Bank Stocks – Turkish Market News

Determinants of Bank Profitability

Examining the determinants of the banks profitability is very important in any economy as these foundations perform key financial functions. In Turkey it is even more important considering the fact that the stock market is heavily dominated by the banks. See here, here and here for more about the bank-intensive style of Turkish financial markets.

Lately we noted that on historical basis profitability indicator ratios of Turkish banks have been dramatically declining despite the relatively high valuations. We observed those bank stocks losing momentum and the benchmark equity index evaporation right after, a harbinger for what might happen remainder of the year.

At this stage we find it important to find out what the industry-specific and macroeconomic determinants of Turkish banks’ profitability are because of its strong impact on the characteristics of stock market. To be more accurate I narrow the scope of this research and used the data of the commercial banks only -which is compiled by Turkish Banking Watchdog (BRSA)-.

Below is a list of possible determinants of Turkish commercial banks’ profitability.

Total Assets (log)
Capital Adequacy Standard Ratio
Loans to Assets
Non-performing Loans Ratio
Liquid asset to assets
Deposit to Assets
Loan to Deposit
Net Interest Margin
Non-interest Income
Annual Real GDP Growth
Annual Inflation
Real Interest Rates

After collecting the data over the time period between 2003 and 2014 I calculate the correlation between the variables listed above which is as follows:

As a profitability measure again we use the return on equity (RoE) ratio. Following that, this next table demonstrates the relationship between the profitability of Turkish commercial banks and the given independent variables through a regression analysis.

The results suggest that the relationship between the banks’ profitability and the selected macroeconomic variables is significantly weak. On the other hand we find out that the banks can improve their profitability through increasing their capital adequacy and decreasing their loan/asset or loans/deposit ratio. Our main deduction from the latter finding is that to improve their profitability the commercial banks in the country need pay more attention to being well-capitalized and having a more liquid financial position with lower loan/deposit ratio.

For the issue of declining capital adequacy ratios in Turkish banks read this.

and this is for the increasing risks around loan/deposit spreads.

Considering the above-mentioned developments it would not be surprising to see banks posting lower income figures in the upcoming quarters.

Banks to Stay Under Pressure

One of the main functions that banks provide is liquidity transformation. To simplify this financial term, one can interpret it as funding shorter term assets with longer term liabilities. In case of failure of this process, the banks face a liquidity mismatch which would put them at serious risk.

Like any of its peers in other countries, Turkish watchdog, or shortly BRSA applies tough risk rules in order to stem the financial system facing the risks that we tried to explain above.

Previously we stated that the banks in Turkey have ridden toward the danger zone in terms of liquidity management for the period of last three year. To see how just check the blog post titled Turkish Banks: Solvent but Illiquid? with explanatory charts.

So how things have gone since then? It is evidenced by BRSA data that it has been even more worrisome. The chart below visualizes the data and proves that proves that liquidity in the banking system hitting the dip.

In order to show the significance of the issue, a cross sectional analysis must be studied at this point. First, the relationship between Capital Adequacy Standard Ratio (Tier 1 Common Capital Ratio) and Liquidity Adequacy Ratio is apparently very strong. However, the positive relationship may indicate that when banks are less vulnerable to under-capitalization, they take more liquidity risk. In other words, capital and liquidity may act as substitutes. Interestingly, this relationship is only observed after the crisis, as can be seen in the second chart below.

The relationship between the credit-risk taking and liquidity is also another indicator for analyzing the behaviors of the bank in Turkey. As expected, two risk components are negatively correlated, suggesting that the two risks are substitutes.

Finally this is where the punchline comes. Normally it is expected that the lower is profitability, the higher is liquidity due to the costs of holding liquidity. Then, returns should be lower when a pick-up in liquidity is observed. However, this does not seem to be the case for Turkey. A negative correlation is realized between return on equity and liquidity.

Specifically, the last chart seems to be the most shocking one among all. At the same time, it makes the liquidity of Turkish banks a non-negligible variable to track for any investors who look Turkey as a play. It is even gaining more importance in view of the ability of the bank stocks to drive the whole market in Turkey. And it is also a serious issue for regulators to focus on, since the conclusions of the flying liquidity in the banking industry are widely known in the country.

Will Banks Be Able to Help Turkey to Survive A Crisis?

Previously I noted about the de-facto deregulation around Turkey’s financial industry with an example of financing a shareholder business by a Islamic finance foundation. In this article, I will focus on deteriorating fundamentals enough to make concerns around the way the industry goes rise.

Key fundamentals build a disincentive case

Fundamentally the year about to finish was absolutely a failure for Turkish banks. This statement is to easy to be supported by the numbers. Here is chart showing us how the efficiency at generating profits decrease in years.

The period between 2004 and 2010 was clearly was a heyday with a average return on equity (RoE) ratio of 18%. After that a RoE has never been observed above 15%.

RoE ratio is an important measure of company’s earnings performance, because it demonstrates how effectively their money is being employed. In general, RoE ratios in the 15-20% range is considered as representing attractive levels of investment quality by financial analysts. By this, one can suggest that Turkish banks are not effective at generation profits, therefore not attractive for investors.

Compared Turkey to other emerging markets, how does Turkish banks do? The answer is not well. South Africa, Russian and Indonesian banks are with RoE ratios of 15.5%, 19% and 20%, respectively. Even within Turkey, the banking industry really underperformed compared to the other industries such as telecoms, automotive with RoE ratios around 25%.

Generating insufficient profit is not the only trouble, also the capital adequacy ratios are telling us an ugly story. For a long time, Turkish financial services industry has been known with its reassuring capital structure. The asset quality has usually been a building block of a supportive case, but not anymore as the chart below shows the whole story.

The Macroeconomic Effects

Due to its financial system backed by sound fundamentals, Turkey was among the limited number of economies who was able to recover fast. Thanks to their generating profit ability and high capital adequacy, Turkish banks conveniently could rollover the consumer and business loans that prevent the whole economy from entering a long-term recession.

Turkish corporates have a huge short term external debt stock. Unluckily, Turkish Lira was hit by corruption probe including Cabinet ministers. Rising political risks may lead the economy to enter another recession period, but this time with a weaker financial system due to reasons I mention above.

Next, I will post some scenario analysis with possible outcomes and why I think a crisis like the one that occurred in South Korea in late 90s might crash Turkey.