World Economy

Turkey Banking System Outlook Negative

Turkey Banking System Outlook NegativeTurkey Banking System Outlook Negative

The Turkish banking sector’s dependency on external wholesale markets could contribute to higher funding costs in light of a weaker international investor confidence, says Moody’s Investors Service in a report published Wednesday.

Banks also face challenges from a slower economic growth, increasing dollarization of liabilities and volatile sentiment towards emerging markets, all of which keeps the banking system on a negative outlook.

The rating agency’s report is an update to the markets does not constitute a rating action. “While muted economic prospects will weigh on loan performance and profitability, the banking system remains well capitalized. We expect delinquencies to rise to about 3.5% or 3.8%, in light of the lira’s depreciation and the slower economy,” says Irakli Pipia a vice president and senior credit officer at Moody’s.

The agency expects problem loans to rise by 40-60 basis points, albeit from a low base of 3.1% at end-2015, with loans for consumers and small to mid-sized companies bearing the brunt. The stock of problem loans in these segments has already grown significantly over the past year.

Though corporate loans have so far proven resilient to the economic slowdown, they remain vulnerable to a combination of local currency depreciation and a likely increase in their borrowing costs.

 Narrowing Margins

Moody’s says the sector’s growth is vulnerable to changing investor sentiment, given Turkey’s high external financing needs. Profitability of Turkish banks will face pressure from narrowing net interest margins due to the banks’ rising borrowing costs, driven by their large foreign currency liabilities.

The banks have solid capital buffers that can absorb a rise in loan losses. The system’s average tier one capital ratio was 13.3% as of end-2015. On balance, given Moody’s moderate credit growth expectation this year, system-wide capital ratios will likely remain broadly steady, although they are vulnerable to any further local currency depreciation due the large volumes of foreign currency assets on banks’ balance sheets.

Turkish banks will depend heavily on capital market borrowing to finance a substantial part of their lending reflected in the loan to deposit ratio of 123% at end-2015. Short-term wholesale funding, the bulk of it denominated in foreign currency, is a growing part of liabilities.

Although Moody’s expects relationship-driven interbank borrowings (about 40% of the total wholesale funding) to roll-over during 2016, the rating agency notes that this refinancing may incur higher borrowing costs in the context of investors cautious appetite towards emerging markets.

In Moody’s view, the probability of government support for troubled banks will diminish gradually, with some legislative developments planned during 2016 that will enhance the authorities’ powers to impose losses on creditors to recapitalize an ailing bank, if needed.