Outlook for Turkish banks remains negative as crisis worsens

Turkey's economic crisis, which is worsening following a spat with the US over metal tariffs, is putting “significant strain” on its banking sector, with H2 2018 and 2019 outlook for profitability remaining "negative," Switzerland-based Indosuez Wealth Management said in a new report.

The profitability of the Turkish banking sector has improved over the past few years with a return on average of equity of 15.48 percent at end-2017.

"However, looking ahead to the second half of 2018 and 2019, the outlook for profitability is negative as funding costs increase, credit growth slows, and impairment charges seem destined to rise," said Aabid Hanif, senior credit analyst, Indosuez.

"The increased risk of a hard landing for the economy coupled with reduced investor sentiment is negative for the sector," he noted.

The economic crisis has been deepened after US President Donald Trump said in a tweet on Friday that he was doubling metals tariffs on Turkey.  

In response, Turkish President Recep Tayyip Erdogan called on his citizens to convert their dollars and other foreign currencies and gold holdings to Lira.

The Lira plunged 15 percent to its lowest level on Friday, its biggest one-day fall since its 2001 financial crisis. The contagion effect pulled down Euro, after reports said that the European Central Bank was concerned about the exposure of some euro zone banks to Turkey. Argentine peso, South African rand and Russian ruble also declined as a result.

The currency weakness has also aggravated inflation. The weaker lira makes imports more expensive. While the Turkey’s central bank has an inflation target of 5 percent, Turkish Statistical Institute said the annual inflation surged to 15.85 in July.

According to Indosuez, the headline non-performing loans (NPLs) of Turkish banks have remained broadly stable at around three percent of gross loans at end-H1 2018, but asset-quality risks have risen given the weakening growth outlook.

“A significant portion of banks’ lending is in foreign currency (equal to about 37 percent of sector loans) and the potential impact of local currency depreciation on weakly hedged borrowers' ability to service debt is negative for the health of banks’ balance sheets,” Hanif noted.

Other sources of risk for asset-quality include high borrower concentrations and large exposures to the construction and energy sectors.

Meanwhile, the capital ratios are facing significant pressure from the Lira’s depreciation due to the inflation of foreign currency risk-weighted assets and higher interest rates which result in negative mark-to-market of government bond portfolios.

However, the only consolation for the sector is that Turkish banks do have a track record of accessing external funding during adverse market conditions.

The banks have sufficient foreign currency liquidity to cover their short-term (12 months) foreign currency wholesale funding maturities, the report added.