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Turkey: Banking System Developments and Reforms

Author(s):
International Monetary Fund
Published Date:
July 2002
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I. Introduction

1. Turkey’s banking problems have many causes: poor governance and excessive risk taking by banks, abuse by owners, weak regulatory and supervisory frameworks for banking, lack of market discipline to drive weak banks into mergers or out of the market, and extreme macroeconomic volatility. The Turkish adjustment programs since 1999 have sought to correct these deficiencies through macroeconomic stabilization, deep structural reforms seeking to bring the operating rules and environment for Turkish banks up to EU and international standards, and a concerted strategy to deal with system weaknesses and a strengthening of the core of the banking system. The latter has included deep restructuring of the state banks, takeover by the Savings Deposit Insurance Fund (SDIF) and resolution of insolvent banks, and efforts to strengthen the capital position of the core private banking system. The worsening economic environment and prospects of larger loan losses for banks than what had been envisaged, has led to a new and strengthened strategy to shore up the capital base and operations of the core private banking system.

2. This report summarizes the main causes of the banking problems, reviews the measures already implemented to reform the regulatory and operating frameworks for banks, and describes the measures contemplated under Turkey’s new program supported by the Fund. Following the February 2001 crisis, the authorities redoubled their efforts to deal with existing problems and strengthen the banking system. The strategy aimed at eliminating existing distortions in the money market, while strengthening the capital position of all banks and reducing the system’s vulnerability to market shocks. The sections below describe developments under the program to date and especially the additional measures to be introduced in early 2002 aimed at safeguarding the private banking system.

II. Background

A. Structure of the Banking System

3. The Turkish banking system has total assets amounting to some US$119 billion (including repos) as of end-September 2001, roughly 80 percent of 2001 GNP. Credit to the private sector accounts for 28 percent of total assets, while holdings of government securities account for some 38 percent of assets (Table 1). Deposits amounted to 63 percent and interbank borrowing from abroad to 13 percent of banks’ total liabilities. More than half of banks’ assets and liabilities are either denominated or linked to foreign exchange (FX).1

4. The banking system is becoming more concentrated, with seven banking groups counting for two-thirds of banking system assets (Table 2). Three large state banks represent about 27 percent of total assets (excluding repos), while the 5 largest private banks account for 39 percent of system assets. While the number of banks is still large, it has shrunk from 81 at end-1999 to 61 at end-2001. Most of the banks have no systemic importance as they are branches of foreign banks (17 banks) or nondeposit taking investment banks (16 banks) that together count for only 8 percent of total system assets.2 The remaining 28 banks are domestic commercial banks, of which eight are the large state and private banks mentioned above, and 20 (including five owned by the SDIF) are small- and medium-sized.

5. From 1997 to January 24, 2002, the number of small- and medium-sized commercial banks has declined from 34 to 20. 14 banks have remained in private hands throughout, one has merged with another private bank, while 19 banks have been taken over by the SDIF. Of these 19 banks (representing some 14 percent of total system assets), 11 have exited the market, 5 remain under SDIF control,3 while 3 banks (representing 2 percent of assets) have been sold to new owners (one to another domestic bank, one to a foreign bank operating in Turkey, and one sold on a stand-alone basis). As a result, 15 small- and medium-sized commercial banks are left in private hands, which represent about 15 percent of total system assets.4

6. The ownership of private banks is highly concentrated and insider lending is prevalent. Most private banks have a tradition of being closely held and only ten banks, including the largest ones, are listed on the Istanbul Stock Exchange; typically 25-30 percent of their shares are listed. Many banks are run as treasuries of their respective corporate groups. Until 2000, banks were relatively free to lend to their owners and to related companies (due to lax definitions of related parties and ample limits in relation to capital), which has made related party transactions prevalent. Traditionally, weak prudential rules allowed excessive risk-taking. Relaxed accounting rules in general and loan valuation rules in particular have allowed banks to inflate asset values and to operate with overstated capital numbers with impunity. As a result, many banks have failed and most of the 19 banks taken over by the SDIF since 1997 failed largely due to defaults on loans to related parties; some also have failed because of high exposures to volatile government securities and maturity mismatches. Since late 1999, a wide range of regulatory and supervisory reforms has sought to bring the framework for bank ownership and operations up to EU and international standards as explained below.

7. Until recently, the operations of state banks led to huge market distortions. The accumulation of “duty losses” without regard to the banks’ escalating liquidity needs and the lack of incentives to minimize the cost of their borrowing (due to yield formulae that were not linked to market rates), made these banks the source of massive distortions in the market and extremely vulnerable to liquidity and interest rate shocks. Chronic under-capitalization added to the distortions. These shortcomings now have all been dealt with as explained below. A third state-owned bank, Vakif, is in the process of privatization. One insolvent state bank, Emlak, was closed in 2001 and part of its balance sheet absorbed by Ziraat.

B. Prudential Regulation and Supervision

8. The legal and regulatory framework for banking has undergone major reforms since 1999, and is expected to fully conform to EU and international standards by 2002. In the past, inadequate prudential rules allowed private banks to take excessive risks, and undercapitalized or clearly unviable private banks were allowed to operate and distort the market (an operational legal definition of insolvency was lacking). Different prudential rules applied to state banks. Accounting and reporting rules for banks were lax, and loan valuation and loan loss provisioning rules were particularly inadequate. Since early 2000 a new banking law and several new regulations have corrected these shortcomings: new loan classification, loan loss provisioning and collateral valuation rules were put in place, loan concentration exposure limits were tightened, connected lending rules were defined (with a schedule for gradual compliance by 2006, given the extreme concentration to start with), FX exposure rules were tightened, new rules regulated FX exposure and capital adequacy ratios based on consolidated statements were established, as well as for risk management by banks, fitness and propriety of owners and managers, and new accounting standards. Particularly important were new rules for the exit of banks that were insolvent or illiquid. Prudential rules applicable to private banks were also extended to cover the state banks. Finally, tax rules were changed to promote adequate loan loss provisioning, facilitate bank and corporate mergers and transfers of distressed assets, and promote deposits of longer maturities through differentiated withholding taxes.

9. An independent Banking Regulation and Supervision Agency (BRSA) was established in September 2000, and the SDIF, which was previously managed by the Central Bank of Turkey (CBT) was transferred under the BRSA. Before, banking supervision was performed by a department in the Treasury, including by a semi-autonomous group of bank examiners (the so called Sworn Bank Auditors). Although it was known in the past that certain banks were facing difficulties and were paying increasingly high premia for deposits to maintain their liquidity, little corrective action was taken until the Banking Law was changed and the supervision and enforcement functions were transferred to the BRSA. Initially, the new agency was run by a board that was more political than professional, and started to function as intended only after the board had been largely replaced in June 2001. The BRSA has steadily improved its performance as supervisor and is in the process of implementing plans for its institutional strengthening, including through strengthening banks’ regulatory reporting, better integrating its on-site examination, off-site monitoring and enforcement functions, and new recruitment.

C. Recent Banking System Developments

10. The banking system experienced large market and credit losses as banks’ various structural weaknesses were exposed to extreme market turbulence in late 2000 and early 2001 and the economic slowdown thereafter. Early in the year, the state banks’ exposure to overnight borrowing caused them to incur massive losses when interest rates spiked in February. Following their financial restructuring, state banks have been performing well, especially as their loan portfolios are very small, making them less vulnerable to the slowdown in economic activity.

11. The performance of private banks deteriorated substantially in 2001, even before considering that their profits are likely to be overstated due to inadequate loan loss provisioning. The financial crises of late 2000 and early 2001 seriously affected private banks’ profitability. In the case of some banks, interest rate gains, mainly at the expense of state banks, offset exchange rate losses. Direct exchange and interest rate gains and losses are largely reflected in their financial statements already; so is the loss of profitable overnight lending to state banks. For the first nine months of 2001, the private banks reported net profits (Table 3) of about TL 721 trillion (roughly US$500 million), compared to net profits of TL1,387 trillion or some US$2 billion during the same period in 2000 (and a return on assets of 0.8 percent and a return on equity of 8.8 percent). The average risk weighted capital adequacy ratio (CAR) of private banks declined from 19 percent at end-2000 to 11 percent by end-September 2001. However, the full force of credit losses are yet to be reflected in banks’ profitability and capital. Private banks still show NPLs of only some 4 percent of total loans.5 Undoubtedly, inadequate loan classification and loan loss provisioning is overstating banks’ capital.

12. Private banks have traditionally kept large short FX exposures to reap profits from very high real returns on domestic debt instruments (Table 4). During most of 2000, the on-balance sheet short foreign exchange position of the private banking system (excluding SDIF banks) grew steadily to reach about US$13 billion in September 2000. However, after netting out forward cover and FX-indexed loans, as allowed under prudential rules, the short position remained consistently at about US$1 billion, or well within the regulatory limit of 20 percent of capital. Market analysts’ concerns about the creditworthiness of the institutions providing the forward cover, turned out to have had some basis. The February devaluation of the TL led to substantial valuation losses for banks, as a significant amount of forward cover contracts, in particular contracts with related counterparties, were not honored.6 However, after the debt swap of June 2001, in which some US$5 billion equivalent of TL-denominated securities were exchanged for FX-indexed papers, the banking system appears protected from further direct exchange rate risks.

13. Interest rate risk in the banking sector increased in 2000 and early 2001 as there was a marked shortening of deposit maturities, while the average maturity of government securities increased. In addition, in 2000, consumer lending grew very rapidly with longer maturities and in TL at fixed interest rates. This widening of the maturity gap exposed banks to a significant interest rate risk. State banks, which by early 2001 had become largely dependent on overnight liabilities, were the most vulnerable. When short-term interest rates skyrocketed during the exchange rate crisis of February 2001, these banks took enormous losses and became massively insolvent overnight. Private banks that held government securities suffered market losses when their portfolios had to be marked to market. The exposure of the system to interest rate risks has diminished in recent months as the Treasury increasingly has issued securities at floating rates and with shorter maturities, the overnight exposure of state and SDIF banks was eliminated, and these banks aligned their interest rates closer to those of private banks.

14. Lending to the private sector (except for lending to related parties) traditionally has been relatively modest and usually short-term and heavily collateralized. This has been due in large part to the ownership structure of private banks but also to very high real interest rates that have made few credits bankable. Bank lending in Turkey is extremely concentrated, with some 100 borrowers accounting for about 50 percent of total credit outstanding (based on data in the largest banks). This includes credit to related group companies, which traditionally has been very high, especially in smaller banks. The authorities have sought to reduce such related exposures through legal and regulatory means but it will take some time before that can be achieved—in fact, there are indications that related party exposures, many of which are denominated in FX, have grown relative to capital as a result of the depreciation of the TL. Although the books of the banks (except for SDIF and state banks, which have been through rigorous valuation exercises) do not yet show any significant deterioration in asset quality, there are reports that the number of loans on banks’ watch lists is increasing. Partial data also indicate that banks’ NPLs are highly concentrated: in the six largest banks some 50 borrowers count for nearly half of all recorded NPLs. As mentioned above, NPLs are undoubtedly underestimated (Table 5) and it is expected that the upcoming targeted valuation of loan portfolios (as explained below) will provide a better basis for estimating loan losses and determining banks capital adequacy ratios (CARs).

III. The Restructuring of the Banking Sector

15. Following the February 2001 crisis, the authorities redoubled their efforts to deal with existing problems and strengthen the banking system. The strategy aimed at eliminating existing distortions in the money market, while strengthening all banks’ capital positions and reducing the system’s vulnerability to market shocks. The program centered on a complete revamping of the operations of the state banks, an accelerated strategy to resolve the banks under SDIF ownership, and a program to strengthen the capital position of private banks. The worsening economic environment and prospects of larger loan losses than envisaged before, has led the authorities to revise and strengthen their strategy to deal with the core private banking system, which up until now had been considered sound. The sections below describe developments under the program to date and especially the additional measures to be introduced in early 2002 aimed at safeguarding the private banking system.

A. The Restructuring of State Banks

16. The overnight exposure of public banks (state and SDIF owned banks) had become a major source of vulnerability in the banking system. The rollover of these liabilities at very high interest rates resulted in sharply growing losses and liquidity problems in those banks. In the week starting February 19, 2001 the withdrawal of TL liquidity by private banks to buy FX resulted in extreme pressures on the state banks and overnight TL market rates above 5,000 percent p.a. (on an uncompounded basis). This resulted in losses in that week alone of around TL 4 quadrillion. As of mid-March, the total amount of overnight liabilities had reached close to TL 20 quadrillion (close to TL 8 quadrillion were owed to nonbank customers) or equivalent to over 300 percent of base money. The need to fund the rapidly growing losses of the state and SDIF banks became a vicious circle and led the CBT to lose monetary control.

17. The removal of the overnight positions of the public banks became the highest priority. The overnight debt of the banks was converted into term claims on the Treasury and CBT, where it could be managed much more effectively, at lower cost and longer maturities. This conversion consisted of the Treasury transferring securities to the banks to regularize all receivables from the government (“duty losses”) in the books of Halk and Ziraat, and to recapitalize those two banks and the SDIF banks.7 The CBT provided repos and subsequently bought securities from the banks, which allowed them to pay off their overnight borrowing from other banks and customers. By June 2001 the entire overnight position of the state banks had been eliminated and since then those banks have engaged in no further overnight borrowing.

18. The public banks were also recapitalized and one insolvent state bank (Emlak) was closed. The capital adequacy ratios (CARs) of Ziraat and Halk were brought up above the regulatory requirement of 8 percent. Emlak (the housing state bank) has had its license revoked and its banking assets and liabilities transferred to Ziraat (the latter received from the Government TL 1.7 quadrillion to cover the net difference in liabilities and assets transferred).

19. Operational restructuring complemented the financial restructuring. The boards of the state banks were replaced by a joint board consisting of professional bankers with instructions to restructure their operations so as to bring them back to profitability and prepare them for eventual privatization. Direct political influences in the operations of the banks was thus dramatically reduced. In order not to distort market interest rates, a committee with observer representatives of the CBT was established to set deposit rates of public banks in a coordinated manner. As a result, deposit rates of state banks have converged to those paid by the main private banks (Figures 1 and 2). In May 2001, the state banks started reporting on their financial performance to the Treasury, which in turn started to control them more closely.

Figure 1.Turkey: Turkish Lira Deposit Interest Rates, 2000-2001 1/

(In percent; weighted average interest rate)

Source: Central Bank of Turkey.

1/ Weighted average Interest rate of 5 private banks: T.Iş Bankasi, Yapi ve Kredi Bankasi, Akbank, T. Garanti.

Figure 2.Turkey: US Dollar Deposit Interest Rates, 2000-2001 1/

(In percent; weighted average interest rate)

Source: Central Bank of Turkey.

1/ Weighted average Interest rate of 5 private banks: T.Iş Bankasi, Yapi ve Kredi Bankasi, Akbank, T. Garanti.

20. Ziraat and Halk have been restored to financial soundness and their operations are now being streamlined with a view to their eventual privatization. The banks have fully provisioned or set aside capital for all problem loans and now have positive cash flows8. These banks are no longer seen as causing distortions in the deposit and money markets and are now seen by the public as being sound, and have even benefited from flight to quality in recent months despite much lower deposit rates relative to private banks than earlier in 2001. Legal changes are being proposed to allow the planned downsizing of the staffing and branch networks of these banks (Table 6). Both banks are expected to be highly profitable in 2002 and can be expected to transfer dividends to the Treasury. After their extensive financial and operational restructuring they can also be expected to become valuable franchises for privatization.9 No specific measures have been introduced for the third state-controlled bank, Vakif, for which privatization bids are presently being solicited and final decisions regarding the privatization are expected to be made in mid-2002.

B. The Resolution of SDIF Banks

21. Since 1997, 19 private banks have been taken over by the SDIF, of which 16 since December 1999. Bank runs have been avoided and the stability of the system maintained, first by keeping all banks in operation, and later by introducing in January 18, 2001 an explicit general guarantee of all bank depositors and creditors. Five banks were taken over in late 1999, three banks in 2000, two in early 2001, five banks in mid-2001, and one in late November 2001 (Table 7). While most of the banks were relatively small, some were also medium-sized. Altogether, these banks represented some 14 percent of total banking system assets. Initial efforts to sell intervened banks were less successful than the authorities expected. After a slow start, the resolution of SDIF banks started in earnest in late 2000 with the introduction of new fit-and-proper criteria for bank ownership and a more proactive sales effort in the form of public auctions. However, the auctions failed to attract much interest in the wake of the November 2000 crisis. As a result, in early 2001 six banks were merged and a part of the merged bank eventually sold.10 Three banks merged in mid-2001 did not find a buyer and the merged bank was closed in late 2001. Three other banks were closed in late 2001 with part of their assets and liabilities transferred to the “bridge” bank and their remaining balance sheet transferred to SDIF for liquidation. In December 2001, SDIF successfully auctioned off to private banks most of the deposits of the banks in liquidation; this was done without any market distress and at no additional cost to the government.

22. Considerable momentum has been reached in the resolution of SDIF banks. Despite a deteriorating environment, four banks (including one representing the merger of six) have been sold (even if only a part of their balance sheet was purchased by new investors); two of the banks have been bought by foreign and two by domestic investors. Of the remaining ten SDIF banks, 6 have been closed and put into liquidation. Four SDIF banks remain in operation: one small bank that is being kept by the SDIF as a bridge bank for asset management purposes (see below), a recently intervened bank for which a buyer is still being sought, and two banks that SDIF has tried to close but has been forced to keep in operation under court injunctions. All the banks taken over by SDIF through mid-2001 have thus been dealt with. The authorities are expecting to have their resolution strategy for the recently intervened bank finalized in February 2002.

23. The SDIF is strengthening its capacity to deal with nonperforming assets. The authorities are contracting additional staff, have sought the advice of an international consulting firm and have started to outsource loans for workouts. SDIF will use one small bank as a bridge bank to assist it in the asset management process; this bank will not be allowed to accept deposits. While SDIF has legal “superpowers” for loan recovery exceeding those of other creditors, it is quite restricted by public sector operating rules in what it can do in the case of loan workouts and corporate debt renegotiations; here the use of the publicly incorporated bridge bank with its different legal status, small branch network and established IT system would give SDIF much needed flexibility.

C. Strengthening the Private Banking Sector

24. Since the start of the program supported by the Fund in December 1999, the authorities’ strategy for dealing with private banks has been to bring about a proper valuation of their assets and then force undercapitalized banks to bring in new capital or have insolvent banks taken over by the SDIF. In mid-2001, undercapitalized banks were required to bring in new capital. Six banks were unable to do so and were taken over by the SDIF. Some other undercapitalized banks were required to strengthen their capital base and improve their financial condition through outright increases in paid-in capital, mergers tied to operational restructuring efforts, or participation of foreign investors. They were given until end-2001 to reach the committed targets or face takeover by the SDIF. About US$700 million of new capital was raised this way. Another US$400 million was raised by other banks on a voluntary basis in 2001.

25. The adverse macroeconomic environment and likelihood of increasing future credit losses has led the authorities to adopt a new strategy designed to support and protect the core private banking system. The authorities expect banks to incur credit losses as a result of corporate distress in the face of falling demand and high real interest rates. The efforts in 2001 to raise private capital were important but insufficient to deal with the likely further deterioration in banks’ financial condition. Planned mergers with strategic foreign partners appear to have stalled after the events of September 11.

26. A solvency support scheme for private banks therefore has become the priority of the authorities in order to safeguard the core private banking system. This is needed in addition to the general guarantee of all depositors and creditors already in place. Given the likelihood of larger additional credit losses in banks, and that additional capital from existing owners or new investors can be expected to be scarce, the authorities have designed a scheme that would provide public capital support. The scheme would safeguard the solvency, profitability and continued confidence in the banking system. The scheme will require that all existing losses be identified by independent external audits and borne by existing owners. It is designed to show strong government support of the banking system, and create the conditions for renewed lending to the real sector, while minimizing up-front cash outlays for the SDIF and overall public sector costs. The scheme will be introduced in January 2002 and will be implemented by end-June 2002. It is expected to lead to a more efficient and profitable banking system with more risk-aware banks engaged in more lending to a less volatile corporate sector.

27. The scheme will be based on a rigorous targeted valuation exercise of banks’ loan portfolios and certain other exposures, especially exposures to connected parties. This is the only way to get a reliable valuation of banks’ net worth. This up-front valuation exercise is crucial and the authorities are taking measures to make sure that it is thorough and viewed by markets and investors as being technically of the highest quality and honest. Accordingly, the BRSA will establish clear guidelines with criteria, templates and detailed instructions for the assessment exercise and have asked for Bank-Fund technical assistance in that regard. The BRSA will ask banks’ existing external auditors (typically local affiliates of the big-five auditing firms) to do the assessments. Once asset values and capitalization needs have been established by the auditors, banks will hire auditing firms for a third party assessment of the integrity of the exercise. The BRSA will then establish the possible need for additional capital. These numbers would then feed into recapitalization plans that banks would be required to comply with and would also feed into banks’ balance sheets for end-June 2002. This would coincide with the introduction of new international accounting standards starting July 1, 2002.

28. Once a bank’s capital shortfall has been established, the BRSA will require banks to write down their capital and ask existing owners or new investors to raise capital. Banks’ shareholders and private investors would be asked to provide necessary capital to bring up banks Tier—1 capital to 4 percent and overall CAR to 8 percent as called for under existing regulations. Legal amendments will provide new fast—track procedures for these operations. Banks that meet their CARs or can raise capital on their own would only be required to show a business plan to ensure their continued solvency.

29. For banks that would not be able to raise the full amount of new capital on their own, the SDIF would stand ready to provide support to banks that meet certain capital adequacy thresholds. Insolvent banks or banks unable to raise the necessary capital would be taken over by the SDIF (legal changes will be introduced to increase SDIF’s powers to take over chronically undercapitalized banks) and/or otherwise resolved. In any bank in which SDIF would hold equity, it would have board representation with veto rights. In addition, majority shareholders would be required to pledge theirshares to guarantee that SDIF could sell its shares in the future and recoup its investment, including carrying costs. A bank would adhere to restrictions on the distributions of dividends, while SDIF remains a shareholder. The detailed regulations regarding the scheme will be issued by the BRSA as soon as the recapitalization scheme has been enacted into law.

30. Under the proposed support scheme the SDIF is authorized to put in Tier—1 equity capital in private banks (on behalf of the government) provided that: (i) SDIF’s Tier-1 equity contribution does not exceed the new private contribution and (ii) the bank’s Tier-1 capital is raised to 5 percent CAR, and (iii) the bank, or banks to be merged, represent a market share of at least 1 percent of total banking system assets.11 Banks’ capital contributions in cash in 2001 would count as new capital, after a bank’s CAR has been brought to zero. The SDIF will make any Tier-1 capital contributions with government securities issued at market terms.

31. SDIF is also authorized to contribute Tier-2 capital in the form of convertible subordinated debt. Such capital would be available to all banks with a Tier-1 CAR of at least 5 percent (regardless of market share). SDIF will make any Tier-2 contribution with seven-year government bonds that cannot be transferred to any third party without prior approval of the BRSA. If a bank were to make further losses and its Tier-1 CAR were to decline below 5 percent, Tier-2 capital would convert to equity in order to bring the Tier-1 CAR back up to 5 percent on a quarterly basis. This would give private owners incentives to rehabilitate their bank and prevent the SDIF from becoming the majority owner. If SDIF were to become the majority owner of a bank, this would allow it to pursue “least-cost” early resolution options. The regulations for the scheme will spell out the precise conditions under which the SDIF can sell its shares, for bank owners to purchase shares held by SDIF, and for SDIF to convert Tier-2 capital into equity.

D. Public Sector Gross Cost of Restructuring

32. The regularization of the “duty losses” in state banks and the recapitalization of the state and SDIF banks in May 2001 required the issuance of TL 45 quadrillion in new government FRNs (24 percent of 2001 GNP).12 For Ziraat and Halk, the Treasury injected TL 27.3 quadrillion, the bulk of which was used to regularize unsecuritized “duty losses” with floating rate Treasury securities. In addition, the Treasury provided TL 1.7 quadrillion in securities to cover the transfer of net liabilities from Emlak to Ziraat. For SDIF banks, the Treasury issued about TL 16 quadrillion of FRNs and FX denominated securities to replace some earlier issues and cover the accumulated losses in the banks taken over prior to mid-May.

33. The contingency of TL 5.5 quadrillion (3 percent of 2001 GNP) “set aside” in the public debt projections in mid-2001 to cover potential future resolution and takeover costs of the SDIF is expected to be sufficient to cover the additional costs of the public support scheme and additional SDIF resolution costs. The contingency will grow to some TL 8 quadrillion in the 2002 debt projections due to accumulated interest. There are two types of claims on this contingency: first, the public support scheme and, second, the resolution of the remaining SDIF banks. There may also be costs of additional bank takeovers and resolutions, the magnitude of which are not likely to be known until mid-2002, when the results of the valuation exercise and the uses of the public support scheme are known. For now, including subordinated bank debt to the government, it is expected that the additional costs will remain within the contingency.

For more information on foreign exchange exposure see paragraph 12

Three investment banks have closed since late 1999 and are being liquidated.

Of the five banks left under SDIF control, two remain in operation under court injunctions, one is in the process of being sold to a foreign bank group, one will be converted into an asset management vehicle, while one taken over in November 2001 is still being prepared for sale.

Banks with a market share of 1-5 percent of total system assets are considered medium-sized, those with less than 1 percent are considered small.

Several factors contribute to the underestimation of NPLs: (a) in mid-1999 banks were given four years to provision for existing loans; (b) loan classification is still more affected by the type of collateral than by the borrower repayment capacity; (c) many banks have not yet properly classified and provided for nonperforming related party loans; and (d) the typical lag in the recognition of credit losses in an economic downturn.

The authorities will pursue claims on these owners with the full force of the law (unlimited liability) to the extent their banks are taken over by the SDIF.

Although most of the accumulated “duty losses" up until then were not formalized in the form of regular government securities and not included in government debt statistics, most of them had been included IMF’s presentation of debt numbers.

In some cases capital has been set aside but, because of tax considerations, has not yet been used to provide for the loan loss.

In privatization, Ziraat’s special role in the government payment system (i.e., in revenue collections, expenditure disbursements and cash management) will need to be considered.

In January 2001, five banks were merged with Sumerbank; one third of the balance sheet of this bank was sold to another bank in August 2001, and the remainder transferred to the SDIF for liquidation.

This measure is designed to encourage mergers—nearly one half of the remaining 20 private commercial banks have a market share below 1 percent.

As some of the new issues replaced earlier heavily discounted issues, the increase in the stock of public debt was somewhat less than this amount.

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