session6 ahmet erturk

Islamic Banking: Case of Turkey : Islamic Banking: Case of Turkey 6th IADI Annual Conference Malasia, 1-2 Nov 2007 Ahmet ERTÜRK President of SDIF


Outline : Outline 1 –Need for DIS 2 – Risks of Participation Banks 3 – Challenges and Conclusion


Share of Participation Banks in the Banking Sector : Share of Participation Banks in the Banking Sector As of the end of June 2007 total assets of participation banks rose to USD 12.869 million while share of participation banks in terms of total assets rose to %3,14. 0,8% of the %1,05 drop due to İhlas Finans House


Levels of deposits at participation banks : Levels of deposits at participation banks Source: Yılmaz, Rasim, Bank Failures and Deposit Insurance in Emerging Market Economies: The Case of Turkey, 2007 Concerns due to the revoke of the license of İhlas Finans, IFH, caused further withdraw of funds from participation banks. Introduction of Deposit Insurance Fund, DIF, stabilized the market and reduced the withdraw of funds. Introduction of DIF


Slide5 : Percent decline in deposits at participation banks Concerns due to İhlas Finans caused a decline of 63% in the participation funds in the period between 31/12/2000-30/6/2001. Yılmaz, Rasim : Bank Failures and Deposit Insurance in Emerging Market Economies: The Case of Turkey, 2007


Deposit insurance for participation banks : Deposit insurance for participation banks


Slide7 : Participation funds have grown %40 annually during 2001 - 2007 (Million USD) Growth of participation funds İhlas Finans


Deposit classification in Turkey : Deposit classification in Turkey Since customer base of participation banks is broader, SDIF gives more protection to their customers. 62% of funds in participation banks have less than one month maturity, whereas maturity of deposits in conventional bank is longer.


Ratios to total assets : Ratios to total assets Participation Banks are exposed to much higher credit risk relative to deposit banks. Their funding is from mostly short term deposits.


Example of profit sharing : Example of profit sharing Question: In the case of 10% of credit defaulted, what will be capital adequacy ratios for participation banks and deposit banks? Assumptions: - Same credit portfolio and similar liability portfolio is hold. - Under Basel-I, 100% risk weight applied. No collateral. - Current Capital Adequacy Ratio is %20(=20/100) - For time deposit in participation banks, 20% of return hold by bank for management and 80% paid to customer


Risk comparison to deposit banks : Risk comparison to deposit banks


Challenges for the supervisory authority : Challenges for the supervisory authority Due to the differences in the assets and liabilities structure participation banks are subject to higher level of credit risk and liquidity risk. As participation funds holders are less sensitive to interest income, participation banks have a substantially lower level of interest rate risk. Since 62% of participation funds have less than one month maturity, liquidity risk is higher. To give enough confidence to customers, sound supervision and strong deposit insurance systems are required. Deposit banks deduct provisions for non-performing loans (NPL) from bank’s capital, which causes a decrease in the capital adequacy ratio (CAR), whereas provisions for non-performing loans of participation banks are shared with customers and have limited effect on their CAR.


Challenges for the deposit insurance fund : Challenges for the deposit insurance fund Participation banks and deposit banks are subject to the same risk based premium system. However, their assets and liabilities structure and risks require differentiated risk factors to be identified. Participation banks have a small market share in Turkey and contain high correlation of default risk, which increases the total risk of deposit insurance system. Therefore, insurance funds for participation banks and deposit banks are managed in the same pool. Moreover, as participation funds are the only instrument bearing no interest in Turkish financial system, their deposit insurance funds could not be managed in a different pool. In case participation banks need public funds due to systemic risk and liquidity risk, there are no non-interest financing tools.


Conclusion : Conclusion Growth of participation funds is very high in Turkey and fund owners require sound supervision and strong deposit insurance. Ihlas Finans is the first participation bank revoked its license. Concerns on its default became contagious to other participation banks and turned out to be a systemic risk. Establishment of DIS gave confidence to the fund owners. Participation banks are subject to the same supervision and regulations as deposit banks. However, due to significant differences in assets-liabilities structure and risk exposures, supervision and risk based DIS should be differentiated. For development of participation banks, innovation for new instruments needed.