## _cr07361

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---

### Executive Summary — Overview
- Turkey’s financial system has strengthened markedly over the last five years and is likely to continue to develop rapidly and become more integrated internationally, but this process must be carefully managed to preserve soundness.
- The financial system does not appear to face major immediate threats, but vulnerabilities remain—a conclusion supported by the extensive stress testing exercise.

### Risk factors and vulnerabilities
- Macroeconomic volatility and current account:
  - Large current account deficit; dependence on capital inflows and international investor sentiment.
  - Continued efforts needed to anchor inflation at low levels; government debt stock remains relatively high, albeit declining.
- Legacy and confidence:
  - Legacy of macroeconomic and financial market instability; savers’ and investors’ confidence may still be fragile.
- Rapid credit expansion and product shifts:
  - Rapid expansion into housing lending and credit cards; credit growth slowed since June 2006 but remains rapid.
  - Competitive pressures (e.g., for housing loans after Mortgage Law) may lower underwriting standards.
- Interest rate and sovereign risk:
  - Banks bear large interest rate risk due mainly to duration mismatch between government securities and housing loans on the one hand and customer deposits on the other.
  - Large holdings of public sector debt make banks’ solvency, profitability, and liquidity highly sensitive to adverse market revaluation.
- Foreign-currency lending:
  - Lending in foreign currency still accounts for almost one third of bank loans; restrictions on foreign currency lending to non-exporters are sometimes circumvented (offshore loans, indexing).

### Regulation, supervision, and enforcement — key findings
- Regulatory improvements:
  - Regulation and supervision by the BRSA and other agencies much improved; immediate challenges include full implementation of the new Banking Law (BL) and accompanying regulations.
- Supervision capacity and credibility:
  - Authorities need to reinforce reputation for decisive action and move toward trigger points for supervisory action.
  - Supervision must keep up with advances in banking practice (e.g., risk modeling) and new forms of business (mortgage companies).
- Cross-border cooperation:
  - Growing international connections increase need for intensive cooperation with foreign supervisors; BRSA should conclude MoUs with significant foreign counterparties.
- Resolution and SDIF concerns:
  - CBRT has effective liquidity instruments and flexibility for emergency lending.
  - SDIF can resolve problem banks but transfer procedures may be delayed; SDIF powers to keep banks open up to 270 days (plus possible 90 day extension) can create a de facto blanket guarantee.

### Broadening the financial sector
- Non-bank financial sector (NBFIs):
  - NBFIs beginning to grow rapidly; new framework for mortgage securitization and Insurance Law presented to parliament.
  - Prospective Insurance Law helpful for institutional savings schemes.
- Capital markets and debt management:
  - Authorities extending maturities and increasing local-currency financing share.
  - First inflation-indexed debt after several years issued in February 2007; first domestic local currency corporate bond for a decade issued in August 2006.
- Transparency and corporate governance:
  - Balance sheets of non-listed companies not fully transparent; corporate ownership often difficult to track; major shareholders enjoy some residual privileges.

### Policy recommendations (selection and priorities)
- Macro stability preconditions:
  - Commitment to declining inflation path and fiscal consolidation are preconditions for sound financial sector development.
- Short term (next six to twelve months) — High priority actions:
  - Complete and implement regulations associated with the new Mortgage Law and pass the Insurance Law; establish prudential norms for mortgage lending and assign oversight responsibilities.
  - Implement all regulations for the new BL; develop and implement a comprehensive BRSA supervisory plan aligned with the new framework.
  - Review and amend procedures for handling failing banks; ensure active involvement of all relevant agencies.
  - Review major corporate shareholders’ regulatory treatment to remove residual privileges.
- Medium term — High/Medium priority actions:
  - Phase out transaction taxes (All, High).
  - Complete privatization of public banks (Banking, High).
  - Conclude MoUs with remaining significant foreign supervisory counterparties (Banking, High).
  - Adopt the Capital Markets Law in 2008 (Capital mkts., High).
  - Strengthen minority shareholders’ protection and raise board members’ accountability (Corporate governance, High).
  - Further strengthen accounting and auditing, especially in smaller nonfinancial firms (Corporate governance, High).

### Financial intermediation, deposit and loan structure
- Deposits and loans expansion:
  - Consumer credit and housing loans expanded rapidly; system transitioning toward private sector intermediation.
  - Government securities account for about a third of banks’ total assets; remaining non-marketable premium-bearing securities set to mature.
- Ownership and market structure:
  - At end-2006, about 25 percent of the Turkish banking system was effectively under foreign control.
- Maturities and dollarization:
  - Average deposit maturity below three months; loan maturity rising, increasing maturity mismatches.
  - About one third of loans are in foreign currency or foreign exchange indexed.
  - Dollarization of deposits declining relative but not absolute; some rise after May–June 2006 turbulence.

### Key macroeconomic indicators (selected, 2001–2007 projections)
- GNP (US$ billions): 144.0; 182.7; 238.5; 301.5; 361.9; 401.4; 2007 Proj. ...
- GNP per capital (in US$): 2,140; 2,671; 3,431; 4,271; 5,054; 5,534; 2007 Proj. ...
- Population (in millions): 67.3; 68.4; 69.5; 70.6; 71.6; 72.6; 73.6
- Nominal GNP growth rate: 40.5; 55.8; 29.7; 20.3; 13.4; 18.4; 12.4
- Real GNP growth rate: -9.5; 7.9; 5.9; 9.9; 7.6; 6.0; 5.0
- CPI (12-month, end-of period): 68.5; 29.7; 18.4; 9.4; 7.7; 9.7; 6.0
- Savings/GDP: 19.3; 20.7; 19.6; 20.6; 18.5; 15.6; 16.1
- Investment/GDP: 16.9; 21.5; 23.0; 25.8; 24.8; 23.5; 23.4
- Public sector overall balance/GDP: -17.1; -12.5; -9.1; -4.6; -1.2; -0.8; -0.9
- Public sector net debt/GDP: 90.4; 78.4; 70.3; 64.0; 55.3; 44.8; 40.9
- Gross official reserves (US$ billions): 19.8; 28.1; 35.2; 37.6; 52.2; 63.3; 68.6
- Exchange rate (YTL/US$, eop): 1.45; 1.64; 1.40; 1.34; 1.35; 1.41; ...

### Deposits, taxes, and funding costs
- Transaction taxes discourage domestic intermediation:
  - BITT generates revenue of 0.5 percent of GDP.
  - RUSF generates revenue of 0.3 percent of GDP.
- Authorities agree on desirability of eliminating transaction taxes but intend to do so gradually as fiscal space is created.
- Banks obtained longer-term syndicated or securitized loans from abroad, hedged through swap operations; interbank YTL market only moderately active; repos limited.

### Nonbank Financial Institutions (NBFIs), insurance, and pensions
- NBFIs are growing rapidly but remain small; insurance sector reviving and should be boosted by proposed Insurance Law.
- Individual pension saving plans introduced October 2003; pension assets nearly YTL 2 billion in August 2006 (0.5 percent of GDP), covering almost 1 million participants.
- Insurance companies “seem to be highly capitalized and currently report high profits,” though adequacy of reserving policies is difficult to determine.

### Trends in Financial Soundness Indicators (FSIs) and bank performance (selected)
- NPLs and provisioning (selected end-of-period ratios):
  - Non-performing loans/total loans: 12.7; 8.9; 4.9; 3.9; 3.3; 3.2
  - Specific provisions/gross non performing loans: 64.2; 88.5; 88.1; 89.8; 90.8; 90.8
  - Non performing loans net of provisions/Tier I capital: 16.3; 3.1; 1.9; 1.7; 1.5; 1.4
  - Specific provisions/gross loans: 11.3; 10.2; 5.3; 4.3; 3.0; 2.9
  - General provisions/gross loans: 3.2; 2.3; 2.2; 2.0; 1.7; 1.7
- Capital adequacy:
  - Regulatory capital/risk-weighted assets: 24.4; 29.5; 27.4; 22.8; 17.2; 21.1
  - Regulatory Tier I capital/risk-weighted assets: 24.7; 30.1; 26.9; 23.2; 19.1; 20.3
  - Capital/assets: 11.5; 13.7; 14.4; 12.9; 10.5; 11.3
- Profitability:
  - ROAA: 1.2; 2.4; 2.3; 1.6; 1.2; 2.3
  - ROAE: 10.6; 18.8; 16.7; 11.9; 10.1; 21.5
- Liquidity and FX exposure:
  - Core liquid assets/total assets: 10.7; 9.9; 9.4; 11.4; 12.8; 14.9
  - Liquid assets/total assets: 51.6; 53.1; 50.2; 47.8; 48.3; 48.0
  - Foreign currency loans/total loans: 50.7; 41.5; 34.2; 27.9; 30.5; 26.1
  - Foreign currency deposits/total deposits: 57.3; 48.6; 44.7; 36.4; 36.9; 38.8
  - Deposits/assets: 65.6; 62.8; 63.0; 61.9; 62.5; 61.8
  - Loans/deposits: 42.3; 47.2; 54.3; 63.7; 71.0; 72.2
  - Foreign currency loans/Foreign currency deposits: 37.4; 40.4; 41.5; 48.7; 58.7; 48.5

### Market turbulence (May–June 2006) — impacts and recovery drivers
- Immediate effects:
  - Sharp YTL depreciation and fall in stock prices; CBRT raised interest rates and absorbed liquidity.
  - Average CAR declined to 17 percent in mid-year from over 22 percent at end-2005; some banks’ CARs declined to significantly lower levels.
- Recovery in H2 2006 driven by:
  - Recovery in market prices and valuation gains on purchase of government securities,
  - Sale of fixed assets,
  - Some injections of fresh capital by shareholders.
- Lending effects:
  - Household lending slowed in H2 2006 partly due to higher rates and resurgence of dollarization; supply of loans may have shifted downwards.

### Stress testing results — system resilience and scenarios
- System CAR baseline: "System CAR before shocks was 22.9 percent."
- Sensitivity and scenario highlights (selected quantitative outcomes preserved):
  - A. Macroeconomic Shocks (impact on regulatory capital, in percent):
    - Sudden stop: 2006: -8.7; 2007: -20.8; 2008: -35.3
    - Oil Shock: 2006: -6.8; 2007: -14.3; 2008: -20.4
  - B. Trading Portfolio — Interest Rate shocks (mark-to-market impact on present value of interest sensitive items):
    - YTL: +1500 bps; non-YTL: +1000 bps => -18.9
    - YTL: +400 bps s.e.; +1500 bps l.e.; non-YTL: +300 bps s.e.; +1000 bps l.e. => -12.5
    - YTL: +1500 bps s.e.; +400 bps l.e.; non-YTL: +1000 bps s.e.; +300 bps l.e. => -12.7
  - C. Entire Balance-Sheet and all Off-Balance Sheet Positions:
    - Interest Rate (i) YTL: +1500 bps; non-YTL: +1000 bps => -40.7
    - (ii) YTL: +400 bps s.e.; +1500 bps l.e.; non-YTL: +300 bps s.e.; +1000 bps l.e. => -26.5
    - (iii) YTL: +1500 bps s.e.; +400 bps l.e.; non-YTL: +1000 bps s.e.; +300 bps l.e. => -20.2
    - Interest Rate and Exchange Rate combined with YTL depreciation: 45 percent => impacts range from -25.7 to -18.0
  - D. Credit Portfolio:
    - Global Portfolio — Increase in PDs of all performing credits of 200 percent => -10.7
    - Corporate Portfolio — Increase in PDs of all performing credits of 400 percent => -8.0
- Interpretation:
  - Scenarios involving sudden stop of capital inflows, reversal after credit boom, or persistent large oil-price increases threaten profitability of some important institutions.
  - Banking profits and capital highly sensitive to persistent increases in interest rates on YTL and domestically issued non-YTL instruments.
- Top-down market risk headline (selected outcomes):
  - Interest rate increase; Parallel YTL: 400 bps; Non-YTL: 300 bps — Impact on end-2005 after-tax profits: -70.2; Impact on end-2005 regulatory capital: -17.2; Post-Shock CAR: 18.8
  - Interest rate increase; Parallel YTL: 1500 bps; Non-YTL: 1000 bps — After-tax profits: -231.4; Regulatory capital: -32.9; Post-Shock CAR: 15.2
  - Exchange rate shocks generally have negligible impact due to almost closed foreign exchange position.

### Global Credit Portfolio Shock and macro scenarios (selected)
- PD increases:
  - PDs on each loan increases by 200 percent — impact reported across sample (see source for weighted averages).
  - PDs on each corporate loan increases by 400 percent — impact reported across sample (see source).
- Macroeconomic scenarios (four):
  - (i) permanent increase in oil prices to US$140 per barrel;
  - (ii) fiscal slippage scenario;
  - (iii) boom-bust scenario (growth initial overshoot then sharp decline);
  - (iv) zero net capital inflow (complete cessation of capital inflows).
- Zero net capital inflow results:
  - Dynamic analysis over 12 quarters forecasts rapid increase in NPLs and cumulative losses in banking capital estimated at almost 40 percent relative to end-2005 levels; could reduce average CAR by 9 percentage points absent management action; several banks, including some medium-sized ones, likely to require substantial fresh capital.
- Oil price shock:
  - Capital reductions could reach 20 percent by end-2008; sector-level CAR likely to remain comfortably above the 12 percent regulatory threshold though some institutions may need capital injections.

### Supervisory capacity, Basel II, and BRSA recommendations
- Basel II implementation:
  - Planned: implement Basel II as of January 2008, with model-based approaches implemented one year later; implement VaR models for market risk valuation.
  - Risk weights: retail portfolio capital requirements to be reduced; risk weight of longer-term housing loans to fall from 50 to 35 percent.
  - Authorities may need to use Pillar II flexibility for Turkey-specific risk factors.
- BRSA operational challenges:
  - BRSA lacks full operational independence in regulatory and budgetary matters; government sets annual limits on expenditures and must approve staff travel.
  - Difficulty recruiting and retaining specialized staff; need to strengthen training and CAST (computer-assisted supervision tools).
- Recommended supervisory enhancements (selected):
  - Issue sub-regulations and guidelines on country and transfer risk, interest rate risk in banking book, and legal risks.
  - Amend BL/sub-regulations to lower aggregate insider exposure limit from 50 percent to 25 percent (align with other groups) while maintaining 20 percent sub-limit for exposures to large shareholders.
  - Introduce provisioning requirement for "special mention" loans (international practice suggests 2 to 5 percent); increase general loan loss provisions to 1 percent for new loans already implemented.
  - Define explicit criteria for timely and graduated supervisory actions; establish formal exit meeting and enforcement timetables.
  - Strengthen consolidated supervision of mixed conglomerates; require banks to identify beneficial owners and cross-holdings.

### Securities market regulation and IOSCO findings
- CMB progress and reforms:
  - CMB achieving fair degree of compliance with IOSCO principles; Action Plan to harmonize with EU acquis; Capital Markets Law amendments expected in 2008.
  - Twinning arrangement with German regulator underway.
- Main IOSCO recommendations (selected):
  - Reinforce regulator independence and funding; improve cooperation and information-sharing with other regulators.
  - Clarify CMB–ISE roles; establish clearer oversight of SROs and regular inspections.
  - Improve market intermediaries’ operational risk standards and ladder of intervention measures.
  - Include large shareholders in insider definition; complete real-time surveillance project and insider module without undue delay.
  - Improve valuation and disclosure practices for illiquid assets and CISs.

### Payment and securities settlement systems — CPSS/IOSCO findings and recommendations
- TIC-RTGS and ICH:
  - TIC-RTGS transaction volume and value (2005): volume: 77.7 million; value: YTL 7,844.2 billion.
  - Check volume (2005): 23.5 million; value: YTL 156.1 billion.
  - Legal finality: recommendation to embed explicit finality clause in law to prevent challenges to irrevocability of RTGS payments.
  - ICH conversion to same-day settlement planned; recommended explicit “failure to settle” mechanisms (loss-sharing, pre-funding, guarantee fund).
- Takasbank/CRA and TIC-ESTS:
  - Securities settlement operates on Model 1 DvP for government securities and Model 3 DvP for ISE equities via Takasbank/CRA integrated system.
  - Recommendations include establishing active oversight work program, implementing T+1 confirmation upgrades, publishing CPSS/IOSCO Disclosure Framework, and assessing need for international connectivity and possible CCP mechanism for equities.
- CBRT oversight:
  - CBRT to consider consumer protection policy for payments; evaluate structural separation between service provider and overseer functions.

### Insurance, leasing, and market structure
- Insurance:
  - Most insurance companies affiliate with banks; 20 percent cession to Millie Re terminated in 2006.
  - Guarantee Fund used extensively for motor claims; 18 companies exited market over five years.
- Leasing:
  - Leasing tripled since 2000 to over US$4 billion; average lease about US$100,000; 75 percent of leases for machinery and equipment.
- Government debt and equity markets (selected):
  - Gross domestic government debt slightly over 50 percent of GNP at end-2005; average maturity just under two years.
  - Composition: 43 percent variable rates; 41 percent domestic currency fixed; 16 percent linked/denominated in foreign currency.
  - ISE: 306 companies listed at end-December 2005; market capitalization about 40 percent of GDP; turnover 155 percent of market capitalization in 2005.

### Credit information, collateral, and legal framework
- Credit Bureau (KKB):
  - Performs well; plans to expand to corporate sector and include leasing and credit cooperative data; potential addition of utility payment data.
- Collateral and creditor rights:
  - High taxes and fees for creating collateral relative to region; land titling and registration modernization needed.
  - Judicial limitations: limited financial expertise and court congestion; heavy taxes on collection (in some cases as high as 32 percent) and prohibition on negotiating solutions directly.
- Bankruptcy law:
  - New bankruptcy law effective 2003 with suspension mechanism similar to U.S. Chapter 11; complexity in eligibility determination and asset management suggests need for further review.

*Source: Executive Summary and excerpts from the IMF financial sector assessment (FSAP) material in content unit _cr07361.*

### Executive Summary ......................................................................................................

### Executive Summary

### Overview
- Turkey’s financial system has strengthened markedly over the last five years and is likely to continue to develop rapidly and become more integrated internationally, but this process must be carefully managed to preserve soundness.
- The financial system does not appear to face major immediate threats, but vulnerabilities remain—a conclusion supported by the extensive stress testing exercise.

### Risk factors and vulnerabilities
- Macroeconomic volatility, especially because of the large current account deficit. Turkey remains dependent on capital inflows and thus on international investor sentiment. Continued efforts are still needed to anchor inflation at low levels, and the stock of government debt remains relatively high, albeit declining.
- The legacy of macroeconomic and financial market instability. While the credibility of economic management has been strengthened over the past five years, savers and investors’ confidence may still be fragile.
- Rapid credit expansion into new activities—including housing lending and credit cards—involving new borrowers. Although credit growth has slowed since June 2006, it remains rapid. Competitive pressures (e.g., for housing loans, which may increase following passage of the Mortgage Law) may lower underwriting standards.
- Banks bearing large interest rate risk due mainly to duration mismatch between government securities and housing loans on the one hand and customer deposits on the other.
- Sovereign risk. Large holdings of public sector debt by banks make their solvency, profitability, and liquidity highly sensitive to adverse market revaluation of these securities in the event of external shocks or/and internal political uncertainties.
- Lending in foreign currency, which still accounts for almost one third of bank loans, exposing banks to foreign currency risk indirectly via credit risk. It appears that restrictions on foreign currency lending to non-exporters are sometimes circumvented, for example, by granting foreign currency loans offshore or indexing loans to foreign currency.

### Regulation, supervision, and enforcement
- Regulation and supervision by the Banking Regulation and Supervision Agency (BRSA) and other relevant agencies is much improved. Immediate challenges are to implement fully the new Banking Law (BL) and accompanying regulations, and to ensure that all deviations from regulatory requirements are corrected promptly.
- Authorities need to reinforce their reputation for taking decisive action, and should move toward a system of trigger points for supervisory action.
- Supervision must keep up with rapid advances in banking practice (e.g., risk modeling) and cover new forms of business such as mortgage companies, likely to expand following passage of the Mortgage Law.
- Growing international connections of banks (notably through foreign direct investment, FDI) may improve risk management and product development but increase the need for domestic supervisors to cooperate intensively with counterparts abroad.
- Levies of transaction taxes raise the cost of investment financing and discourage saving, and favor use of offshore and overseas banks, which can facilitate circumvention of prudential requirements.
- Improvements have been made in enhancing procedures for dealing with periods of strain and the eventual exit of failing banks, but further enhancements are needed:
  - The Central Bank of the Republic of Turkey (CBRT) has effective instruments for managing liquidity and flexibility to provide emergency lending assistance.
  - The Savings Deposit Insurance Fund (SDIF) has powers to resolve problem banks, but procedures for transferring a failing bank to the SDIF may be prone to delay, and the framework may generate fiscal costs by creating a de facto guarantee on all deposits of a transferred bank.
- Capital market regulation and supervision is broadly satisfactory. The Capital Markets Board (CMB) is implementing an action plan to achieve convergence to European practices, and a new Capital Markets Law is scheduled to be presented in 2008.
- Payment and security settlement systems are modern, and generally well-regulated and supervised.

### Broadening the financial sector
- The non-bank financial sector is beginning to grow rapidly. Major steps include the new framework for mortgage securitization and the presentation of the Insurance Law to parliament.
- The prospective Insurance Law will be helpful in fostering the development of institutional savings schemes.
- The Istanbul Stock Exchange (ISE) functions well, but issues relating to its eventual privatization should not be allowed to delay on-going modernization and the maintenance of its international competitiveness.
- Authorities have been extending the maturities of public sector debt and increasing the share of local-currency financing as part of a comprehensive debt management strategy.
- Transparency and corporate governance still need improvement: balance sheets of non-listed companies are not fully transparent; corporate ownership is often difficult to track; and major shareholders enjoy some (limited) privileges in terms of market conduct and lending.

### Policy recommendations
- Policies to maintain macroeconomic stability, such as a commitment to a declining path of inflation and fiscal consolidation, are preconditions for sound financial sector development. The authorities will need to remain unwavering in their commitment to sound policies to reinforce confidence and create room for the new financial markets to flourish.
- FSAP recommendations are designed to reduce financial sector vulnerabilities while promoting financial sector development and overall growth. Many recommendations relate to strengthening preventative, prudential measures, and improving mechanisms to deal efficiently with difficulties (for example, in the resolution of problem banks). Others—on bank privatization, development of the nonbank sector, access to finance, and corporate governance—should contribute to economic efficiency and diversification of the financial system.
- The authorities have already taken measures in line with FSAP recommendations, including raising required general provisions, strengthening the minimum capital adequacy ratio (CAR), issuing inflation indexed debt, and taking forward the Mortgage and Insurance Laws.

### Main recommendations (priority, timing)
- Short term (actions to be undertaken within the next six to twelve months)
  - All, High: Complete and implement the regulations associated with the new Mortgage Law and pass the Insurance Law. In particular, establish prudential norms for mortgage lending, and assign related oversight responsibilities.
  - Banking, High: Implement all regulations for the new BL. Develop, and implement, a comprehensive plan for the BRSA to supervise banks in line with the new legal and regulatory framework, including their risk management.
  - Banking, High: Review and amend procedures for handling failing banks, and ensure active involvement of all relevant agencies, to ensure timely and cost-effective action.
  - Banking, Medium: Ensure that foreign-currency linked domestic currency loans are subject to similar constraints as foreign currency loans.
  - Corporate governance, High: Review major corporate shareholders’ regulatory treatment to remove residual privileges.
- Medium term (less time-critical or require a longer lead time; preparations should begin in the short term)
  - All, High: Phase out transaction taxes.
  - Banking, High: Complete privatization of public banks.
  - Banking, Medium: Refine data collection and analysis.
  - Banking, High: Conclude Memoranda of Understanding (MoUs) with remaining significant foreign supervision counterparties.
  - Banking, Medium: Review mechanisms to ensure financial independence of supervisory agencies.
  - Insurance, High: Establish mechanisms to generate more reliable data on insurance companies’ provisions and capital.
  - Capital mkts., High: Resolve problems regarding privatization of the ISE.
  - Capital mkts., High: Adopt the Capital Markets Law in 2008.
  - Access to finance, Medium: Reduce the costs of creating and realizing collateral.
  - Corporate governance, High: Strengthen minority shareholders’ protection and raise board members’ accountability.
  - Corporate governance, High: Further strengthen accounting and auditing, especially in smaller nonfinancial firms.

*Source: Executive Summary of IMF financial sector assessment (FSAP) material.*

### 4.      With the return of confidence and greater economic predictability, deposits and

### _cr07361 - 4.      With the return of confidence and greater economic predictability, deposits and

### Financial intermediation and credit expansion
- Deposits and loans, especially consumer credit and housing loans, have expanded rapidly.
- The system is transitioning from financing government and a few major enterprises to extensive private sector intermediation.
- Government securities account for about a third of banks’ total assets; remaining non-marketable securities paying premium interest rates are set to mature.
- At end-2006, about 25 percent of the Turkish banking system was effectively under foreign control.  
- Trend increase in intermediation began in the mid-1990s but was interrupted by the 2001 crisis.

### Key macroeconomic indicators (selected, 2001–2007 projections)
- GNP (US$ billions): 144.0; 182.7; 238.5; 301.5; 361.9; 401.4; 2007 Proj. ...
- GNP per capital (in US$): 2,140; 2,671; 3,431; 4,271; 5,054; 5,534; 2007 Proj. ...
- Population (in millions): 67.3; 68.4; 69.5; 70.6; 71.6; 72.6; 73.6
- Nominal GNP growth rate: 40.5; 55.8; 29.7; 20.3; 13.4; 18.4; 12.4
- Real GNP growth rate: -9.5; 7.9; 5.9; 9.9; 7.6; 6.0; 5.0
- CPI (12-month, end-of period): 68.5; 29.7; 18.4; 9.4; 7.7; 9.7; 6.0
- Savings/GDP: 19.3; 20.7; 19.6; 20.6; 18.5; 15.6; 16.1
- Investment/GDP: 16.9; 21.5; 23.0; 25.8; 24.8; 23.5; 23.4
- Public sector overall balance/GDP: -17.1; -12.5; -9.1; -4.6; -1.2; -0.8; -0.9
- Public sector net debt/GDP: 90.4; 78.4; 70.3; 64.0; 55.3; 44.8; 40.9
- Gross official reserves (US$ billions): 19.8; 28.1; 35.2; 37.6; 52.2; 63.3; 68.6
- Exchange rate (YTL/US$, eop): 1.45; 1.64; 1.40; 1.34; 1.35; 1.41; ...

### Deposits, maturities, dollarization, and market structure
- Average deposit maturity is below three months, while loan maturity is rising, increasing maturity mismatches.
- About one third of loans are in foreign currency or foreign exchange indexed.
- Dollarization of deposits has been declining in relative, but not absolute, terms; some rise occurred after May-June 2006 turbulence.
- Banks have obtained longer-term syndicated or securitized loans from abroad, hedged through swap operations.
- The interbank New Turkish Lira (YTL) market is only moderately active; repurchase operations (repos) are limited.
- Transaction taxes (Banking Transaction and Insurance Tax (BITT) and Resource Utilization and Support Fund (RUSF)) have discouraged domestic intermediation:
  - BITT generates revenue of 0.5 percent of GDP.
  - RUSF generates revenue of 0.3 percent of GDP.
- Authorities agree on desirability of eliminating transaction taxes but intend to do so gradually as fiscal space is created.

### Public debt management and capital markets
- Outstanding stock of government debt is large, but public debt management has improved:
  - Treasury actively extending duration and maturity and decreasing reliance on foreign currency denominated debt, though a large portion still carries a floating rate.
- The first inflation-indexed debt after several years was issued in February 2007.
- Stock market capitalization has risen sharply, but equity and corporate bond market development remains limited.
- First domestic local currency corporate bond for a decade was issued in August 2006.
- Initial public offerings and sales of additional equity in listed companies are resuming on the ISE.

### Nonbank financial institutions (NBFIs)
- NBFIs are growing rapidly but remain small.
- Insurance sector is reviving and should be boosted by the proposed Insurance Law.
- Introduction of individual pension saving plans in October 2003 represented an important positive development.
- Ongoing reform of corporate pensions included in the proposed Insurance Law is expected to expand the scope of private pensions further.

### Resilience, vulnerabilities, and supervisory challenges
- Improved risk management, regulation, supervision, and intervention have made the system more resilient; enabling macro conditions include reduced inflation, a flexible exchange rate regime, and improved fiscal performance.
- Persisting and emerging vulnerabilities:
  - Rapid expansion into household lending raises new vulnerabilities.
  - History of macroeconomic and financial instability continues to affect savers’ and investors’ confidence.
  - Traditional conglomerate connections may continue to contribute to vulnerabilities, although their relative importance is probably declining.
- Internationalization of banking activity:
  - Consolidated supervision is in place; BRSA should ensure banks account for total risks, including those from lending in foreign currency through offshore subsidiaries or branches.
  - Foreign partnerships can import better risk management and access cheaper financing and capital, but may accelerate aggregate credit expansion, risk taking, and circumvention of prudential measures.
- Market turbulence:
  - May-June 2006 turbulence had largely temporary effect on banks’ capitalization levels but slowed credit expansion.
  - Renewed world-wide market turbulence in Q1 2007 did not have an especially strong impact on Turkey.

### Trends in Financial Soundness Indicators (FSIs) and bank performance (selected)
- Aggregate improvements in FSIs parallel macroeconomic indicators; banks rebuilt capital and provisions; NPL rates have fallen steadily (except recent rises in NPL ratios for credit card debt).
- NPLs and provisioning (selected end-of-period ratios):
  - Non-performing loans/total loans: 12.7; 8.9; 4.9; 3.9; 3.3; 3.2
  - Specific provisions/gross non performing loans: 64.2; 88.5; 88.1; 89.8; 90.8; 90.8
  - Non performing loans net of provisions/Tier I capital: 16.3; 3.1; 1.9; 1.7; 1.5; 1.4
  - Specific provisions/gross loans: 11.3; 10.2; 5.3; 4.3; 3.0; 2.9
  - General provisions/gross loans: 3.2; 2.3; 2.2; 2.0; 1.7; 1.7
- Capital adequacy and capitalization:
  - Regulatory capital/risk-weighted assets: 24.4; 29.5; 27.4; 22.8; 17.2; 21.1
  - Regulatory Tier I capital/risk-weighted assets: 24.7; 30.1; 26.9; 23.2; 19.1; 20.3
  - Capital/assets: 11.5; 13.7; 14.4; 12.9; 10.5; 11.3
- Profitability:
  - Return on Average Assets (ROAA): 1.2; 2.4; 2.3; 1.6; 1.2; 2.3
  - Return on Average Equity (ROAE): 10.6; 18.8; 16.7; 11.9; 10.1; 21.5
- Liquidity and foreign currency exposure:
  - Core liquid assets/total assets: 10.7; 9.9; 9.4; 11.4; 12.8; 14.9
  - Liquid assets/total assets: 51.6; 53.1; 50.2; 47.8; 48.3; 48.0
  - Foreign currency loans/total loans: 50.7; 41.5; 34.2; 27.9; 30.5; 26.1
  - Foreign currency deposits/total deposits: 57.3; 48.6; 44.7; 36.4; 36.9; 38.8
  - Deposits/assets: 65.6; 62.8; 63.0; 61.9; 62.5; 61.8
  - Loans/deposits: 42.3; 47.2; 54.3; 63.7; 71.0; 72.2
  - Foreign currency loans/Foreign currency deposits: 37.4; 40.4; 41.5; 48.7; 58.7; 48.5
- Market indicators:
  - Estimated expected default frequencies (EDFs) for 15 quoted banks show a trend decline (Moody’s).
- Specific concern: full recognition of banks’ pension liabilities under IFRS may affect some banks’ profitability; introducing a discount rate consistent with Turkey’s inflation targets could lead to a higher valuation of liabilities.

*Sources: Data provided by the Turkish authorities; BRSA; CMB; UT (GD of Insurance); CBRT; TUIK; Moody’s; and IMF staff estimates and projections.*

### 18.      The limited FSIs available for NBFIs are broadly satisfactory. Most insurance

### _cr07361 - 18.      The limited FSIs available for NBFIs are broadly satisfactory. Most insurance

### Nonbank Financial Institutions (NBFIs) — available FSIs and observations
- The limited FSIs available for NBFIs are described as "broadly satisfactory."
- Most insurance companies "seem to be highly capitalized and currently report high profits," although "the adequacy and appropriateness of reserving policies are difficult to determine."
- Footnote observation: "In most countries, profitable companies tend to overstate reserves and lower reported profits to save taxes, while struggling companies tend to understate reserves to hide their weakness."

### Financial sector impact of the market turbulence of mid-2006 (Box 1)
- Event and immediate market reaction:
  - Market turbulence in May-June 2006 caused a sharp depreciation of the YTL and a fall in stock prices; these movements "have subsequently been largely reversed."
  - The CBRT raised interest rates and "actively absorbed liquidity from the money markets."
- Banking sector effects:
  - Banks experienced mark-to-market valuation losses on large holdings of government securities; the average CAR declined to 17 percent in mid-year, from over 22 percent at end-2005.
  - Some banks' CARs "declined ... to significantly lower CAR levels."
  - Accounting losses were reversed once securities matured and were rolled over.
  - State-owned banks were less affected because a large share of their government securities "is not tradable and so not marked to market."
  - Given banks’ small net foreign currency open positions, direct exchange rate effects were "minor."
- Recovery drivers in second half of 2006:
  - Capitalization levels rebounded, driven mainly by:
    - recovery in market prices;
    - valuation gains on purchase of government securities sold by others after the turbulence;
    - sale of fixed assets;
    - some injections of fresh capital by shareholders.
  - Profitability was helped by declining NPLs and provisioning (aggregate figures distorted by "large exceptional charges incurred by one bank in 2005").
- Lending and funding effects:
  - Lending to households slowed in the second half of 2006; possible causes:
    - higher rates discouraged borrowing;
    - resurgence of dollarization of deposits reduced banks’ domestic YTL funding;
    - cost of foreign funding hedged by swaps "rose sharply."
  - Supply of loans "may thus have shifted downwards" as banks became "more concerned about costs and risks and less concerned about building their client bases."
- Concluding assessment:
  - Episode suggests banks are "more resilient to market turbulence than in the past," and that banks and authorities are "in some regards better at managing the attendant risks."
  - Recovery was aided by rapid revival of investor appetite for emerging market assets and "limited spill-over from the shock on to the domestic economy."

### Corporate sector performance and vulnerabilities (Paragraph 19, Table 4, Box 2)
- General corporate sector trends:
  - Since 2000 the corporate sector has been rebuilding financial strength, but "foreign exchange exposure remains something of a concern."
  - Larger corporations that publish more financial information exhibit higher profit margins, greater debt service capacity, and decreased leverage, but maintain "significant unhedged foreign currency positions," though these have "declined somewhat recently."
  - Corporates were "able to rebuild financial strength after the turbulence in mid-2006."
- Household sector summary:
  - "Available data on the financial burden borne by households suggest that they are not very leveraged," though aggregates may hide concentrations in segments such as urban salary-earners.
- Key financial ratios (selected figures from Table 4):
  - Selected financial ratios for all nonfinancial corporates — Net margin (in percent): 2001: 3.0; 2002: 4.3; 2003: 4.2; 2004: 2.9; 2005: ......; 2006Q2: ......; 2006Q3: ......  
  - Total liabilities to equity: 2001: 2.3; 2002: 1.8; 2003: 1.4; 2004: 1.0; 2005: 1.0; 2006Q2: ......; 2006Q3: ......  
  - Interest coverage (all nonfinancial corporates): 2001: 1.1; 2002: 1.8; 2003: 3.3; 2004: 3.3; 2005: 3.2; 2006Q2: ......; 2006Q3: ......  
  - Selected financial ratios for large corporations (20 companies representing 37 percent of ISE market capitalization; net sales = 13 percent of GDP in 2005):
    - Net margin (in percent): 2001: -2.9; 2002: 2.3; 2003: 6.3; 2004: 6.2; 2005: 3.8; 2006Q2: 3.9; 2006Q3: 10.3
    - Return on assets: 2001: -1.2; 2002: 1.0; 2003: 2.4; 2004: 2.0; 2005: 1.3; 2006Q2: 1.5; 2006Q3: 4.0
    - Return on equity: 2001: -4.5; 2002: 3.1; 2003: 5.8; 2004: 3.8; 2005: 2.3; 2006Q2: 2.9; 2006Q3: 7.5
    - Total liabilities to equity: 2001: 2.8; 2002: 2.3; 2003: 1.5; 2004: 0.9; 2005: 0.7; 2006Q2: 1.0; 2006Q3: 0.9
    - Foreign liabilities to total liabilities: 2004: .........; 2005: 0.5; 2006Q2: 0.6; 2006Q3: 0.5
    - Interest coverage: 2001: 0.4; 2002: 1.6; 2003: 3.1; 2004: 5.8; 2005: 4.4; 2006Q2: 2.8; 2006Q3: 5.9
    - Net foreign exchange position to current assets: 2004: .........; 2005: -0.3; 2006Q2: -0.4; 2006Q3: -0.4; -0.3
  - Household sector ratios: Total financial assets/GDP: 47.0, 41.7, 42.7, 42.0, ...... (years not fully enumerated in source table fragment).
  - Notes: 2004 figures for nonfinancial corporates derived from inflation-adjusted statements; sample sizes provided for CBRT Company Accounts database; definitions for ratios as in table footnotes.
- Box 2 aggregated balance-sheet findings (20 listed firms sample):
  - Sample accounts for 37 percent of market capitalization of listed nonfinancial companies; net sales equivalent to 13 percent of GDP.
  - For aggregated balance sheet of these companies:
    - 72 percent of total liabilities are of short term duration.
    - nearly 60 percent are denominated in foreign currency or are exchange-rate indexed.
  - Debt servicing indicators:
    - Total liabilities to assets below 50 percent.
    - Interest coverage ratio of nearly 6.
    - Current assets are about three times as large as net open foreign exchange position.
  - Sectoral variation: some sectors (foodstuffs, energy, metal and machinery) have "relatively higher leverage, short term debt indicators, and foreign exchange exposure."
  - EDFs (endogenous default probabilities):
    - At end-March 2006, one-year ahead EDFs for selected corporates averaged 2.5 percent, and ranged from under 1 to 5 percent across sectors.
    - Scenario analysis: volatility such as that in May/June 2006 is estimated to "roughly double EDFs."

### Stress testing results and vulnerabilities (Section B, Table 5)
- Overall assessment:
  - Stress tests indicate the sector as a whole has "substantial capital buffers," but "some large banks are vulnerable to major interest and credit quality shocks."
  - A deterioration in credit quality would have "a substantial impact on profits and, to a lesser extent, on regulatory capital."
  - Most large banks "would seem able to absorb the associated losses without falling below the required minimum CAR," but "there could be problems for some."
  - Liquidity risk appears small, contingent on "the liquidity of the sovereign bond market" under system-wide deterioration.
- System CAR baseline:
  - "System CAR before shocks was 22.9 percent."
- Selected stress scenarios and reported impacts on end-2005 regulatory capital (in percent) from Table 5:
  - A. Macroeconomic Shocks (reported impact on regulatory capital):
    - (i) Sudden stop: 2006: -8.7; 2007: -20.8; 2008: -35.3
    - (ii) Oil Shock: 2006: -6.8; 2007: -14.3; 2008: -20.4
  - B. Trading Portfolio — Interest Rate shocks (based on banks' estimates of mark-to-market impact on present value of interest sensitive items):
    - (i) YTL: +1500 bps; non-YTL: +1000 bps => -18.9
    - (ii) YTL: +400 bps s.e.; +1500 bps l.e.; non-YTL: +300 bps s.e.; +1000 bps l.e. => -12.5
    - (iii) YTL: +1500 bps s.e.; +400 bps l.e.; non-YTL: +1000 bps s.e.; +300 bps l.e. => -12.7
    - (s.e.: short end of term structure; l.e.: long end of term structure)
  - C. Entire Balance-Sheet and all Off-Balance Sheet Positions (based on banks' estimates of impact on discounted net cash flows on all interest sensitive items on and off-balance sheet):
    - Interest Rate (i) YTL: +1500 bps; non-YTL: +1000 bps => -40.7
    - (ii) YTL: +400 bps s.e.; +1500 bps l.e.; non-YTL: +300 bps s.e.; +1000 bps l.e. => -26.5
    - (iii) YTL: +1500 bps s.e.; +400 bps l.e.; non-YTL: +1000 bps s.e.; +300 bps l.e. => -20.2
    - Interest Rate and Exchange Rate combined:
      - (ii) YTL: +400 bps s.e.; +1500 bps l.e.; non-YTL: +300 bps s.e.; +1000 bps l.e.; and YTL depreciation: 45 percent => -25.7
      - (iii) YTL: +1500 bps s.e.; +400 bps l.e.; non-YTL: +1000 bps s.e.; +300 bps l.e.; and YTL depreciation: 45 percent => -18.0
  - D. Credit Portfolio (based on banks' estimates of impact on expected losses):
    - Global Portfolio — Increase in PDs of all performing credits of 200 percent => -10.7
    - Corporate Portfolio — Increase in PDs of all performing credits of 400 percent => -8.0
- Interpretation:
  - "Scenarios involving a sudden stop of capital inflows, a sudden reversal after a credit boom, or a persistent large increase in oil prices are projected to threaten the profitability of some important institutions."
  - "Banking profits and eventually their capital are also highly sensitive to persistent increases in interest rates on YTL and domestically issued non-YTL instruments."

### Financial sector regulation, infrastructure, and policy recommendations (Section III, A–B)
- Liquidity management and lender-of-last-resort:
  - The CBRT "actively manages liquidity" within its inflation targeting framework and "has adequate facilities and procedures to manage overall liquidity and assist banks in normal times."
  - Interbank rates are steered using repurchase tenders, supported by standing facilities and reserve requirements.
  - The CBRT Act provides ample flexibility for emergency lending assistance and "additional mechanisms to provide limited amounts of foreign currency liquidity."
  - Recommendation: Authorities "have yet to define a formal strategy for handling support in the case of liquidity crisis," including ensuring "protracted liquidity support is not granted to insolvent institutions."
  - The CBRT "fully observes almost all provisions of the monetary transparency code" under the inflation targeting regime introduced in January 2006; observance of CPSS Core Principles for Systemically Important Payments Systems is "also high."
- Bank intervention and resolution:
  - Substantial efforts made since 2005 BL to improve safety net and crisis management, but "some areas require further strengthening" to ensure expeditious and efficient resolution, including for small non-systemic banks.
  - SDIF role and decision process:
    - SDIF responsible for dealing with failing banks.
    - Decision process to transfer a bank from BRSA to SDIF should be "accelerated," possibly by amending requirement for a super-majority of the BRSA board.
    - SDIF needs "to be fully integrated into contingency planning during difficult periods."
  - Concern over SDIF keeping banks open:
    - SDIF may keep a bank open up to 270 days (with possible 90 day extension) "without any clearly specified rationale."
    - Keeping a bank open under SDIF is widely understood to confer full depositor protection as the bank "has become a state bank," creating a de facto blanket guarantee and potentially large costs to the government.
    - Recommendation: Adopt regulatory measures to ensure a transferred bank remains open "only in specified limited cases" (e.g., investor clearly at hand or closure would risk system stability); align objective to "find the solution that minimizes the cost to public funds and maintains the smooth functioning of the system as a whole."
  - Judicial interference:
    - The capacity of the judicial branch to "interfere in, and even reverse, a bank liquidation process initiated by the BRSA remains an issue."
    - Recommendation: Banking authority's decision to withdraw license and undertake liquidation "should be a definitive and irreversible administrative process."
- Deposit insurance:
  - Blanket deposit guarantee replaced in 2004 by limited deposit insurance managed by SDIF.
  - Maximum coverage is "YTL 50,000 per depositor, equivalent to about 7 times GDP per capita."
  - Recommendations:
    - Develop procedures to ensure "a faster repayment process of insured deposits."
    - Once confidence is further established, consider reviewing whether "the level of insurance should be revised downward."
  - SDIF condition:
    - SDIF has made progress recovering assets from 2001 crisis resolutions but "it is technically insolvent and its liquid reserves cover only a small fraction of the insured deposits."
    - Insolvency explained by interest accrued on loans obtained from the Treasury during the 2001 banking crisis; resolution of such loans would "reassure depositors and signal that the episode has been closed."
- Regulatory and supervisory framework:
  - Progress:
    - Turkey has made "impressive progress" updating regulatory and supervisory framework; 2005 BL and sub-regulations "have filled most gaps."
    - BRSA prepares an annual supervisory cycle for each bank and is "developing capacity to conduct information systems and technology audits."
  - Recent prudential moves:
    - Decisions to require a minimum 12 percent CAR for all banks wishing to open a new branch (already applied to banks with offshore affiliates).
    - Increase rate of general loan loss provisions to 1 percent from 0.5 percent for new loans.
    - Recommendation: Introduce a provision requirement on "special mention" loans; international practice suggests a provisioning rate of "2 to 5 percent" may be appropriate. Note: "Banks’ current profitability could easily support such additional provisioning."
  - Supervisory capacity and enforcement:
    - BRSA has legal authority and capacity to identify unsafe practices and request corrective actions, but "has not had recent occasion to demonstrate strong commitment to enforcement."
    - Recommendation: Define explicit criteria for "timely and graduated action" in coordination with the SDIF; past delays in resolution in 2001 increased public costs.
    - Constraints on BRSA:
      - Lacks operational independence in certain budgetary and regulatory issues because the government can set limits on its expenditures budget.
      - This may hinder issuing prudential sub-regulations.
  - Cross-border supervision:
    - Supervision of cross-border banking needs more attention.
    - BRSA lacks Memoranda of Understanding (MOUs) with banking supervisors from critical home countries of foreign banks operating in Turkey and with those where Turkish banks have large operations.
    - Recommendation: Intensify exchange of information and analysis with foreign supervisors, "particularly those from EU countries."

*Italic: Source: _cr07361 - 18.      The limited FSIs available for NBFIs are broadly satisfactory. Most insurance (PDF chapter/section).*

### 35.      A major challenge facing the BRSA, as for supervisors around the world, is to

### _cr07361 - 35.      A major challenge facing the BRSA, as for supervisors around the world, is to

### Supervisory capacity and Basel II implementation
- Major challenge: ensure supervisory practice keeps up with developments in banking and the increasingly complex risk management procedures and risk models used by banks.
- Risks of outsourcing: "Outsourcing validation would limit supervisors’ ability to assess risks on a continuous basis."
- Box 3 — Implementation of Basel II:
  - Planned timeline: "The Turkish authorities plan to implement Basel II as of January 2008, with the model-based approaches implemented one year later."
  - Additional change: authorities will "implement VaR models for the valuation of market risk."
  - Impacts on capital and incentives:
    - "Capital requirements for the retail portfolio will be reduced as a result of the decrease in the risk weights of residential mortgages and other retail credits."
    - "Risk weight of longer-term housing loans will fall from 50 to 35 percent."
    - "Full deduction" of significant investments in commercial interests from capital will affect certain banks significantly.
    - Banks have begun to "adjust their portfolios to reduce capital required under Basel II."
  - Policy implication: "authorities may need to make use of the flexibility afforded under Pillar II to address those risk factors that are especially relevant to Turkish banks."
- Stability concern: "capital allocation to cover maturity mismatches deserves special attention."

### Coordination among regulators and data management
- Cooperation:
  - "Cooperation among regulators needs to be further strengthened."
  - Financial Sector Commission (FSC) "has met very rarely" and "may because of its diverse composition not discuss bank-specific matters; a sub-committee comprising just representatives of official agencies might be formed to work on detailed specific matters."
- Data management:
  - "Better data management must remain priority."
  - Authorities should "make better use of the information that is already available, and, as needed and selectively, gather new types of information (e.g. on portfolio duration, corporate and household financial indicators, and dealings in derivatives as the activity develops)."

### Anti-money laundering and countering the financing of terrorism (AML/CFT)
- Recent legal developments:
  - "A new money laundering offence was introduced in June 2005, and the stand-alone terrorist financing offence was introduced in July 2006."
  - "The new Law no. 5549 of October 2006 provides, among other things, for a more comprehensive system for disclosures of cross-border transactions of cash and monetary instruments."
- FATF assessment: "The Financial Action Task Force (FATF) noted these developments in its recent assessment."
- Outstanding issues:
  - "the number of suspicious transaction reports and convictions for money laundering is relatively low, and confiscation measures have also not yet produced substantial results;"
  - "preventive measures requiring financial institutions to undertake customer identification and certain other measures do not fully meet the FATF standards for ongoing customer due diligence (CDD), identification of the beneficial owner, and enhanced CDD for high-risk customers and operations;"
  - "the framework for international co-operation is adequate, although certain limitations in the coverage of the money laundering and terrorist financing offences could provide a technical limitation to such assistance."

### Securities market regulation and supervision
- CMB status and reform path:
  - "The CMB has adequate supervisory powers" and "has already achieved a fair degree of compliance with the International Organization of Securities Commissions (IOSCO) principles."
  - "Amendments to the Capital Markets Law are expected to be submitted to parliament in 2008."
  - CMB "approved a well-designed Action Plan on harmonizing regulations with the EU acquis over the next two years."
  - CMB is "currently involved in a twinning arrangement with the German financial regulator."
- Key regulatory issues:
  - Treatment of market conduct of large shareholders and corporate governance in publicly-owned corporations and securities market firms (often linked to banks).
  - Improving the system for valuing illiquid assets.
- Market infrastructure: "IOSCO and CPSS-IOSCO Securities Settlement assessments rated highly the infrastructure at the ISE and the settlement bank."

### Insurance and pension sector supervision
- Insurance:
  - "The insurance regulatory framework, including risk-based capital requirements, has been modernized."
  - "An early warning system introduced in 1997 has been used to identify financially weak companies and initiate on-site inspections and intervention action."
  - "A modern insurance law has been presented to Parliament and is expected to be passed shortly." The law addresses "minimum capital, fit and proper requirements, direct licensing, and changes in control."
  - Remaining issues: "conglomerate supervision; market conduct; and coordination between licensing, offsite supervision and enforcement, and onsite inspections."
  - Data initiative: "the new Insurance Monitoring System is an important initiative" to generate reliable sector data.
- Pensions:
  - "The new voluntary system of individual pension saving plans is supported by a solid regulatory framework and effective supervision."
  - Supervisory shift recommended: replace a focus on rule compliance with "an emphasis on internal control systems and ex-post assessment of good conduct."
  - Recent changes: "The lower limit on private pensions’ investments in government securities and upper limit on offshore investments have recently been eliminated."

### Structural issues — banking sector, housing finance, and state banks
- State banks:
  - "State banks have been put on a more commercial footing, and have lost privileged access to public sector deposits."
  - Remaining nonmarketable government securities carrying an interest rate premium "are set to mature."
  - Privatization importance: "Bank privatizations is important to enhance efficiency and level the competitive playing field." Noted: "the initial public offering (IPO) for 25 percent of one public sector bank in May 2007 is an important step."
- Housing finance and mortgage developments:
  - "Housing lending may resume its rapid growth soon, particularly in the context of the 2007 Mortgage Law, which could, however, heighten certain risks."
  - Mortgage Law allows banks to "charge floating rates on mortgages and prepayment penalties" and "to securitize their housing loans."
  - Development constraints: "housing titles will need to be improved and standard mortgage contracts introduced."
  - Competition and product design: "competition will tend to limit use of prepayment penalties, and floating interest rates mean that lenders need to pay even more attention to risk management."
- Supervisory recommendations for housing lending:
  - BRSA should ensure:
    - "housing loans are granted on the basis of moderate loan to value ratios (e.g., 80 percent),"
    - "monthly payments do not exceed 25–30 percent of borrowers’ well-documented income,"
    - "exotic (subprime) mortgages are avoided."
  - Allocation of supervisory responsibilities: "BRSA will be in charge of supervising primary lending, which includes the Housing Finance Corporations (banks, leasing companies and consumer finance companies), while the CMB will be in charge of supervising securitization of housing loans, as well as Mortgage Finance Companies." Emphasis: "Coordination and information exchange will be key."

### Nonbank financial institutions, securities markets, and corporate governance
- Securities market development constraints:
  - Depends on "sustained macroeconomic stability and further microeconomic and regulatory changes."
  - Investors deterred by "long memories of past deficiencies."
- Information quality and ownership concerns:
  - Non-listed companies "often need to improve their accounting practices to reach CMB standards."
  - "Identifying the ownership and location of decision making in corporations is often difficult."
  - Disclosure of "significant events" by major shareholders and board members may "leave room for interpretation and delays."
  - Minority shareholder protection concerns: "minority shareholders are not well protected from actions by controlling shareholders."
- Commercial Code recommendations (corporate governance):
  - Strengthen enforcement action; accountability of board members; presumption of due diligence; fit and proper criteria beyond level of education; permitting legal entities on boards; permitting legal entities to exercise voting rights related to their equity shareholdings; a one-share-one-vote rule; and a broader interpretation of minority shareholder protection.
- ISE governance and competitiveness:
  - Concerns that ISE's "status as an autonomous government agency could create regulatory overlaps and limit its future ability to provide internationally competitive services."
  - Government needs to ensure: governance that allows competitiveness and cost-effectiveness; sufficient capital for investment in technology; and maintenance of regulatory quality.
  - Resolve issues impeding ISE privatization to avoid losing out in increased competition among exchanges in Europe.
  - Money market development aided by "greater standardization of repo contracts, and more competition between the ISE and the over-the-counter market by lowering registration costs."

### Public debt management and treasury operations
- Institutional framework: "established under the 2002 Law on Regulating Public Finance and Debt Management (Law 4749) appears to be well designed and implemented."
- Strategy: "extending maturities and shifting further towards local-currency financing should reduce vulnerabilities and contribute to financial sector deepening."
- Treasury actions:
  - "Treasury recently successfully issued inflation-linked bonds, and plans regular quarterly issues."
  - "The Treasury has been issuing 5 year fixed coupon bonds monthly since the beginning of 2007, and in March 2007 issued a 7 year floating rate bond."
  - Recommendation: Treasury should "increasingly seek to integrate asset and liability management, for example, by inviting banks to tender for deposits of the Public Depository System now that the state-owned banks have lost their monopoly."

### Pension reform and private pensions
- Social security reform: planned reform "had been rejected by the Constitutional Court" and authorities are "devising an alternative reform."
- Private pensions improvements in proposed Insurance Law:
  - Allow enrollees in corporate pension funds to "transfer to the private system as a group."
  - Such pensions will be "vested" earlier and "will follow the worker through job changes in the formal sector."

### Credit information, collateral, and legal framework
- Credit Bureau of Turkey (KKB):
  - "generally performs well, but could expand its information sources."
  - KKB plans "to expand its operations to the corporate sector; inclusion of data from leasing companies and credit cooperatives would be desirable."
  - Potential data additions: "data on payments to utility companies" to help borrowers outside the financial system build credit reputations.
- Collateral and creditor rights:
  - "Problems in creating collateral and executing creditor rights affect the volume of lending."
  - "Taxes and fees for creating collateral are high relative to other countries in the region."
  - Turkish Cadastre and Registration General Directorate could "moderniz[e] land titling and registration systems, and develop[] a property valuation system."
  - Judicial issues: limited financial expertise in judiciary and court congestion persist; "Creditors are penalized by heavy taxes on collection (in some cases as high as 32 percent) and are legally prohibited negotiating solutions directly."
  - These problems likely to increase with growth of mortgage lending.
- Bankruptcy law:
  - "A new bankruptcy law was put into effect in 2003" with a suspension mechanism similar to U.S. Chapter 11, but "determination of the eligibility of an applicant for this procedure, and the management of assets while the applicant is under this protection, have proven to be complex" and "further review in the light of this experience would seem warranted."

*Source: IMF FSAP chapter content provided in the supplied PDF excerpt.*

### 60.      The assessment is based on information available in April 2006, and specifically

### _cr07361 - 60.      The assessment is based on information available in April 2006, and specifically

### Assessment basis
- The assessment is based on information available in April 2006, and specifically on:
  - A review of relevant laws and regulations then in force.
  - Publications issued by the Turkish authorities, and material posted on websites.
  - The authorities’ response to a questionnaire and their self-assessment of observance of the code.
  - Discussions held with the Turkish authorities—mainly from the CBRT—and representatives of the private financial and nonfinancial sector during the FSAP missions.
- The most important legal document underpinning the assessment is the Law on the CBRT, Law No. 1211, first passed on January 14, 1970, and most recently amended on April 25, 2001 by Law No. 4651 and on October 19, 2005 by Law No. 5411 (the BL).
- Extensive use was made of other CBRT documents, such as the “General Framework for Inflation Targeting Regime and Monetary and Exchange Rate Policy for 2006” of December 2005.
- The main assessor was Mr. Daniel Hardy of the Monetary and Capital Markets Department of the IMF.

### Main findings — Monetary policy transparency
- The level of monetary policy transparency is generally high.
- Contributing factors:
  - The CBRT’s primary objective of achieving and maintaining price stability is embedded in law.
  - The CBRT has broad powers to define and deploy monetary instruments to achieve that objective.
  - The CBRT makes extensive efforts to explain its objectives and decision-making, and mechanisms are in place to ensure accountability.
- Institutional developments:
  - The 2001 amendment of the CBRT Law gave the CBRT substantially greater independence in the implementation of monetary policy and freed it of any obligation to finance the public sector.
  - The CBRT introduced a formal inflation targeting framework from the beginning of 2006.
  - The inflation target is set jointly by the CBRT and the government.
  - The CBRT publishes a periodic inflation report and uses other means to explain objectives and measures.
- Accountability and transparency practices:
  - The CBRT is accountable to the government and to the Grand National Assembly of Turkey.
  - The CBRT regularly publishes explanations of Monetary Policy Committee decisions, holds frequent press briefings and public addresses by senior staff, and publishes extensive statistics and economic analysis.
  - The CBRT regularly publishes its own detailed balance sheet and income statement, which is independently audited on an annual basis.
  - Turkey has subscribed to the Special Data Dissemination Standards since 1996.
  - Information on internal audit functions, staff regulations, and legal protection of staff for actions taken in the course of their duties is publicly available.
- Shortcomings and risks:
  - A lacuna in the CBRT Law is lack of specificity concerning the removal from office of members of the governing bodies on grounds of physical or mental incapacity, for malfeasance, or on other grounds.
  - There is no presumption in law that consultations will be undertaken when monetary instruments are modified, nor that any consultations will be public; in practice consultations seem to have been limited.
  - A medium-term challenge: if economic conditions worsened considerably, the CBRT could come under increased political pressure to pursue conflicting objectives.

### Recommended actions to improve monetary policy transparency
- Recommendations are limited and none are urgent. The most important recommendation is establishing processes for public consultation on changes to monetary policy instruments and arrangements.
- Specific recommended actions (as listed in the assessment):
  - Reference 1.1.7 — Practice: The procedures for appointment, terms of office, and any general criteria for removal of the heads and members of the governing body of the central bank should be specified in legislation.
    - Recommended Action: In due course, the CBRT Law should be amended to specify in more detail the conditions under which the Governor, Vice Governors, or members of the governing bodies may be removed from office.
    - Additional note: Consideration should be given to staggering the terms of office of the Vice Governors in order to ensure continuity.
  - Reference 1.2.2 — Practice: The amounts and terms of credits, advances, or overdrafts to the government by the central bank and those of deposits of the government with the central bank should be publicly disclosed.
    - Recommended Action: The conditions under which the CBRT provides advances to the SDIF should be publicized.
  - Reference 1.2.5 — Practice: The manner in which central bank profits are allocated and how capital is maintained should be publicly disclosed.
    - Recommended Action: In due course, provisions and obligations on the maintenance of capital should be specified in the CBRT Law.
  - Reference 2.5 — Practice: For proposed substantive technical changes to the structure of monetary regulations, there should be a presumption in favor of public consultations, within an appropriate period.
    - Recommended Action: The CBRT should establish a procedure for public consultations with banks, other financial institutions, and others on proposed substantial technical changes to the structure of monetary regulations.
  - Reference 4.2.1 — Practice: The financial statements should be audited by an independent auditor. Information on accounting policies and any qualification to the statements should be an integral part of the publicly disclosed financial statements.
    - Recommended Action: In due course, the CBRT Law should be amended to make an independent audit mandatory.

### Authorities’ response (CBRT)
- The Central Bank of the Republic of Turkey finds all the FSAP assessments, findings and recommendations very valuable and beneficial, and is pleased that monetary policy transparency in Turkey is found as “generally high.”
- The CBRT broadly agrees with the FSAP findings and notes the following points for near-future consideration:
  - Advances to the SDIF can be utilized under extraordinary conditions as stated in the related law; therefore it is difficult to set definite conditions in advance. The CBRT agrees that publicizing the conditions (maturity, amounts, repayment conditions, interest rates) of such advances to the SDIF helps enhance transparency. There is no outstanding balance for the time being and the CBRT will consider publicizing such information in the future.
  - Currently the CBRT undertakes unofficial consultations for proposed substantive technical changes to the structure of monetary regulations with relevant organizations and banks. The CBRT is planning to establish a procedure for such public consultations.

### Assessment of banking supervision and the Basel Core Principles (BCP)
- Information and methodology:
  - The BCP assessment was based on review of relevant laws, regulations and other guidelines related to the financial sector; documentation of supervisory practices; and discussions with the BRSA and other relevant authorities and stakeholders.
  - The assessment takes into account new regulations issued in November 2006 to implement BL No. 5411 of October 19, 2005, while recognizing that implementation through a full supervisory cycle could not have been achieved at the time the assessment was completed.
  - The BCP team received the BRSA’s self-assessment (undertaken before the new regulations) and suggests that once the new regulatory framework has been fully implemented, the BRSA commissions an assessment by an external team of assessors or performs a new self-assessment based on the new BCP methodology.
- Institutional and market structure — overview:
  - The Turkish financial system is dominated by 50 banks, including three large public sector commercial banks and 18 majority foreign-owned banks.
  - All banks are subject to the same regulatory and supervisory regime.
  - Many banks are affiliated with NBFIs, and some have links to non-financial corporations; group structures complicate regulation and supervision.
  - Banking regulation and supervision is exercised by the BRSA, based on the BL and secondary sub-regulations. The BRSA also regulates and supervises financial leasing, factoring and consumer financing companies.
  - The SDIF provides deposit insurance and has a leading role in bank resolution and liquidation. The CBRT is the monetary authority, and securities market oversight is exercised by the CMB.
- General preconditions and system features:
  - Macroeconomic stability: Improvements in monetary and fiscal policy have contributed to better macroeconomic performance; growth has been strong, inflation has fallen to the lowest level in decades, money and credit stocks have recovered, banks have rebuilt capital to comfortable levels, bank profitability has been restored, and the NPL ratio has declined. Good prospects have attracted large-scale foreign direct investment into the banking sector.
  - Public infrastructure: Turkey has a reasonably independent judicial system but there is a history of the judicial branch amending or reversing bank liquidation processes. Banks can sue to block monetary fines imposed by the BRSA. Prosecuting technically complex financial cases may be problematic due to shortage of expertise in the judicial system.
  - Corporate governance and accounting: The BL established a framework for corporate governance in banks; sub-regulations issued include internal controls and audit and corporate management principles. Banks’ accounting practices are required to meet standards compliant with IFRS and IAS.
  - Payment system: Turkey is in observance of the great majority of the CPSS Core Principles for Systemically Important Payments Systems. Main outstanding issues relate to full legal certainty in settlement in the national check clearing system and lack of explicit failure-to-settle mechanisms.
  - Financial safety nets and crisis management: The CBRT has adequate facilities and procedures to manage overall liquidity and assist banks in normal times and can grant emergency lending assistance in periods of instability. A formal strategy for handling support in the case of a liquidity crisis has yet to be designed.
  - Deposit insurance: The deposit insurance scheme currently covers all depositors in all locally-incorporated banks up to a limit of YTL 50,000 (about US$35,000) each.
  - Bank intervention and resolution: The BL codifies procedures for bank intervention, resolution and crisis management, but current provisions could lead to delays and higher overall costs in closing weak banks; guidelines are lacking to ensure appropriately graduated action is taken in a timely fashion and that a bank transferred to the SDIF would remain open only in limited and highly specified cases.
- Main conclusions on supervision:
  - Authorities are commended for extensive work on the new BL and recent improvements in prudential supervision, but considerable work remains to fully meet supervisory requirements of the evolving banking system.
  - The BRSA has reacted positively to significant recommendations but newly issued sub-regulations and communiqués need full implementation by supervised entities and enhancement of the BRSA’s supervisory framework.
  - Objectives, autonomy, powers and resources (CP 1):
    - In practice the BRSA lacks full operational independence in regulatory and budgetary matters: before issuing a regulation the BRSA must conduct consultations with the related Ministry and the Undersecretariat of the State Planning Organization; the process is perceived as binding and the related Ministry can file a lawsuit for cancellation of the Board’s regulatory decision.
    - The BRSA should remain the final decision maker regarding the text of sub-regulations.
    - All visits abroad by BRSA management or staff must be approved by the government.
    - BRSA funding comes from fees assessed on supervised institutions, but the government sets annual limits on expenditures.
    - The BRSA has difficulty recruiting and retaining staff with expertise in areas including banking supervision, information technology, stress testing, contingency planning assessment, and evaluation of financial models; training has started but needs substantial strengthening.
    - Legal protection exists for BRSA management and staff for actions taken in good faith; civil actions are deemed to have been brought against the BRSA and may only be recoursed if staff acted in “default.” Legal costs in defending legal actions are covered by the BRSA (up to a cap).
    - In cases alleging criminal offenses by the BRSA Board and its Chairman or by staff, the relevant minister or the BRSA Chairman, respectively, has legal power to authorize or veto an investigation; this provision could lead to conflicts of interest and its exercise should be guided by internal guidelines.
  - Cooperation among regulators needs strengthening: the coordinating FSC has met very rarely and routine coordination, collaboration and sharing of information among functional supervisors and other agencies seem weak; the division of work and sharing of analyses between the BRSA and the SDIF need clarification. A MoU with the CMB should be concluded.
  - Licensing and structure (CPs 2–5):
    - The BRSA uses conservative accounting criteria for recording banks’ investments in insurance companies and other financial companies, but ex ante approval of such investments is not required, creating potential supervision challenges.
    - Treasury and CMB reportedly seek the BRSA’s opinion in approval processes for acquisitions by a bank of an insurance company or capital markets institution not under BRSA supervision, but the BRSA should not have to rely on information provided by other authorities.
  - Prudential regulations and requirements (CPs 6–15):
    - Large improvements have taken place, but a few prudential norms and supervisory practices are not fully in line with international best practices.
    - Effectiveness of prudential regulation is limited by absence of certain sub-regulations, such as on country and transfer risk and interest rate risk in banks’ books.
    - Concerns exist about identification of beneficial owners; while the full extent was not determined, this highlights potential weaknesses in identifying excessive concentration of credits, compliance with prudential norms, and consolidated supervision.

*Assessment based on information available in April 2006 (document _cr07361).*

### 87.      There is an appropriate limit on exposures to groups of borrowers who

### 87–96: Assessment of BRSA Supervision and Recommended Actions

### Limits on exposures and connected lending
- Banks apply a limit of 20 percent of own funds for the aggregate exposures to large shareholders and to other connected parties, as prescribed by the BL and in line with sound international practices.
- Banks are allowed to apply a higher limit of 50 percent for the aggregate exposures to large shareholders and other connected parties plus exposures to small shareholders.
- The 50 percent limit is identified as in excess of international practices and should be lowered to the 25 percent limit applicable to groups of borrowers not connected to the bank, or less.
- Recommended amendment: BL should be amended to ensure that the aggregate limit for exposures to a bank’s insiders (including both small and large shareholders) should not be higher than the 25 percent limit set for exposures to other groups of connected borrowers (not related to the bank). The recently enacted sub-limit of 20 percent for exposures to large shareholders and other connected parties should be maintained.
- BRSA should ensure banks implement risk management procedures to identify all beneficial owners and effectively monitor concentrations of credit and adherence to prudential risk limits.

### Loan evaluation, classification, and provisioning (BCP 7, 8)
- BRSA supervisors have introduced “forward-looking” criteria when assessing loan quality.
- More internal guidance should be developed to support on-site inspectors in using “forward-looking” criteria.
- Commencing with the 2007 supervisory cycle, supervisors should routinely perform rigorous assessments of banks’ credit policies when inspections lead to substantial amounts of loans to be reclassified.
- Loans classified as Group 2 exhibit weaknesses (e.g., negative trends in borrowers’ repayment capacity) indicating that full and timely repayment may not be forthcoming; specific provision should be set aside for Group 2 loans.
- The sub regulation on loan classification and provisioning of loans should be amended to provide for specific provisioning for loans in the special mentioned category.
- BRSA should encourage supervisory staff to further use “forward-looking” criteria by issuing an internal list of examples (e.g., cash flow calculations, weak geographical or macroeconomic sectors, or weak connected companies or shareholders).
- BRSA should continue to ensure supervisory staff retains up-to-date skills on loan evaluation techniques.

### Market risk oversight and validation (BCP 12)
- BRSA has taken important measures to improve oversight of market risks but needs to further improve capacity to monitor complex market activities.
- Recommended actions:
  - Provide additional training opportunities for supervisors in assessing market risks and validating banks’ VaR models.
  - Include in the 2007 work plan the inspection of banks’ implementation of the new market risk sub-regulations.
  - Proceed to introduce the computer-assisted supervision tools (CAST) and train personnel accordingly.

### Anti–Money Laundering (BCP 15) and operational risk
- Turkey amended the Prevention of Laundering Proceeds of Crime Law (No. 5549) on October 11, 2006.
- Considering AML issues constitute a main operational risk for banks, BRSA should ensure relevant AML aspects, in compliance with BCP and FATF standards, are fully incorporated into the supervisory process.
- When carrying out supervisory responsibilities, BRSA should have access to any suspicious transaction report documentation necessary to assess adequacy of reporting and compliance with the legal framework.
- Banks should report suspicious activities and incidents of fraud to BRSA when they are material to the safety, soundness or reputation of the bank.
- Bank reports on suspicious activities of material amounts with regards to the safety, soundness or reputation of the bank should always be submitted not only to MASAK but also to the BRSA.

### Methods of ongoing supervision — on-site and off-site integration (BCP 16, 18, 19)
- BRSA introduced a full supervisory cycle in line with international best practices, but challenges remain in implementation.
- Documentation from on-site supervision is fragmented: the main inspection report does not contain findings of other examinations of the same bank conducted during the same supervisory cycle.
- Inspection reports are not adequately focused on analyses and judgments.
- The main examination report by the on-site team should always contain a list of recommendations and orders (whenever there are such) to the bank, in a prioritized order; unless the BRSA Board disagrees, this is the list the Enforcement Department should follow.
- Off-site analysis, enforcement functions, and on-site supervision are not seamlessly integrated.
- Recommended actions:
  - Main inspection report should contain findings of other examinations during the same supervisory cycle to present a complete picture of a bank’s soundness.
  - Inspection reports should start with an “executive summary” (e.g., no more than two pages) outlining main findings and draft recommendations; general bank developments should be moved to appendices or separate reports.
  - Fully integrate off-site analysis with on-site processes and enforcement of supervisory orders and recommendations.
  - Advance off-site supervision by expanding the information base to include unconsolidated information on nonbank financial subsidiaries and affiliates and periodically collect and analyze information on banks’ parents and affiliates.
  - Enhance IT inspections, improve staff capacity (number and experience), and consider adopting a work standard requiring a report to be issued within 60 days of completion of an examination visit and following the exit review.

### Consolidated supervision and mixed conglomerates (BCP 20, 23)
- Major challenge: consolidated supervision and surveillance of mixed conglomerates.
- Work required includes full implementation of sub-regulations on consolidation of financial and non-financial companies in line with IFRS, and supervision of financial conglomerates in line with the EU Directive on Supplementary Supervision of Credit Institutions, Insurance Undertakings and Investment Firms in a Financial Conglomerate.
- BRSA has not adopted a general policy or practice to conduct an “integrated” supervision inspection of an entire banking group assessing potential effects on the bank emanating from other entities.
- BRSA does not regularly request information (e.g., inspection reports) from other domestic supervisors for securities firms and insurance companies nor regularly obtain and analyze information on banks’ parent companies and, when relevant, the parent’s affiliates.
- Recommended actions:
  - Adopt a general practice to conduct an “integrated” supervision inspection of the entire group, assessing effects from other financial and nonfinancial entities.
  - Proactively request inspection reports and relevant documents from other regulators; plan and conduct simultaneous on-site inspections in concert with other domestic regulators.
  - Issue sub-regulations and supporting guidelines requiring banks to adopt risk management procedures to identify beneficial owners and cross-holdings to support compliance with large exposure and connected lending principles.
  - Be prepared to conduct on-site visits of banks’ parent companies (financial or nonfinancial) focusing on parent–bank relationships and, when relevant, the parent’s affiliates.
  - Include in supervision of a bank group its foreign affiliates of supervised entities on a fully consolidated basis, including assessing potential reputational and legal risks on the parent bank emanating from foreign operations.

### Remedial measures and enforcement (BCP 22)
- The enforcement process may lead to undue delays and neglect of important elements of on-site inspectors’ recommendations.
- Integration between on-site supervision and enforcement functions is not transparent; supervisors are reluctant to initiate action unless a bank has breached a small number of predetermined quantitative limits.
- Courts impede BRSA’s powers to take appropriate remedial measures.
- Recommended actions:
  - Enforcement process should not reassess nor reprioritize supervisors’ recommendations unless material evidence of mistakes exists or the BRSA Board decides otherwise.
  - Inspection reports should clearly spell out recommendations in priority order and measures for corrective actions.
  - Accelerate BRSA review processes in the internal review phase and enforcement phase.
  - Implement a formal “exit meeting” involving onsite and offsite supervisors and the Enforcement Department at the end of a supervisory cycle for an individual bank to ensure timely and comprehensive follow-up.
  - Over the next one or two years, adopt guidelines activating a progression of more severe supervisory and enforcement measures according to objective and consistent criteria, without precluding additional action if warranted.

### Cross-border banking cooperation (BCP 24, 23–25)
- Informal or formal cooperation arrangements are not in place with all countries where Turkish banks have major operations or with all home countries of banks with a large presence in Turkey.
- In the absence of such arrangements, BRSA is reluctant to develop relations with foreign supervisors from these countries.
- Recommended actions:
  - Develop informal or formal arrangements with foreign supervisors (particularly where Turkish banks have material presence or with the home countries of banks with a major presence in Turkey) to ensure ongoing cooperation and information sharing.
  - Include foreign affiliates of supervised entities in supervision on a fully consolidated basis and assess potential risks on the parent bank emanating from foreign operations.

### Recommended Action Plan (summary of selected BCP references)
- BCP 1.2: Amend legislation to allow BRSA to manage its expenditures budget without consulting the relevant Minister and prevent government interference; BRSA should have final decision on technical sub-regulations and authority over staff travel/training decisions; expand efforts to retain staff with banking and supervision experience and obtain budgetary means to hire sufficient staff for NBFI supervision.
- BCP 1.6: Strengthen formal and practical cooperation and information sharing between BRSA and other financial regulatory authorities; amend bilateral MoU with SDIF; conclude MoU with CMB; FSC to establish a subcommittee composed only of public regulatory and supervisory agencies or a parallel committee if legally necessary.
- BCP 5: Amend BL or sub-regulations to empower BRSA to require prior permission for banks establishing or acquiring financial institution subsidiaries and assess banks’ capabilities to handle new subsidiaries.
- BCP 7: Ensure rigorous assessment of bank credit policies when inspectors require reclassification of material loan amounts; ensure appropriate standards and credit information for lending to households, SMEs and conglomerates.
- BCP 11: Issue explicit regulations and guidelines to address gaps in supervisory framework for country risk and fully implement them.
- BCP 13: Issue sub-regulations and supporting guidelines for legal risks and interest rate risks in the banking book.
- BCP 21: Proceed with 2007 work plans to assess banks’ implementation of updated Turkish accounting standards.

*Source: IMF staff assessment of BRSA supervisory practices (excerpts 87–96).*

### 97.      The BRSA has been in the final stage of an organizational and regulatory

### _cr07361 - 97.      The BRSA has been in the final stage of an organizational and regulatory

### BRSA organizational and regulatory transition
- The BRSA has been in the final stage of an organizational and regulatory transition process at the time of the assessment.
- The regulatory framework, supervisory practices and organization of the BRSA have been significantly changed in the last two years to reflect past experiences and international best practices.
- The new BL has been approved, new sub-regulations have been issued afterwards and new Risk Focused Supervision has been initiated.
- On and off-site supervision is united; all supervision guidelines and tools are reviewed according to the new regulations.
- The BRSA Strategic plan, which determines the goals and targets of the Agency, has been prepared and announced to the public.
- The last couple of years is considered as a challenging period for the BRSA.
- BRSA will focus on the recommended action plan to further progress its supervisory practices.

### Specific supervisory areas — Licensing and structure (CPs 2-5)
- Regulation and supervision of factoring, leasing and financing companies are under the authorization of BRSA as of January 1, 2006.
- Regulation and supervision of other NBFIs such as insurance companies and intermediary companies are under the authorization of other authorities, but BRSA’s prior affirmative views are required by the related authorities in all cases.
- The prior-affirmative view procedure is characterized as an “ex-ante” evaluation since the transaction will be prevented before its realization.

### Prudential regulations and requirements (CPs 6-15)
- BRSA is preparing regulations in line with Basel II/CRD.
- Risks such as country and transfer risk, interest rate risk in the banking book will be dealt with in these regulations.
- Internal processes, procedures and policies of banks regarding their credit portfolios and operations as well as their compliance with the appropriate regulations are assessed by examiners during on-site supervision.
- Supervision teams consider standards applied and information required by banks when lending to different segments such as corporate firms, SMEs and conglomerates, and make appropriate recommendations.
- Based on findings in examination reports, banks are enforced by BRSA to correct deficiencies and defects.

- Regulation on Loan Loss Provisioning includes:
  - Criteria based on the period that the loan under consideration is overdue (described as “objective criteria”).
  - Forward-looking criteria for loan classification including assessments of the financial strength of firms and project evaluation for investment credit.
  - Risk assessment reports and safety and soundness reports include macro economical sector analysis, shareholder structure and other subjective criteria.
  - Examples of adverse classification regarding subjective criteria were submitted.

- Shareholder credit limits under the BL:
  - A significant non qualified shareholder is subject to 25 percent limit.
  - The sum of credit extended to all non qualified shareholders shall not exceed 50 percent of banks’ own funds to the extent that they do not constitute a risk group.
  - A significant person who has not any relation with bank subjects to 25 percent limit as well.
  - There is no limit on the total amount of these kinds of credits, unless these significant persons constitute a risk group.
  - BRSA believes this criterion makes “insiders” less favorable than related parties.

- Market risk work:
  - The risk team has examined 12 private banks and 3 state-owned banks and is preparing Market Risk Reports according to 2007 work plan.
  - The team completed a report on overall evaluation of these 12 private banks, including comparisons between these banks, and a report on the overall evaluation of state-owned banks, including comparisons between the state banks and the comparison of state banks with private banks.
  - Examinations are conducted in light of new sub-regulations.

- On-site audit teams:
  - Evaluate market activities of banks taking into account the risk appetite of the bank and sufficiency and effectiveness of internal policies and procedures and their compliance with relevant sub-regulations.
  - Working instructions for 2007 require supervisors to inspect banks’ implementation of all new sub-regulations including market risk.

- AML and KYC:
  - AML examination is a routine task in on-site inspections and is included in “Working Programs” and “Supervision Plans”.
  - Onsite supervisors pay particular attention to compliance with “know your customer” rules during supervision of branches.
  - In 2006, AML reports were prepared for 39 banks.
  - BRSA will ensure AML is included in all “Supervision plans” and a separate section in “Safety and Soundness Reports” will be devoted to AML.
  - Related supervision guidelines will be updated accordingly.

### Methods of ongoing supervision (CPs 16-20)
- The main inspection report does not necessarily contain the findings of other examinations; special examinations generate separate reports that are equally powerful as the main inspection report and trigger necessary enforcement actions.
- Offsite analysis has been integrated with the on-site process under the new organizational structure of Supervision Departments.
  - New supervision teams include both on-site and off-site supervisors as members of the same audit team(s).
  - Reports produced by off-site supervisors provide essential feedback for on-site supervisors.
  - Any non-compliance observed by off-site supervisors is immediately reported to the examiner-in-charge who adjusts the audit plan to prepare the compliance report.
  - In addition to safety and soundness reports, there are also compliance reports involving off-site supervisors.

- Supervision enhancements:
  - Initiation of risk focused supervision.
  - Implementation of CAST (computer adapted supervision tool).
  - Setting up new risk and macro reporting groups.
  - These are described as major progressions toward “best practices.”

### Remedial measures (CP 22)
- If there is a priority order in the recommendation part of an inspection report, the enforcement process does not reprioritize it.
- The enforcement process needs to prioritize the recommendations in inspection reports that are not in priority order if there is any prompt need to take remedial actions.
- BRSA is working on written guidelines for enforcement activities covering:
  - Time frames for banks to take necessary actions.
  - Objective criteria that enforcement actions are based on.

### IOSCO assessment — scope and methodology
- The assessment of the IOSCO Objectives and Principles of Securities Regulation was conducted in April 2006 in the context of Turkey’s participation in the FSAP.
- Reference used: the February 2002 version of the Objectives and Principles of Securities Regulation and the Methodology for Assessing Implementation adopted in October 2003 by IOSCO.
- The assessment focuses on responsibilities, power and authority of the CMB as established in Turkish Capital Market Law No. 2499 (1981) and Decree Law No. 91 incorporated into Law No. 2810 in 1983.
- The assessment was based on:
  - (i) a detailed self-assessment by the CMB;
  - (ii) documentation provided by the CMB including all relevant legislation, the annual report of the CMB, and relevant statistical data; and
  - (iii) meetings with the CMB, market participants including the stock exchange, investment service providers, and industry associations.

### Capital market and structural overview
- The CMB is responsible for regulation and supervision of the securities market and institutions, determination of the operational principles of the capital markets, and protection of the rights and interests of investors.
- The CMB, established in 1982, regulates and supervises:
  - Corporations offering their securities to the public;
  - Security market intermediaries;
  - Open-end mutual funds and closed-end companies;
  - Independent external auditing firms offering services to capital markets institutions;
  - Stock exchanges and secondary markets;
  - Precious metal and derivative exchanges (Istanbul Gold Exchange, TurkDex, the Futures and Options Exchange);
  - Other related institutions such as rating agencies, clearing and depository institutions (Takasbank).
- As the CMB is a part of the government, its decisions are subject to judicial review.

- ISE and market metrics:
  - The ISE, established as a public institution and the only stock exchange in the country, serves three markets: (i) the stock market, (ii) the bonds and bills market and (iii) the international market.
  - At the time of the assessment, the ISE had 306 listed companies with a market capitalization of YTL 259 billion or approximately 41 percent of the 2005 GNP.
  - Its traded value reached YTL 270 billion in 2005.
  - Government securities dominate the bonds and bills market.
  - Outstanding amounts of government bonds and Treasury bills stood at YTL 227 bullion (including non-marketable debt) and YTL 18 billion respectively as of end-December 2005.

- Intermediaries and funds:
  - Of the 141 intermediary institutions operating on the ISE at end-December 2005, 41 were banks and another 30 were subsidiaries of banks.
  - The 30 bank-affiliated intermediaries had YTL 311 million in paid-in capital compared to YTL 251 million in the 70 other intermediaries.
  - Domestic mutual fund market: 275 funds with aggregate assets of about YTL 29 billion at end-December 2005.
  - Another 53 foreign-incorporated mutual funds operated in the country.
  - Assets of pension funds and investment trusts were 0.5 and 0.2 percent of market capitalization respectively at end-December 2005.
  - Investment trusts are closed-end investment companies investing in capital market instruments, gold and precious metals.

- Foreign participation and taxation:
  - Turkey allows foreign institutional and individual investments in securities listed on the ISE.
  - Turkish stock and bond markets are open to foreign investors without restrictions on repatriation of capital and profits.
  - The taxation method and tax base may differ for various categories of foreigners.

### General preconditions and ongoing reforms
- Turkish securities regulations and practices are undergoing substantial change.
- A draft amendment to the Capital Markets Law is expected to be presented to the National Assembly in 2008 to include results of a twinning project with the German financial regulator on harmonizing regulations with the EU “acquis” pertaining to capital markets.
- The acquis outlines sound standards for capital market supervision, corporate governance and transparency which, if adopted, would bring Turkey’s capital market and financial supervision into closer alignment with the IOSCO principles.

- CMB action plan:
  - In 2005, the CMB approved an Action Plan based on the results of a self assessment.
  - Implementation of the Action Plan is proceeding; some areas identified require further attention.

### Main findings of IOSCO assessment
- Overall quality of the supervisory framework for securities markets in Turkey is deemed satisfactory, but several aspects of regulation and enforcement require further improvement.

- Principles relating to the Regulator (Principles 1 to 5):
  - Responsibilities of the CMB are clear and objectively stated, but duties overlap with other regulators: Banking Regulation and Supervision Agency, the Undersecretariat of the Treasury, the Ministry of Finance and the related Minister of State, and recently the Turkish Accounting Standards Board and the Individual Pension Advisory Board.
  - No operative procedures in place for regular cooperation, consultation and exchange of information among responsible authorities.
  - The CMB’s self assessment does not describe existing arrangements as effective.
  - The CMB has adequate funding from transaction fees and specified contributions from authorized exchanges; when markets are inactive, shortfalls must be covered by a budgetary transfer from the Ministry of Finance, which could affect independence.
  - Draft amendments to the Law provide for additional revenues from increasing registration fees on issuers and introducing new fees on various types of market participants.

- Principles of Self-Regulation (Principles 6 to 7):
  - Turkey has four Self-Regulating Organizations (SROs), notably the ISE, with clear responsibilities for regulating and supervising their members and promoting markets.
  - CMB cooperates in conducting market surveillance with the SROs and has responsibility for SRO oversight.
  - Legal relationships between the CMB and ISE, a public autonomous agency, could be clarified.
  - CMB lacks systematic programs of inspection of SRO operations.
  - Some SROs are established as public legal entities; effective oversight programs could establish recognition criteria and performance standards.

- Principles for Enforcement of Securities Regulation (Principles 8 to 10):
  - Investigative and enforcement powers to collect information and conduct inspections are adequately granted to the CMB.
  - Need for a well articulated strategy to ensure consistency and efficiency in supervision and enforcement.

- Principles for Cooperation in Regulation (Principles 11 to 13):
  - Regulator has authority to share information with other domestic regulators, but actual information sharing in practice is unclear.
  - Absence of a definition in the law of financial conglomerates could confound information gathering.
  - No systematic procedures in place for cooperation among responsible authorities.
  - No restrictions imposed on information sharing with cross-border counterparts.

- Principles for Issuers (Principles 14 to 16):
  - Measures taken to harmonize treatment of listed banks and other publicly traded companies in accounting and disclosure.
  - Recent adoption of IFRS and international auditing standards poses supervisory challenge in ensuring compliance.
  - Continued need to protect minority shareholders, especially in mergers and takeovers and in large complex conglomerates.
  - Better disclosure by listed firms and issuers would be desirable.

- Principles for Collective Investment Schemes (Principles 17 to 20):
  - Establishment of a Collective Investment Scheme (CIS) requires a license from the CMB and CMB approval of schemes and marketing across jurisdictions.
  - On-site inspections of CISs should be undertaken on a regular basis; more detailed tasks should be specified for their internal auditors.
  - Rules on segregation and safe custody of assets applied on pension mutual funds should be imposed on all types of CISs.
  - Use of consistent valuation models of illiquid assets across all types of CIS should be monitored and improved.
  - A more effective mechanism for dealing with investor complaints is desirable.

- Principles for Market Intermediaries (Principles 21 to 24):
  - Regulation provides minimum entry standards for market intermediaries, including adequate capital to cover market, credit and liquidity risks.
  - No provisions regarding operational, legal and reputational risks.
  - Market intermediaries are not required to comply with standards for internal organization and operational conduct to protect clients’ interests and ensure proper risk management.
  - Measures for dealing with firm failure are contained in the law, but clear guidelines should be issued to stipulate the ladder of intervention measures to be implemented in any given case.

- Principles for Secondary Markets (Principles 25 to 30):
  - Exchange operating companies require approval by the CMB; however, the CMB delegates certain regulatory powers to the ISE and Takasbank.
  - No clear performance criteria for the ISE, which operates as a public legal entity.
  - Current oversight arrangements restrict the CMB’s powers and could give rise to conflicts of interest.
  - Draft amendments to the Law provide that all securities exchanges shall be established as private law entities; the existence of exchanges as public legal entities will be possible only in exceptional cases.
  - Conditions for establishment and operation of exchanges should be clearly specified in the amendments and exchanges should be subject to full inspection by the CMB.
  - The status of the ISE should be clarified and arrangements made so that it can operate effectively in an increasingly competitive international environment for exchanges.

*Source: IMF staff assessment content unit _cr07361.*

### 133.     Trade transparency and detection of market abuses are facilitated by the

### _cr07361 - 133.     Trade transparency and detection of market abuses are facilitated by the

### Market transparency and insider trading
- Trade transparency and detection of market abuses are facilitated by the electronic trading system and market surveillance undertaken by the CMB and the exchanges.
- Large shareholders are not included in the definition of insiders, which inhibits the effective monitoring of insider trading and may reduce the attractiveness of the market for some investors.
- The real-time surveillance project, developed jointly by the CMB and ISE, is expected to be operational in the near future and will later include an insider trading module.
- Draft amendments to the Law will include large shareholders in the definition of insiders, which should increase confidence in the operation of the market.
- Article 47 of the Law does not explicitly define large shareholders as insiders, but CMB currently has the ability to investigate their transactions under the broad scope of Article 47.
- Article 5/h-1 of the Communiqué on the Disclosure Principles of Material Events: purchase or sale of the stocks of the corporation by shareholders who directly or indirectly own 5 percent or more of the capital or voting rights, and the persons acting in concert, is defined as a material event and should be disclosed through ISE daily bulletin.
- In practice, large shareholders are routinely within the scope of insider investigations.

### Recommended Plan of Actions to Improve Implementation of the IOSCO Objectives and Principles for Securities Regulation
- Principles Relating to the Regulator (1 to 5)
  - Reinforce independence of the regulator including: clear stipulation of circumstances under which the Related Minister may request information from the CMB; increase in its sources of funding; provision of legal immunity to regulators for actions taken in good faith; and effective cooperation with other regulators.
- Principles of Self-Regulation (6 and 7)
  - Promote a clearer distinction in the respective roles of the CMB and the ISE (an autonomous public agency): CMB to have regulatory and supervisory powers over the ISE; ISE to focus on promoting efficiency and development of the stock exchange.
  - Institutional changes may be necessary to enhance transparency and reduce conflict of interests.
  - Undertake an effective program of periodic inspections of the operations of the SROs.
- Principles for Enforcement of Securities Regulation (8 to 10)
  - CMB should prepare a forward and consolidated strategy for supervision to promote consistency and efficiency.
  - Enhance effectiveness of court actions by promoting knowledge of financial markets within the courts.
- Principles for Cooperation in Regulation (11 to 13)
  - Establish systematic procedures for regular cooperation and sharing of information among responsible authorities.
  - Financial conglomerates should be better defined in the applicable laws.
- Principles for Collective Investment Schemes (17 to 20)
  - Undertake on-site inspections of CISs on a regular basis.
  - Require all CIS prospectuses to explain risks involved in reaching investment objectives (currently only pension funds are required).
  - Adopt and improve common valuation principles for illiquid assets across CISs.
- Principles for Market Intermediaries (21 to 24)
  - Implement relevant provisions of the Action Plan addressing capital adequacy requirements, provision of clear explanations of investment risks to clients, and a clear ladder of intervention measures when firms face financial difficulties.
  - Require intermediaries to provide an effective mechanism for resolving investor complaints.
- Principles for Secondary Markets (25 to 30)
  - Implement relevant provisions of the Amendments to the Law and the Action Plan: establish all securities exchanges as private law entities; include large shareholders in the definition of insiders.
  - Clarify status of the ISE to remain internationally competitive in terms of costs and services.
  - Complete and operate the joint real-time surveillance project; develop the insider trading module without undue delay.

### Authorities' response and implementation status
- Supervisory relationship between the CMB and the ISE: authorities state the supervisory relationship is clear and CMB is obliged to supervise all ISE operations, although ISE is not an SRO with four corners.
- Inspections of SROs: CMB annually conducts operational and financial inspections over the SROs including inspections of IT Systems.
  - IT audits are performed periodically by the IT Department of CMB within the concept of materiality and its relationship with audit risk.
  - IT audits focus on information security, information systems strategy and planning, information systems operations, network infrastructure, database, business continuity planning, relationships with outsourced service providers, utilizing frameworks and standards such as COBIT, ISO 27001, COSO.
  - Aim: provide IT Governance for SROs by maximizing security, availability, integrity, performance and effectiveness of IT systems; improve IT processes and awareness about information security issues.
- Internal auditors of mutual funds: on September 22, 2006 an amendment was made in the communiqué related to mutual funds stating rules and procedures of internal control of the funds and the tasks of the internal auditor.
- Mutual fund prospectuses: cover risk and investment objectives but are not as detailed as pension funds; CMB plans to review mutual fund communiqué and introduce hedge funds, capital guaranteed funds, funds of funds, etc., with draft communiqués prepared and prospectus standards to be reviewed to reflect differing risk and investment objectives.
- Disclosure of material changes and cross holdings:
  - CMB Communiqué numbered Serial:VIII, No:39 Principles Regarding Public Disclosure of Material Events ensures prompt filing of material changes in ownership or operations of listed enterprises.
  - Disclosure requirement relating to cross holdings is not at sufficient level.
- Valuation of illiquid securities:
  - Mutual fund communiqué Article 45: “although traded on stock exchange, stocks not subject to sale and purchase at the date of valuation shall be valued at exchange price at the last transaction date whereas, debt securities, reverse repos and repos shall be valued at internal rate of return of the last transaction date (discount rate equalizing daily cash inflows to cash outflows).”
  - This article specifies valuation method for illiquid assets in mutual funds.
- Customer protection:
  - Amendment to Article 13 of Communiqué Serial: V, No: 46: “Intermediary institutions can not conclude a written agreement or provide services, unless the customers have signed the “capital market activities risk notice form” explaining the risks of the capital market, and the contents of the form will be determined by the Board.”
- Supervisory strategy and enforcement:
  - CMB states it plans and organizes working plans in response to complaints and notifications; examples of focus areas by period:
    - 1997–2000: many unregistered public offerings → intensive supervision and enforcement.
    - 2000–2003: many market manipulation cases → enforcement and supervision focused on manipulation; introduced “trading with customer account number” and started development of real-time surveillance system; enhanced cooperation with ISE on manipulation cases and shortened investigation period; additional precautions on manipulative stocks such as limiting margin trading, short selling.
    - 2005: scope was on investment funds.
    - 2006: scope was on insider dealing.

### Payment and settlement systems: overview and main findings (CPSS/IOSCO assessment)
- Assessment context:
  - Assessment conducted in the context of the FSAP mission to Turkey in April 2006.
  - Main counterparts: CBRT, the CMB, the ISE, Takasbank (ISE Settlement and Custody Bank), and the CRA (Central Registry Agency).
- Systems assessed as systemically important:
  - TIC-RTGS (Turkish Interbank Clearing - Electronic Funds Transfer System): the real-time gross settlement system of Turkey; designed to process both large value and low value transactions; a second generation TIC-RTGS based on CAS System was installed in 2000.
  - ICH: standard multilateral net settlement system for checks supporting check clearing services throughout Turkey.
- Other systems:
  - Postal check accounts: well-used retail system, not of systemic importance due to small transaction values.
  - Interbank Card Center (BKM): clears credit card operations; final settlement of net debits and credits takes place over accounts at the Istanbul branch of CBRT via the TIC-RTGS system; high operational importance but not of systemic importance.
- Key statistics (2005):
  - TIC-RTGS transaction volume: 77.7 million, value: YTL 7,844.2 billion.
  - Check volume: 23.5 million, value: YTL 156.1 billion.
- Main findings (by CP):
  - Legal foundation (CP I)
    - Sound legal framework provided by CBRT Law, TIC-RTGS Operational Rule Book, CBRT circulars, and related laws.
    - Definition of payment finality is not explicitly defined in the CBRT Law, which could conceivably lead to legal challenges.
    - “Arrangement of Payments by Check and Protection of Check Bearers Act” (Law No. 3167) governs payment by check; final settlement of ICH balances takes place through TIC-RTGS.
    - A new electronic clearing regulation is being prepared; new system with imaging and truncation techniques introduced in September 2006.
  - Understanding and management of risks (CPs II–III)
    - Readily available system information is sufficient for participants to understand financial, operational, and reputational risks in TIC-RTGS.
    - Liquidity features and intraday liquidity arrangements (mobilization of required reserves and collateralized intraday credits) are sufficient to mitigate liquidity risk.
    - Queuing facilities with priorities and gridlock resolution mechanisms, pricing incentives, and time scheduling are in line with best international practice.
    - ICH allows proactive management of liquidity and credit risks, provides intraday liquidity facility, and as last resort provides for unwinding; unwinding is technically feasible but not preferred; settlement risk could be mitigated through “failure to settle/ loss sharing” arrangement and transfer of large value check payments into RTGS payments.
  - Settlement (CPs IV–VI)
    - TIC-RTGS involves no netting; settlement takes place immediately in real time or during gridlock busting; settlement is assured no later than the end of the operational day.
    - Settlement is in CBRT’s funds; intraday credit is fully collateralized so no credit risk to CBRT.
  - Security, operational reliability, and contingency arrangements (CP VII)
    - TIC-RTGS is robust from reliability and security perspective; logical and physical reliability, contingency and security features are of a high standard.
    - ICH system is robust and operationally reliable; a new system was introduced in September 2006.
  - Efficiency and practicality (CP VIII)
    - TIC-RTGS is well accepted, operationally and cost effective.
    - Current ICH system satisfies market needs; opportunities exist to exploit technology improvements to reduce the settlement cycle.
  - Criteria for participation (CP IX)
    - Participation criteria are fair, objective, and publicly available.
  - Governance (CP X)
    - TIC-RTGS is owned and operated by CBRT; formal and informal arrangements exist to ensure system satisfies user needs and best practices.
    - Executive Board of the ICH includes representatives of the CBRT and 11 commercial banks; primary objective is responsiveness of ICH system to membership needs.

*Source: _cr07361 - 133.     Trade transparency and detection of market abuses are facilitated by the*

### 149.     Below are some actions that the CBRT could take to improve the already high quality

### Below are some actions that the CBRT could take to improve the already high quality of Turkey’s systemically important payments systems.

### TIC-RTGS — Legal foundation (TIC-RTGS CP I)
- A sound legal basis for the national payment system must satisfy five basic requirements: (a) the power to establish payment systems; (b) the power to make regulations; (c) the power to enter into contracts; (d) the power to arbitrate and bind parties, and e) the existence of a clear and unambiguous finality of payment definition embedded in law.
- The CBRT already has powers (a) through (d). An adequate definition of the immediate finality of payments is embedded in the TIC-RTGS Rule Book.
- The definition of payment finality is not explicitly defined in the CBRT Act, Law No: 1211 and thus a challenge to the finality of payments might be attempted, though it is unlikely that such a challenge would prevail.
- Recommended legislative clause to eliminate the possibility of challenge (text reproduced from source):
  - "A payment or transfer made through the TIC-RTGS payment system established under Article 4–I–f is final and irrevocable. Notwithstanding anything to the contrary in any other law, (including the law relating to insolvency and priority of creditors) no payment or transfer made through the TIC-RTGS payment system shall be required to be reversed, repaid or set aside and no court shall order such payment or transfer to be rectified or stayed."
  - "Nothing in the paragraph above shall affect any other legal right or remedy available to a person who has suffered any loss or damage by a payment, transfer or settlement effected through the TIC-RTGS system."

### ICH — Legal foundation and failure-to-settle risks (ICH CP I; CP III, CP IV, CP V)
- The recommended action relating to the TIC-RTGS system will also remove any legal uncertainty relating to settlement in the ICH system as final settlement of the net positions are affected through the TIC-RTGS system.
- The ICH Executive Board is planning to convert the ICH system into a same day settlement system.
- Recommended explicit “failure to settle” mechanisms to remove dependency on an unwinding procedure and to remove uncertainty; possible approaches include:
  - a suitable form of loss sharing arrangement,
  - a pre-funding of net debit position arrangement,
  - a suitable guarantee fund mechanism.
- Additionally, settlement failure likelihood could be further reduced through the conversion of large value check payments into RTGS payments.

### Central Bank’s Responsibilities
- Responsibility A:
  - Although CBRT has an explicit responsibility to assure public confidence, there is no mention of a specific consumer protection role.
  - Recommended: develop a consumer protection policy confirming the CBRT role in monitoring the national payments systems from a consumer fairness perspective.
- Responsibility B:
  - Prior to implementing the updated ICH system, the CBRT should assure that all relevant CPs are satisfied.
- Responsibility C:
  - Although the CBRT has the authority to oversee all payment systems in Turkey, it is evident that little oversight activities have actually been implemented.
  - Recommended: CBRT should evaluate the need to establish a structural separation between its activities as service provider and its activities as payments system overseer.

### Securities settlement system — Overview
- Elements of securities settlement infrastructure focused on in the assessment:
  - Takasbank/CRA (Electronic Security transfer and Settlement System) transfers and settles transactions related to the organized markets operated by The ISE in accordance with Model 3 Delivery versus Payment (DvP) principles. There is a separate but linked (to the ISE Settlement) DvP settlement system operated by Takasbank, which uses Model 1 RTGS DvP in transactions between indirect participants (broker to custodian transactions). The CRA is the central depository for equities, mutual fund certificates, and corporate bonds that are dematerialized. Takasbank has a 65 percent shareholding in the CRA. For FSAP purposes, the Takasbank system and the related CRA system is viewed as a single integrated system.
  - TIC-ESTS, the Turkish Interbank Clearing (the Electronic Security Transfer and Settlement System) that transfers and settles Turkish government securities transactions in accordance with “Model 1 Delivery versus Payment” (DvP) principles. It is also the Central Depository for government securities.

- Market and system scale statistics:
  - Equities issued by some 315 companies are traded on the ISE.
  - Average daily number of contracts agreed amongst the 98 members is in the order of 173,000 with a value in the order of US$1.2 billion.
  - In the secondary market for government securities, market turnover exceeded YTL 800 billion in 2005, implying an annual turnover ratio of about 4 times relative to the stock of marketable debt outstanding.

- Takasbank role:
  - Takasbank is the clearing and settlement institution for the ISE and the Turkish Derivatives Exchange, and acts as custodian for pension funds and the national numbering agency.
  - The CRA is authorized to dematerialize and register capital market instruments and associated rights.
  - All transfers processed in the Takasbank and CRA systems are realized in book entry form.

### Securities settlement system — Main findings (numbered recommendation references preserved)
- Legal risk (recommendation 1):
  - Laws, regulations, rules and procedures and contractual provisions governing the operation of the Taksbank/CRA system and TIC-EST are public and accessible to system participants.
  - The legal framework demonstrates a clear legal basis and a high degree of legal assurance for each aspect of the settlement process.
  - The rules and contracts are enforceable in the event of insolvency of a system participant, subject only to the payments finality issue mentioned under TIC-RTGS CP I.
  - TIC-RTGS-ESTS settles securities transfers on a model 1 DvP basis; thus no netting issues arise.

- Pre-settlement risk (recommendations 2–5):
  - Confirmation of trades in government securities is available on a timely basis.
  - Integration of TIC-ESTS and TIC-RTGS ensures prompt settlement; there is no netting.
  - Securities lending is supported.
  - For equities, direct dealer participants receive confirmation on T+0.
  - Indirect participants (institutional investors such as investment funds, mutual funds) also receive trade reports from their office terminals on T+0.
  - System upgrade: Takasbank has started a project called “SWIFT Integration Process to RTGS Model 1 DvP settlement” to establish a system whereby the custodian banks and brokerage houses can receive confirmation messages from each other on T+1.
  - Final settlement is on a T+2 basis.
  - Securities lending and borrowing is fully supported, fully collateralized, marked to market daily, and supported by margin calls.

- Settlement risk (recommendations 6–10):
  - Almost all government securities are de-materialized.
  - Government securities are settled on a gross basis.
  - Final settlement occurs intraday or at the latest by the end of day.
  - As the TIC-RTGS-ESTS operates as a RTGS system using central bank funds for settlement, there is no risk of failure on either side of the transaction.
  - Overdraft and debit balances in securities are not allowed.
  - CMB regulations require that all Equity Certificates and Mutual Fund Certificates be dematerialized.
  - Comprehensive plans are being implemented to fully dematerialize all securities traded in the organized markets operated by the ISE.
  - DvP is achieved in a suitable manner in the Takasbank/CRA integrated system.
  - Settlement is finalized with same day securities and cash (using central bank funds).
  - Appropriate monitoring controls are in place to assure settlement.
  - Potential legal vulnerability associated with the insolvency of a participant in the TIC-RTGS system could also impact the finality of settlement in the Takasbank/CRA system.

- Operational risk (recommendation 11):
  - Contingency plans and business continuity plans are well designed, documented and practiced.

- Custody risk (recommendation 12):
  - The TIC-ESTS permits and encourages segregation of dealer direct participant accounts from the customer accounts, which protects customer securities.
  - All entities holding securities in custody are supervised or regulated.
  - CRA participants are required to segregate assets held for their own benefit and assets they hold for their client.
  - Custodians are subject to audit by CMB and ISE.

- Other issues (recommendations 13–19):
  - Since TIC-ESTS is embedded in an integrated TIC-RTGS-ESTS, governance arrangements and access rules are similar to those relating to TIC-RTGS.
  - The TIC-ESTS fulfils participant, public, government and central bank demands on a security settlement system in a cost efficient and business efficient manner.
  - The participant contract and the operational rules are detailed and give sufficient information for participants to evaluate the risk and costs associated with using TIC-ESTS.
  - The tools to implement the CBRT oversight function in regard to all payment systems are in place. However, no formal oversight plan exists, and the oversight function is not organizationally separate from operational functions.
  - The TIC-RTGS-ESTS system is not designed to support cross border security transfers.
  - For equities, Takasbank is owned by the ISE and 90 ISE members.
  - CRA’s Board of Directors composition: one representative from CMB who also acts as Chairperson, two representatives from Takasbank, two representatives from ISE, one representative from The Association of Capital Market Intermediary Institutions of Turkey, and the General Manager of CRA.
  - For both institutions, objectives and major decisions are disclosed. Access criteria are fully disclosed and are not restrictive.
  - Takasbank and CRA systems provide required services in a technically efficient manner. It has not been possible to assess formally the degree to which users are satisfied with all critical aspects of the systems.
  - There are provisions for international connectivity, but the system is essentially nationally-based.
  - Cross border transactions: ISO 15022 standard (via SWIFT messages) and other international coding standards (ISIN, CFI, MIC etc) are used.
  - In 2007 the CRA published its completed CPSS/IOSCO Disclosure Framework.

### Recommended actions regarding securities settlement systems (CPSS-IOSCO)
- TIC-ESTS (Oversight, Rec. 18):
  - Active oversight function should be established and become operational with a formal work program underpinning its activities.

- Takasbank/CRA:
  - Trade confirmation (Rec. 2): The planned modifications that facilitate T+1 confirmation for indirect participants should be implemented.
  - Cost and business efficiency (Rec. 15): An independent assessment and confirmation of user confidence in the system from a service fee perspective should be undertaken.
  - International connectivity (Rec. 16): Discussions should take place with participants to determine the degree to which market evolution will require international connectivity. A suitable action plan should be developed and implemented as soon as a compelling business need has been identified and agreed.
  - Opportunity to understand all risks associated with membership (Rec. 17): The CPSS/IOSCO Disclosure Framework should be published by CRA.
  - Other Issues (Rec. 4) — Benefits of introducing a CCP mechanism: Takasbank should initiate a new study to determine whether the cost versus benefit relationship has changed since the last study in 2001.

### Authorities’ response
- CBRT general stance:
  - In general, CBRT agrees with the findings and assessments of the FSAP team and appreciates the recommendations for further improvements of the payment systems.
  - The CBRT is well aware of the importance of the payment system's oversight. Extension of the CBRT's oversight role in regard to all payment systems has already taken place in the CBRT’s medium term strategic plans.
  - Although consumer protection concept is not directly referred to the payments system legislation, consumer claims can be based on the Law on Consumer Protection (Law No. 4077), the BL (Law No. 5411) and the Law of Obligations (Law No. 818). However, a separate payment system law may be considered for further improvement in the efficiency of payment system.

- Securities settlement system response:
  - All outstanding issues are on the agenda of the CMB and the other related institution, and encouraging steps will be made in the following years.
  - On recommendation 2 (trade confirmation): indirect participants (institutional investors such as investment funds, mutual funds) already receive trade reports on T+0. Takasbank has started the “SWIFT Integration Process to RTGS Model 1 DvP settlement” project to establish T+1 confirmation messaging between custodian banks and brokerage houses.
  - On recommendation 4 (CCP mechanism): Takasbank has already started a project in coordination with the ISE for serving as a CCP for equities traded at the ISE. Takasbank is a CCP for the derivatives market.

### Appendix I: Structure of the financial system — Financial institutions (Banks and NBFIs)
- Banks:
  - The financial system remains dominated by banks, and increasingly by the larger private banks.
  - Ten banks account for around 80 percent of total banking sector assets.
  - The two major banks in state ownership (of which one is scheduled to be privatized) account for around 30 percent of banking sector assets.
  - “Duty losses” (quasi-fiscal costs of subsidized loans) have been written off, and the banks operate on a commercial basis, although their assets still include large amounts of high-earning non-marketable government securities.
  - One bank is under the control of charitable foundations and thus can be considered public sector.
  - The one bank remaining under the control of the SDIF is being used as a “bridge bank” in asset realization operations.
  - Foreign interest in the banking sector is reviving strongly, evidenced by a wave of take-overs and new partnership arrangements at favorable valuations of Turkish banks.
  - Among the smaller banks are four “participation banks” that operate on the basis of risk and profit sharing; they have been enjoying especially strong growth and attracting new capital, including from abroad.
  - Participation banks do not invest in (interest bearing) government securities; their assets are dominated by investments in the private sector.
  - Participation banks are subject to the same regulations as other banks, and are eligible for deposit insurance as regards their sight deposits.
  - Access to finance is growing with stabilization and the banks’ recovery from the 2001 crisis. There is intense competition for corporate business and household business in urban areas.
  - Banks have expanded deposit taking activities via electronic banking and ATMs; Turkey ranks fairly high in Europe on ATMs, and branch numbers have increased compared to 2002.
  - Bank loans recovered from 18 percent of GDP in 2002 after the crisis to about 30 percent currently.
  - Major growth areas: credit cards and housing loans, which together account for over 20 percent of lending, compared to only 8 percent in 2002.
  - Within commercial lending, SMEs account for about 50 percent of the total, compared to 48 percent in 2002.
  - Agricultural lending has fallen to only 5 percent of bank lending.
  - Many major banks have overseas subsidiaries and offshore operations. Offshore lending to the Turkish nonfinancial sector amounts to about one tenth of total bank lending.
  - Stamp duties previously a reason for locating offshore have been eliminated. BITT at 5 percent of the receipts of financial institutions and a RUSF that applies a charge of at 3 or 10 percent to interest receipts and certain loans remain.
  - The overwhelming part of overseas business is conducted through branches of Turkish banks, which consolidate their accounts, and there are arrangements between the BRSA and many overseas supervisors.
  - Banks are restricted by the BRSA as to how much of their total business for Turkish residents they can conduct offshore.

- Nonbank financial institutions (NBFIs):
  - The main NBFIs are insurance companies and pension companies, and leasing and factoring firms, but together they constitute only about 13 percent of the system.
  - There are also financial service providers without significant own-assets such as securities firms and asset management companies.
  - Many NBFIs are affiliated with banks, which also have connections to nonfinancial corporations.

*Excerpt from IMF FSAP content unit _cr07361 - 149–162*

### 163.     Most insurance companies are affiliates of banks, which creates opportunities

### _cr07361 - 163.     Most insurance companies are affiliates of banks, which creates opportunities

### Insurance market structure and dynamics
- Most insurance companies are affiliates of banks, creating opportunities for bancassurance.
- Foreign companies with global operations are increasing their presence in the local insurance market.
- Insurance distribution channels are dominated by agents; brokers play a big part in insuring large risks.
- Reinsurance is mostly used for large risks.
- The 20 percent cession to Millie Re (the formerly state-owned reinsurance company) was terminated in 2006, allowing the reinsurance market to operate free of compulsory cessions.
- Eighteen companies have exited the market in the past five years through license suspension or termination, or liquidation or bankruptcy.
- The Guarantee Fund has been used to settle a large number of motor claims.
- Several small motor-insurance specialists facing financial difficulties have been taken over by stronger domestic or foreign companies.

### Pension sector developments
- New pension companies have experienced impressive growth:
  - Assets reached nearly YTL 2 billion in August 2006 (0.5 percent of GDP), less than 3 years after launch.
  - They cover almost 1 million participants.
- Tax and withdrawal rules:
  - Contributions and investment returns benefit from modest tax incentives.
  - Withdrawals are less heavily taxed if they occur after reaching retirement age.
- Safekeeping and supervision infrastructure:
  - The Central Register Agency provides safe custody of the assets of pension mutual funds; these assets are segregated from those of the life and pension companies that manage them.
  - The Pension Monitoring Center, jointly-owned by the Treasury and the authorized pension companies, is a highly computerized system that has enhanced the effectiveness of supervision.

### Leasing market
- Leasing firms raise their funds from banks; banks are prohibited from engaging directly in leasing.
- Since 2000, leasing has tripled in dollar terms, to over US$4 billion in leases.
- The average lease is about US$100,000.
- 75 percent of leases are for machinery and equipment.
- Policy note: Changes in taxation could be considered to facilitate new types of leasing, such as operational leases.

### Securities markets — government debt and equities
- Government debt:
  - Gross domestic government debt was slightly over 50 percent of GNP at end-2005, mostly in the form of bonds, with less than a tenth in bills.
  - Turnover ratios in 2005: 309 percent for bonds and 432 percent for bills.
  - As of December 2005, the average maturity of the outstanding debt stock was just under two years.
  - Composition: 43 percent carrying variable rates, 41 percent in domestic currency with fixed rates, and 16 percent linked to or denominated in foreign currency.
- Treasury issuance and investor behavior:
  - The Treasury has been extending duration and maturity of its debt.
  - Banks strongly prefer shorter-duration instruments such as floating rate notes.
  - Retail participation declined from 22 percent in 2004 to 15 percent in 2005.
  - External bond portfolio maturity (duration) increased from 5.4 years (3.4 years) at end-2003 to 8 years (4.9 years) as at end-2005, following 20- and 30-year U.S. dollar bonds and 12-year Euro bonds issued in 2004 and 2005.
- Equity market:
  - 306 companies listed at end-December 2005.
  - Market capitalization: 40 percent of GDP.
  - Turnover: 155 percent of market capitalization in 2005.
  - ISE-100 index: fell from about 19,200 to 7,600 in September 2001, rose since end-2003 and reached 47,000 in February 2006.
  - Some companies have begun to raise funds in the market again; number of listed companies has begun to rise after crisis delistings.
  - August 2006 saw the first Turkish lira denominated corporate bond issue in a decade.
- Asset-backed securities and housing finance:
  - Legislation on housing finance will allow banks more flexibility in design and securitization of mortgages.
  - Turkey has a relatively long history of using ABS.
  - Since 1995, impediments on banks issuing securities against consumer loans have discouraged ABS issuance for these assets; some banks have issued ABS abroad based on international receivables.

### Legislation and regulatory organization
- BRSA:
  - The independent BRSA was established in September 2000.
  - Oversight of the SDIF (deposit insurance and bank resolution agency) was moved from the CBRT to the BRSA.
- CBRT and banking law:
  - The CBRT Law was amended in 2001 to strengthen central bank independence and powers.
  - A new BL was passed in October 2005, which:
    - Strengthens loan classification, loan loss provisioning and collateral valuation rules.
    - Introduces loan concentration exposure limits.
    - Tightens foreign exchange exposure rules.
    - Establishes new rules for consolidation, risk management, fitness and propriety of owners and managers, and the exit of insolvent or illiquid banks.
  - Prudential rules were extended to cover the state banks.
  - New accounting standards were introduced.
  - Implementing regulations were required within 12 months of passage of the law, i.e., by end-October 2006.
- Other legal updates:
  - New laws on mortgages and on credit card law were recently passed.
  - The insurance supervision law is of recent vintage.

### Stress testing: coverage, methods, and overview of results
- Purpose and scope:
  - Stress tests assessed resilience of the banking system to key risks.
  - Tests were conducted at consolidated level for the banking sector and for a set of major deposit-taking banks.
  - Covered market risk, interest rate risk, credit risk, and liquidity risk (sensitivity analysis) and scenario analysis over a three-year window using the SPO’s quarterly forecasting model.
- Coverage:
  - Bottom-up exercises included 9 banks, including 8 of the largest 9 banking groups, encompassing over 80 percent of banking assets.
  - Top-down and assessor complementary exercises used supervisory data and models and dynamic macro-stress tests combining dynamic panel models with scenario analysis.
- Methodology notes:
  - Institutions used their own datasets and internal models while applying agreed sensitivity test assumptions.
  - Shock calibrations for sensitivity analyses were based on Turkey’s historical experience of relatively high market and macroeconomic volatility and current market conditions.
  - Scenarios focus on events most likely to affect macroeconomic stability (e.g., major changes in world energy prices, unexpected reversals of capital flows).
  - For scenario projections, estimated deterioration in credit quality is projected forward corresponding to macroeconomic forecasts of the SPO model based on initial conditions as of end-2005 and specified shocks.
- General findings:
  - Low impact on solvency when applied to the sector’s consolidated portfolio, reflecting fairly comfortable capital buffers, particularly of the state-owned banks.
  - Estimated impact of protracted interest rate and credit shocks on individual banks is quite large.
  - Banks’ higher reported sensitivity to credit risk may reflect superior databases and better estimates of embedded loan portfolio risk.

### Sensitivity analysis and stress-test results — selected quantitative outcomes
- Top-down market risk stress-test headline (Table 9):
  - System CAR before shocks was 22.9 percent.
  - Interest Rate Risk:
    - Interest rate increase; Parallel YTL: 400 bps; Non-YTL: 300 bps — Impact on end-2005 after-tax profits: -70.2; Impact on end-2005 regulatory capital: -17.2; Post-Shock CAR: 18.8
    - Interest rate increase; Parallel YTL: 1500 bps; Non-YTL: 1000 bps — After-tax profits: -231.4; Regulatory capital: -32.9; Post-Shock CAR: 15.2
    - Interest rate increase; Positive tilt (short; long) YTL: (400 bps; 1500 bps) and Non-YTL: (300 bps; 1000 bps) — After-tax profits: -72.7; Regulatory capital: -17.4; Post-Shock CAR: 18.7
    - Interest rate increase; Negative tilt (short; long) YTL: (1500 bps; 400 bps) and Non-YTL: (1000 bps; 300 bps) — After-tax profits: -229.2; Regulatory capital: -32.7; Post-Shock CAR: 15.3
  - Exchange Rate Risk:
    - Depreciation; Mild -15 percent — After-tax profits: -0.4; Regulatory capital: 0.0; Post-Shock CAR: 20.4
    - Depreciation; Strong -45 percent — After-tax profits: -1.3; Regulatory capital: -0.1; Post-Shock CAR: 20.4
    - Appreciation; Mild 15 percent — After-tax profits: 0.4; Regulatory capital: 0.1; Post-Shock CAR: 20.5
    - Appreciation; Strong 45 percent — After-tax profits: 1.3; Regulatory capital: 0.1; Post-Shock CAR: 20.5
  - Market Risk Combined shock 1 (Interest rate increase; Positive tilt and Depreciation; Strong) — After-tax profits: -74.1; Regulatory capital: -7.2; Post-Shock CAR: 21.1
  - Market Risk Combined shock 2 (Interest rate increase; Negative tilt and Depreciation; Strong) — After-tax profits: -230.6; Regulatory capital: -22.4; Post-Shock CAR: 17.6
  - Note: For interest rate risk, loss estimates equal the reduction in (discounted values) of cash flows for the first 12 months following the shock.
- Banks’ market risk self-assessments (Table 10) — selected entries:
  - Average and lowest CAR before shocks were 21.9 and 7.2 percent respectively.
  - Interest rate increase; parallel YTL: 400 bps; Non-YTL: 300 bps — Average impact on end-2005 after-tax profits: -10.8; Worst: -40.5; Average impact on end-2005 regulatory capital: 20.7; Worst: 6.9 (*)
  - Interest rate increase; parallel YTL: 1500 bps; Non-YTL: 1000 bps — Average after-tax profits: -40.7; Worst: -109.8; Average regulatory capital: 13.8; Worst: -1.1 (*)
  - Exchange rate risk; Depreciation; mild -15 percent — Average after-tax profits: 1.6; Worst: -0.9; Average regulatory capital: 23.5; Worst: 7.2
  - Market risk Combined shock 1 — Average after-tax profits: -25.7; Worst: -109.7; Average regulatory capital: 16.5; Worst: -1.1 (*)
  - Sources: Participating credit institutions, BRSA, and IMF staff estimates.
  - Notes: Missing observations affect some post-shock CARs; an asterisk denotes lowest post-shock CAR belongs to a different institution than lowest pre-shock CAR.
- Market risk impact on mark-to-market portfolios (Table 11) — selected entries:
  - Average and Worst CAR before shocks were 21.9 and 7.2 percent respectively.
  - Interest rate increase; Parallel YTL: 400 bps; Non-YTL: 300 bps — Average impact on end-2005 after-tax profits: -23.0; Worst: -36.3; Average impact on regulatory capital: -5.7; Worst: -8.8; Post-shock CAR average: 21.2; Worst: 6.9
  - Interest rate increase; Parallel YTL: 1500 bps; Non-YTL: 1000 bps — Average after-tax profits: -75.0; Worst: -118.6; Average regulatory capital: -18.9; Worst: -28.6; Post-shock CAR average: 18.3; Worst: 6.4
  - Exchange rate risk; Depreciation; Mild -15 percent — Average after-tax profits: 60.2; Worst: 0.0; Average regulatory capital: 13.9; Worst: 0.0; Post-shock CAR average: 26.9; Worst: 7.2
  - Market risk Combined shock 1 — Average after-tax profits: 109.4; Worst: -65.3; Average regulatory capital: 26.2; Worst: -12.5; Post-shock CAR average: 29.7; Worst: 8.0
- Credit risk sensitivity (banks’ estimates; Table 12 and text):
  - Bank-performed sensitivity: increase in PDs over entire loan portfolio by 200 percent, and separately over corporate loan portfolio by 400 percent from end-2005 levels:
    - About half of participating institutions would miss the target of 12 percent minimum CAR, although almost all CARs remain above the lower regulatory threshold of 8 percent.
    - Participating credit institutions produced average losses of 11 percent and 8 percent respectively of regulatory capital.
  - Assessor top-down exercise for corporate portfolio (400 percent increase in PDs) yielded a 4 percent reduction in regulatory capital with negligible impact on system-level CAR.
    - Lower loss estimates by assessors may reflect database limitations: corporate sector PDs estimable only from default statistics beginning January 2002, a period containing an upswing but not a downswing of the business cycle; attempt to correct using higher LGDs may not fully remove PD downward bias.

### Additional risk and liquidity observations
- Top-down stress tests indicate sector resilience to most market price shocks; large negative repricing gaps at the short end produce severe profitability impacts from upward yield curve movements but substantial resolution within first 12 months.
- Exchange rate movements have negligible impact due to the sector’s almost closed position in foreign exchange.
- Banks’ self-assessments show greater sensitivity to market price movements than assessor analysis at sectoral level and wide variation across banks.
- Sensitivity of mark-to-market portfolio value to combined interest and exchange rate shocks is low for most banks because foreign currency asset mark-to-market gains on depreciation can offset interest-rate-related market value losses; however, interest rate channel dominates income impact when considering entire balance sheet and off-balance-sheet positions.
- Exposure to liquidity risk appears small but depends on liquidity of the sovereign bond market under system-wide deterioration.
- Liquidity coverage for foreign exchange liabilities through liquid foreign exchange assets is superior for most banks compared to the YTL portion, possibly reflecting decreased exchange rate and macroeconomic volatility after the 2001 crisis.

*Source: Excerpt from IMF FSAP chapter provided in content unit _cr07361 - 163.*

### 1. Global Credit Portfolio Shock

### 1. Global Credit Portfolio Shock

### Credit shock scenarios and sample bank impacts
- PDs on each loan increases by 200 percent-51.6-142.4-10.7 -37.4 15.25.3
- PDs on each corporate loan increases by 400 percent-43.7-213.5-8.0 -56.1 15.45.5(*)
- Shift of risk characteristics in corporate loan portfolio  
  Downgrade by one notch of all loans (IR scale)-11.2-15.6-2.4 -3.7 19.712.2(*)

Notes from source:
- Impacts are weighted averages across the sample of banks for each shock.
- 1/ Expected losses are added to general provisions and hence, reported as a percentage decrease in after tax 2005 profits.
- 2/ Taken to mean the expected reduction in capital should the expected loss occur.
- 3/ Post-shock CAR is greater than pre-shock CAR in certain cases despite declines in sample average regulatory capital owing to missing observations.
- 4/ Lowest CAR reflects the temporary situation of one bank, which has since been corrected.
- (*) An asterisk denotes a case where the lowest post-shock CAR belongs to an institution different from the one having the lowest pre-shock CAR.
- (In percentage points)

### Macroeconomic scenario analysis — design and qualitative outcomes
- Four macroeconomic scenarios considered:
  - (i) a permanent increase in oil prices to US$140 per barrel;
  - (ii) a fiscal slippage scenario;
  - (iii) a boom-bust scenario, wherein growth over the first four quarters succeeding end-2005 exceeds expected levels, but declines dramatically thereafter;
  - (iv) a zero net capital inflow scenario.
- The first and fourth scenarios represent very large and persistent deteriorations in economic performance.
- Zero net capital inflow (complete cessation of capital inflows) results:
  - Dynamic macroeconomic analysis over a 12 quarter horizon used to forecast impacts on GDP growth, unemployment, domestic prices, and exchange and relevant interest rates.
  - The economic contraction results in a rapid increase in non-performing loans, generating cumulative losses in banking capital estimated at almost 40 percent relative to end-2005 levels.
  - This could reduce average CAR by 9 percentage points in the absence of management action.
  - A number of banks, including some medium-sized ones, are likely to require substantial injection of fresh capital from shareholders to meet CAR thresholds under this severe downturn.
- Sustained and large increases in oil prices:
  - Impact is smaller than the sudden stop scenario, mainly owing to lower sensitivity of key macroeconomic variables to this exogenous shock.
  - Capital reductions could still reach 20 percent by end-2008.
  - At a sectoral level, CAR is likely to comfortably exceed the regulatory 12 percent threshold, albeit with certain individual institutions requiring fresh injections of capital.

### Table 13 — Impact of Scenarios on Banking Sector Capital, 2005–2008 (selected figures)
- Scenario A. Termination of capital inflows (Impact on regulatory capital, in percent)
  - 2006-8.7
  - 2007-20.8
  - 2008-35.3
- Scenario B. Oil Price Shock (Impact on regulatory capital, in percent)
  - 2006-6.8
  - 2007-14.3
  - 2008-20.4
- Scenario C. Boom-Bust Dynamic (Impact on regulatory capital, in percent)
  - 2006-0.2
  - 2007-1.6
  - 2008-7.0
- Scenario D. Fiscal Slippage (Impact on regulatory capital, in percent)
  - 20060.3
  - 2007-1.4
  - 2008-4.8

*Sources: Participating Credit Institutions, BRSA, and FSAP Calculations.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2007/_cr07361.pdf_