## _cr12261 ## Source details **Canonical URL:** [_cr12261](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12261.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12261.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12261.pdf.json) --- ### Executive Summary — Systemic resilience and recent performance - The Turkish financial system "has weathered the 2008-09 global financial crisis relatively well." - Contributing factors cited: "significant capital buffers built up following the 2000-01 banking crisis," "more effective fiscal and monetary management," "strengthened banking regulation and supervision," "conservative banking practices," and a "rapid rebound in capital flows and real activity." - Emerging macro-financial risks: - Credit boom "in the period to mid-2011" accommodated by "easy domestic policies and global monetary conditions." - Large capital inflows, strong domestic demand, "a sharp widening in the current account deficit" and increases in short-term external debt. ### Financial system structure and balance-sheet trends - Banking sector dominance and size: - Banking system assets: "63 percent of GDP in 2005 to over 90 percent of GDP by August 2011." - Public banks: "the largest bank being state-owned and the three state-owned banks in aggregate accounting for close to a third of total banking sector assets." - Balance-sheet shifts and risks: - Share of government securities in total bank assets fell to "29 percent of total bank assets by end-2010." - Largest loan share: "50 percent" allocated to corporates. - Loan growth outpaced deposit growth; rising reliance on foreign funding increases liquidity and FX-related risks. - Growth in loans to households and SMEs noted as higher profitability but higher risk. - Group complexity: - "Three financial holding companies" as defined under Turkish Banking Law at end-2010, plus "three other financial groups" operating across subsectors, and ownership links between banks and non-banks. ### Credit expansion, asset quality, and conjuncture - Credit growth and access: - Since 2003, loans from the banking sector have been growing at annual rate of just over 25 percent in real terms. - Turkey's credit to GDP ratio: below 50 percent (relatively unbanked). - During 2010 Q4–2011 Q2, private sector loans grew at an annualized rate of around 40 percent. - Annualized credit growth: around 10 percent in October 2011; "had slowed to 30.5 per cent year-on-year." - Crisis-era buffers and measures: - By end-2007 system-wide official CAR was 19 percent; gross NPLs were 3.5 percent of loans. - Key crisis measures (selected adoption dates preserved): - Reclassification of government securities to hold-to-maturity: October 2008. - Dividend policy restrictions requiring BRSA approval: October 2008; extended 2010 and 2011. - Reclassification of restructured loans allowing some loans to be treated as performing: January 2009; extended March 2010. - FX liquidity requirements counting FX-indexed assets/liabilities at 45 percent coefficient: January 2009; still in effect. - Restrictions on FX lending to non FX-earnings companies: June 2009. - General provisioning relief for banks with CARs above 16 percent: March 2010, effective till March 2011. - Non-performing loans and provisioning: - System average NPL ratio rose in 2009, fell to just under 4 percent by end-2010 and was at an historical low of 2.8 percent. - Footnote: NPLs would likely have been 1-1.5 percentage points higher at their peak absent forbearance measures (terminated March 2011). - In some banks up to 20 percent of loans benefited from restructuring; one case ceded NPLs to other entities of the same owner. - Macro-financial conjuncture: - Post-crisis recovery characterized as import intensive and credit-dependent, supported by low-cost foreign financing and an overvalued real exchange rate. - Short-term external debt climbed sharply to 15 percent of GDP. - CBRT policy adjustments mid-November 2010 to emphasize financial stability: differentiated TL and FX reserve requirements, widened interest rate corridor, reduced policy rate, increased volatility to discourage very short-term inflows. - Early August (implied year) measures: policy rate lowered by 0.5 percent, O/N borrowing rate increased, FX and TL RRs reduced, banks allowed to hold up to 40 percent of TL RR in FX. ### Funding, maturity mismatch, and sectoral balance sheets - Funding and maturity mismatch: - Loan-to-deposit ratio reached close to 100 percent. - Banks’ external funding is 13 percent of total liabilities. - Overall banks’ maturity mismatch up to one year is US$117 billion (both net on- and off-balance sheets). - Banks’ on-balance-sheet short FX positions close to historical peaks of US$20 billion in September 2011. - Deposits concentrated: largest 0.1 percent of accounts hold more than 46 percent of system-wide deposits. - Counterparties for swaps: London-based global banks account for 89 percent of total swap transactions. - Household sector: - Household liabilities growing fast from a low base; strong positive net worth; debt service burden manageable. - Households not permitted to borrow in foreign currency; FX-indexed loans to households banned since June 2009. - Loan defaults jumped in 2009, moderated to pre-crisis levels thereafter. - Corporate sector: - Non-financial corporates profitable through crisis but increasingly leveraged and FX-exposed. - Corporate sector debt rose by about 19 percent to around 40 percent of GDP during 2010. - Net short FX position of corporates increased by over 60 percent since end-2009. - Overall net FX exposure of the corporate sector, including SMEs, at a record-high US$120 billion with net short-term liquidity needs of US$15 billion. ### Stress testing framework, scenarios, and key findings - Coverage and data: - Two approaches: FSAP team with CBRT/BRSA (top-down) and individual banks (bottom-up); nine largest banks accounting for over 80 percent of the banking system. - Risk horizon: four-quarter horizon for sensitivity tests; scenario tests cover multi-year horizons (sudden stop: three-year horizon beginning January 1, 2011; boom-and-bust: four-year period with a 2-year boom). - Shocks and calibrations (selected): - Aggregate credit risk sensitivity: moderate shock = 200 percent increase in PD and 30 percent increase in LGD; severe = 400 percent PD and 100 percent LGD (relative to through-the-cycle levels). - Market risk: parallel yield moves from mild (200 bps TL; 300 bps FC) to severe (1000 bps); other calibrations include +500 to +2000 bps tilts. - Exchange rate shocks: appreciation mild 10 percent / strong 45 percent; depreciation mild 20 percent / strong 60 percent. - Combined market risks: TL and FC yields increase plus 60 percent depreciation. - Scenario calibrations (top-down): - Sudden stop: GDP (-9 percentage points (ppts)), unemployment (+4 ppts), domestic interest rate (+10 ppts), real interest rate (+5 ppts), exchange rate (60 percent depreciation). - Boom-and-bust: contraction in bust: GDP (-10 ppts), unemployment (+4 ppts), domestic interest rate (+9 ppts), real interest rate (+4-8 ppts), exchange rate (60 percent depreciation). - Funding withdrawal assumptions: - Sudden Stop: TL and FX deposits run-off rates of 10 and 20 percent, respectively; short-term wholesale funding overall withdrawal rate ~50 percent; long-term funding ~20 percent. - Boom-Bust: overall loss of short-term funding ~50 percent; loss of demand and term deposits on average ca. 7 and 14 percent, respectively. - Solvency and scenario results: - Top-line resilience: banks’ internal tests show vulnerability to one-off rate rises or credit quality deterioration, but capital buffers leave institutions resilient to large shocks. - FSAP top–down tests: resilience to a severe macroeconomic shock of the magnitude/duration of 2008–10, though capital ratios significantly impacted. - Sudden-stop scenario: sector as a whole would remain adequately capitalized relative to regulatory threshold under both Basel I and economic risk-based measures; up to four of nine largest banks may be susceptible to undercapitalization at end of 36-month scenario depending on methodology. - Boom-and-bust scenario: a protracted bust after a two-year boom could push a sizeable majority of the nine banks into undercapitalization using the economic risk-based measure of CAR. - Basel I vs economic risk-based metrics: Basel I may overstate capital buffers; economic risk-based ratios yielded lower capital ratios, with ratios falling close to regulatory thresholds if measured in 2010. - Liquidity findings: - Current liquidity buffers judged adequate to meet funding shocks in a near-term sudden stop for a majority of systemic banks using liquid assets, repo sales and freeing a proportion of required reserves. - Under boom-and-bust, reliance on non-deposit wholesale funding and reduced repo-eligible assets could leave a few banks facing significant funding pressure absent policy response. - Observations on recent developments: - Credit growth continued strongly for just over six months then slowed abruptly with a capital outflow. - Regulatory capital reduced as risk-weighted assets increased during high credit growth; liquidity ratios have been declining though remain above minimum regulatory ratios. ### Macroprudential framework, institutional arrangements, and policy recommendations - Institutional developments: - Financial Stability Committee (FSC) formed in mid-2011 via decree law; chaired by Minister in charge of Treasury (Deputy Prime Minister) and comprising Treasury, BRSA, CMB, CBRT and SDIF. - FSAP recommends primary legislation to strengthen FSC accountability, mandate and powers. - Consideration suggested for separating macroprudential policy (crisis prevention) from crisis management. - Governance options to consider include assigning chairmanship to CBRT to harness central bank expertise. - Policy implications and operational recommendations (selected): - Near-term/high priority: - "Consider further prudential action to ensure strong capital positions and stability of funding." - "Ensure data are available to assess the risk from unhedged corporate net short FX positions and take corrective action as necessary." - "Review and revise key aspects of the supervisory and regulatory framework to bring it fully into line with the Basel framework, especially as regards the supervision of key risks and the definition of capital." - "Reform the current insurance regulation and supervision processes by making them more transparent, consultative, and accountable to the industry." - "Adopt a new Law on Combating the Financing of Terrorism (CFT) to address the deficiencies identified by the FATF." - "Establish a definition for Politically Exposed Persons (PEP) and requirements for reporting entities in line with the FATF standard." - Medium-term: - "Consider further measures to address the risk of worsening lending standards in the consumer and SME segments." - "Develop an approach to risk identification that combines the monitoring of key indicators with qualitative information... jointly developing databases and modeling frameworks for financial stability analysis." - "Ensure appropriate communication and accountability of the FSC and strengthen its mandate and powers through primary legislation." - "Implement consolidated banking supervision and enhance the coverage of risks emanating from non-banking entities in the group." - "Transfer the responsibilities for insurance regulation and supervision to an independent integrated insurance supervisory body." - Macroprudential and microprudential tools taken/considered: - BRSA measures (post-mission, adoption dates preserved): - Loan-to-value ceilings on housing loans at 75 percent and commercial real estate at 50 percent (December 2010). - Higher risk weights for fast growing consumer loans: 150 percent for new general purpose loans < two years; 200 percent for > two years (June 2011). - Increased provisions for new general purpose consumer loans (general provisions 1 percent to 4 percent; specific provisions 2 percent to 8 percent) conditional on portfolio size or NPL thresholds (June 2011). - Limits to credit card payments for repeat underpayments (June 2011). - Interest rate risk capital measures effective from 2012 (August 2011). - Changes to minimum Capital Adequacy Requirements for banks with foreign strategic shareholders (September 2011; applying as of January 2012). - SDIF deposit premium surcharges and new scoring factors (September 2011). - Suggested further measures if credit growth resumes: - Increase risk-weights (expand beyond consumer/credit cards). - Cap on debt-to-income ratios; development of comprehensive credit register suggested. - Capital surcharges penalizing short-term funding; add requirements on funding stability at longer horizons. - FX-related measures: increases in FX reserve requirements, tighter capital/liquidity rules on derivatives, cap on on-balance-sheet short position relative to capital (phased in gradually). ### Banking regulation, supervision, and institutional capacity - BRSA supervision: - Uses a hybrid of CAMELS and risk profiling modules; strengths include round-the-year presence in banks. - Shortcomings: emphasis on rules over prospective risk; need for valuation systems for market risk positions and collateral oversight; capacity building for risk-model oversight and Basel II transition. - Quality control: five-grade rating scale concentrates banks in two middle grades reducing discriminative power; enhanced internal review recommended. - Consolidated supervision: arrangements not fully in place; several banks lack full group-level risk monitoring. - Legal/operational independence constraints: limits on establishment of departments, recruitment of mid-career hires, salary scales linked to Government scale; need to strengthen operational autonomy. - Insurance supervision: - Legal framework transformed; institutional setup lags. - Issues: insurance supervision part of government with rigidity, limited technical talent, inadequate resources and IT infrastructure, fragmented delegation across GDI and ISB. - Recommendations: enhance consultation, reduce compliance cost burden, conduct impact assessment of solvency regulation, strengthen insurance AML/CFT expertise. - AML/CFT: - Progress since 2007 FATF evaluation; ML offense largely aligned with international standards. - Key gaps: adoption of CFT Law to criminalize terrorism financing; weaknesses in implementation/effectiveness of STRs and supervision. - Supervisory integration needed to leverage sector supervisors’ knowledge; BRSA to consider a dedicated AML/CFT component and incorporate ML/TF risks into bank ratings. - Urgent actions: establish PEP definition, resume STR inspections for banks/insurance/exchange offices, strengthen beneficial ownership identification provisions. ### Crisis management, resolution, SDIF, and Emergency Liquidity Assistance (ELA) - Crisis management and SRCC/FSC: - Crisis management mandated in the Banking Act; Council of Ministers authorized to determine extraordinary measures. - SRCC established April 2009 via MoU among SDIF, CBRT, UT, BRSA to jointly identify systemic events and coordinate. - Recommendations: clarify decision-making rules, separate monitoring from crisis management, clarify relationship between SRCC and newly established FSC. - Bank resolution and SDIF: - BRSA can apply corrective/rehabilitating/restricting measures; can transfer bank to SDIF with affirmative vote of five out of seven Board members. - SDIF resolution responsibilities include developing Resolution Action Plan, verifying insured deposits, deploying personnel, transferring assets/deposits, providing financial support, selling or merging restructured banks. - Resolution period: SDIF must complete resolution in nine months, extendable by three months. - SDIF deposit insurance and resources: - SDIF reserve/insured deposit ratio about 6.0 percent. - SDIF legally able to obtain liquidity from CBRT and capital from Treasury in crisis; past obligations to Treasury before end-2007 were cancelled (TL 93 billion). - SDIF can borrow securities from Treasury without parliamentary approval up to yearly limit of 1 percent of annual budgetary allocations (for 2011 this would be about TL5 billion). - Legal mandate to reimburse depositors "no later than three months" though in practice time is much shorter. - CBRT ELA framework and constraints: - ELA available to solvent banks temporary up to one year (renewable monthly); access limited to twice a bank’s capital. - Interest on ELA charged at the overnight CBRT lending rate for interbank transactions. - Usage of ELA triggers regular on-site inspections; CBRT relies primarily on BRSA to determine solvency. - Collateral and haircut regime: haircuts range from 8.5 percent for foreign exchange deposits to 30 percent for domestic government securities (maturity > one year) and Eurobonds. - CBRT’s ability to provide FX liquidity constrained by limited official reserves; reserve cover of short-term debt declined to 70 percent as of end October 2011. - Recent RR changes allow banks to post up to 40 percent of TL RR in FX; CBRT reduced FX RR three times (July, August and October) and announced resumption of intermediation in FX deposit market as of November 10. ### Risk Assessment Matrix — key threats, likelihood, and expected impacts - Reversal of capital inflows / external funding collapse (Staff assessment: High) - Triggers: Euro area debt crisis spillovers, depreciation pressures, high current account deficit. - Expected impacts (selected exact figures preserved): - Sharp depreciation could push Turkey into recession; banks affected by collapse of external funding and rising NPLs. - Loan-to-deposit ratio close to 100 percent; maturity mismatch up to one year is US$117 billion. - Banks’ on-balance sheet short FX positions near US$20 billion (September 2011). - Corporate net FX exposure at record-high US$120 billion; net short-term liquidity needs US$15 billion. - Continued boom in demand and credit followed by bust (Staff assessment: Medium likelihood, High expected impact) - Triggers: insufficient policy tightening, procyclical fiscal policy, continued low foreign rates encouraging FX borrowing. - Expected impacts: - Build-up of NPLs in aftermath of bust; deterioration of capital buffers due to shift toward higher risk-weighted loans. - Increased reliance on short-term funding and higher interest rate and rollover risks; capital losses from sovereign holdings if yields rise. ### Selected financial soundness indicators (select figures from Table 12) - Household sector (select rows preserved in sequence): - Rate of growth of financial assets: 21.1 15.8 27.8 12.1 16.2 14.4 14.3 - Rate of growth of liabilities: 110.2 81.1 50.1 35.5 23.9 14.0 30.3 - Financial assets (percent GDP): 34.0 34.0 37.1 37.4 38.6 44.0 43.0 - Financial Liabilities (percent GDP): 5.1 7.9 10.1 12.2 13.6 15.4 17.2 - Loan default rate: 2.6 3.2 2.9 2.9 3.7 6.0 4.1 - Interest payments to disposable income: ......4.6 4.6 5.6 5.2 4.4 - Corporate sector (select rows preserved in sequence): - Growth rate of total corporate debt: 1.5 20.5 -5.4 34.0 77.9 12.5 19.0 - Corporate debt to equity ratio: 1.1 1.1 1.1 0.9 1.3 1.2 ... - External borrowing to total borrowing: -35.7 37.1 37.0 43.5 39.2 30.0 - ROA: 7.2 5.8 10.0 9.5 7.9 7.2 ... - ROE: -13.3 20.3 22.5 20.5 17.4 ... - Number of Private Companies: 6,645 7,086 5,281 6,862 7,333 8,062 ... *Source: IMF staff Executive Summary and IMF staff report content (document _cr12261).* ### Executive Summary ...................................................................................................... ### Executive Summary ### Systemic resilience and recent performance - The Turkish financial system "has weathered the 2008-09 global financial crisis relatively well." - Contributing factors: "significant capital buffers built up following the 2000-01 banking crisis," "more effective fiscal and monetary management," "strengthened banking regulation and supervision," "conservative banking practices," and a "rapid rebound in capital flows and real activity." - New macro-financial risks emerged, notably: - A credit boom "in the period to mid-2011" accommodated by "easy domestic policies and global monetary conditions." - Large capital inflows, strong domestic demand, "a sharp widening in the current account deficit" and increases in short-term external debt. ### Financial system structure and balance-sheet trends - Banking sector dominance: - Banking system assets increased from "63 percent of GDP in 2005 to over 90 percent of GDP by August 2011." - Public banks remain important: "the largest bank being state-owned and the three state-owned banks in aggregate accounting for close to a third of total banking sector assets." - Balance-sheet shifts and risks: - Share of government securities in total bank assets fell to "29 percent of total bank assets by end-2010." - Largest loan share: "50 percent" allocated to corporates (Table 4 context). - Loan growth outpaced deposit growth; banks "are increasingly relying on foreign funding," raising liquidity and FX-related risks. - Growth in loans to households and SMEs (higher profitability but higher risk). - Group complexity: - "Three financial holding companies" as defined under Turkish Banking Law at end-2010, plus "three other financial groups" operating across subsectors, and ownership links between banks and non-banks (Table 5). ### Stress testing and vulnerabilities - Stress tests based on end-2010 data indicate: - The system could "come under strain, especially if a macroeconomic shock was protracted or preceded by a sustained period of rapid credit growth." - Major banks’ sensitivity analysis suggests "limited vulnerability to higher interest rates or a deterioration in credit quality." - Top–down tests show system capital could withstand "a severe, albeit short-lived, macro-economic shock of the magnitude and duration that occurred in Turkey in 2008/9," though "liquidity may be strained for a few banks." - System capital buffers "might be insufficient in the event of a protracted reduction in economic activity amidst a reversal of capital flows and mark-to-market losses," or if "bank capital and credit quality were eroded by continued rapid loan growth." - Under adverse scenarios "some banks may face significant funding pressure." - Sensitivity of funding and FX: - Corporate sector "foreign exchange (FX) exposure is at a record high." - Banks increasingly reliant on "short-term foreign funding" despite deposits remaining the main funding source. ### Macroprudential framework and institutional arrangements - Turkey is developing a macro-prudential framework; a "Financial Stability Committee (FSC) was formed in mid-2011." - FSC roles: "financial sector systemic risk monitoring function and a crisis management function." - Recommendations on governance: - "Consideration could be given to separating the two functions more clearly, and ensuring a leading role of the CBRT in systemic risk monitoring and prevention." ### Regulatory and supervisory developments - Progress since the 2007 FSAP: - BRSA "moved quickly to promulgate the various sub-regulations needed to bring the new Banking Law into full effect." - Insurance regulatory framework "major overhaul." - Remaining weaknesses: - "Oversight of market and liquidity risks, consolidated supervision, and supervision of banks’ risk management techniques and models" are areas with weaknesses. - Need for "a fully transparent, consultative, and accountable supervision and regulation framework" in insurance. ### Crisis management, resolution, and liquidity - Bank resolution and deposit insurance: - The Savings Deposit Insurance Fund (SDIF) has a "broad menu of resolution tools" including "mergers, insured deposit transfers, purchase and assumption transactions, and outright bank liquidation." - Deposit insurance framework "is in line with EU and international practices." - Emergency liquidity: - CBRT "has a well-articulated framework for emergency liquidity provision," but "scope for FX liquidity provision is constrained by limited official reserves." ### AML/CFT status - Enhancements since the 2007 FATF evaluation, but deficiencies remain: - FATF (June 2011) included Turkey on a list of countries that "have not made sufficient progress in addressing strategic AML/CFT deficiencies." - Authorities "still need to adopt a new Law adequately criminalizing terrorism." - Shortcomings exist in the AML legal framework, in "implementation and effectiveness" of suspicious transaction reporting, and in supervision for AML/CFT compliance. - Institutional supervisory framework "needs to be better integrated to incorporate individual sector supervisors’ knowledge, experience, and perceived ML/TF risks." ### Key recommendations (Table 1) - Overall financial sector oversight (priorities and timing preserved): - High / Near term: "Consider further prudential action to ensure strong capital positions and stability of funding." - High / Near term: "Ensure data are available to assess the risk from unhedged corporate net short FX positions and take corrective action as necessary." - Medium / Medium term: "Consider further measures to address the risk of worsening lending standards in the consumer and SME segments." - Medium / Medium term: "Develop an approach to risk identification that combines the monitoring of key indicators with qualitative information. Better leverage the expert resources of the BRSA and CBRT by jointly developing databases and modeling frameworks for financial stability analysis." - Macro-prudential policy framework: - Medium / Medium term: "Ensure appropriate communication and accountability of the FSC and strengthen its mandate and powers through primary legislation." - Medium / Medium term: "Consider separating macroprudential policy and crisis management arrangements and ensuring a leading role of the CBRT in systemic risk monitoring and prevention." - Micro-prudential regulation and supervision — Banking: - High / Near term: "Review and revise key aspects of the supervisory and regulatory framework to bring it fully into line with the Basel framework, especially as regards the supervision of key risks and the definition of capital." - High / Medium term: "Implement consolidated banking supervision and enhance the coverage of risks emanating from non-banking entities in the group." - Medium / Medium term: "Revise the Banking Law to enhance the operational and organizational autonomy of the BRSA for banking supervision." - Micro-prudential regulation and supervision — Insurance: - High / Near term: "Reform the current insurance regulation and supervision processes by making them more transparent, consultative, and accountable to the industry." - High / Near term: "Improve the “early warning” system for the required solvency margin." - Medium / Medium term: "Transfer the responsibilities for insurance regulation and supervision to an independent integrated insurance supervisory body." - AML/CFT regime: - High / Near term: "Adopt a new Law on Combating the Financing of Terrorism (CFT) to address the deficiencies identified by the FATF." - High / Near term: "Strengthen and integrate the institutional supervisory framework for AML/CFT to include participation of sector supervisors’ within the monitoring, selection, planning and coordination of AML/CFT activities." - High / Near term: "Establish a definition for Politically Exposed Persons (PEP) and requirements for reporting entities in line with the FATF standard." *Source: IMF staff Executive Summary (document _cr12261).* ### 4. Credit has expanded rapidly over the last eight years, albeit from a relatively ### 4. Credit has expanded rapidly over the last eight years, albeit from a relatively ### Credit expansion and access - Since 2003, loans from the banking sector have been growing at annual rate of just over 25 percent in real terms even when including the recent global turbulence. - Turkey is still relatively unbanked compared to other emerging market countries with a credit to GDP ratio below 50 percent. - During 2010 Q4–2011 Q2, loans to the private sector grew at an annualized rate of around 40 percent. - Annualized credit growth stood at around 10 percent in October 2011, and had slowed to 30.5 per cent year-on-year. ### Crisis-era reforms, buffers, and policy actions - A decade of reforms and banking-sector restructuring following the 2000-01 crisis included a modernized supervisory framework via a banking law in 2005 and reorganization of the BRSA. - By end- 2007 the system wide official CAR was 19 percent; gross NPLs were 3.5 percent of loans; profits were robust. - The CBRT engaged in unprecedented monetary easing during the crisis; no direct public financial support was provided, but prudential regulation amendments aimed at preserving banks’ earnings and capital adequacy while maintaining credit. - Table 6 (Main Crisis-Related Measures Affecting the Financial Sector, Prudential Framework) (selected measures and adoption dates preserved from source): - Reclassification of banks' holdings of government securities: Allowed banks to reclassify on a one-time basis available-for-sale securities to hold-to-maturity status, or fair value through profit or loss to avoid mark-to-market capital write-downs. October 2008. - Dividend policy: Requires BRSA approval before distributing dividends. Maximum dividend payout rules by CAR bands. October 2008; extended in 2010 for 2009 profits; and again in 2011. - Reclassification of restructured loans: Allows reclassification from “less than 90 days overdue” to “performing” under specified conditions; TL 11 billion in loans (about 3 percent of total loans) were restructured under this provision through March 2010. January 2009; extended in March 2010 for another year. - FX liquidity requirements: FX-indexed assets and liabilities could be counted toward the FX liquidity requirement with a coefficient of 45 percent. January 2009; still in effect. - Restrictions on FX lending: Non FX-earnings companies allowed to borrow in FX from local banks provided FX loan amount is greater than US$5 million and maturity longer than a year; bans consumers from taking out FX-linked loans. June 2009. - General provisioning on new loans: Banks with CARs above 16 percent allowed to lower general provisioning rate from one to zero percent for cash loans other than credit cards until March 2011. March 2010, effective till March 2011. ### Non-performing loans and asset quality - NPL increases were most marked in manufacturing (SME) and consumer loans during the crisis; loan performance substantially improved in the post-crisis rebound. - NPL increases were much more moderate in state-owned banks. - The system average NPL ratio rose in 2009, fell back to a level just under 4 percent by end-2010 and is now at an historical low of 2.8 percent. - Shortcomings in asset classification and provisioning requirements mean actual NPLs could be somewhat higher. - Footnote: NPLs would likely have been 1-1.5 percentage points higher at their peak in the absence of the forbearance measures related to loan classifications; the measures were terminated in March 2011. - Note: In some banks, up to 20 percent of loans benefited from restructuring; in one case, NPLs were ceded by the banking entity to other entities belonging to the same owner. ### The current conjuncture and key macro-financial risks - The strong post-crisis recovery has been accompanied by an externally financed demand boom, characterized as import intensive and credit-dependent, supported by low-cost foreign financing and an overvalued real exchange rate. - Current account deficit widened sharply; short-term external debt has climbed sharply to 15 percent of GDP. - About a third of the banking sector has links to euro-area banks under stress, but direct funding is low. - Currency has recently come under depreciation pressure, and inflation has risen. - Capital inflows are dominated by potentially-volatile financing. - The CBRT adjusted its policy framework in mid November 2010 to emphasize financial stability alongside price stability, differentiating and increasing TL and FX reserve requirements, widening the interest rate corridor, reducing the policy rate to lower the front-end of the yield curve, and increasing volatility to discourage very short-term capital inflows. - In early August (year implied by context), the CBRT lowered the policy rate by 0.5 percent, increased the O/N borrowing rate to narrow the interest rate corridor, reduced FX and TL RRs, and allowed banks to hold up to 40 percent of their TL reserve requirements in FX. ### Financial sector risk assessment and capital - Near-term risks include a collapse of external funding (which could push Turkey into recession) and a deteriorating domestic economy. - Alternatively, continued strong credit growth could pose medium-term risks through weakened risk management and subsequent deterioration in bank balance sheets. - Liquidity risks have built up from increasing reliance on short-term FX funding and increased FX exposure of unhedged corporate borrowers. - Capital buffers remain above the BRSA’s floor of 12 percent but have declined to below 17 percent from 19 percent at end 2010 (and 21 percent at end 2009). - Capital ratios are expected to decline by 1-2 percentage points due to increased risk weights with the introduction of Basel II, and could fall further with currency depreciation or a rise in sovereign yields leading to marked-to-market losses. - Banks expect the overall impact on capital ratios from Basel II to be between 1 and 2 percentage points. - Increases in bond yields reduce banks’ capital buffers since a high proportion of sovereign holdings are booked as available-for-sale (AFS) and therefore marked to market. ### Competition, margins, and profitability - Competition between banks has compressed net-interest margins, pressuring banks to shift loan books towards higher-margin but higher-risk lending. - State banks with lower loan to deposit ratios expanded lending and gained market share. - Profits have declined since 2009 but remain comfortable: return on assets and equity of 1.6 percent and 13.8 percent, respectively, as of September 2011. ### Credit composition and recent trends - Post-crisis lending composition shifted away from corporate sector toward consumers and SMEs since early 2010. - Private and state owned banks led consumer lending resumption; foreign banks lagged. - Loan growth began easing from mid-2011 due to concerns about the current account deficit, prior monetary and prudential tightening, and capital outflows linked to global funding strains. ### Funding risks and maturity mismatch - Recent rapid credit growth outpaced deposit growth; the loan to deposit ratio reached close to 100 percent. - Banks’ external funding is 13 percent of total liabilities. - Increased reliance on wholesale FX funding and use of increased CBRT repos as a funding source contribute to increases in banks’ maturity mismatch. - Banks’ on-balance-sheet short FX positions have widened, requiring increasing recourse to cross-currency swaps. - Banks use short-duration swaps for liquidity and position-taking and longer-term swaps to hedge FX risks. - Repeated rollovers of funding swaps with shorter maturities than the assets they fund exposes banks to interest rate risk, manifested when sharp increases in CBRT and market interest rates raised costs for short-term cross-currency swaps. - The banking sector faces a large structural maturity mismatch: - Large majority of deposits have maturities of less than three months. - Banks rely significantly on short-term CBRT repo funding. - Corporate loans are generally of short maturity, but overall maturity mismatch exposes the sector to funding rollover and interest rate risks. - Deposits are extremely concentrated: the largest 0.1 percent of accounts hold more than 46 percent of system-wide deposits. - Policy responses and measures: - Reserve requirements differentiated according to liability duration have led to marginal shifts away from deposits of less than a month toward the 3–12 month deposit bracket, though it is too early to assess meaningful effects on maturity mismatches. - The BRSA announced a new interest rate risk measure in August 2011 that discourages duration gaps through capital charges on large exposures to interest rate risks; adjustments to reserve requirements on local and foreign currency deposits may also help lengthen average deposit maturity. - Counterparty considerations for swaps: - London-based global banks are the main swap counterparts, with 89 percent of total swap transactions. - Swap contracts are OTC but counterparts typically have credit support annex (CSA) agreements and daily margining to mitigate credit risks. ### Household balance sheets - Household sector liabilities are growing fast, outpacing growth in assets by a large margin, though from a low base. - The sector has strong positive net worth and the debt service burden remains manageable. - Households are not permitted to borrow in foreign currency and, since June 2009, are no longer permitted to borrow through FX-indexed loans, limiting their FX exposure. - Absence of variable rate loans (only housing mortgages allowed to be indexed to the CPI and the total amount of these loans is negligible) protects households from interest rate risks. - Loan defaults jumped in 2009 reflecting higher unemployment and despite some loan restructuring, have since moderated to pre-crisis levels. ### Corporate balance sheets - Non-financial corporates remained profitable throughout the crisis but are increasingly leveraged and exposed to FX risk. - Corporate sector debt rose by about 19 percent to around 40 percent of GDP during 2010. - The net short FX position of the sector, which had started to decrease after the global crisis, has increased by over 60 percent since end-2009. - Currency risk for corporates could have knock-on implications for credit risk for banks. - As of June 2009, Turkish firms with no FX income can borrow in FX on-shore provided the loan is for at least one year and for a minimum of US$5 million; prior restrictions had channeled these loans through off-shore branches. ### Stress tests - (Section header present; detailed stress-test results and methodology not included in the supplied content.) *Source: IMF staff and Turkish authorities (excerpt from the IMF staff report text provided).* ### 18. Stress tests indicate that the banking sector is robust to relatively extreme shocks ### 18. Stress tests indicate that the banking sector is robust to relatively extreme shocks ### Stress testing framework and coverage - Two complementary approaches: FSAP team in conjunction with CBRT and BRSA (top down/bottom up sensitivity tests, scenario tests and liquidity tests); and individual banks (sensitivity tests). - Institutions covered: Nine largest banks accounting for over 80 percent of the banking system. - Data used: FSAP team/Authorities: supervisory and audited data; Banks: data from the internal risk management systems; Supervisory data. - Risk horizon: Four quarter horizon for sensitivity tests; scenario tests used: - Sudden stop: four quarter contraction followed by eight quarters of sluggish recovery (three-year horizon beginning January 1, 2011). - Boom-and-bust: two-year boom starting January 1, 2011 followed by a four-quarter contraction and then four to eight quarters of sluggish recovery (four-year period with a 2-year boom). - Positions and risk factors included: On-balance sheet positions for all positions except those related to the direct exchange rate risk; Credit risk, market risk, and contagion risk. - Methodology: - Banks’ internal risk models applied to own data on portfolios, positions, and incomes as of December 31, 2010. - FSAP team/Authorities: IMF baseline and a combination of models. - Tests combine loss of funding liquidity with liquidity inflows from haircuts on liquid assets, possible fire sales of unencumbered liquid assets and freeing up of a proportion of required reserves corresponding to the volume of departing deposits. ### Severity and design of shocks (sensitivity and scenario calibrations) - Aggregate credit risk (sensitivity tests): Two shocks ranging from moderate (200 percent increase in PD of all exposures-at-default combined with 30 percent increase in LGD, both relative to through-the-cycle levels) to severe (400 percent increase in PD of all exposures-at-default combined with 100 percent increase in LGD, both relative to through-the-cycle levels). - Market risk (interest rates): - Parallel yield curve movements up and down ranging from mild (200 bps for TL; 300 bps for FC) to severe (1000 bps). - Increase (ranging from +500 bps to +2000 bps)/decrease (ranging from -400 bps to -1000 bps) of yields with tilting of the curve. - Movements combined with deposit cost changes (200 bps up or down for TL; 300 bps up or down for FC). - Shock to the swap curve ranging from mild (parallel up or down by 200 bps) to severe (parallel up or down by 600 bps). - Exchange rate shocks: Appreciation (mild: 10 percent; strong: 45 percent) and depreciation (mild: 20 percent; strong: 60 percent). - Combined market risks: Increase in TL and FC yields (strong case with increasing term premium) with 60 percent depreciation of the Lira. - Scenario calibrations (top-down): - Near term sudden stop: sharp contraction in economic activity over four quarters followed by a sluggish recovery over the next 12 quarters. During the contraction: GDP (-9 percentage points (ppts)), unemployment (+4 ppts), domestic interest rate (+10 ppts), real interest rate (+5 ppts), exchange rate (60 percent depreciation). - Boom and bust: a two-year boom in robust economic growth (around 8 percent per year in real terms) and associated credit growth followed by a sharp contraction over four quarters and then a sluggish recovery. During the contraction: GDP (-10 ppts), unemployment (+4 ppts), domestic interest rate (+9 ppts), real interest rate (+4-8 ppts), exchange rate (60 percent depreciation). - Funding withdrawal assumptions: - Sudden Stop Scenario: TL and FX deposits run-off rates of 10 and 20 percent, respectively; short-term wholesale funding overall withdrawal rate ~50 percent; long-term funding ~20 percent. - Boom-Bust Scenario: overall loss of short-term funding ~50 percent; loss of demand and term deposits on average ca. 7 and 14 percent, respectively. - Asset haircuts (examples): - Sudden Stop: Cash 0 percent; government securities 15 percent (trading), 30 percent (available-for-sale and held-to-maturity); Eurobonds 30 percent; equities 50 percent. - Boom-Bust: Cash 0 percent; securities portfolio 44 percent overall haircut with 20 percent of the securities portfolio one encumbered and the haircut on the rest is 30 percent. ### Key stress test findings — solvency and scenarios - Top-line resilience: - Stress tests performed by banks suggest vulnerability to a one-off rise in interest rates and/or deterioration in credit quality, but capital buffers leave institutions resilient to even large shocks. - The FSAP team’s top–down tests suggest resilience to a severe macroeconomic shock of the magnitude and duration that occurred during 2008–10, albeit with a significant impact on capital ratios of all banks. - Sudden-stop scenario results: - Sector as a whole would remain adequately capitalized relative to the regulatory threshold under both Basel I and economic risk-based measures. - Up to four of the nine largest banks may be susceptible to risk of undercapitalization at the end of the 36-month scenario period, depending on the stress test methodology utilized. - Boom-and-bust scenario results: - Continued credit growth for two years followed by a protracted bust: despite assumed improvement in capital buffers during the boom, the NPL effect dominates losses in the bust. - The subsequent macroeconomic shock would push a larger number among the nine banks—a sizeable majority when using the economic risk-based measure of CAR—into undercapitalization within two years into the downturn. - Basel I vs economic risk-based metrics: - The team’s analysis suggests that Basel I capital adequacy metrics may overstate capital buffers. - Basel I risk weights are not sensitive to the cycle and do not account for increases in probability of default and loss-given-default during downturns. - The team’s estimates of bank capital ratios based on the economic risk of assets yielded ratios lower than current regulatory ratios, with capital ratios falling close to regulatory thresholds if measured in 2010. ### Liquidity findings - Current liquidity buffers: - The stress tests suggest the sector currently has adequate liquidity buffers to meet funding shocks. - Given the prominent role of (relatively stable) deposit funding, a majority of systemic banks would be able to meet extreme yet plausible outflows in short-term funding in a near-term sudden-stop event. - Most banks would be able to meet outflows using a combination of existing liquid assets, repo sales of government securities and freeing up a proportion of required reserves corresponding to departing deposits. - Liquidity under boom-and-bust: - If strong credit growth continued, reliance on non-deposit wholesale funding would rise and the proportion of assets usable in repo sales would fall. - Extreme yet plausible wholesale funding runs in the post-boom downturn indicate that a few banks could face significant funding pressure absent a policy response. - Liquidity risks would tend to rise with continuation of the trend toward non-deposit wholesale funding. ### Observations on recent developments relative to scenarios - Macroeconomic and credit developments since the mission moved the baseline between the two tail scenarios: - Credit growth continued very strongly for just over six months then slowed abruptly with a capital outflow. - Developments include a reduction in regulatory capital as risk weighted assets increased during high credit growth and steadily declining liquidity ratios (albeit still comfortably above minimum regulatory ratios). - These developments are broadly consistent with assumptions under the stress test scenarios and do not significantly alter FSAP team conclusions on system robustness. ### Policy implications and recommendations (operational and technical) - Immediate policy and operational implications: - The recent period of rapid credit growth necessitates enhanced scrutiny of underwriting practices. - Interest rate increases and duration mismatches are important sources of bank vulnerability, especially given large mark-to-market portfolios of fixed coupon and discount government bonds. - Unhedged exchange rate risk among Turkish banks does not appear to be significant at present, but the stress tests did not explicitly consider all risks associated with derivatives (e.g., loss of access to the swap market and counterparty credit risk). - Liquidity risk appears manageable at the moment given significant volumes of government securities held for repo funding; however some banks could face significant funding shortfalls in a full-blown sudden stop and increased recourse to short-term, non-deposit wholesale funding would substantially increase refinancing risk. - Enhancing stress testing capacity and use: - Scenario stress testing should evolve from point-in-time combined-shock exercises to testing resilience to a dynamic evolution of the macro-economy that captures tail risks; development of macroeconomic forecasting models is a key technical priority. - Bottom-up stress tests applied to individual systemically important banks should be incorporated into BRSA’s and CBRT’s regular off-site analysis to provide additional information on systemic vulnerabilities beyond top-down analysis. - Greater coordination between the BRSA and the CBRT at the technical level would assist faster and superior incorporation of refinements to modeling and databases. - Stress testing should be used to support policy decisions targeted at safeguarding macro-financial stability, with attention to design and communication of results to strategically support and justify policy decision-making. *Source: FSAP stress testing team.* ### 27. The authorities are aware of the financial stability risks and have responded, ### _cr12261 - 27. The authorities are aware of the financial stability risks and have responded, ### Authorities' assessment and initial response - At the time of the FSAP mission to Turkey (April 2011), policy responses had been predominantly monetary, with the CBRT relying on successive increases of reserves requirements to temper loan growth. - Prudential tools were relatively underutilized at that point; the BRSA had introduced loan-to-value limits on real estate loans and allowed regulatory forbearance measures introduced following the global crisis to lapse in March 2011. - Authorities used moral suasion to target a uniform 25 percent increase on banks’ annual loan growth for 2011, adjusted for exchange rate movements. - FSAP concern: overly aggressive increases in reserves requirements could reduce returns and encourage a shift into high-margin and high-risk segments (consumer and SME loans). The FSAP team recommended a macroprudential approach utilizing a range of complementary measures to better target emerging risks. ### Expanded macroprudential measures (post-mission) — summary of key actions (see Table 10) - Adoption dates as reported: - December 2010 - June, 2011 - June 2011 - June 2011 - August 2011 - September 2011 - September 2011 - Measures introduced by the BRSA and other authorities: - Implements loan-to-value ceilings on housing loans to consumer (at 75 percent) and on purchases of commercial real estate (at 50 percent). - Adoption Date: December 2010 - Higher risk weights introduced for fast growing consumer loans: - For new general purpose loans with maturities below two years, the risk-weighting increased to 150 percent (from 100 percent). - For new general purpose loans with maturity greater than two years, the risk-weight increased to 200 percent (from 100 percent). - Adoption Date: June, 2011 - Increased provisions for consumer loans: - For new (performing) general purpose loans, general provisions increased from 1 percent to 4 percent. - Specific provisions for (pre-nonperforming) loans increased from 2 percent to 8 percent. - The higher provisioning requirements are conditional on banks having a consumer loan portfolio exceeding 20 percent of total loans or having a general purpose loan NPL greater than 8 percent. - Adoption Date: June 2011 - Limits to credit card payments: - If three or more monthly payments within a calendar year are less than half of the outstanding balance for the period, the individual credit card limits cannot be increased and cash advances for such credit cards cannot be permitted, unless the outstanding balance for the period is fully covered. - Adoption Date: June 2011 - Interest rate risk measures: - Announced by the BRSA to contain interest rate risk through capital changes on large maturity mismatches, discouraging duration gaps. Effective from 2012. - Adoption Date: August 2011 - Changes to minimum Capital Adequacy Requirements: - Amended by the BRSA in September 2011 to apply to banks with foreign strategic shareholders as of January 2012. - The minimum ratio would depend on various factors such as the CDS spread of the parent and its sovereign, EBA stress test results and the public debt ratio in the country of origin. - Adoption Date: September 2011 - Changes to deposit insurance premiums: - SDIF introduced a premium surcharge for large banks and a new factor to calculate the banks’ score for the deposit premium determination. - Adoption Date: September 2011 - Impact noted: The June measures on consumer loans, though delayed, contributed to the recent slow-down in credit growth and improved the resilience of the system. ### Further actions and monitoring (recommended conditional responses) - If recent reduction in loan growth proves short-lived and strong credit growth resumes, consider additional measures and explore countercyclical use of prudential tools. - Banks’ portfolio composition monitoring and corrective actions: - Risk of erosion of lending standards and increases in non-performing loans if credit shifts strongly into high-margin segments (consumer loans, SME loans). - Possible corrective actions (non-exhaustive): - Increases in risk-weights. (The authorities increased risk weights for credit cards in 2008 and for general purpose loans in June 2011.) Higher risk-weights could be expanded to other segments including new SME loans. - A cap on debt-to-income ratios. A debt-to-income ratio exists for credit cards (a limit of two times salary for new cards). This could be complemented by a cap on the ratio of all consumer debt to income; full implementation could require creation of a comprehensive credit register. - Capital buffers: - BRSA operates a capital target (at 12 percent) above the regulatory minimum and introduced measures to ensure prudent dividend payouts by banks as part of its crisis response. - Capital buffers can erode quickly when banks expand balance sheets and shift from zero risk-weighted government securities towards higher risk-weighted loans. - BRSA announced steps to boost capital buffers for banks with foreign strategic shareholders in light of the ongoing European debt crisis. - Liquidity buffers: - Current strengths: high share of core deposits and large holdings of sovereign paper. - Risks: credit growth likely to outstrip deposit growth over the medium term, leading banks to increase short-term wholesale funding (much sourced from abroad) and decrease holdings of sovereign paper, eroding liquidity buffers. - Potential preemptive measures: - Tightening existing local standards. - Add requirements on the stability of funding at longer horizons. - A capital surcharge that penalizes short-term funding in addition to current 7- and 30-day ratios. - Note: newly announced capital surcharge on interest rate risk may help funding resilience to a certain extent. - Caution: Timing and calibration of new measures need care to avoid unintended deleveraging. - FX mismatches and corporate sector FX exposures: - Banking sector has a high structural short on-balance-sheet net open position hedged in OTC swap markets with international counterparties. - Increased recourse to FX wholesale funding likely to increase short on-balance-sheet positions and hedging needs, raising counterparty credit and roll-over (basis) risks when swap durations fall short of asset maturity. - Potential corrective measures to limit excessive FX mismatches: - Increases in FX reserve requirements. - Tighter capital and liquidity rules on derivatives. - A cap on the on-balance-sheet short position relative to capital (to constrain very large net open positions relative to capital for individual banks); any new measure should be phased in gradually. - Corporate sector: little systematic data on how much FX borrowing by corporates is hedged. Authorities need to fill this data gap to enable policy action; the BRSA draft regulation on banks’ credit risk management is a step forward. ### Macroprudential policy framework and institutional arrangements - Context: Turkey is systematizing its macroprudential framework in reaction to the 2007/8 crisis. FSAP assessed BCP and IAIS and updated AML/CFT elements. - Institutional findings: - Turkey’s regulatory structure is fragmented, complicating establishment of a strong macroprudential policy framework. - Existing Financial Sector Commission and Systemic Risk Coordination Committee (SRCC) were judged not to provide the right institutional set-up for a focused macroprudential framework. - Recommendation and developments: - FSAP recommended creation of a new Financial Stability Committee (FSC); a decree law created the FSC chaired by the Minister in charge of Treasury (currently the Deputy Prime Minister), comprising Treasury, the BRSA, the CMB, the CBRT and the SDIF. - FSAP view: FSC has improved coordination but institutional structure could be further strengthened. - The framework should ensure accountability and appropriate communication; for example, the Financial Stability Report issued by the CBRT could be used to communicate committee decisions. The new arrangements only require informing the Council of Ministers of FSC conclusions. - It is recommended that a revised macroprudential framework be established through primary legislation rather than an executive decree to enable formal accountability to parliament and clearer design of voting arrangements and powers. - Institutional design options to consider: - Maintain consensual coordinating committee preserving operational autonomy of participating agencies (as in Canada). - Committee able to reach a majority view and issue non-binding recommendations to constituent agencies (as in Mexico and the EU). - Closer institutional integration between CBRT and BRSA (as in the UK), noting benefits and transitional costs—study trade-offs carefully. - Governance suggestion: - Consider assigning chairmanship of the macroprudential committee to the CBRT to harness central bank expertise in risk assessment and preserve independence of macroprudential policy. - Consider distinct arrangements for crisis prevention (macroprudential policy) and crisis management (where SDIF and Treasury might take leading roles). ### Banking regulation and supervision — progress and remaining gaps - Progress since 2007 FSAP: - BRSA promulgated regulations to implement the new Banking Law and adapted regulations to the international environment. - New or draft regulations on internal control, compliance and accounting; draft regulations ahead of planned migration to Basel II (parallel run commenced in July 2011). - Improvements to supervisory and regulatory aspects including major acquisitions, off-site reporting, internal control, and information sharing with foreign supervisors. - Remaining gaps in regulation and supervision: - Definition of regulatory capital needs to be brought fully into line with Basel standards. - Asset classification and provisioning requirements need strengthening to ensure prompt identification of impaired assets and adequate provisioning. - Risk management and requirements for banks in the areas of country risk, liquidity risk, and operational risk should be enhanced. - The framework for related party exposures needs to be strengthened. *Source: IMF staff summary of the FSAP mission content in _cr12261.* ### 46. The BRSA follows a hybrid of CAMELS and risk profiling modules for ### _cr12261 - 46. The BRSA follows a hybrid of CAMELS and risk profiling modules for ### Banking supervision: structure, strengths, and weaknesses - The BRSA follows a hybrid of CAMELS and risk profiling modules for supervising banks, but its risk orientation could be enhanced. - Strengths: - Round-the-year presence in all banks provides an efficient foundation for identifying and dealing with banking problems. - Shortcomings and needs: - Focus is more on rules rather than prospective risks. - Need to put in place systems to ensure valuation of market risk positions and collateral is subject to appropriate levels of management and supervisory oversight. - BRSA needs to continue to build capacity to keep pace with the increasing use of risk models in banks, especially in the transition toward Basel II. - Quality control framework for on-site supervision should be further strengthened: - BRSA has adopted a five-grade rating scale for banks, but most banks tend to be placed in one of two middle grades, reducing discriminative power. - An enhanced internal review process could help ensure consistency across the supervisory review process. - This is particularly important as BRSA has planned to implement Pillar 2 of Basel II. - AML on-site inspection process should be strengthened: - AML issues do not receive significant weight in banking supervision. - Inspections on behalf of the Financial Crimes Investigation Board (MASAK) should be more intrusive and frequent. - This will require increased training on AML issues for BRSA staff and action from MASAK to ensure quality and frequency of the process. - Arrangements for effective consolidated supervision are not in place: - Significant given complexity of Turkish banking system, number of financial and mixed financial/industrial conglomerates, and growing cross border linkages. - Several banks do not monitor all their risks adequately at the group level, particularly market risk and operational risk. - Consolidated supervision should be enhanced to address risks emanating from unregulated entities in the group and monitor intra-group transactions. - Legal and operational independence constraints remain: - New Banking Law provided more autonomy, but some provisions still potentially limit operational and organizational independence. - Constraints include establishment of new departments or directorates, recruitment of expert staff (rules limit mid-career hires to certain jobs), and capacity to attract talent with market related compensation due to linkage of BRSA salary scale to the Government scale. - Continued inability to issue regulations without referring them to the related Ministry and the State Planning Organization limits full operational independence. ### Insurance supervision: legal reform versus institutional capacity - Legal framework transformed, laying a solid foundation for a modern supervisory function, but institutional setup has not progressed as much. - Key institutional shortcomings: - Insurance supervision remains a part of government, causing rigidity and lack of independence. - Government salary scale and hiring practices limit the pool of technical talent. - Inadequate resources: financial resources, modern IT infrastructure, and regulatory tools. - Delegation of key supervisory functions to two departments impedes coordination: - Off-site supervision, regulation and enforcement to GDI; on-site supervision to ISB. - GDI prepares regulations and ISB follows up with on-site supervision but often falls behind implementation. - Functional redundancies and impeded information sharing. - FSAP assessment (mixed): - Successes: - Maintained financial stability and solvency of the insurance market; few and orderly insolvencies and involuntary company liquidations; companies’ solvency ratios have been rising following the introduction of the new solvency regulation in 2006. - Protected interests of policyholders, including creating an effective arbitration mechanism (the Arbitration Commission) to quickly resolve disputes between insurers and policyholders. - Shortcomings and recommendations: - Lack of consultation with the industry when implementing regulatory and supervisory changes, limiting transparency and accountability. - Government passage, after the FSAP mission, of new regulations instituting a consultation process with the industry, and related improvements in transparency and consultation by the ISB, should address these shortcomings once fully implemented. - Efforts should be made to reduce the heavy cost burden on the insurance industry of regulatory and supervisory processes and data reporting requirements. - An impact assessment study of the current solvency regulation should be carried out to ensure realistic assessment of risk capital requirements for companies of different size and risk profile. - Insurance sector-specific aspects of AML/CFT legislation are vague; ISB expertise is not leveraged effectively by MASAK. ### AML/CFT: progress, gaps, and supervisory integration - Progress since 2007 FATF mutual evaluation: - Money laundering (ML) offense largely in line with international standards. - Remaining weaknesses and priorities: - Need adoption of a new CFT Law to adequately criminalize the financing of terrorism (FT) and to set up and implement an adequate legal framework for identifying and freezing terrorist assets. - Several implementation and effectiveness issues require immediate attention. - Supervision enhancements needed: - Supervision of Turkish obliged parties with respect to AML/CFT compliance needs to be strengthened. - Institutional supervisory framework should be integrated to include institutional knowledge and experience of sector supervisors to improve effectiveness of offsite and onsite activities. - Specific actions for banking and insurance supervisors: - For the BRSA: consider developing a new and separate component for AML/CFT, and a new methodology and criteria for addressing potential ML/TF risks. - The new component should assess the cross-cutting nature of ML/TF risks within banking and insurance institutions. - Results to be incorporated into BRSA’s rating approach to arrive at a consolidated institutional risk rating and risk profile to enhance onsite inspections. - Strengthening in legislation covering AML in the insurance sector is needed. - Additional oversight measures recommended: - Establish a definition for PEP and specific requirements for handling this type of relationship. - Immediately resume inspections of obliged parties, particularly banks, insurance companies, and exchange offices, to ensure compliance with requirements to combat ML and FT. - Sector-specific concerns: - From 1997 to 2006, 13 percent of all ML cases referred by MASAK to the public prosecutor involved purchasing real estates. - No suspicious transaction report (STR) had been submitted so far by real estate agencies to MASAK. - Steps taken to strengthen AML/CFT framework relating to real estate agencies, but lack of effective implementation and little awareness in the sector persist. - Current legal framework does not provide for provisions relating to identification of beneficial owners when establishing legal persons, preventing timely access to adequate, accurate and current information on beneficial ownership and control of legal persons. - Additional attention needed to strengthen system for compiling and producing reliable statistical information/data for AML/CFT matters. ### Crisis management framework and coordination - Legal mandate and institutional arrangements: - Turkey’s crisis management framework is mandated in the Banking Act. - Council of Ministers authorized to determine extraordinary measures to deal with a negative development identified jointly by the SDIF, the CBRT, the BRSA and the Undersecretariat of Treasury; those agencies authorized to promptly implement such measures. - Memorandum of Understanding (MoU) and SRCC: - MoU signed in April 2009 by SDIF, CBRT, UT, and BRSA established SRCC and charged it with jointly identifying a systemic event. - SRCC responsibilities include: (a) assessing financial developments; (b) reporting to the Council of Ministers in case of a systemic event; (c) identifying and assessing measures to rebuild stability; (d) establishing working groups; (e) ensuring cooperation, coordination and exchange of information among SRCC members; and (f) assessing implementation and consequences of measures taken. - Annexes to the MoU outline indicative potential negative systemic scenarios and a menu of actions. - Shortcomings and recommendations: - Decision-making process could be clearer and more expedient: - Unclear whether SRCC collective decision requires unanimity and procedures if disagreement arises. - Work of committee has focused on risk monitoring and assessment rather than updating crisis contingency plans. - Relationship between SRCC and newly established FSC is unclear and could lead to disputes. - Consider more clearly separating risk monitoring and crisis management functions. ### Bank resolution framework and SDIF role - Exit procedures and BRSA powers: - 2005 Banking Law improved procedures for exit of failing banks. - BRSA measures can escalate from corrective measures (suspension of distribution of dividends, liquidation of assets, bonus restrictions, etc.), to rehabilitating measures (increase in capital, restrictions on issuance of loans to related groups, changes in board members, etc.), to restricting measures (temporary suspension of activities, dismissal of management, forced merger, etc.). - If bank’s financial position remains weak or risks to financial system stability exist, BRSA can revoke operating permission or transfer the bank to SDIF with affirmative vote of five out of seven members of its Board. - SDIF early warning and resolution responsibilities: - On basis of a protocol between BRSA and SDIF, BRSA notifies SDIF when a bank has been asked to take rehabilitating or restricting measures. - SDIF develops a Resolution Action Plan, including design of bank-specific resolution alternatives, verification process for insured deposit amounts, and plans for rapid deployment of personnel to safeguard IT systems and data. - SDIF legal powers include: - Transfer assets, deposits and participation funds subject to insurance to another bank and ask BRSA to revoke the failed bank’s operating license. - Provide financial support to intervened bank by increasing its capital and/or liquidity. - Sell the financially restructured bank or orchestrate a merger with another bank. - Resolution period: - SDIF has to complete the resolution process in nine months, which might be extended by three additional months. - Concern: relatively long resolution period can exacerbate funding problems and fiscal costs, though it allows scope to deal with legal challenges to transfers. ### Deposit insurance: SDIF assessment - Overall assessment: - Deposit insurance framework managed by SDIF broadly conforms to best international practice. - Key points: - Objectives and mandates: - Under the Banking Act, SDIF’s main policy objectives are to protect rights of depositors and ensure confidence in financial markets; SDIF also charged with resolving intervened banks and managing recovery of assets. - Governance: - SDIF’s operational decisions are legally protected from outside influence; budget subject to parliamentary approval but not part of central government’s budget preparation process; SDIF free to allocate resources as needed subject to certain civil service wage ceilings. - Safety net participation: - SDIF is a member of the FSC; exchanges information with BRSA regarding condition of individual banks and banking sector at coordination meetings held at least quarterly. - SDIF participates in a common information database system run jointly with other safety net participants as part of an early warning system framework. - Reimbursing depositors: - SDIF is legally mandated to reimburse depositors promptly, no later than three months. - While three months appears overly long, in practice the time needed is much shorter. - Financial resources: - Current reserve/insured deposit ratio is about 6.0 percent, somewhat higher than in other comparator countries. - Existing legal mechanisms ensure SDIF can obtain liquidity from the monetary authority (CBRT) and capital from the Turkish Treasury, particularly in crisis times. - Under Treasury’s Debt Management Law dated July 23, 2008, SDIF’s obligations to the Treasury that were contracted prior to end-2007 were cancelled (TL 93 billion). Therefore, the SDIF has been financially solvent since then. - Legally, SDIF can borrow securities from the Turkish Treasury without parliamentary approval (only ministerial approval) up to a yearly limit of 1 percent of annual budgetary allocations. For 2011, that limit would be about TL5 billion. ### Systemic liquidity and Emergency Liquidity Assistance (ELA) - CBRT ELA framework: - Established and sound framework allowing provision of temporary liquidity to solvent banks. - Under CBRT law, banks in need of temporary liquidity (available for up to one year, renewable every month) are eligible for ELA, subject to a CBRT finding that the bank is solvent. - Access to ELA is limited to twice a bank’s capital. - Interest rate charged on ELA facility is the overnight CBRT lending rate for interbank transactions. - Usage of ELA results in regular on-site inspections to confirm that liquidity support conforms to its intended purpose. - Note: The CBRT relies primarily on the BRSA to determine solvency of applicant banks. *Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12261.pdf* ### 70. The ELA is subject to relatively strict collateral and haircut rules which are ### _cr12261 - 70. The ELA is subject to relatively strict collateral and haircut rules which are ### Emergency Liquidity Assistance (ELA): collateral and haircuts - The haircut on the list of eligible collateral ranges from 8.5 percent for foreign exchange deposits to 30 percent for domestic government securities (with a maturity longer than a year) as well as Eurobonds. - The list of eligible collateral for ELA provision is available on the CBRT web page. - The ELA is subject to relatively strict collateral and haircut rules which are explicitly specified in the relevant CBRT regulation. ### ELA eligibility and non-bank market support - The CBRT’s power to provide ELA is limited to banks; the CBRT could not provide ELA to non-bank providers of credit or securities brokers. - Non-bank providers of credit are currently small. - The inability to support security brokers may be an undesirable constraint going forward as securities markets become more important. - The CBRT is already in a position, through repo operations, to provide liquidity to the market as a whole. ### FX liquidity constraints and reserve cover - The CBRT’s ability to provide FX liquidity to banks is constrained by limited official reserves. - The CBRT’s reserve cover of short-term debt declined to 70 percent as of end October 2011. - Banks can draw on a limited CBRT FX depositor facility in times of FX liquidity needs. - Recent changes to the RR framework allow banks to post up to 40 percent of TL RR in FX which serves as a countercyclical measure. - The CBRT has reduced FX RR three times (in July, August and October) providing banks with FX liquidity. - The CBRT has announced to resume its intermediation role in the FX deposit market as of November 10, as seen last during the global financial crisis in 2008/2009, so as to mitigate counterparty risk and enhance the FX liquidity distribution among banks. ### Financial soundness and sectoral indicators (select figures from Table 12) - Household sector: - Rate of growth of financial assets: 21.1 15.8 27.8 12.1 16.2 14.4 14.3 - Rate of growth of liabilities: 110.2 81.1 50.1 35.5 23.9 14.0 30.3 - Financial assets (percent GDP): 34.0 34.0 37.1 37.4 38.6 44.0 43.0 - Financial Liabilities (percent GDP): 5.1 7.9 10.1 12.2 13.6 15.4 17.2 - Loan default rate: 2.6 3.2 2.9 2.9 3.7 6.0 4.1 - Interest payments to disposable income: ......4.6 4.6 5.6 5.2 4.4 - Corporate sector: - Growth rate of total corporate debt: 1.5 20.5 -5.4 34.0 77.9 12.5 19.0 - Corporate debt to equity ratio: 1.1 1.1 1.1 0.9 1.3 1.2 ... - External borrowing to total borrowing: -35.7 37.1 37.0 43.5 39.2 30.0 - ROA: 7.2 5.8 10.0 9.5 7.9 7.2 ... - ROE: -13.3 20.3 22.5 20.5 17.4 ... - Current ratio: 1.3 1.4 1.4 1.5 1.3 1.3 ... - Quick ratio: 1.0 1.0 1.0 1.1 1.0 1.0 ... - Number of Private Companies: 6,645 7,086 5,281 6,862 7,333 8,062 ... - Notes: - For 2010 liabilities to TOKI are as of September 2010. - For 2004 household liabilities do not include liabilities to TOKI due to TOKI’s housing sales with long-term maturity. - Growth rates for debt are computed as the percentage rate of change of level of debt from a given year to the following year's level, 2010 annualized as of September. - Data include only borrowings of corporate sector from financial sector. Figure for 2010 is as of November 2010. ### Risk Assessment Matrix — key threats, likelihood, and expected impacts - A reversal of capital inflows/ external funding collapse in the near term - Staff assessment: High - Triggers and channels: - The continuing uncertainty in the Euro area debt crisis can trigger a sharp increase in external funding costs for Turkish banks, corporates, and the sovereign. - About a third of the banking sector has links to euro-area banks under stress, but direct funding is low. - European banks, pre-occupied with deleveraging, might only roll-over a portion of market funding to Turkish banks (e.g., syndicated loans) and corporates. - Continuing depreciation pressures and a high current account deficit, combined with skepticism regarding the domestic policy mix, can be other triggers. - Expected impact: - A capital flow reversal is likely to lead to a further sharp depreciation and could push Turkey into recession, affecting banks through a collapse of external funding and rising NPLs. - A loan-to-deposit ratio close to 100 percent and stronger reliance on wholesale and money market funding (including CBRT repos) exposes banks to interest rate and roll-over risks on both FX and TL funding. - Overall banks’ maturity mismatch up to one year is US$117 billion (both net on- and off-balance sheets). - Banks’ on-balance sheet short FX positions are close to historical peaks of US$20 billion in September 2011 and would need to be hedged at elevated costs. - The overall net FX exposure of the corporate sector, including SMEs, is at a record-high (US$120 billion) with net short-term liquidity needs at more manageable US$15 billion. - High exposure to the Turkish sovereign exposes banks to the risk of sharp increases in yields and falls in prices given a high proportion of sovereign holdings are marked to market (booked as available for sale). - Stresses on the banking sector are likely to aggravate the recession; a large proportion of corporate loans is at shorter maturities and might not be rolled-over in a sudden stop. - Despite strong balance sheets, households would be impacted from depreciation, inflation, worsening credit quality, higher unemployment and lower earnings. - A continued boom in demand and credit with insufficient policy tightening, followed by a bust in the medium term - Staff assessment: Medium (likelihood), High (expected impact) - Triggers and channels: - Existing macroprudential policies, while contributing to higher loan interest rates and declining credit supply, have not been able to fully rein in strong credit growth. - Fiscal policy has been procyclical and reliant on transient revenues while the CBRT’s unorthodox policy has not been successful in effectively halting the sustained rise in inflation and depreciation pressures. - As long as foreign interest rates remain low, corporates may further increase FX borrowing, increasing their exposure to depreciation and roll-over risks especially with a record-high US$120 billion corporate net FX exposure position. - Continuing demand for credit and strong competition between banks is likely to lead to lowering of lending standards, including in the consumer and SME segment, which could feed a strong build-up in NPLs (from a low base) in the aftermath of the bust. - A shift to higher risk-weighted loans can lead to deteriorating capital buffers; higher provisioning for weaker loan quality will reduce retained earnings’ and capital buffers, though there is some offset from mandated retained earnings. - Continued demand for credit is likely to lead banks to become more dependent on short-term funding (including from the CBRT) as the marginal funding source, increasing vulnerabilities. - Any aggressive policy tightening at the peak of the boom from further depreciation pressures or an unsustainable current account deficit will expose banks to significant interest rate risk given the predominance of short-term funding and to capital losses from government securities’ holdings. - The risk of a real estate bubble appears low, since available data do not indicate significant price increases. ### Status of main recommendations from the 2007 FSAP (selected updates) - Banking law and supervision - All the sub-regulations issued pursuant to the banking law are in effect and executed on a continuous basis. - Procedures related to handling problem banks are given explicitly in Banking Law articles 67–71; BRSA retains view that a supermajority to transfer control of a failed bank to the SDIF is essential. - Coordination Committee (including SDIF) convenes once every three months; contingency planning is evaluated by a Systemic Risk Coordination Committee. - Independence and cooperation - No progress on full financial independence of BRSA since last FSAP report. - BRSA has signed MoUs with 13 out of 26 countries where Turkish banks have presence; a recent law reduced obstacles to information sharing and is expected to enable further MoUs. - Prudential norms and consumer FX exposure - Need no longer arises for FX-indexed loans to consumers as FX-indexed loans to consumers are now prohibited. - Data management and consolidated supervision - Supervision IV Department established in September 2008 to produce consolidated analyses; daily information is obtained from banks and regularly analyzed. - Circular on transferring IT audit reports and new supervision guidelines are being prepared; Supervision program for 2010 formed per guidelines. - Privatization and capital markets - In the 2010–2012 Medium-Term Program, the government announced preparation studies for public offerings of some shares of Ziraat Bank. - The decree law 662 of the Government, dated November 2, 2011, aims to accelerate the privatization process of the ISE. - Amendment in the Capital Markets Law was planned by December 31, 2011 (depending on Parliament Schedule); some provisions were amended by Omnibus Law No: 6111 in February 2011. - Households, insurance, and mortgage rules - New mortgage and insurance law passed; Bylaw on Insurance Related Individual Credits published on January 17, 2009. - General Conditions for Payment Protection Insurance in effect since February 2008. - New mortgage lending legislation announced in December 2010 (effective from 2011): Loans secured by residential real estate limited to 75 percent of collateral value; commercial real estate loans to end buyers capped at 50 percent of collateral value; appraisals must be provided by companies authorized by the BRSA or Capital Markets Board. - Accounting and auditing - Adoption of the Commercial Code in January 2011 will harmonize accounting of small and non-listed firms with internationally accepted accounting standards; requirements enter into force on January 1, 2013. *Source: IMF staff report content as provided in the supplied PDF excerpt.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr12261.pdf_