Market analysis: Islamic banking to advance in Turkey

Turkish Islamic banks’ market share is expected to double by 2025. Kerem Uzel / Bloomberg

ISTANBUL // The anticipated introduction of new players to the banking sector in Turkey would spur further growth in the predominantly Muslim country’s interest-free banking, a recent report says, while market observers cite the risk of low profitability as an impediment before such expansion.

Growth in Turkish Islamic banking will gain momentum with the addition of capital by new Islamic lenders and a recent government initiative to involve state-run banks in the interest-free lending system plays a key role in this, according to a report by the S&P released last Wednesday.

The S&P report, The Emergence Of New Turkish Islamic Lenders: A Game Changer?, says that growth rate in the Turkish Islamic banking is poised to exceed that of conventional lenders against all odds in economy. “Although Turkey’s overall economic structure and demographics are distinctly different from those of Gulf countries, we expect the Turkish Islamic banks’ market share to double to more than 10 per cent by year-end 2025,” said S&P’s Mohamed Damak in the report.

In May last year, the government established Turkey’s first ever public-run Islamic lender with a branch under the state bank Ziraat Bankası. In February this year, another state-run lender, Vakıfbank, also introduced an Islamic branch while a third public lender, Halkbank, is expected to join this list soon. However optimistic the report may sound, some economists and financial market experts have reservations.

“There is always a growth potential for interest-free banking in Turkey thanks to millions of pious Muslim customers who seek a viable alternative to conventional banking. However, profitability in overall banking operations is currently too low for new players, especially foreign banks, to enter Turkey,” said Atilla Yesilada, a consultant with Global Source Partners in Istanbul.

Mr Yesilada said that the profit margins in the Turkish banking system had fallen to as low as 11 per cent and this is not enough to entice global players to enter this market.

“We might expect financial institutions from Saudi Arabia or Qatar to enter Turkey but these investments will only be strategic manoeuvres with relatively low capital … Besides, competition is tough, some leading global lenders are currently having problems in exiting Turkey and relocating elsewhere,” Mr Yesilada said.

After months of efforts to exit the country, HSBC said in February that it decided to retain Turkey operations after it failed to find a favourable buyer. Another foreign bank that plans to dispose its business in Turkey is Russia’s Sberbank.

Sberbank, Russia’s largest bank by assets, is reportedly not satisfied with the performance of its Turkish unit Denizbank. Mr Yesilada said that Sberbank also faces the risks of failing to exit Turkey under desirable terms.

Turkey was introduced to Islamic lenders, known as participation banks, at the end of 1980s and the sector grew rapidly by the beginning of 2000s. The year 2005 was a turning point for participation banks in Turkey when the government officially recognised them and offered state guarantees on capital deposited in these banks. Turkey’s Islamic banking market, also helped by an Islamist-rooted government, enjoyed a rapid growth between 2005 and 2013, collecting billions of Turkish liras in assets from pious depositors in the Anatolian heartland and thus nearly doubling its share.

New regulations

One setback that the S&P reports in Turkish Islamic banking is the introduction of regulations aimed at curbing rapid growth in retail lending and stricter regulatory capital requirements. According to the economist Ufuk Sanli, in Istanbul, the low interest on deposits already prevents customers in Turkey from switching to Islamic lenders.

“The interest rate on deposits is 9 per cent and inflation around 7 per cent; it does not sound attractive for many Turks to prefer interest-free banking,” said Mr Sanli.

He added that financial tools employed by Islamic lenders in Turkey are not as diversified as in the conventional banks and penetration is relatively low, which are key disadvantages before they can expand. “Islamic insurance system, for instance, is fairly new in Turkey and Islamic lenders need to develop new financial products to raise public awareness and attract even more customers.”

According to a separate report in January by the US credit rating agency Fitch, increased penetration and the introduction of new players would drive a growth in loans extended by Turkish Islamic Lenders throughout this year.

As far as Islamic finance instruments are concerned, the S&P says that issuance of sukuk has grown in Turkey, denominated in local and foreign currency, offering local participation banks with liquidity management and capital-boosting instruments.

Data from the Participation Banks Association of Turkey (TKBB) reveals that total assets in five Turkish Islamic lenders grew by 15.3 per cent last year compared with the preceding year to reach 120.3 billion Turkish lira (Dh150.8bn). The Islamic banks' share in the Turkish banking market increased from 4 per cent in 2009 to 5.1 per cent at the end of last year, TKBB said. The association said this share would increase to 15 per cent by 2025. Fahrettin Yahsi, the head of the TKBB, told The National that the association has faith that the goal of a 15 per cent share would be realised thanks to government efforts to diversify the market. "We expect to reach even more customers with the opening of new interest-free banking offices including small towns," Mr Yahsi asserted.

There were 1,080 Islamic banking branches in Turkey that employed nearly 17,000 people by the end of last year.

Despite a slowdown in the economy, declining domestic demand and low profit margins, Turkey’s Islamic lenders still have their eyes on the global cake. The total assets in the global Islamic banking market will reach US$93bn in 2020, a staggering 78.8 per cent growth when compared to last year, said E&Y’s World Islamic Banking Competitiveness Report 2016.

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