LONDON, 29 March 2004 — The Gulf countries may be attracting the news headlines regarding the rapid growth of Islamic finance as underlined by the record 33 times over-subscription to the Amlak Finance IPO in Dubai in January and the spate of recent Sukuks such as the Caravan 1 and Tabreed issues in Saudi Arabia and Dubai, respectively.
But in neighboring Turkey, the country’s five special finance houses (SFHs) (Islamic banks), the talk is about reaching 10 percent to 15 percent of the total banking market share within the next five years. This despite legal and structural constraints which in the past has slowed down the expansion of the sector, which some sections of the ruling establishment and the media are still suspicious about for political and ideological reasons.
Nevertheless, Islamic banking in Turkey has been thriving almost in adversity - not only having to cope with structural problems such as a serious mismatch between short-term deposits and money and longer term maturities; the volatility of the Turkish lira, in which even some Turks relished to speculate when appropriate especially in a high interest-rate environment (this impacted on the SFHs which operate on an interest-free profit-and-loss banking basis); and the general state of the Turkish economy.
Of course, the Turkish banking sector has emerged from a crisis only three years ago when over 19 conventional banks and one SFH collapsed. The IMF injected billions of dollars through conditional loans to help the Turkish Central Bank to stave off a liquidity crisis in the banking sector in the event of a run on deposits. However, the sole collapse of the SFH was not really due to the crisis as such, but the fact that the SFH, a subsidiary of a large holding group with interests in media, industry, and finance, had over 60 per cent exposure to group companies.
In other words, the SFH was predominantly financing the operations of its parent’s subsidiaries, which was technically illegal. Today, the Islamic banks in Turkey have emerged much stronger — they are now incorporated under the Turkish Banking Act like their conventional counterparts, subject to the same capital, compliance, risk management and other requirements; and are regulated by the Banking Regulation and Supervision Board.
Islamic bankers such as UFUK Uyan, CEO of Kuwait Turk Evkaf Finance House (KTEFH), a subsidiary of Kuwait Finance House, and Dr. Adnan Buyukdeniz, CEO of AlBaraka Turk Finance House, a subsidiary of the Jeddah-based Dallah AlBaraka Group, stress that confidence is returning to the Islamic banking sector in Turkey which last year reached 2.5 percent of the total banking market share.
The Islamic finance sector, stresses Uyan, “will accelerate very significantly. It will not be comparable to the development in the previous 14 years. For example, our market grew by 50 percent in 2003 on a US dollar basis. There is no reason why turkey should not reach the level of development of the Malaysian Islamic banking sector, which accounts for 10 percent of the total banking sector there. Our research shows that appetite for Islamic banking products in Turkey is not less than 15 percent of the total banking market. We can easily reach 10 percent with the right product development. And we do not need that much government support as in Malaysia. But if we can succeed in developing the right products, the market potential is huge.”
In fact, in March, Fitch Ratings, the international rating agency, assigned long-term foreign and local currency ratings of “B+” to KTEFH. The outlook for KTFEH, stresses Fitch, is “Stable”. Fitch also assigned individual, national, support and short-term ratings of “D/E”, “BBB+(tur)”, “4”, and “B”, respectively. The outlook on the national rating similarly is “Stable”. The rationale for the long-term, short-term and support ratings “reflect the high propensity of KTEFH’s majority shareholder, Kuwait Finance House (rated “BBB+”) to support the finance house in case of need but this might by constrained by the sovereign ceiling of Turkey. KTEFH is 62 percent-owned by Kuwait Finance House, a sizable and well-positioned Islamic financial institution, which has been a source of capital and funding in the past.”
Perhaps another indicator of the sea change in the Turkish Islamic banking sector is the move away from the parochialism of yesteryear. KTFEH, for instance, last year got an offshore banking license from the Bahrain Monetary Agency. According to KFTEH Chief Executive Ufuk Uyan, there are two main reasons for setting up an offshore subsidiary in Bahrain. “We want to be near the market to source funds and financing, and also for investing, since we also have an international investment portfolio and do not restrict our investments to the local Turkish market. For instance, we participate in deals with Kuwait Finance House and others. We also want to be an international bank with our own identity. In southeast Turkey, there is good LC (letters of credit) business through Bahrain. There are many Turkish banks operating through Bahrain offshore doing many LC transactions through Bahrain and Dubai. We also want to conclude such LC transactions for our clients over there.”
From a regulatory and national policy level, there are also developments which only a couple of years ago would have been unthinkable. Islamic bankers in Turkey have been in talks with the government to consider the possibility of launching a sovereign Sukuk (Islamic bond). Both Dr Buyukdeniz and Uyan agree that there is a good possibility of this happening. The Turkish Treasury, in fact, has already tested the Sukuk concept with an international conventional bank such as HSBC or Citigroup has a market maker, as in the case of the Malaysia, Qatar, and Bahrain sovereign Sukuk and the $400 million issue of the Islamic Development Bank. If the tenor is right, and the return is acceptable, the Turkish government has indicated that it is ready to issue its debut sovereign Sukuk.
The Turkish Islamic bankers argue that their reserves with the central bank and other such contingencies could also be invested in such Sukuk, not only creating more liquidity but also opening up Islamically acceptable investment avenues for such tied capital. Turkey of course already accesses millions of dollars of Islamic finance from the international markets on a regular basis. HSBC, Citibank, WestLB and other banks regularly arrange Islamic finance syndications for Turkish corporates and entities. The expansion of the international terminal of Ataturk International Airport is being financed by a syndicated Murabaha facility arranged by HSBC.
The Islamic Development Bank together with HSBC also recently lead managed a $100 million Murabaha facility for Turkcell, the Turkish mobile phone operator.
Both these facilities attracted the participation of Islamic and conventional banks. Turkey, as a founder member of the IDB, also accesses trade and development finance from the multilateral development bank. Perhaps, Turkey may also emerge as a rival Islamic banking model to Malaysia. In one important area Turkey has emerged ahead of all the other countries, which suggest both policy vision and flexibility, albeit that it may have been driven by circumstances rather than design. One reform resulting out of the banking crisis, is the need to protect depositors.
As such, the government decreed that all banks must participate in the country’s deposit guarantee fund. The government has allowed the Islamic banks to set up a parallel Islamic deposit insurance scheme, which is the same as the conventional counterpart in all but one respect. The Islamic scheme only invests the deposit insurance pool according to Islamic investment principles. The scheme is managed by the Association of Special Finance Houses of Turkey but regulated by the Banking Regulation and Supervision Board. The scheme, introduced in July 2003, is the only Islamic deposit insurance scheme in the world, although Malaysia is now working on launching its own scheme.