.
  - Loan write ups require more support and context as well as the need to present the nature of the collateral and provision impact.
  - Examination conclusions focus more on internal control issues rather than higher level implications for the condition and management of the credit portfolio under examination.
- Missed opportunities and recommended improvements:
  - Given the lack of documented focus on implications of important bank processes, the examination exercise missed opportunities to identify linkages and draw conclusions on:
    - Management’s understanding of their business and credit risk, ability to identify deterioration proactively – thereby allowing for early intervention.
    - Implications for internal systems (in particular, the function, role, and independence of credit risk management) – thereby validating the systems that the bank’s board and the BRSA depends upon in order to effectively oversee the institution. These systems are key to the exercise of risk based supervision by the BRSA.
    - Inputs to evaluate corporate governance of the bank.
    - Accuracy of information conveyed to the board and the BRSA.
  - The historical and statistical support for standard (general) and special mention loan categories is not substantiated by accumulated loss experience.
  - It is not clear if appraised values, within a range, are being realized upon the sale of the properties or if provisioned amounts are adequately covering loss experience on classified loans.
  - Clear parameters should be established for periodic valuation of underlying collateral on NPL exposures.

*cr1735 - 3. Cooperation and*

### 19. Concentration risk

### 19. Concentration risk and large exposure limits

### Concentration risk and large exposure limits — findings
- The legal framework addressing concentration risk and large exposures limits is generally in line with international standards.
- The definition of connected parties is comprehensive.
- The BRSA examines and monitors various exposures including, inter alia, large exposures, concentrations by sector, product, customer, and risk group.

### Transactions with related parties — findings and issues
- The legal and regulatory framework for related parties is comprehensive.
- The offsite department receives and regularly monitors reporting from banks.
- The onsite review process for related parties is well structured; related party exposures and the controls and board processes therein are reviewed during the onsite processes.
- There is no explicit provision that requires prior approval of related party transactions by the bank’s board.
- No explicit provision requires approval (prior or post) of write-off of related party transactions.
- While Article 48 of the BL provides a comprehensive definition of “loan” and related party limitations address such, legislation does not include other non-crediting transactions within the limitations addressing related parties.
- A draft revision of the BL is being prepared by the BRSA; within this context, article 50 (a and b) may be revoked to allow board member borrowing from the bank and it will also address related party “transactions” as well.
- The assessment team cautions the BRSA on relaxing related party risk parameters, noting that countries continue to rigorously restrict extension of credit, as well as transactions with, related parties of the bank, including board members, and that this area historically has proven consistently problematic in distressed bank situations.

### Country and transfer risks — findings
- BRSA guidance adequately captures country and transfer risk as well as other relevant risks.
- Banks are expected to establish country risk parameters as well as systems for monitoring exposures, including indirect foreign-exchange risk and indirect country risk.
- Country risk is evaluated through the CAMELS review process and via the risk matrix of the bank.

### Market risk — findings and recommended enhancement
- The BRSA has adopted comprehensive regulation and guidance to direct banks to identify, measure, and monitor their market risk exposures, including parameters for valuation, stress testing, and model use.
- For examination purposes, these elements are largely addressed through the CAMELS rating/GAR methodology review process, and on an overall basis, during the ICAAP review.
- Currently, specialist expertise is not deployed to evaluate the scenarios or calculation details of the stress testing exercises.
- Examiners review the models used to measure market risk but depend substantially on the banks’ model validation process.
- Recommendation: The BRSA could consider deploying trained specialists to assess stress test approaches and mathematical integrity and to leverage resulting advice/input on specialized exams. Enhanced examiner expertise in model evaluation could provide added assurance on the integrity of bank models used.

### Interest rate risk in the banking book — findings and recommended enhancement
- BRSA supervision of interest rate risk is addressed through several activities: review as part of the overall ICAAP review process; captured as an input in the stress testing conducted therein; covered through the GAR process (onsite but not to the depth of a special examination).
- Specialized examinations of this area are not yet conducted.
- Recommendation: The BRSA should develop specialized examination procedures for interest rate risk where it identifies increasing or high risk areas and should use specialized expertise to evaluate scenarios and assumptions used for more complex stress testing as well as to review model validations during onsite examinations or as an offsite exercise.

### Liquidity risk — findings and recommended enhancements
- The BRSA has set up a comprehensive framework for liquidity regulation, monitoring, and assignment of bank responsibilities; regulation is in some cases more rigorous than international benchmarks.
- A wide range of tools is in place for monitoring banks’ liquidity positions and funding experience.
- The CAMELS review/GAR methodology addresses liquidity, and specialized examinations are conducted when a change in trends or strategy is detected.
- The BRSA underwent a Regulatory Consistency Assessment of its Basel III LCR regulations and received a “compliant” rating.
- Onsite documents indicated that conclusions regarding liquidity, funding stability, and management processes stopped short of considering other areas of the balance sheet, growth trends, asset quality, and management processes to support conclusions.
- Some banks may have tight liquidity positions including relatively high loan to deposit ratios.
- The central bank has taken steps to support the strengthening of foreign currency funding.
- Recommendation: Strengthen liaison between the BRSA and the CBRT on monitoring and management of foreign liquidity risk.
- Recommendation: Consider increasing the ultimate target for the FX LCR from 80 percent to 100 percent to further strengthen the management of liquidity risk.

### Operational risk — findings
- Oversight of operational risk is anchored in RICAAP and further expanded in the GORM which comprehensively addresses relevant aspects of this risk.
- The supervisory process explicitly addresses operational risk through evaluation of the ICAAP process and reports submitted by banks, through the GAR process, and as part of Management and Information Systems (MIS) evaluation and controls during specialized examinations.

### Internal control and audit — findings and recommended enhancement
- The legal framework is comprehensive for internal systems and specifically directed to the internal audit function.
- Review of the internal audit process is an important part of the onsite (GAR) process covered each supervisory cycle.
- Recommendation: Targeted or specialized examinations of the internal audit process, leveraging the GAR results as well as specialized examination results as partial inputs, could enhance validation of this function and maintain or increase confidence in audit outputs as early warning indicators.

### Financial reporting and external audit — findings
- Procedures surrounding financial reporting and external audit are well established.
- Accounting standards closely follow IFRS and provisioning standards are set to dovetail with the implementation of IFRS 9.
- Valuation procedures for financial assets are comprehensive.
- BRSA conducts review of valuation procedures and of valuation models as part of the onsite examination process.
- Parameters for banks’ external audit process are well established.

### Disclosure and transparency — findings
- Banks are required to disclose their financial statements according to TFRS and TAS, the Turkish version of IFRS and IAS, on both a solo basis and consolidated basis.
- Disclosure requirements for nonfinancial information are adequate.
- BRSA regularly evaluates the timeliness and content of external audit/annual reports for compliance with regulatory parameters and Pillar III disclosures.

### Abuse of financial services — findings and recommendations
- The assessment of this principle was limited to applicable regulation and BRSA activities and did not include MASAK coordinated inspections and other activities.
- The AML law and related regulations form the framework to prevent the abuse of financial services; the framework includes customer due diligence (CDD) rules and procedures to report suspicious transactions but has shortcomings that need to be addressed.
- Recommendation: The CDD requirements should include a customer acceptance policy that identifies business relationships that the bank will not accept based on identified risks and enhanced due diligence on politically exposed persons.
- Recommendation: The framework should require banks to report to the BRSA suspicious activities and incidents of fraud when such activities/incidents are material to the safety and soundness or reputation of the bank.

### Key recommended actions (selected, as presented)
- Principle 20:
  - Enumerate explicit legal provisions that require prior approval of related party transactions by the bank’s board as well as board approval of related party exposures that are written off the bank’s books.
  - Expand the requirements surrounding related parties to capture all transactions with related parties, not just loans.
  - Exercise caution on relaxing related party risk parameters and possible revocation of parameters surrounding board member borrowings.
- Principle 22:
  - Deploy trained specialists to assess banks’ stress test approaches and the mathematical integrity therein and to leverage resulting advice/input on specialized exams.
  - Enhance examiner expertise in the area of model evaluation to provide added assurance to the BRSA on the integrity of models used by banks.
- Principle 23:
  - Develop specialized examination procedures for interest rate risk in the banking book.
  - Deploy specialized expertise to evaluate scenarios and assumptions used for more complex stress testing and to review model validations during onsite examinations or as an offsite exercise.
- Principle 24:
  - Expand written analysis during liquidity/funding risk examinations to capture the impact of and relation to other areas of the balance sheet, growth trends, asset quality, and management processes to support higher level conclusions.
  - Strengthen liaison between the BRSA and the CBRT on the monitoring and management of foreign liquidity risk.
  - Consider increasing the ultimate target for the FX LCR from 80 percent to 100 percent to further strengthen the management of liquidity risk.
- Principle 29:
  - Include in the CDD framework a customer acceptance policy that identifies business relationships that the bank will not accept based on identified risks and enhanced due diligence on politically exposed persons.
  - Require banks to report to the BRSA suspicious activities and incidents of fraud when such activities/incidents are material to the safety and soundness or reputation of the bank.

*Source: cr1735 - 19. Concentration risk (https://www.imf.org/-/media/files/publications/cr/2017/cr1735.pdf)*

### 33.      Although there is no explicit statement in the BL regarding financial safety and

### cr1735 - 33.      Although there is no explicit statement in the BL regarding financial safety and

### Objectives, legal framework and independence
- Although there is no explicit statement in the BL regarding financial safety and soundness is being the primary objective, it is implied in BRSA’s regulatory and supervisory functions. All regulations and sub-regulations as well as supervisory manuals issued stress the financial safety and soundness objective of BRSA.
- BRSA will review the current objectives and consider subordinating the objective of development of the financial sector to the objective of financial stability in BL.
- An amendment to BL is being drafted that proposes the revocation of article 105 which enables related ministry to file a lawsuit to revoke BRSB’s regulatory decisions.
- BRSA will review its alternatives regarding the transparent scrutiny of its activities in relation to its objectives and responsibilities without hindering its independence and autonomy.

*Supervisory Approach, Techniques and Tools (Principle 8–9):*
- BRSA assesses that within the current framework of supervision, all risks that banks are exposed to as well as the financial safety and soundness of banks are adequately supervised and BRSA has a well understanding of both individual banks and banking industry as a whole.
- BRSA agrees supervision products need to have explicit and clear narratives about supervisory view on the risks faced by banks and has started to revise its supervisory manuals and processes as part of an established ongoing improvement framework.
- BRSA will enhance forward-looking components of its supervisory framework by incorporating an expected trend element for each CAMELS component and risk type within its ratings and risk assessment methodology.
- BRSA is planning to fully incorporate the results of ICAAP and stress tests to its supervisory framework and to increase the depth of the current analysis conducted on stress test and ICAAP results.

### Resolution, recovery planning and international alignment
- In 2013, BRSA and SDIF jointly established a working group to conduct a self-assessment of current resolution procedures with respect to the Financial Stability Board (FSB) Key Attributes.
- Based on the working group recommendations, a draft legislation has been prepared to align the national framework with the above mentioned international standards.
- A joint task group established by BRSA and the SDIF has been reviewing technical details to finalize the draft, which includes the principles of recovery planning and resolvability assessment.
- BRSA will continue efforts to decrease gaps in its regulatory and supervisory framework regarding recovery planning and resolvability assessments.

### Organization of supervisory functions and coordination
- On-site and off-site examination functions are organized under different departments; there are both formal and informal communication channels between on-site and off-site functions to ensure effective supervision.
- Periodic bank-specific surveillance reports and sector-wide reports are sent to on-site examiners, and off-site function is notified about the on-site supervision findings continuously.
- Enforcement departments, responsible for formal correspondence of supervisory findings, are organized separate from on-site and off-site functions to serve as a means for internal review and evaluation of examination products.
- All supervisory findings stated in reports are communicated to banks without exception formally by enforcement departments.
- BRSA will review alternatives to further improve coordination and integration among its on-site, off-site examination and enforcement functions.

### Interaction with banks and supervisory communication
- On-site examiners hold entry and exit meetings with senior management and audit committee members and several additional meetings with bank managers and directors when needed.
- BRSA management also holds meetings with bank managers and directors (especially audit committee members) when there is an issue to discuss, although there are no periodic meetings held with the whole board of directors.
- If serious issues require actions stated in article 68, 69, and 70, instructions are directed to BOD of the bank.
- BRSA will consider establishing periodic meetings between supervisors and the board of the bank to further improve communication.

### Corporate governance (Principle 14)
- Turkish banking legislation is based on one-tier structure where members of the board who do not have any management responsibilities are nonexecutive members.
- In practice except the general manager (CEO) who is a natural member of the board, the members generally do not have management responsibilities in the bank.
- BL has imposed banks to have minimum 2 nonexecutive board members; in practice the majority of domestic systemically important banks do have more than 2 independent members in the board.
- This regulation is in line with paragraph 47 of “Guideline on Corporate Governance Principles of Banks,” issued by the Basel Committee on Banking Supervision in July 2015, stating that board of the bank should be comprised of a sufficient number of independent directors.
- Current executives (except general manager) of banks cannot be elected as board members according to BRSB resolution.
- RICAAP Article 6 defines the nonexecutive members similarly to the definition of independence given in the CMB Communiqués; nonexecutives are expected to be objective and independent from the influence of other parties according to this sub-regulation.
- CMB’s Communiqué on Corporate Governance (applicable to publicly traded companies including banks) requires that:
  - majority of board of directors should consist of nonexecutive directors,
  - there should be independent directors who are able to perform their tasks without any influence from the third parties,
  - the number of independent board members should correspond to at least one thirds of the total number of members.
- CMB’s Communiqué elaborates required qualifications of independent board members, similar to those mentioned for nonexecutive members in RICAAP.
- Since 10 deposit banks in Turkish Banking Industry are publicly traded (six of them are large scale banks), they are subject to CMB’s Communiqué; a publicly traded bank with five members of the board of directors is required to have at least three independent directors.
- These banks are required to include the Corporate Governance Principles Compliance Report as a separate section in their annual reports, with explanations about adoption of CMB principles and disclosures on board structure (number of nonexecutive and independent directors).
- According to corporate governance compliance reports:
  - number of board members of the large scaled publicly traded banks range between 9 and 14.
  - Five of these banks have two members and one of them has five members in their audit committee.
  - Five of the large scaled publicly traded banks have three and one of them has five independent members.
  - The number of nonexecutive directors ranges between 5 and 10.
  - In all cases, the chairman of the board of directors is nonexecutive.
- Principle 3 of the RCGP requires the board to be able to make independent evaluations about the operations of the bank and to consist of a sufficient number and composition of members to support decision making free of influence and conflicts of interest.
- BRSA has communicated expectations to banks regarding corporate governance through RICAAP, RCGB and recent best practice guidelines.
- BRSA will review its current regulatory framework for Corporate Governance and will consider:
  - expanding the qualifications of the collective board,
  - reviewing its definition of “nonexecutive/independent member,”
  - expanding the minimum number of directors on the audit committee,
  - explicitly requiring banks to establish risk committees.
- Governance structures are examined in detail within Special Inspections for Organization, Management and Strategy. In 2014 and 2015 three Special Examinations focused on corporate governance issues.
- Effectiveness and efficiency of corporate governance is also assessed during CAMELS Rating and Risk Evaluation (CRRE) process under the “Management” component, affecting Management component rating and final rating of the bank.
- During Special Inspections in other areas (loan portfolio or liquidity), identified issues indicating serious weakness in corporate governance are included in reports and communicated immediately before finalization.
- BRSA will enhance examination procedures for corporate governance issues to:
  - incorporate clear narratives on implications of supervisory findings over integrity of internal systems, quality of management oversight and capacity, MIS,
  - consider conducting holistic assessment for corporate governance in an appropriate time frame.

### Credit risk, problem assets, provisions and reserves (Principle 17–18)
- Organization of Credit Risk Management in banks (governed by RICAAP and the Guideline on Credit Management of Banks (GCM)) has four key parts: active board and senior management oversight over credit function, adequate loan policies and procedures, adequate credit risk measurement, monitoring and MIS, adequate internal control and internal audit functions over loan activities.
- Risk Management Unit within internal systems and credit monitoring departments are parts of the credit risk management framework together with credit operations (back office), financial control, internal control and internal audit functions.
- According to GCM, loan activities should be organized to enable functional segregation of duties and prevent conflicts of interest. In practice loan activities are organized under three main functions: marketing, underwriting and monitoring, which are all line management functions. GCM requires banks to establish these three functions separately without causing any conflict of interest.
- Banks are required to have information systems that enable credit monitoring department to conduct functions on the basis of customer, group, and portfolio. According to GCM Principle 7, banks’ information systems related to credit monitoring are required to be based on reliable data and should be validated periodically.
- Internal audit reviews loan activities regularly; accuracy and reliability of reports submitted to the board and audit committee is reviewed by internal audit units according to RICAAP article 21.
- According to REPL, banks are required to review their loan portfolio in terms of classification at least quarterly and document those reviews for the largest 200 loans (or the ones above TRY 250.000). The loan review documentation for the largest 200 loans is usually prepared by internal audit.
- The adequacy of banks’ credit risk management is assessed regularly by on-site examinations both in Special Inspections and CRRE process. Loan activities are frequently subjected to Special Inspections. In 2014 and 2015, 70 Special Inspections were conducted in 27 banks.
- Weaknesses identified during Special Inspections are communicated to banks during inspections and formal correspondence stage; conclusions feed into CRRE ratings.
- BRSA considers banks to have generally well established credit risk monitoring structures that are adequately supervised, but will:
  - review regulatory and practical aspects of credit risk monitoring and risk management organizational arrangements to further improve independence, effectiveness and efficiency of credit risk management organizations in banks,
  - increase standardization in examiner loan write-up so they include all relevant information to substantiate overall credit relationship, creditworthiness of borrower and its impact on overall credit exposure,
  - incorporate clear narratives in loan review reports regarding implications of findings on other areas such as management oversight and capacity, risk management process and corporate governance.
- BRSA will consider reviewing current definition of credit classifications to make them more concise and clear cut.

### Conclusions and commitments
- BRSA has issued an extensive number of best practice guidelines and made numerous regulatory changes to increase compliance with international best practices.
- BRSA has committed to increasing compliance level of its regulatory and supervisory framework and will take the remaining recommendations of FSAP mission in the Report into consideration for future arrangements towards increasing compliance with the BCP for effective banking supervision.

*cr1735 - 33.      Although there is no explicit statement in the BL regarding financial safety and (source: IMF staff report content provided).*

### 7.      Regulation and supervision of insurance and pensions is vested in the Undersecretary

### 7.      Regulation and supervision of insurance and pensions is vested in the Undersecretary

### Regulatory and Supervisory Structure
- Regulation and supervision are vested in the Undersecretary of the Treasury and divided between two departments:
  - General Directorate of Insurance (GDI): responsible for development and drafting of legislation and regulations, off-site supervision, and certain intervention and enforcement activities.
  - Insurance Supervision Board (ISB): responsible for supervision, particularly on-site supervision.
- Both organizations use offsite information from a common information systems platform.
- When the ISB identifies a serious problematic situation through off-site monitoring or on-site activities, it reports findings to GDI, which then assumes responsibility for dealing with the troubled institution.
- Under the Insurance Law 5684, an Insurance Agencies Executive Committee exists to establish professional rules for insurance agents, training activities, and disciplinary activities; it has a small staff of less than ten people.

### Staffing and Location
- Combined staff of GDI and ISB: 172 employees.
  - ISB employees: 66.
  - GDI employees: 106.
- ISB staff majority located in Istanbul, head office in Ankara.
- GDI staff all located in Ankara.

### Principal Legislation
- Major legislative instruments regulating the insurance sector include:
  - The Insurance Law No. 5684 of 2007 and related regulations
  - The Road Traffic Act No. 2918 and regulations (motor third party liability insurance)
  - The Catastrophe Insurance Law No. 6305
  - Law No. 5363, the Agriculture Insurance Law
  - Civil Aviation Act No. 2920

### Industry Association and Assurance Account
- All authorized insurance, reinsurance and pensions companies are required to become members of the Association of Insurance, Reinsurance, and Pension Companies of Turkey (TSB).
  - TSB has no direct power over companies but engages in advocacy, intermediation, development of new legislation, research, education, literacy improvement, and compiles industry statistics.
  - TSB manages the Assurance Account.
- Assurance Account:
  - No general policyholder compensation scheme exists; the Assurance Account pays certain compulsory insurance claims (e.g., motor insurance and other compulsory third party liability insurances) including failure of a compulsory insurance provider.
  - Funded from fees on the regulated industry.
  - Claims eligible must be related to:
    - personal injuries to a person where the insured cannot be identified,
    - personal injuries caused by parties who do not have the required insurance coverage at the date the risk has occurred,
    - personal injuries and damages to property for which the insurer is obliged to pay but is unable due to withdrawal of license or bankruptcy,
    - personal injuries where the vehicle involved is stolen or involved in violent crime, and
    - payments within Turkey made by the Turkish Motor Insurers’ Bureau relating to foreign insurants under the Green Card Insurance Program.

### Preconditions for Effective Insurance Supervision
- Competitiveness and economy:
  - Turkey ranked 45th in global competitiveness by the World Economic Forum (WEF).
  - GDP in 2015: USD 720 billion; Turkey was the world’s 17th largest economy in 2015.
  - Historical growth: From 2001–2008 averaged close to 6 percent per annum real GDP growth.
  - 2009: GDP contracted; rebounds with real growth rates of 9.2 percent in 2011 and 8.8 percent in 2012.
  - Growth moderated: 4.2 percent in 2013, 2.9 percent in 2014.
  - Real growth in 2015 expected to have been in the 4 percent range.
  - Per capita income currently exceeding USD 10,600 per person.
- Legal and dispute resolution context:
  - Court costs and legal fees are high and judgments can take several years.
  - Insurance Arbitration Commission (IAC) established by Article 30 of the Insurance Law No 5684 in 2007:
    - Settles contract disputes between policyholders/beneficiaries and insurers.
    - Voluntary for insurance companies to join; compulsory insurance products engage all companies in arbitration even if not a member.
    - IAC decisions binding for cases up to TRY 5,000; disputes TRY 5,000 and above may be appealed once within the IAC system within ten days; awards of TRY 40,000 may be appealed to courts.
  - Mediation Law No 6325 (2012) provides mediation in civil disputes, including insurance; concept is new and relatively unproven in insurance.
- Accounting, auditing and actuarial standards:
  - Turkish Financial Reporting Standards are essentially IFRS for insurance, reinsurance and pensions companies.
  - Independent auditors must be licensed with the Public Oversight, Accounting and Auditing Standards Authority; licensing requirements require training in insurance business, IFRS, international auditing standards, corporate governance, risk management and internal controls.
  - Independent Auditors must use actuaries to review technical accounts and reserves.
  - Insurers can contract with the same audit firm for up to seven years but audit staff may only work on audits of a single company for a maximum of five years.
  - Approximately 127 actuaries currently licensed with the UoT; a well-established actuarial professional association exists.

### Main Findings on Industry Size and Recent Improvements
- Industry size and growth:
  - In 2015, the insurance sector comprised less than 3 percent of all financial services sector assets.
  - From 2006 until 2015, gross premiums written grew at an average annual rate of approximately 22 percent (7.4 percent at constant prices).
  - Insurance penetration remains below many countries in the region and very low compared to countries with similar per capita incomes.
- Regulatory and supervisory improvements noted:
  - Efficiency of information reporting, insurer monitoring and supervision greatly increased.
  - Solvency tests strengthened.
  - Reserving and investment practices improved.
  - Improvements in international cooperation and information exchange.
  - AML/CFT requirements improved.
  - Management of fraud and market conduct requirements improved.
  - Licensing requirements for insurance brokers and agents improved.

### Key Regulatory and Supervisory Challenges
- Objectives and independence:
  - Primary objectives of the supervisory authority need clarification; policyholder protection should be clarified as the principal objective.
  - Supervisory authority does not meet international standards for operational independence; independence, governance, and accountability need further work.
  - Consideration should be given to alternative delivery models with increased independence (e.g., an independent supervisory authority covering both securities and insurance).
- Ownership transparency and suitability:
  - Controlling beneficiaries of insurance companies need better mapping; UoT may not be aware of ultimate controlling beneficiaries for all insurers; they should be identified and required to meet ongoing suitability requirements.
- Corporate governance and internal controls:
  - Develop and enforce higher and more specific requirements for insurer corporate governance and internal controls, including:
    - Specific standards regarding composition of insurer Boards and duty of individual Board Directors.
    - Expanded role and requirements for risk management and internal control functions.
  - Require actuaries to opine on adequacy of premium pricing policies and external auditors to opine on adequacy of risk management and internal control systems.
- Enterprise Risk Management:
  - Develop and implement more specific ERM requirements (e.g., Own Risk Solvency Assessment (ORSA) requirements, and ERM process) on an individual entity and group basis.
- Supervisory model and conduct supervision:
  - IMS and SEUS are significant achievements, but efficiency and timeliness of conducting monitoring and supervision through two disparate UoT departments is a concern.
  - Consider integrating offsite, onsite, and enforcement activities within a single supervisory organization.
  - Develop a more fulsome and risk based approach to Conduct of Business supervision, including market analysis, offsite and onsite monitoring and thematic review.
- Preemptive action and enforcement:
  - Consider vesting decision making authority with the insurance supervisor rather than the Minister and developing a formal “ladder of intervention” commensurate with this change.
- Solvency regime and reserving:
  - As part of plans to move towards Solvency II, introduce a risk based capital measure including a greater range of risks.
  - Strengthen reserving practices, particularly inclusion of a Margin Over Current Estimate (MOCE) and cash flow discounting.
  - Establish a clear solvency control level below which an insurer will not be allowed to operate.
- Intermediaries and consumer protection:
  - Ongoing oversight of insurance intermediaries should be improved.
  - Consider expanding representation on the Insurance Agents Executive Committee to include insurer, intermediary and lay member representation, broaden its mandate to cover all intermediaries, and increase its enforcement powers and resources.
  - Establish strong, clear rules for intermediaries regarding compensation disclosure and conflict of interest vis a vis insurance consumers.
  - Require insurer Boards to approve policies relating to fair treatment of consumers and to receive regular reports on implementation (particularly complaint handling).
- Group supervision, macroprudential and crisis planning:
  - Continue developing framework for group-wide supervision.
  - Initiate work to develop a macroprudential framework and crisis management and contingency plans within the supervisory organization and in larger institutions.
- Sequencing and implementation:
  - Consider sequencing recommendations within a multi-year regulatory and supervisory transition plan (e.g., three to five years) with regular consultation with industry, focused on increasing supervision efficiency without unduly increasing administrative burden and cost.

### ICP Observance Summary (select highlights)
- ICP 1 (Objectives, Powers and Responsibilities of the Supervisor):
  - Objectives not fully consistent with two standards: ICP 1.2 (objectives set out in primary legislation) and ICP 1.3 (principal objectives to promote maintenance of a fair, safe and stable insurance sector for the benefit and protection of consumers).
- ICP 2 (Supervisor):
  - No clear separation of insurance supervision activities from other UoT roles.
  - Major intervention decisions rest with the Minister rather than the supervisory authority.
  - Human resource and budget functions ultimately controlled by Government rather than insurance supervisors.
  - Appointment and dismissal of the head of the supervisor does not meet ICP 2 requirements; independence, governance and accountability are adversely affected.
- ICP 3 (Information Exchange and Confidentiality Requirements):
  - Supervisor has necessary legislative authority and demonstrates ICP standards in practice.
- ICP 4 (Licensing):
  - Legislative requirements sufficient, but UoT lacks information on natural person controlling beneficiary for all licensed insurers, impacting integrity of licensing.
- ICP 5 (Suitability of Persons):
  - Regulatory requirements should be strengthened to ensure insurers report when officers or directors no longer meet suitability criteria.
  - Consider developing specific competency requirements for control functions after requirements for these functions are established.
  - UoT should ensure all natural person controlling beneficiaries meet suitability requirements.
- ICP 6 (Changes in Control and Portfolio Transfers):
  - Controlling beneficiary of all licensed insurers is not presently identified.
  - ICP 6.10 requires portfolio transfers be subject to Supervisor approval not the Minister; current practice vests approval as permissive with the Minister without obligation that approval be in the best interests of policyholders.

*Source: IMF staff assessment as presented in the provided chapter.*

### 7. Corporate Governance Corporate governance requirements for insurers should

### 7. Corporate Governance Corporate governance requirements for insurers should

### Corporate governance (ICP 7)
- Finding: Corporate governance requirements for insurers should be strengthened and made more legally enforceable.
- Recommendation:
  - Corporate governance requirements for insurers should be strengthened and made more legally enforceable.
  - UoT may wish to consider development of a new corporate governance and internal controls regulation consisting of a mix of mandatory and voluntary (apply or explain) requirements as has been done in other jurisdictions recently (e.g., South Africa).

### Risk Management and Internal Controls (ICP 8)
- Finding:
  - The ICP requires insurers to have four effective internal control functions: compliance, actuarial, risk management, and internal audit.
  - At present, there is only a requirement for an internal audit and designated internal control staff.
  - Actuaries should be required to opine on the adequacy of premium pricing policies.
  - External auditors should be required to opine on the adequacy of the insurer’s risk management and internal control systems.
- Recommendations:
  - Require insurers to establish all four internal control functions required by the ICP and ensure that they have appropriate independence and resources.
  - Require actuaries to opine on the adequacy of premium pricing.
  - Require external auditors to opine on the adequacy of the insurer’s risk management and internal control systems.

### Supervisory Review and Reporting (ICP 9)
- Finding:
  - The UoT has made significant progress in developing its monitoring and supervisory framework for insurers.
  - While the development of IMS and SEUS are significant achievements, the efficiency and timeliness of monitoring and supervision through two disparate departments is an ongoing concern.
- Recommendations:
  - Consideration be given to integrating offsite, onsite and enforcement activities within a single supervisory organization.
  - Consideration be given to developing a more fulsome and risk based approach to Conduct of Business supervision including a broader range of tools (e.g., market analysis, offsite and onsite monitoring and thematic review).
  - UoT continue work to develop a group wide supervisory framework.

### Preventative and Corrective Measures (ICP 10)
- Finding:
  - The ICP requires the authority to take timely preventive and corrective actions be vested with the supervisor and not the Minister.
  - Consideration should be given to amending the Regulation on the Measurement and Assessment of Capital Adequacy to empower the supervisor to set the timeframe for insurers to improve their capital position.
  - The existing legislated timeframes for insurers who fall below 100 percent (one year) and 70 percent (1.5 years) to meet required capital levels appear to be excessive.
  - While UoT has power to require insurers to comply within a shorter time frame, the current timeframes set in the regulation set an expectation in industry that deficiencies in capital adequacy do not need to be remedied quickly.
- Recommendations:
  - The authority takes timely preventive and corrective actions be vested in the Insurance Supervisor.
  - Consideration be given to amending the Regulation on the Measurement and Assessment of Capital Adequacy to empower the Supervisor to set the timeframe for insurers to improve their capital position.
  - Development of a formal “ladder of intervention” commensurate with this change would also be of benefit.

### Enforcement (ICP 11)
- Finding: The ICP requires the authority to take enforcement action be vested with the supervisor and not the Minister.
- Recommendation: The law be amended to establish the supervisory authority as the decision maker for major enforcement decisions.

### Winding-up and Exit from the Market (ICP 12)
- Finding:
  - The legislation does not specify a point at which it is no longer permissible for an insurer to continue its business.
  - The authority to act is vested with the Minister rather than the supervisory authority.
- Recommendations:
  - Amend insurance legislation to ensure the supervisory authority rather than the Minister has the authority to wind-up an insurer.
  - Legislation should clearly establish a point at which it is no longer permissible for an insurer to continue its business; this could be tied to a risk based solvency requirement for insurers.

### Reinsurance and Other Forms of Risk Transfer (ICP 13)
- Finding:
  - There do not appear to be rules for prompt documentation of reinsurance transactions though UoT monitors the practice through on-site examinations.
  - There are no rules or approval requirements for Alternative Risk Transfer arrangements.
- Recommendations:
  - Amend legislation to require explicitly that insurers promptly document all reinsurance transactions.
  - Consider developing specific requirements to ensure appropriate use of Alternative Risk Transfer arrangements as the market develops (e.g., requirement for prior UoT approval).

### Valuation (ICP 14)
- Finding:
  - The current standards do not provide for the inclusion of MOCE or for discounting of cash flows.
  - A more sophisticated approach to earthquake/catastrophic reserving should be considered.
- Recommendation:
  - As part of plans to move towards Solvency II, revise reserving requirements to provide explicit MOCE, discounting of cash flows and more sophisticated approaches to earthquake reserving be considered.

### Investment (ICP 15)
- Finding:
  - There should be more specific requirements established to ensure the appropriate use of derivatives (e.g., only for hedging purposes).
  - The legislation should be amended to establish a stronger duty of care for directors to act prudently and in the interests of policyholders (e.g., a “prudent person” definition for investment purposes).
- Recommendations:
  - Consider developing more specific requirements regarding the use of derivatives (e.g., only for hedging purposes).
  - Amend legislation to establish a stronger duty of care for directors to act prudently and in the interests of policyholders (e.g., a “prudent person” definition for investment purposes).

### Enterprise Risk Management for Solvency Purposes (ICP 16)
- Finding:
  - In conjunction with strengthening governance and internal control requirements, more specific ERM requirements should be developed and implemented (e.g., ORSA, and ERM process) on an individual entity and group basis.
- Recommendations:
  - Engage industry in dialogue about the need for an ERM framework.
  - Gradually expand internal control and risk management system requirements to include ORSA, risk tolerance statements, interconnected risk management, AML and capital plans and feedback loops for individual entity and insurance groups.

### Capital Adequacy (ICP 17)
- Findings:
  - The current solvency approach is a standardized approach but not a total balance sheet approach.
  - The Solvency I formula does not consider interdependence between assets, liabilities, regulatory capital requirements, and capital resources for determining the solvency requirements.
  - The risk based formula recognizes a greater range of risks but not all the major risks that are likely to affect the value of assets and liabilities (e.g., operational risk).
  - The solvency control levels set a limit above which the supervisor does not intervene but do not clearly establish a minimum floor below which an insurer is regarded to be unviable.
  - Should the solvency control level fall below the minimum, the Minister has a range of options he/she may use to “remediate” the insurer rather than liquidate it.
  - It is not clear that existing regulatory capital requirements are calibrated so that in adversity an insurer’s obligations to policy holders will be fully met.
  - Current solvency control levels provide a very generous amount of time for insurers to correct solvency deficiencies; combined with Ministerial decision-making authority, the intervention process could be too slow to protect the interests of policy holders.
- Recommendations:
  - Continue intended transition towards Solvency II Pillar One capital requirements as part of a broader strategy for Solvency II implementation.
  - Establish a clear solvency control level as part of the capital requirements below which an insurer will not be allowed to operate.

### Intermediaries (ICP 18)
- Findings:
  - The level of ongoing supervision related to agents’ conduct appears to be inadequate.
  - There is no requirement to disclose to customers the basis on which agents are remunerated by insurers or other potential conflicts.
  - The Code of Conduct for intermediaries includes few specific conduct rules or examples of inappropriate conduct.
- Recommendations:
  - Consider expanding representation on the Insurance Agents Executive Committee to include insurer, intermediary and lay member representation, broaden the mandate to cover all intermediaries and increase its enforcement powers and resources to discipline intermediaries.
  - Consider developing a more fulsome and rule based Code of Conduct for intermediaries.

### Conduct of Business (ICP 19)
- Findings:
  - Conflict of interest/disclosure of compensation requirements for agents and intermediaries should be strengthened.
  - Board approval and reporting is not specifically required for insurer’s policies related to fair treatment of consumers.
  - There is no specific requirement that the complaint handling function of insurers be separate from the area of the organization that is subject of the complaint.
- Recommendations:
  - Establish strong clear rules for intermediaries regarding compensation disclosure and conflict of interest vis a vis insurance consumers.
  - Specifically mandate that specific Board approval be required for policies relating to fair treatment of consumers and that the board receive regular reporting on adherence to these policies especially regarding complaint handling.
  - Require insurer complaint handling functions be operationally separate from the program that is subject to the complaint.

### Public Disclosure (ICP 20)
- Findings:
  - Some items described in the ICP, such as capital adequacy (solvency ratio), investment objectives and policies and ERM/ALM, are not required to be disclosed.
  - More information on governance and internal controls should be considered.
  - Consideration should be given to expanding information requirements to include company information on market conduct policies and risks (e.g., information on management of complaints).
- Recommendations:
  - Expand disclosure requirements to provide more information on governance, capital adequacy, investment objectives and policies and ERM/ALM.
  - Consider expanding information requirements to include company information on market conduct policies and risks (e.g., information on handling and disposition of complaints).

### Countering Fraud in Insurance (ICP 21)
- Finding: Significant progress has been made since the last assessment in this area particularly with the establishment of the Fraud Bureau and data base.
- Recommendation: No recommendation.

### AML and CFT (ICP 22)
- Findings:
  - While the UoT is not the AML /CFT authority, UoT staff are knowledgeable about AML/CFT issues and conduct on-sites on AML/CFT internal control systems.
  - The AML/CFT authority leverages knowledge of UoT staff in carrying out its AML/CFT responsibilities.
- Recommendation: No recommendation.

### Group-wide Supervision (ICP 23)
- Findings:
  - The ICP contemplates a supervisory framework for insurance groups that sets out the preconditions for group-wide supervision, group-wide regulatory requirements and group-wide supervisory review and reporting. This does not currently exist in Turkey though many of the powers and processes for carrying out group wide work currently exist.
  - The UoT is aware of this and is working to develop its framework.
- Recommendations:
  - Enhance efforts to supervise insurance groups by developing a more detailed monitoring and supervision framework.
  - Allow the group wide supervisor (in most cases the BRSA) rather than the committee of supervisory authorities to determine the scope and entities subject to supervision in Turkey.

### Macroprudential Surveillance and Insurance Supervision (ICP 24)
- Finding:
  - The UoT identifies, monitors and analyses extensive market, financial, and insurer data but does not yet have a formal macro-prudential framework that feeds into its day to day supervisory programs or supervisory priority setting.
- Recommendation:
  - Develop a systematic macroprudential framework for integration into its general supervisory program for insurance.

### Supervisory Cooperation and Coordination (ICP 25)
- Finding: Establishment of a group wide supervisory framework in the future would strengthen this rating.
- Recommendation: No recommendation.

### Cross-border Cooperation and Coordination on Crisis Management (ICP 26)
- Findings:
  - There is no plan/procedure manual for crisis management.
  - There is currently no requirement for insurers to establish contingency plans and procedures for use in a going and gone concern situation.
- Recommendations:
  - Develop an internal procedures manual or contingency plan for a financial crisis.
  - Require insurers (particularly large insurers with cross-border or cross sectoral linkages) to establish contingency plans and procedures based on their specific risk profile for use in going and gone-concern situations.

_Unit: cr1735 - 7. Corporate Governance Corporate governance requirements for insurers should_

### 2.      The CBRT owns and operates an integrated payment and SSS comprising two payment

### 2.      The CBRT owns and operates an integrated payment and SSS comprising two payment 

### System architecture and participants
- CBRT operates an integrated payment and SSS comprising:
  - EFT (Electronic Funds Transfer System; Interbank Turkish Lira Transfer System) — an RTGS system for inter-bank transfers, fully integrated with ESTS.
  - RPS (Retail Payment System; Customers’ Turkish Lira Transfer System) — handles customer-initiated transactions in RTGS mode.
  - ESTS (Electronic Securities Transfer and Settlement System) — a CSD-cum-SSS for government securities and CBRT bills; settles in DVP mode using Model 1; supports use of these securities as collateral for CBRT liquidity facilities.
- CBRT is system owner and operator; operative/administrative responsibility: Payment Systems Operation Division (Payment Systems Department, PSD); technical responsibility: Analytical IT Development Division (Information Technology Department).
- Any bank operating in accordance with the Banking Law can, with CBRT approval, become a direct participant in EFT, RPS, and ESTS.
- Total number of participants: 54. With the exception of Merkezi Kayit Kurulusu (MKK) all other participants are banks.
- Takasbank functions:
  - SSS for secondary market transactions and repos on government securities on BIST.
  - SSS for equities and corporate bonds traded on BIST.
  - CCP for derivatives traded on BIST and on its Securities Lending and Borrowing (SLB) platform.
  - Money market platform for banks and institutional investors.
  - Collateralized cash credit facility for banks and institutional investors.
  - Legal Entity Identifier Operating Unit (LOU) for Turkey.
- MKK (Central Registry Agency of Turkey) functions as CSD for equities and corporate bonds traded on BIST; monitors government securities held by brokers and investors; holds securities in the name of the beneficial owner; link between MKK and ESTS exists to record movements of government securities; MKK has an account at ESTS reflecting consolidated holdings; MKK received a license from the CMB to function as a TR for derivatives reporting.

### Assessment methodology and materials
- Systems assessed: EFT and ESTS against CPMI-IOSCO PFMIs; observance of responsibilities of authorities also assessed.
- Assessment accounted for integrated nature and interlinkages with Takasbank and MKK; EFT and ESTS assessed separately but common details presented in EFT assessment and referenced in ESTS assessment; recommendations table presents integrated recommendations.
- Information sources provided to mission included:
  - Self-assessment of the EFT system against the PFMIs.
  - Self-assessment of the ESTS against the PFMIs.
  - Self-assessment of the CBRT and CMB on their responsibilities for FMIs against the PFMIs.
  - Excerpts of daily, monthly, quarterly and annual reports produced by the CBRT related to the EFT, ESTS and the RPS.
  - Excerpts of internal policies, procedures and deliberations of relevant working groups and committees.
- Assessment methodology used: CPMI-IOSCO “Assessment Methodology and Disclosure Framework for PFMIs (December, 2012)” and CPMI “Application of PFMIs for central bank operated FMIs” (August 2015).

### Key assessment findings — overall observance
- EFT system:
  - Broadly observes: risk management framework, liquidity risk management, default management and operational risk management principles.
  - Partly observes: tiered participation principle.
  - Other principles: observed or not applicable.
  - PSD has developed a recent departmental-level risk management framework; not yet subject to internal audit (but would be in scope).
  - Framework is internally focused and does not explicitly account for risks from external sources, linkages with other FMIs, or risks posed to other FMIs.
  - Participant exposure to liquidity risk due to transaction concentration closer to end of day.
  - Default risk management framework developed but not comprehensively tested.
  - Business continuity procedures do not fully account for operational risks arising from other FMIs and risks posed to other FMIs.
  - Rules and procedures do not acknowledge tiered participation arrangements, though such arrangements exist in practice.
- ESTS system:
  - Broadly observes: risk management framework, liquidity, default management and operational risk principles.
  - Observations on risk management, liquidity, default and operational risk same as EFT.
  - Legal risk: ambiguity in rules/procedures and overall legal framework related to Takasbank sub-account structure for money markets and government securities secondary market; potential inadequate legal certainty for protection of securities holdings of sub-account holders.
- Authorities’ responsibilities:
  - Responsibilities A and B are broadly observed; the other three responsibilities are observed.
  - CBRT and CMB are two overseers of FMIs with clear articulation of scope.
  - Regulatory and oversight framework for Trade Repositories (TRs), in CMB purview, is in process of development.
  - CMB has not established dedicated organizational arrangements or allocated dedicated resources for its oversight activities.

### Legal basis, governance and policy observations
- Legal basis for EFT and ESTS: CBRT law, Payment Systems Law (PSL) and specific regulations; CBRT Payment Systems Operating Rules (PSOR) provide detailed operating rules; participation contract binds participants to PSOR; participation contract and PSOR have sound legal basis.
- All participants of EFT are subject to Turkish laws and regulations; all operations performed in Turkey.
- Legal certainty issues noted:
  - Collateralized liquidity support arrangements involving securities held in International CSDs (ICSDs) should be ascertained; current usage limited and securities pledged as collateral are held in the name of CBRT.
  - Ambiguity on legal basis for protection of participant securities transferred by participants to Takasbank’s account in ESTS (sub-accounts): protection for securities holdings in sub-accounts from insolvency of Takasbank is not clear; PSOR does not clearly recognize holding of government securities sub-accounts by a participant (Takasbank); CML and provisions related to CSDs do not specifically apply to this arrangement since ESTS is outside scope of CML, but article 46 on segregation of assets of investors in investor firms appears to be applicable; definitions in article 3(v) and article 37(g) of CML may encompass Takasbank activities as SSS.
- CBRT objectives and policies prioritize stability, safety and efficiency; documented governance arrangements define clear lines of responsibility and accountability; same governance framework applied to EFT and ESTS under PSD.
- PSD risk management framework:
  - Based on ISO 30001 framework.
  - Covers risks outlined in PFMIs.
  - Reviewed annually and subject to CBRT audit committee.
  - PSD’s risk management framework has not yet been audited.
  - PSD has mechanisms for measuring/monitoring liquidity risk and operational reliability of EFT.

### Credit, liquidity and collateral management
- Credit risk:
  - Stems from CBRT liquidity support operations to participants.
  - Liquidity support operations are handled by Markets Department and not integrated into EFT system.
  - Credit risk treatment from liquidity support operations is primarily within Markets Department domain.
  - Markets Department credit risk framework includes overall borrowing limits, collateralization with good quality securities, and applying haircuts; collaterals re-valued daily; CBRT can request additional collateral on adverse movements.
- Collateral management:
  - External to EFT and ESTS; managed by CBRT Markets Department.
  - Considered part of CBRT monetary policy operations framework; choice of securities, haircut rates, valuation practices and operational arrangements integral to monetary policy.
  - CBRT maintains a list of eligible securities and haircut rates; haircut rates depend on types and maturity of securities.
  - Eligible securities include: TRY government bonds, central bank bills, lease certificates issued by ALCTT (Asset leasing company of the Turkish Treasury), foreign bonds and notes, International Islamic Liquidity Management (IILM) issuances, foreign exchange deposits and foreign exchange banknote deposits.
- Liquidity access:
  - CBRT itself not constrained in TRY liquidity; participants may face shortages.
  - Participants have access to CBRT liquidity support and inter-bank money markets; liquidity options are collateralized.
  - Intraday and overnight CBRT liquidity support subject to overall borrowing limit for participant; liquidity support is available without any limit within framework of LOLR.
  - No explicit stress testing mechanism currently in place; ongoing review of intraday liquidity support policy framework (no set time-period for review).
  - Transaction pattern in EFT shows substantial liquidity risk; CBRT is studying and evaluating options.

### Settlement, CSD and exchange-of-value arrangements
- EFT:
  - RTGS system with final settlement through the day; settles in central bank money.
  - Settlement finality protected in PSL and articulated in PSOR; sound legal basis.
- ESTS:
  - Securities dematerialized and processed in book entry form.
  - Physical printing of government debt securities terminated as of November 2012; with redemption of latest printed securities there have been no printed government debt securities since July 2013.
  - ESTS functions as CSD-cum-SSS for government securities and central bank bills; settles securities transactions in DVP mode using Model 1; funds leg settled at EFT.
  - CBRT acts as agent of Prime Ministry Undersecretariat of Treasury for dematerialised issue, custody and redemption of government securities.
  - As CBRT is CSD in ESTS, there is neither custody risk from CSD insolvency nor risk of participant securities sequestration due to other activities of system operator.
  - In ESTS, securities owned by participants’ customers are segregated from participants’ own holdings and kept in special securities account of MKK; MKK keeps securities by customer details enabling customer tracking.
  - All CBRT operations in ESTS require dual approval, are logged, and can be tracked; participants are notified during end-of-day operations for reconciliation purposes.
  - All securities held in ESTS are dematerialized book entry form; no physical securities.

### Default management and coordination
- PSD has developed a default management procedure covering all CBRT-operated payment and SSS; procedure consistent with PSOR and derives legal basis from PSL.
- Procedure adopted recently and has not been tested in its entirety.
- System participants: all banks except MKK; banks supervised by BRSA, MKK by CMB.
- BRSA and CMB hold sole rights related to insolvency/bankruptcy of participants.
- Existing coordination and information sharing arrangements between CBRT, BRSA and CMB provide high degree of certainty that CBRT will have adequate notice to execute default management process, but delays in execution could escalate system risks.

### Business and operational risk management, pricing and IT resilience
- As central bank-operated FMIs, aspects related to liquid assets, wind-down plans and plans for raising additional capital are not applicable.
- EFT pricing policy aims for full investment and operational expenses recovery; pricing structure clear and communicated; fees recovered monthly; costs covered under general CBRT budget and subject to standard audit.
- Operational risk management framework:
  - Comprehensive, spanning people, process and systems.
  - Reviewed once a year.
  - Uses industry best practices: ISO 27001 and ITIL for IT services management.
  - Periodic IT security reviews in place; dedicated organizational arrangements for monitoring/managing IT security.
  - IT infrastructure built with no single point of failure; full-fledged backup site works on load sharing basis with main site.
  - An application package developed on completely different hardware and software platform to cover risk of simultaneous impact on both infrastructures (mitigating cyber risk scenarios).

### Explicit recommendations and suggested actions appearing in text
- Review legal certainty for collateralized liquidity support arrangements involving securities held in ICSDs.
- Review and address ambiguity on legal protection of securities holdings in sub-accounts held by Takasbank at ESTS, including applicability of PSOR, CML provisions (article 46 on segregation), and related legal frameworks.
- Expand PSD/CBRT risk management framework to explicitly account for:
  - Risks arising from external sources and dependencies on other FMIs.
  - Risks posed by CBRT payment and settlement systems to other FMIs.
- Test comprehensively the default risk management framework and the recently adopted default management procedure.
- Strengthen business continuity procedures to fully take into account operational risks arising from other FMIs and the risks posed to other FMIs.
- Consider instituting an explicit stress testing mechanism for liquidity (no explicit stress testing mechanism currently in place; transaction patterns show substantial liquidity risk).

*Source: IMF staff assessment (cr1735) of CBRT-operated payment and securities settlement systems (EFT, RPS, ESTS) and related FMIs (Takasbank, MKK).*

### 26.      There is a well-laid out Business Continuity Plan (BCP) plan with an organized

### 26. There is a well-laid out Business Continuity Plan (BCP) plan with an organized governance arrangement to monitor and review its execution.

### Business continuity and operational risk (Principles 17–20)
- There is a well-laid out Business Continuity Plan (BCP) with an organized governance arrangement to monitor and review its execution.
- BCP scenarios are focussed on the infrastructure of the CBRT payment and SSS; scenarios arising within the CBRT payment and SSS, within the CBRT or externally, which can cause a widespread impact, have not been included.
- Participants are included in BCP tests; plans are underway to include complex scenarios to fully cover business continuity risks arising from and posed to other FMIs and participants, in particular Takasbank and MKK.
- The PSOR covers operational risk management in articles 17-20, but there is no explicit mandate on this and no structured process to measure ongoing compliance with these aspects.
- The CBRT recently surveyed participants to assess their BCP plans and cyber resilience; all participants reported having BCPs, but there were gaps in the quality of some BCPs and cyber resilience readiness.
- The CBRT is addressing these gaps as part of its revised business continuity guide.

### Access, participation, and tiering (Principles 18–20)
- Criteria and requirements for participation are clearly stated in the PSOR and disclosed to related parties.
- Only banks and the MKK (special participant of ESTS for safekeeping of securities in the name of customers) are accepted as participants in the CBRT payment and SSS.
- Only banks are participants in the EFT system.
- Policy decision to allow access only to banks is based on considerations of liquidity risk management.
- The CBRT does not allow access to specific components of the CBRT payment and SSS; all participants have access to the EFT, RPS and ESTS systems with MKK as the only exception.
- The CBRT monitors operational compliance with participation criteria and is guided by the BRSA for continued qualification of participants to function as a bank.
- Suspension and orderly exit rules are stated in the PSOR and disclosed to participants.
- The PSOR acknowledges and regulates only direct participants; there is no definition or rules for indirect participation though the EFT system in practice has tiered arrangements.
- Entities not eligible for participation can perform operations through participants but are treated as customers of participants rather than indirect participants.
- One bank and one entity carrying out electronic payment services access the EFT system via other banks.
- Use of TETS by brokers and other market intermediaries is an example of tiered participation for the EFT system; ESTS by design does not have tiered participation.
- The CBRT has developed capability to track initiator, recipient and purpose of transactions via specialized fields in message formats; these tools can support a comprehensive monitoring framework for tiered participation arrangements.
- The ESTS and the MKK system have an issuer CSD–investor CSD link; the risk management framework does not explicitly acknowledge this arrangement as a link. The MKK is overseen by the CBRT for its SSS functions and the CBRT has a full integrated view of risks from the ESTS-MKK link.

### Efficiency (Principles 21, 22)
- Message exchange of the CBRT Payment and Securities Settlement System is managed via secure services using industry standard technologies and using XML based proprietary message formats.
- It is possible to easily convert XML messages used in the CBRT payment and SSS into other message formats.
- The PIS used to interface with the CBRT payment and SSS offers adequate tools to allow STP mode.
- The process for secondary market transactions on Government securities varies based on nature of counterparty, creating inefficiencies: settlement processes for securities and funds leg vary whether counterparty is another bank, a custodian, individual investor or other institutional investor.
- Addressing inefficiencies will require changes in ESTS and introducing new interfaces between the MKK, ESTS and Takasbank.

### Transparency (Principles 23, 24)
- Rules and procedures for the CBRT Payment and Settlement Systems are defined clearly and shared with participants.
- System descriptions, system rules, general structure and workflows, summary statistics and pricing policy are disclosed to the public through the CBRT web page and the CBRT Payment Systems User Group web site.
- Pricing tariff is defined yearly based on pricing policy and disclosed to participants and to the public at least one month before its entry into force.
- The CBRT is committed to publish the details of the assessment of the EFT system and ESTS in line with the requirements of this principle.

### Prioritized recommendations for the EFT system and ESTS (selection of items)
- Principle 1 — Conflict of law with respect to collateral holdings in ICSDs
  - Recommended Action: The CBRT could consider seeking an external legal opinion on the enforceability of the PSOR, all contractual arrangements and also with respect to the certainty of legal basis with respect to the securities held in the ICSDs.
  - Relevant Parties: CBRT
  - Priority: Low
- Principle 1 — Protection of securities holdings in Takasbank
  - Recommended Action: The CBRT should review the legal and regulatory framework for the protection of customer assets held by Takasbank and implement specific amendments if any gaps are identified.
  - Relevant Parties: CBRT, CMB
  - Priority: High
- Principle 2 — Lack of explicit performance indicators for system as a whole
  - Recommended Action: The CBRT could consider including specific indicators related to efficiency and effectiveness of the EFT system and satisfaction levels of the participants, and use these to measure performance of the EFT system.
  - Relevant Parties: CBRT
  - Priority: Medium
- Principle 3 — Risk management framework is internally focused
  - Recommended Action: The CBRT should include its dependencies on other FMIs and internal dependencies for the EFT system in the risk management framework.
  - Relevant Parties: CBRT
  - Priority: High
- Principle 4 — Credit risk management not fully integrated
  - Recommended Action: The credit risk management framework of the Markets department should be more fully integrated into the risk management framework of the EFT system.
  - Relevant Parties: CBRT
  - Priority: Medium
- Principle 7 — Gaps in liquidity risk management
  - Recommended Actions include:
    - Consider daily and periodic analysis of liquidity risk jointly by the PSD and Markets departments of the CBRT.
    - Consider additional indicators like estimates of participants available from the CBRT and inter-bank money markets.
    - Encourage earlier settlements in the inter-bank money markets to allow more liquidity into the EFT system earlier.
    - Analyze options to make intra-day liquidity support by the CBRT more attractive and implement suitable options.
    - Evaluate if pricing policies could incentivize earlier settlement perhaps as part of overall throughput guidelines.
  - Relevant Parties: CBRT
  - Priority: High
- Principle 13 — Default management
  - Recommended Action: The CBRT should conduct periodic testing of the default management procedure as a whole and include participants in this exercise; integrate with BCP or conduct standalone at least once a year. Publish key elements of the default and operations rules of the EFT and ESTS.
  - Relevant Parties: CBRT
  - Priority: Low
- Principle 17 — Gaps in Business Continuity Plans
  - Recommended Actions include:
    - Build on PSOR provisions to include explicit mandates with respect to operational risk management for participants and establish mechanism to assess compliance on an ongoing basis.
    - Consider more stringent operational risk management measures for participants with a large share of transactions based on monthly network analysis.
    - Incorporate a structured assessment of operational risks posed to and from other FMIs; use this to develop detailed complex scenarios for BCPs.
  - Relevant Parties: CBRT
  - Priority: High
- Principle 19 — No monitoring of Tiered participation
  - Recommended Action: Institute mechanisms to collect information about nonbank financial companies that access EFT through participants (service terms, typical transaction volume and value, any credit extension and liquidity facilities offered) and assess risks from tiered arrangements.
  - Relevant Parties: CBRT
  - Priority: Medium
- Principle 21 — Lack of efficiency in Government securities secondary market
  - Recommended Action: Address process variation by counterparty; require changes in ESTS and new interfaces between the MKK, ESTS and Takasbank.
  - Relevant Parties: CBRT
  - Priority: Medium
- Principle 23 — Operating rules and procedures are not publicly disclosed
  - Recommended Action: As part of the disclosure framework or separately, include details of key elements of the operating rules and procedures.
  - Relevant Parties: CBRT
  - Priority: Medium

### Responsibilities: key findings and follow-up
- Legal framework:
  - The CBRT law, the PSL and the CML clearly lay out the specific payment and market infrastructures subject to regulation, supervision and oversight.
  - Combined, these laws assign responsibility for regulating, supervising and overseeing payment systems and SSS to the CBRT; CCPs, CSDs and TRs to the CMB.
  - Authorities have publicly announced adoption of the CPMI-IOSCO PFMIs; the CMB has stated PFMIs would be applicable for MKK and Takasbank.
  - The CBRT requires all payment and SSS in its purview to adopt the PFMIs and has completed self-assessment for FMIs it operates; CBRT has asked Takasbank and MKK to complete self-assessments as SSS; CMB has asked Takasbank and MKK to complete self-assessments as CCP and CSD respectively.
  - The CMB has not yet issued regulations for TRs; it has licensed MKK as a TR but MKK has not commenced operations; CMB intends to issue a regulation/communique to articulate regulatory and oversight powers related to TRs before MKK becomes operational.
- Powers and resources:
  - The CBRT and the CMB have relevant powers to obtain information and induce change for oversight; these powers are explicitly articulated in secondary regulations for payment systems and SSS by the CBRT, and for CCPs and SSS by the CMB.
  - The CMB’s powers with respect to TRs have not been explicitly articulated yet.
  - The CBRT and CMB have adequate resources and qualified staff for oversight; CBRT has designated oversight staff. The CMB houses FMI oversight within a department that also covers regulation and supervision of brokers and BIST; the CMB has not allocated dedicated resources specifically for FMI oversight.
- Data sharing and collaboration:
  - Legal and regulatory measures allow data sharing between CBRT and CMB and with other authorities, particularly the BRSA (which regulates Takasbank as a banking institution).
  - The Financial Stability Committee (FSC) provides a structured mechanism for sharing, analyzing and resolving financial sector issues that may impact financial stability; it is also used for FMI-related discussions. Other ad-hoc mechanisms exist for information sharing and collaboration.

### Prioritized recommendations for Responsibilities (selection)
- Responsibility A — Lack of regulatory framework for TRs
  - Recommended Action: The CMB should ensure it issues a regulation/communique on TRs before according approval to MKK to commence operations as a TR.
  - Relevant Parties: CMB
  - Priority: Medium
- Responsibility B — Oversight resources
  - Recommended Action: The CMB could consider assigning specific responsibilities to staff for FMIs in its scope and issue TR-related regulations ahead of MKK commencing operations.
  - Relevant Parties: CMB
  - Priority: Medium

### Authorities’ response to the assessment (summary)
- The CMB and the CBRT support the FSAP performed by the IMF and WB and consider it helpful for enhancing FMI soundness.
- The assessment provided a useful external opinion highlighting issues requiring attention.
- The CBRT broadly agrees with the FSAP findings and appreciates the recommendations for further improvement of the CBRT’s payment and SSS.
- CBRT comments on specific principles:
  - Principle 3: The Risk Management Framework (RMF) of the CBRT Payment Systems referred to interlinked FMIs; the RMF was reviewed and modified to explicitly include risks related to participants, linkages and interdependencies including interlinked FMIs and third-party service providers; revised RMF is used in its 2016 application.
  - Principle 7: CBRT notes the FSAP report statement that “the CBRT itself is not exposed to any liquidity risk as the operator of the EFT System.” CBRT believes the assessment and rating do not reflect the compliance level of the EFT System with respect to Principle 7 because the Assessment Methodology focuses on liquidity risk of the FMI operator rather than participants.
  - Principle 13: While the Default Management Procedure has not been tested as a whole with all participants, facilities used in the procedure were tested with participants; CBRT has planned a test in its yearly test plan but does not deem necessary to include all participants.
  - Principle 17: The Emergency Guide supports PSOR provisions related to operational risk. The Business Continuity Application Plan (BCAP) has been developed and will replace existing documents; a Participant Guideline (part of BCAP) is soon to be finalized and includes provisions to meet recommendations on business continuity mandates and compliance assessment.
  - CBRT has identified critical participants via a network analysis based on a sink-rank model and has started to work more closely with these participants, planning more stringent operational risk measures; a working group on operational risk was founded at the BATs with systemically important participants and the CBRT.

*Source: cr1735 - 26. There is a well-laid out Business Continuity Plan (BCP) plan with an organized; canonical URL: https://www.imf.org/-/media/files/publications/cr/2017/cr1735.pdf*

### 49.      Moreover, the CBRT has already been working on the issues related to the

### cr1735 - 49.      Moreover, the CBRT has already been working on the issues related to the

### Interlinked FMIs and Operational Risk / Continuity Planning
- The CBRT has been working to incorporate more structural assessment of operational risk for other FMIs and to include more complex scenarios in the revised continuity plan as a result of this assessment.
- The revised RMF explicitly considers the risks related to the interlinked FMIs.
- Based on this consideration, two FMIs, which are also participants of the CBRT Payment Systems, have been identified as critical participants.

### Principle 19 (Tiered Participant Arrangements)
- Turkey’s financial sector is mainly composed of banks; all banks except a very small one are direct participants of the CBRT Payment Systems.
- To fulfill PFMI recommendations on tiered participation, the CBRT has instituted a mechanism using its power in PSOR to assess risks arising from tiered arrangements.
- The CBRT has started to collect and analyze relevant information from the System’s participants about their nonbank financial customers through periodical questionnaires.

### CMB’s Official Comments on Assessment of Observance of the Responsibilities of Relevant Authorities for FMIs
- The CMB thanks the FSAP team for the assessment of observance of the CPMI-IOSCO principles for financial market infrastructures and states the assessment served as an opportunity to detect areas needing improvement.
- The CMB is committed to follow PFMIs for the FMIs under its responsibility and to work towards implementing the FSAP’s recommendations.
- The CMB highlights issues for clarity on its road map and some practical issues.

Key specific points raised by CMB:
- Authorities Responsibility A:
  - The assessment refers to lack of regulatory framework for TRs and recommends the CMB should ensure it issues a regulation/communique on TRs before according approval to the MKK to commence operations as a TR.
  - The Implementing Regulation on Procedures Concerning TR’s Activities and The Communiqué on Reporting Obligations to TRs were drafted and sent to related authorities and professional associations for consultation or proposal in March 2016.
  - Trade reporting requirements and MKK’s operational conditions are regulated through these drafts.
  - The draft regulations are planned to be revised based on proposals received and finalized in the second half of 2016.
  - After adoption of the regulations, related parties will be given time for adaptation.
  - First reporting of transactions are expected to take place as of 2017.
- Authorities Responsibility B:
  - Recommendation requires CMB to consider assigning specific responsibilities to staff with respect to the FMIs in its scope.
  - Before an organizational restructuring, the Market Oversight and Regulation Department was exclusively responsible for central clearing and central depository institutions as well as exchanges.
  - After merger with Intermediary Activities Department, the Intermediary Activities Department is responsible for FMIs as well as investment firms and investment services; employees of this department work on both fields as a result of their job definitions.
- The Turkish authorities look forward to continuing dialogue with the FSAP team to improve FMIs in Turkey.

### Annex V — Follow-up Actions to Key 2011 FSAP Recommendations (selected progress highlights)
- Overall financial sector oversight:
  - Consider further prudential action to ensure strong capital positions and stability of funding. — The BRSA has adopted the various components of Basel II, 2.5 and III according to the framework established by the Basel Committee.
  - Ensure data are available to assess the risk from unhedged corporate net short FX positions and take corrective action as necessary. — Partly implemented
  - Consider further measures to address the risk of worsening lending standards in the consumer and SME segments. — Partly implemented
  - Develop an approach to risk identification combining monitoring of key indicators with qualitative information; jointly develop databases and modeling frameworks for financial stability analysis. — Partly implemented
- Macro-prudential policy framework:
  - Ensure appropriate communication and accountability of the FSC and strengthen its powers through primary legislation. — Partly implemented
  - Consider separating macroprudential policy and crisis management arrangements and ensuring a leading role of the CBRT in systemic risk monitoring and prevention. — Partly implemented
- Micro-prudential regulation and supervision — banking:
  - Review and revise supervisory and regulatory framework to align with Basel framework, especially supervision of key risks and definition of capital. — Implemented
  - Implement consolidated banking supervision and enhance coverage of risks emanating from non-banking entities in the group. — Partly implemented
  - Revise the Banking Law to enhance operational and organizational autonomy of the BRSA for banking supervision. — Not implemented
- Micro-prudential regulation and supervision — insurance:
  - Reform current insurance regulation and supervision processes to be more transparent, consultative, and accountable. — Partly implemented
  - Improve the “early warning” system for the required solvency margin. — Implemented
  - Transfer responsibilities for insurance regulation and supervision to an independent integrated insurance supervisory body. — Not implemented
- AML/CFT regime:
  - Adopt a new Law on CFT to address FATF deficiencies. — Implemented
  - Strengthen and integrate institutional supervisory framework for AML/CFT including sector supervisors. — Implemented
  - Establish a definition for Politically Exposed Persons (PEP) and requirements for reporting entities in line with FATF. — Not implemented

*Annex V notes: "See the FSB Peer Review for Turkey 2015 for additional information provided by the Turkish authorities, and the Detailed Assessment Reports and Technical Notes for additional details."*

### Annex VI — Banking Stress Testing Matrix (key design elements and numeric values preserved)
- Institutional perimeter:
  - Institutions included (Bottom-Up): 10 largest banks: Isbank, Ziraat Bankasi, Turkiye Garanti, Akbank, Yapi Ve Kredi, Turkiye Vakiflar, Turkiye Halk, Denizbank, Finansbank, Turk Ekonomi.
  - Market share: 80 percent of total banking sector assets.
  - Data and baseline date: Audited financial statements as at end-2015.
- Methodology and horizon:
  - Banks’ internal models (BU); common assumptions (TD); balance-sheet regulatory approach as in Schmieder and others (2011).
  - Stress test horizon: 5 years.
- Tail shocks — macro scenarios and calibrations:
  - Macro scenarios include baseline, adverse and severely adverse for both TD and BU, including liquidity stresses.
  - Macro-financial variables: GDP growth/output gap, inflation, 10y government bond yield, official policy interest rate, unemployment, government debt/GDP, credit growth, current account/GDP, property prices, asset prices, TRY/USD, real effective exchange rate, real GDP growth for key trading partners and regions, oil prices and commodity prices.
  - Adverse scenario: GDP growth to fall to -5.5 percent in the first year, recovering afterwards and converging in 2019 to long-run growth of 3.5 percent. The first year shock corresponds to a 10 percent left tail of the historical distribution (or the 5 percent left tail, when excluding the 1999/2001 Russia crisis/Turkey’s sudden stop). The cumulative loss in GDP over five years is equivalent to 0.8 standard deviations of the historical 5-year GDP growth volatility.
  - Severely adverse scenario: assumes two years of negative growth (-2.5 and -2 percent) and a subsequent year with below-par growth of 2 percent. The three year cumulative -2.5 percent growth corresponds to the 1 percent left tail of the historical distribution, or a 1 in 100-year event. Additional shocks for the BU STs are calibrated to be consistent with the period around the 2008/2009 global financial crisis. The cumulative loss in GDP over five years is equivalent to 1.5 standard deviations of the historical 5-year GDP growth volatility.
  - BU STs: banks to assess trading book using outstanding portfolio positions as of end-2015; report their largest 10-day loss and associated capital requirement using expected shortfall at a confidence level of 97.5 percent (a 1 in 40-year event).
- Risks and buffers:
  - Risks/factors assessed include credit losses, profitability, funding costs, market risk, counterparty risk, exchange rate, taxes.
  - Behavioral adjustments: balance sheet growth rules specified by FSAP team; relative balance sheet shares to remain constant under all scenarios. Dividend payout rules in line with FSAP team specifications.
- Calibration and standards:
  - Banks may use internal models to estimate PDs, LGDs and stressed RWAs; regulatory RWAs calculated from Basel-II standardized formulas.
  - Hurdle rate and capital metrics follow Basel II schedule; metrics include Common equity Tier 1, Tier 1 capital.
- Reporting format:
  - Output presentation includes capital shortfall by bank (anonymized), system wide; dispersion of capital ratios: min, avg, max; percentage of assets that fail; share in whole system by assets that failed the hurdle rate.

- Banking sector — Liquidity risk highlights:
  - Institutional perimeter: 10 largest banks included in TD Solvency ST; market share 80 percent of total sector assets; positions end-2015 baseline.
  - Methodology: LCR per currency and consolidated; cash-flow-based using maturity buckets; stress funding conditions impose haircuts on inflows.
  - Tail shocks: LCR adjustments per BCBS (2013); cash-flow based haircuts ranging from 50 to 100 percent depending on asset classes.
  - Buffers: counterbalancing capacity (bank-specific); central bank facilities (regular liquidity facilities and ROM).
  - Reporting: bank-specific and sector-wide stressed LCRs, by currency and overall; liquidity gap by currency and aggregated, by time band, by type of bank (large/small).

### Annex VII — Corporate Stress Testing Matrix (selected parameters and numeric values)
- Domain: Corporate Sector — Interest rate Risk/FX Risk/Credit or default Risk
- Institutional parameters:
  - Institutions included: 390+ publicly-listed companies.
  - Market share: All publicly-listed firms, with assets totaling TRY 900 billion and equivalent to 21 percent of total corporate universe.
  - Data and baseline date: End-2015 financial statements (where available).
- Test parameters:
  - Stress test horizon: 5-year horizon (2016-2020).
  - Scenario analysis: Baseline scenario; Adverse scenario; Severely adverse scenario.
  - Sensitivity analysis: +/- 1 standard deviation shock in inputs (from baseline).
- Risks and buffers:
  - Risks/factors assessed: Interest risk, FX risk, Credit risk/Debt-at-Risk.
  - Buffers/Mitigating factors: Exports/revenues, FX assets, Hedging (derivatives).
- Risk variables calibration:
  - Interest rates: Parallel shifts of yield curve.
  - FX: Depreciation of TRY.
  - Credit: Debt-at-Risk.
  - Sensitivity analyses: +/- 1 standard deviation of inputs.
- Reporting format:
  - Output presentation: Impact on solvency (ICR) ratios; Debt-at-Risk measure; Contribution of individual shocks; Sectoral breakdown.

*Source: cr1735 - 49.      Moreover, the CBRT has already been working on the issues related to the*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr1735.pdf_