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.