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The Banks Association of Turkey: 

The Banks Association of Turkey Turkish Banking System Ersin Özince Chairman London, October 2005

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Outline Economic outlook Economic policy framework Main features of the economy Main targets of the economic policy Short term outcomes Expectations for the near future Turkish banking system Main issues affecting banks Operational environment Towards stronger banking system Short-term outcomes and selected indicators Expectations for the near future

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Economic outlook

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Economic Policy Framework Turkey is an open economy Capital flows are free No exchange rate restriction, under floating exchange rate regime Signed the “Customs Union” with the EU in 1995 The EU’s economic criteria regarded as the nominal anchor Turkey is closer to EU membership The stand-by agreement with the IMF extended until 2008

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Main features of the economy Population of 72 million with GNP USD 325 billion and income per capita USD 4,500 Long term average growth rate is about 5 percent Domestic consumption with 70 percent of total demand is the main force behind the growth Services and industry have shares of 58 percent and 30 percent Unemployment rate is about 10 percent Foreign trade volume amounts to 55 percent of GNP. Exports and imports amount to USD 70 billion and USD 110 billion The main trade partner is EU with 50 percent share

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Main targets of economic policy Setting stable rules and institutions eliminating discretionary measures for well functioning market economy Undertaking fiscal responsibility, focusing to reduce debt to GNP ratio through primary surplus Channelling sources to private sector, sustaining stable growth at annual rate of 5 percent, focusing on reducing inflation and reaching price stability Improving fiscal transparency and ensuring better management in the public sector, increasing role of private sector and foreign capital inflows

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Main targets of economic policy Strengthening financial sector Reaching sustainable stability through structural reforms; social security, widening tax base, bankruptcy law, central bank and regulatory and supervisory institutions’ autonomy Meeting EU main economic criteria by 2008 Leading Turkey to become a global player Stronger institutions and rules for market economy

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Short-term outcomes Quick recovery in growth led by private sector Strong fiscal adjustment, sharp decline in inflation Less pressure from the Government on the financial markets due to decline in gıvernment deficit Stability sustained in money and capital markets; a substantial fall in the cost of borrowing and real interest rates Strong TL demand and strengthened financial institutions

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Short-term outcomes Rapid growth in CB reserves and improvement in fx position Jump in lending to private sector and consumer loans Expanding volume of foreign trade Widening current account deficit Foreign investors’ interest on TL assets as well as the banking sector Acceleration in privatisation Strengthening rating outlooks from B- to BB-

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Expectations for the near future Should current program successfully implemented, macroeconomic aggregates are likely to approach to Maastricht criteria in a few years. Thus, an atmosphere for well functioning of market economy is likely to be further improved.

According to the Government programme public sector deficit targeted to receed to 3% of GDP by 2008: 

According to the Government programme public sector deficit targeted to receed to 3% of GDP by 2008 95 . . . . '00 . . . . '05 . . '08 0 -1 -2 -3 -4 -5 -6 -7 -8 -9 -10 -11 -12 -13 -14 -15 -16 -17 -18 -19 -20 Turkey EU-15

Inflation is down 4 percent in 2008: 

Inflation is down 4 percent in 2008

Government debt is likely to meet EU level in 2008: 

Government debt is likely to meet EU level in 2008

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Turkish Banking System

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Main issues affecting banks Since 2002, banks have been operating in a considerably less risky atmosphere Decline in inflation and strong demand for TL stimulated the competition and restructuring the balance sheet Governments pressures on financial markets lessened Regulation likely to meet the international standarts, notably to EU directives Supervision strengthened Better expectations and vital activity stimulated consumer business Foreign investors’ interest intensified Basel II road map was announced

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Operational environment Banks subject to Banking Act in their universal activities and to Capital Market Act in capital market activities Banking Regulation and Supervisory Board is an autonomous authority of the banking sector since 2000. No discretionary regulation for foreign banks operating in Turkey Regulatory capital for establishment of a bank is currently about USD 15 million Financial sector is small and has low degree of deepening Despite gradual improvement, deposits have very short term maturity

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Traditionally banks occupy majority, 95 % of financial sector Financial services subject to various heavy tax burdens increasing intermediation cost dramatically, although some positive steps taken recently The share of fx or fx denominated items in the balance sheet still high albeit shrinking recently High techonology utilization on services

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Towards stronger banking system An independent regulatory and supervisory body was founded Weak banks were eliminated, remaining banks were recapitilized and restructured Regulation changed in line with the international standards; Reporting, auditing and transparency improved Prudential regulations on related party loans, fx position and equity participations, provisioning tightened Supervision incorporated market risk Banking Act is on the pipe-line

Banking Law No. 5387(adopted by the Parliament ): 

Banking Law No. 5387 (adopted by the Parliament )

General Legal Grounds: 

General Legal Grounds Enhanced legal structure for changing and developing banking activities and risks Dynamic structure for bank supervision and auditing activities Harmonization of the Banking Law with EU directives, international principles and standards

Scope of the Banking Law: 

Scope of the Banking Law deposit banks contribution banks development and investment banks financial holding companies Title of special finance institutions is changed as contribution banks, The scope of the Banking Law is enlarged to cover financial holding companies, Banks Association of Turkey, Turkish Association of Contribution Banks, Banking Regulation and Supervision Agency (BRSA), Saving Deposits Insurance Fund (SDIF) and their activities, Provisions related to supervision and audit of support services institutions and valuation and rating institutions by BRSA are brought .

Definitions: 

Definitions In harmony with international banking terminology the definitions in the Law are redefined, the new definitions added

Permissions for establishment and operation : 

Permissions for establishment and operation fields of banking activities are classified in line with the EU directive the principles and procedures that are applicable for permission applications and granting permissions are determined extensively as a part of prudential supervision the conditions sought for the bank founders are harmonized with EU directives and BIS principles principle is brought to give legal reasons for refusal of applications for authorization the paid-up capital requirement is increased to min. TRY 30 million for credit institutions, TRY 20 million for development and investment banks.

Corporate governance: 

Corporate governance In parallel to international principles, the provisions related to corporate governance principles are set out

Supervision and Audit: 

Supervision and Audit integrity of on-site supervision and audit activities independent audit, internal audit, internal control and risk management in line with the international practices principles of on-site supervision and audit to be determined by Banking Regulation and Supervision Agency (BRSA) all activities including IT systems subject to audit process risk-based approach in bank supervision audit performed in a consolidated and coordinated manner

Protective Provisions: 

Protective Provisions All the limitations and standard ratios shall be considered on a consolidated basis Shareholders equity shall not be less than the paid-in capital. In case the limits and standard ratios set in the Law are reached or exceeded, the relevant bank shall promptly inform the BRSA Provision related to the minimum liquidity regulation to be set by BRSA is brought Loan definition is broadened (bails, avals, receivables incurred from reverse repurchasing transactions, financial leasing receivables)

Legal Obligations: 

Legal Obligations Banking secrecy Customer rights Ethical principles

Limits: 

Limits Limits on loans to a real person or legal entity or a risk group are fully harmonized with the EU directives Banks are prevented to transfer their funds to close the budget deficits of their funds and foundations Provisions dealing with donation limits and hidden transfer of earnings are added

Deposit Insurance : 

Deposit Insurance In conformity to the practices in the EU; the deposit banks are required, to take out insurance cover only for the part of the deposits held with them subject to insurance. to pay saving deposits insurance premiums over the sum insured as above

Measures against systemic risk: 

Measures against systemic risk In case of determination of a systemic risk danger as a result of joint evaluation by the Fund (SDIF), the Treasury Undersecretariat and the Central Bank under coordination by the BRSA, the Council of Ministers is authorized to identify, take and impose extraordinary measures and actions

Exclusion from the banking system : 

Exclusion from the banking system BRSA has administrative and financial autonomy so as to ensure exclusion from the banking system of the institutions which fail

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Short-term outcomes Strengthened confidence in the banking sector and rating outlooks Banks gradually adopting to changing environment; disinflation and recovery are likely support the sector Full quarantee on deposits limited Improvement in asset quality; NPLs’ contained and highly provisioned Regulatory capital requirements met, economic and working capital began to rise Earnings less dependent on windfall and inflationary gain from the Governmet securities as interest margin and income from fees and commission increased Improving return on equity is likely to encourage capital growth

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Short-term outcomes Higher lending tendency to private sector Risks arising from fx and interest rates lowered but maturity gap is still important Foreign banks’ share increasing Concentration rise Risk management improved Foreign borrowing accelerated Banks’ market capitalisation jumped

Reduced pressure on financial sector; demand from non-banks investors, notably from foreign investors: 

Reduced pressure on financial sector; demand from non-banks investors, notably from foreign investors 2002 2003 2004 2005* As % GNP Domestic debt 55 54 52 52 Domestic debt/M2YRF 106 118 110 104 Deposit banks G-securities 14 27 27 27 Non-banks residents G-securities 11 14 15 13 Foreign investors G-securities * As of August 1 1 3 5

Upward trend in TL deposits and loans, notably to households: 

Upward trend in TL deposits and loans, notably to households 27.12.02 26.12.03 31.12.04 02.09.05 As % of GNP Deposits 52 45 46 48 TL deposits 22 23 26 29 Loans/deposits 38 43 52 59 Loans 20 20 24 28 Consumer loans 1 4 4 5 Credit cards 1 4 4 3

Substantial change in the structure of financial assets; share of TL monetary assets and equities up: 

Substantial change in the structure of financial assets; share of TL monetary assets and equities up

Total assets grew rapidly in USD terms but remained almost the same as % of GNP: 

Total assets grew rapidly in USD terms but remained almost the same as % of GNP Total assets 99 '00 '01 '02 '03 '04 '05 J 0 50 100 150 200 250 300 USD billion 0 20 40 60 80 % Total assets As % of GNP

Dramatic decline in number of banks: 

Dramatic decline in number of banks Number of banks 80 85 90 95 99 '00 '01 '02 '03 '04 '05 J 0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 Total Private dep banks

Number of branches began to rise in private banks: 

Number of branches began to rise in private banks

A steady increase in number of employees, notably in private banks: 

A steady increase in number of employees, notably in private banks

Asset size getting larger: 

Asset size getting larger Bank total asset size USD billion/number 99 '01 '02 '03 04 05 J 40+ 1 1 30-40 1 2 20-30 1 1 1 2 2 2 10-20 1 5 5 4 4 2 5-10 6 2 1 1 4 5 1-5 19 10 12 13 11 10 0,5-1 11 4 5 3 1 2 - 0,5 43 28 26 26 25 24 Total 82 50 50 50 48 48

Large banks increase their market share: 

Large banks increase their market share Concentration 80 90 '00 05 J First five* Asset 63 54 48 61 Deposits 69 59 51 65 Loans 71 57 42 54 First ten* Asset 82 75 69 84 Deposits 88 85 72 89 Loans 90 78 71 78 * according to asset size

Structure of the banking system: 

Structure of the banking system Market structure June 2005 Banks Emloyment Brances Assets Loans Deposits % share % share % share Deposit banks 35 125.416 6.034 96,5 94,1 100 State owned 3 39.080 2.039 32,5 19,9 39,5 Private 19 79.870 3.786 60,1 69,3 57,1 Fund 1 401 1 0,5 0 0 Foreign 12 6.065 208 3,4 4,8 3,4 Non-deposit taking banks 13 4.471 19 3,5 5,9 0 Total 48 129.887 6.053 100 100 100

Higher share of loans in the total assets : 

Higher share of loans in the total assets

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Breakdown of loans (%) 2002 2004 Exports 19 14 Working 16 19 Consumers 5 13 Housing 1 3 Automobile 1 4 Credit cards 9 14 Investment 8 6 Others 41 27 Total 100 100

Rising shares of TL deposits and equity in liabilities: 

Rising shares of TL deposits and equity in liabilities

Increase in TL assets in total assets and..: 

Increase in TL assets in total assets and..

...TL sources in total liabilities: 

...TL sources in total liabilities

Rather stable fx position; met the requirements: 

Rather stable fx position; met the requirements Fx position* (Fx assets-fx liabilities) * excluding fx indexed assets and liabilities 88 90 95 '00 '01 '02 '03 '04 '05 June 0 5 -5 -10 -15 -20 USD Billion Sector Including fx indexed

Stronger capital; thanks to the restructuring program and economic recovery: 

Stronger capital; thanks to the restructuring program and economic recovery Shareholders' equity '99 '03 '04 05 J 0 10 20 30 40 USD billion 0 5 10 15 20 % Shareholders' equity As % of t assets State-owned Private

Working capital improved rapidly : 

Working capital improved rapidly Free capital* * Shareholders' equity+current year net income-permanent assets 99 '00 '01 '02 '03 '04 '05 J 0 5 10 15 20 -5 USD billion Sector State-owned Private

More radical reporting for NPLs, higher provisions and strong demand for loans : 

More radical reporting for NPLs, higher provisions and strong demand for loans NPLs 92 93 94 95 96 97 98 99 '00 '01 '02 '03 '04 '05 J 0 1 2 3 4 5 6 7 USD billions 0 1 2 3 4 5 6 % Before provisions After provisions As % of total assets (net)

Permanent assets share in total assets coming down: 

Permanent assets share in total assets coming down Permanent assets* As % of total assets * Fixed assets+equity participations+subsidiaries+NPLs '99 '00 '01 '02 '03 '04 '05 J 0 2 4 6 8 10 12 14 16 % Sector State-owned Private

Recovery in profitability: 

Recovery in profitability Return on assets (%) Figures in 2001-2004 are according to inflation accounting '99 '00 '01 '02 '03 '04 '05 J 0 2 4 6 -2 -4 -6 -8 Sector State-owned Private

From losses to sustained profitability; likely to encourage investors: 

From losses to sustained profitability; likely to encourage investors Return on equity (%) Figures in 2002-2004 are according to inflation accounting '99 '00 '01 '02 '03 '04 '05 J 0 20 40 60 -20 -40 -60 -80 -100 -120 % Sector State-owned Private

Sustained improvement in efficiency : 

Sustained improvement in efficiency Selected efficiency ratios, sector 2002 2003 2004 2005 June Net interest margin/total assets %2.75 %3.90 %4.87 %4.38 Expenses/total assets %4.56 %4.27 %3.59 %3.42 Retun on banking activities -%1.81 -%0.36 %1.27 %0.96 Expenses/Income (ecluding divident) %65.35 %53.36 %48.70 %50.34 Expenses/Income (including divident) %63.23 %52.45 %47.55 %49.02 Return on assets (before tax) %1.65 %3.22 %2.97 %3.56 Return on assets (after tax) %1.11 %2.25 %2.11 %2.50 Return on shareholders' equity (before tax) %13.66 %22.65 %19.81 %25.58 Return on shareholders' equity (after tax) %9.17 %15.79 %14.05 %17.96 * 2005 June simply annualized

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Selected ratios Sector 02 03 04 05 J Capital adequacy Share holders' equity As % of risk weighted assets 24 31 29 26 As % of total assets 12 14 15 14 Free capital 2 6 8 7 As % of total assets Asset quality (%) Securities portfolio 41 43 40 39 Loans/total assets 27 28 34 37 Non performing loans (ap)/total loans 6.6 1.4 0.7 0.6 Provisions for NPL 64 89 88 88 Permanent assets/total assets 10 8 7 7 Liqudity (%) Liquid assets/total assets 34 39 37 38 Liquid assets/short term liabilities 75 81 84 80

Positive developments in the banking system positively reacted by the investors: 

Positive developments in the banking system positively reacted by the investors Market capitilization of financial institutions (shares are traded ISE, (USD million) 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 01 02 03 04 05 June

Rapidly growing numbers of credit and debit cards: 

Rapidly growing numbers of credit and debit cards Selected inditacors Thousands 2002 2003 2004 ATMs 12 13 14 POS machines 496 662 912 Credit cards (1000) 16 20 27 Debit cards (1000) 35 40 43

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Expectations for the near future Larger and deeper financial markets Lengthening the maturities Higher lending to private sector Sufficient earnings to feed capital Decline in margin with widening business activity Positive atmosphere for foreign investors Intense competition on behalf of depositors and borrowers Improvement in transparency and accounting rules for better financial system

Substantial growth during the last years: 

Substantial growth during the last years

Still low degree of banking on the basis of inhabitants: 

Still low degree of banking on the basis of inhabitants Selected figures of deposit banks (for inhabitants) 80 00 05 II Number of banks (for 1000 inha) 1.111 1.105 2.051 Number of branches 7.471 8.636 11.899 Number of employees 356 409 602 Assets (USD) 382 2.196 3.397

Approaching the emerging markets average, substantially low compared to developed countries: 

Approaching the emerging markets average, substantially low compared to developed countries

High growth potantial compared to EU-15: 

High growth potantial compared to EU-15