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From Crisis to Stability: Restructuring of the Turkish Banking Sector

From Crisis to Stability: Restructuring of the Turkish Banking Sector. A. Teoman Kerman Vice President. “Strong Banking Sector, Strong Economy”. Outline. Structural problems Impact of the crisis Restructuring strategy Restructuring of the state banks Resolution of the SDIF banks

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From Crisis to Stability: Restructuring of the Turkish Banking Sector

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  1. From Crisis to Stability: Restructuring of the Turkish Banking Sector A. Teoman Kerman Vice President “Strong Banking Sector, Strong Economy”

  2. Outline • Structural problems • Impact of the crisis • Restructuring strategy • Restructuring of the state banks • Resolution of the SDIF banks • Strengthening of the private banks • Improving the regulatory and supervisory framework • Results of the restructuring • Remaining challenges and BRSA agenda • Lessons learned “Strong Banking Sector, Strong Economy”

  3. Pre-crisis structural problems • Small scale and segmented market structure “Strong Banking Sector, Strong Economy”

  4. Licensing of banks 1980-1999 • 56 banks were licensed (42 deposit banks and 14 Development and Investment banks) • 15 of the 20 intervened banks were licensed in the post-1980 period; of these 13 were licensed in the 1990s. • Ownership details of intervened banks: • 6 were media groups • 12 were conglomerates • Remaining 2 were cooperatives and pension funds • Asset size of these banks were about 21 billion USD while their liabilities were about 30 billion USD (shareholders equity excluded) “Strong Banking Sector, Strong Economy”

  5. Asset growth 1980-2000 “Strong Banking Sector, Strong Economy”

  6. Large FX open positions of private banks Crisis “Strong Banking Sector, Strong Economy”

  7. Crowding out by government Note: 2001 and 2002 data reflect the results of the three-stage audit process and are inflation-adjusted. “Strong Banking Sector, Strong Economy”

  8. State banks: pre-crisis conditions • Liquidity problems • State banks with over-night liabilities of $14 billion • Low asset quality • Inadequate risk assessment and management systems • Lack of good corporate governance “Strong Banking Sector, Strong Economy”

  9. Summing up: Pre-crisis conditions • Banks • Liquidity problems • State banks with over-night liabilities of $14 billion • Large open positions of the private banks • Significant share of holdings of government debt • Low asset quality • Inadequate risk assessment and management systems • Lack of good corporate governance • Operating Environment • Major macroeconomic instability • High public sector deficit • Systemic distortions created by state and weak banks “Strong Banking Sector, Strong Economy”

  10. Sharp increase in interest rates Sharp depreciation of the Turkish Lira Contraction in economic activity Maturity mismatch  funding losses Decline in the value of securities portfolio Short-positionsFX losses Asset Quality Credit Risk Result: Erosion in Capital Base November and February Crises Macroeconomic Shocks Impact on the Banking Sector “Strong Banking Sector, Strong Economy”

  11. The initial fiscal costs of the Turkish crisis have been high In addition, private banks raised $2.4 billion of capital from own resources. Thus, there has been a significant burden-sharing as $7.1 billion of the restructuring costs were borne by the private sector. “Strong Banking Sector, Strong Economy”

  12. But crises also provide opportunities for major restructuring • Banking System Restructuring Program announced on May 15, 2001 • Objective is to eliminate distortions in the financial sector and adopt regulations to promote an efficient, globally competitive and sound banking sector • 4 Main Pillars • Restructuring of the state banks • Resolution of the SDIF banks • Strengthening of the private banks • Improving the regulatory and supervisory framework “Strong Banking Sector, Strong Economy”

  13. Goal: Sound banking-strong economy Sound Banking  Strong Economy and Sustainable Growth Environment Banking Sector Restructuring Program State Bank Reform Strong Capital Base Cost Efficiency Efficient Supervision Market Discipline and Transparency • Structural Reform • Macroeconomic Stability • Decline in Public Deficit Corporate Restructuring

  14. Financial restructuring of the state banks • Liquidation of duty losses • ( $19 billion) • Elimination of the over-night liabilities • ( From $14 billion in March 2001 to zero in 2002) • Strengthening of the capital base • ($2.9 billion) • Appropriation in the budget for any subsidies provided through the state banks • Determination of deposit rates uniformly with market rates • Efficient management of the loan portfolio “Strong Banking Sector, Strong Economy”

  15. Operational restructuring of the state banks • Appointment of a Joint Board of Directors • Monitoring program for profitability, liquidity, and interest margins • Establishment of internal control, financial control and risk management units • Improved efficiency and productivity • As of December 2002, number of branches and personnel were reduced by 32% and 51%, respectively, compared to December 2000. “Strong Banking Sector, Strong Economy”

  16. Intervention of the insolvent banks by the SDIF November 2000 Crisis The Government’s Declaration to Expand the Scope of the Guarantee covering all liabilities of SDIF banks Liquidation limited by the scope of the existing deposit insurance Direct liquidation after takeover by the SDIF Resolution under the SDIF • Legal process has been shortened • compared to direct liquidation • Resolution process has been facilitated • through deposit transfers • Some portion of employees were kept • employed through branch/bank sales • Internal/external confidence • loss to the financial system • Bank runs (Indonesian example) • Withdrawal of deposits • from the banking system • (Total deposit $75.5 billion) • $ 26 billion cash requirement instead of • transferring funds in the form of • Government Securities to the SDIF • Need for over-borrowing • Excessive pressure on interest rates • Impossibility of sustaining the debt • service “Strong Banking Sector, Strong Economy”

  17. Rapid resolution of the intervened banks • 20 banks were taken over by the SDIF 1 bank in 1997 Law Nr.3182 1 bank in 1998 Law Nr.3182 6 banks in 1999 Law Nr.3182 (1), 14.3 (1), 14.3/14.4 (4) 3 banks in 2000 14.3 (1), 14.3/14.4 (2) 8 banks in 2001 14.3 (3), 14.3/14.4 (5) 1 bank in 2002 14.3/14.4 • The resolution of these banks through merger, transfer, sale or liquidation within 2 years (As of today only 2 banks remain under SDIF) “Strong Banking Sector, Strong Economy”

  18. Resolution Process of the SDIF Banks • Financial Restructuring; • Elimination of over-night liabilities • Reduction of FX open positions • Determination of deposit rates uniformly with market rates • Auction of deposits of about $3bn to other banks • Transfer of liabilies to other banks • With operational restructuring, significant reduction in the number of branches and personnel • Excluding 2 remaining banks number of branches were reduced to 6, personnel to 583. • With bank sales, a total of 10,337 jobs were kept. “Strong Banking Sector, Strong Economy”

  19. Initial costs of resolving the intervened banks Most of these funds were used for meeting the deposit liabilities (total $26 billion) of the SDIF banks through payments and/or transfer. “Strong Banking Sector, Strong Economy”

  20. Legal obstacles to a rapid collection of assets of intervened banks • SDIF has collected a total of $1.7 billion via direct collection, sale of subsidiaries, tangible and intangible assets and bank sales. • Dragging legal porcedures and lawsuits are a major impediment to rapid collection. “Strong Banking Sector, Strong Economy”

  21. Strengthening of the private banks Özel Bankalar • Debt swap operation: Private banks’ FX open position to $1.5 bn in December 2001 from $8.4 bn at end-2000 • Lower interest rate risks: Issuance of floating rate, FX indexed and FX denominated government bonds • Financial and Real Sector Council: to develop strategies to resolve NPLs and to restructure corporate debts “Strong Banking Sector, Strong Economy”

  22. Recapitalization scheme for the private banks • Rationale Increase in potential credit risk • Deep-rooted structural problems • Deeper than expected recession • Adverse international environment Limited possibilities of liquidation of assets in current economic conditions Limited scope for raising new capital from domestic and foreign private investors Vicious cycle of banking crisis-real sector crisis “Strong Banking Sector, Strong Economy”

  23. Recapitalization scheme for the private banks Objectives • To ensure transparency and enhance confidence in banking sector • To maximize capital contributions by banks’ owners • To encourage mergers and acquisitions • To enable banks to start extending credits to real sector • To facilitate corporate debt restructuring • To restore market discipline “Strong Banking Sector, Strong Economy”

  24. Recapitalisation Program Phases Announcement of BRSA’s final assessment results to the banks Start of the procedure with the completion of the legal framework Completion of appropriateness control (second audit) 15.05.02 Realization of the capital support by Public Submission of Merger& Acquisition plans (where relevant) to BRSA 01.02.02 22.04.02 Realization of capital increases Finalization of the first audit Application to BRSA for support Meetings of General Assemblies 01.04.02 30.06.02 30.04.02 Assessment Phase Bank Recap. Phase State Recap. Phase “Strong Banking Sector, Strong Economy”

  25. Results of the Audit Process Özel Bankalar • The transparency of the banking sector has increased. • The ability of the public sector authority to design and apply sound policies towards the establishment of a healthy and efficient banking sector has been improved. Statistical Results: • The total capital needs of the 25 banks have been determined as 866 mil. $ • After negotiations, 720 mil. $ of the capital needs has been covered by banks and with other positive developments (e.i. decline in int.rates increased the value of gov’t papers). Remaining capital needs was 146 mil.$. “Strong Banking Sector, Strong Economy”

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

  27. Results of the Recap Scheme Özel Bankalar • Banks realized capital increase of $2.4 billion from their own resources. • As a result of the three-stage audit, 3 banks were found to be capital deficient. • 1 bank applied for state support and received subordinated debt to reach 9% capital adequacy ratio. • Another bank’s capital need was covered in cash by shareholders. The capital increase process was finalized as of September 2002. • Pamukbank, with a capital deficiency of about $2 billion, was transferred to the SDIF “Strong Banking Sector, Strong Economy”

  28. Improving the regulatory and supervisory framework Yasal ve Kurumsal Düzenlemeler Moving towards international standards • Regulations on capital • Regulations on risk management • Regulations on credit and subsidiaries’ limits and loan loss provisioning • Accounting standards and independent auditing • Regulations on facilitating mergers and acquisitions • Regulations on special finance houses • MoUs with other countries supervisory authorities “Strong Banking Sector, Strong Economy”

  29. Results of operational restructuring • Consolidation in the banking sector Number of banks declined from 81 in 1990 to 53 as of April 2003 • Decline in the share of the State and the SDIF banks During 2000-2002 the share of these banks in total loans and deposits from 34.2% to 18% and 53.3% to 39.3%, respectively. • Increase in mergers and acquisitions Total asset size of the mergers and acquisitions that took place in the sector is around $26.5 billion “Strong Banking Sector, Strong Economy”

  30. Results of financial restructuring • Reduction of financial risks to manageable levels. • Improved transparency • Improved profitability In 2002 private banks generated a profit of $1.5 billion, state banks generated a profit of $646 million • Strengthened capital structure CAR rose to 27.1% in December 2002 from 9.3% in December 2000. “Strong Banking Sector, Strong Economy”

  31. Effects on the private sector • Istanbul Approach A total of $3.8 billion of loans of 135 firms were restructured. • Increased credit extension Credits rose to $29.4 billion in 2002 from 23.4 billion in 2001. “Strong Banking Sector, Strong Economy”

  32. Although certain risks have been decreased to more manageable levels... • Interest Rate Risk Issuance of bonds with variable interest rates Distortions created by state banks and insolvent banks eliminated • Credit Risk Adequate classification of NPLs after the 3-stage audit Realistic assessment of collateral Necessary provisions have been set aside • FX Risk Issuance of FX-indexed bonds Implementation of floating rate regime Improvements in risk management “Strong Banking Sector, Strong Economy”

  33. ...some risks still remain • Despite Istanbul Approach share of NPLs are still high Total sector Loan Loss Ratio = 17.8% For 25 Re-cap banks this ratio is 10.1% in 2002 compared to 24.7% in 2001 • Short-term maturity structure of deposits More than 90% of the deposits have a maturity of less than 3 months • 57% of the deposits are in FX • High share of Government bonds in the balance sheet For Private Banks in 2002 Securities /Total Assest= 33.3% • Low level of free capital • High level of operational costs “Strong Banking Sector, Strong Economy”

  34. BRSA’s agenda • Rationalization of intermediation costs • Establishment of financial holding companies • Providing a level playing field in the sector • Establishment of secondary markets for distressed debt • Incentives for rapid resolution of NPLs • Compliance with BASEL-II Accord • Risk based supervision “Strong Banking Sector, Strong Economy”

  35. Challenges faced by the BRSA • Legal obstacles • Lack of political backing and consensus • Intense lobbying by pressure groups • Relationships between media and bank groups • Public awareness • Institutional draw-backs • BRSA - SDIF relationships • Institutional development of BRSA • Lack of secondary markets for distressed debt “Strong Banking Sector, Strong Economy”

  36. Key Lessons: Restructuring instruments utilized by the BRSA • Introduction of blanket guarantee • Voluntary debt swap (TL to FX indexed) • Tax incentives for merger and acquisitions • Tax incentives to lengthen maturity of deposits • Merge then resolve (sell or liquidate) strategy • Superpowers granted to the SDIF to accelerate collection • SDIF deposit auctions • Re-capitalization scheme and provision of Tier-II capital • Agree on protocols to accelerate collection process and to minimise costs • Voluntary corporate debt restructuring (Istanbul Approach) “Strong Banking Sector, Strong Economy”

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