Understanding Turkey: Lower Banking Sector Profitability Ahead

Key takeaway—Over the next five years, Turkey’s banking sector profitability is expected to slow, as ‘return on equity’ will decline from 18.4 (10-year average) to 13 percent; however, banks’ balance sheets will remain healthy, with a capital adequacy ratio above 12 percent.

Over the next five years, Turkey’s economic growth will slow. Over 2015-19, despite volatile politics, AKP and Erdoğan are likely to stay in power. The economy will mature: potential-growth will decline to 3.9 percent—a lower, less-volatile level than the average of the past ten years (5.1 percent), due to a gradual liquidity withdrawal from Emerging Markets (EM) and delayed micro-economic reforms. Yet, performance will be better-than-peers.

A. Banking sector: high but declining profitability, healthy balance sheets.

In the medium term, banks’ profitability is expected to decline… In 2013, banking profitability—measured as ‘return on equity’—declined to 14.2 percent from 15.9 in 2012, down from a 10-year average of 18.4 percent. Profitability was hampered by rising interest rates and TRY depreciation. Over 2015-19, these factors, coupled with lower growth, are likely to keep depressing returns (Figure 1).

Figure 1: Banking sector: lower profitability ahead

Turkey – Banking sector profitability (net income/average shareholders’ equity, %)

Source: BRSA, authors’ calculations, 2014.

… as Turkish banks tend to run both a maturity and currency mismatch… On the maturity side, they borrow on the short-end (through deposits), and lend on the long-end (via fixed-interest rate loans). As a result, rising interest rates hamper profitability. On the currency side, banks borrow in foreign-currency and lend in TRY. Yet, most FX-borrowing is hedged.

but balance sheets will remain healthy. Going forward, interest rates will remain high and the spread between lending and borrowing rates will stay higher than in Developed Markets (DM)—resulting in relatively higher banks’ profitability in Turkey, especially when compared to Europe or the US.

B. Banking risks: rising loan-to-deposit ratios, dependence on foreign funding, declining margins.

1. In the past 6 years, “loan growth” outpaced “deposit growth”, resulting in rising loan-to-deposit (LTD)[1] ratios. At the end of April 2014, banking sector LDRs (excluding financial institutions) stood at 111 percent, up from 74 in December 2009 (Figure 2). To fund this asset expansion, Turkish banks increasingly rely on bond issuances and foreign credit via syndicated loans—rather than on deposits. In the short term, given high liquidity, capital buffers and relatively low non-performing loans (NPLs)—which stood at 3.2 percent in April 2014[2]—lack of local funding is unlikely to be an issue for Turkish banks. However, in the medium term, the FX-mismatch could rise and increase vulnerability.

Figure 2: Rising LTD ratio, while NPLs remain low

Turkey – Loan-to-deposit ratio vs Non-performing loans, share in total (%)

Source: BRSA, 2014.

2. Hidden leverage could result in lower growth. When looking at average data, household indebtedness is low by international standards; in 2012, the average household’s debt–to-income ratio was 51 percent, while the OECD average was 128 percent. However, disaggregating the same data shows a heavily indebted low-income group and a relatively less leveraged upper-income group. When liquidity is withdrawn from EMs, interest rates will rise, and low income-households will find it increasingly difficult to pay back loans, resulting in higher NPLs. As a result, a banking crisis is unlikely, but banks’ balance sheets could significantly weaken, bringing about slower credit growth and—thus—lower economic growth.

3. Lower margins ahead call for a different business model. Currently, banks make profits by “playing the yield curve”; as mentioned, they borrow on the short-end and lend on the long-end. Until recently, declining interest rates and a steep yield curve made good returns possible. However, in the medium-term, liquidity will be tighter. Higher interest rates might push banks to change their business model: with lower interest-rate-margins, banks will need volumes to generate profits. Bigger banks and early-movers will get ahead, and banks with smaller balance sheets will be forced to find a niche to generate returns.

In sum, as Turkey’s economy is maturing, banking sector profitability is expected to slow. Over the next five years, Erdoğan and AKP will face opposition but are likely to stay in power. As economic growth will decline to lower levels, the banking sector’s ‘return on equity’ will slow from 18.4 (10-year average) to 13 percent; however, banks’ balance sheets will remain healthy, with a capital adequacy ratio above 12 percent.


[1] A ratio used to assess the liquidity of a bank, computed by dividing “total bank loans” by “total bank deposits”.

[2] The recent credit expansion brought about a reduction of NPLs due to debt rollover, in both corporates and households.