Surging inflation and the fast depreciation of the Turkish lira have deteriorated the operating environment for domestic banks and made their funding and asset quality more vulnerable to future macro pressures, according to S&P Global Ratings.
The main risks are to systemwide funding because of a high reliance on external debt and to asset quality because of rapid credit growth and foreign-currency lending, Magar Kouyoumdjian, an associate director in the agency's financial services group, said in an online presentation May 24. "Our view is that the economy in Turkey is overheating with persistently high inflation as the central bank has been fairly reluctant to hike interest rates due to political pressure in the pre-election period."
Turkey's central bank on May 23 raised its late liquidity window interest rate to 16.5% from 13.5% in a move to reverse a deep selloff in the lira. President Recep Tayyip Erdogan vowed May 24 to address the double-digit growth in the inflation rate after the June 24 election.
State monetary policy harms banks
The rate on the late liquidity window, which is the main vehicle banks use to borrow money, has been hiked several times since the beginning of 2017, but these have been rather reactionary steps used as a temporary fix to stabilize the currency, according to Kouyoumdjian.
"I think this response came rather late and is rather unclear if it will be effective at stabilizing the lira and inflation going forward," he said.
Erdogan's opposition to rate hikes has contributed to the current situation, and after the election, Turkey needs tighter monetary and fiscal policy, Kouyoumdjian said, suggesting that the independence of the central bank should also be discussed.
The government, which prefers economic growth targets to inflation-based ones, decided in early 2018 to launch a credit guarantee fund to boost growth ahead of the election. This further boosted a credit growth rate that already sat at 22% in 2017.
"Turkish banks tend to be prone to credit bubbles, especially in periods of fast economic growth," Kouyoumdjian said, noting the 30% credit growth rate reached between 2011 and 2014.
"The other area of concern within credit risk is foreign-currency lending, especially among corporates," Kouyoumdjian said. About a third of loans on Turkish banks' portfolios are denominated in foreign currency, mainly U.S. dollars, the analyst noted, and there have been several recent high-profile corporate debt restructurings.
Asset quality risks
"If you look at indicators, nonperforming loans are under 3%, but I think this is somewhat misleading if it is taken at face value," the credit analyst said. The rapid rate of credit expansion means that NPLs are being measured against a growing stock of loans, and the Turkish bank regulator has also made it easier for banks to restructure and reclassify loans.
He suggested that taking into account loose NPL classification standards and Turkish banks' active pursuit of bad-loan sales, NPL ratios might raise to around 10%.
Another reason for concern is the construction boom in Turkey, especially in commercial real estate in big cities, Kouyoumdjian said. Although banks' direct exposure here is limited, there are indirect risks because the economy and employment in Turkey are largely driven by this sector, he said.
Foreign capital dependence
Both Turkey and its banking sector are heavily reliant on foreign capital, and any risks to the country's relations to external partners and markets could adversely affect systemwide funding, which is already under pressure because credit growth accelerated while savings rates remained low, Kouyoumdjian said.
"This is particularly worrying at a time when the U.S. has been hiking interest rates and also Turkey's relation with its Western allies has deteriorated mainly over Syria," the analyst said. Furthermore, there is an ongoing U.S. probe into state-owned Türkiye Halk Bankasi AS regarding alleged violations of sanctions on Iran, which could damage investor sentiment toward Turkey, Kouyoumdjian said.
S&P Global Ratings and S&P Global Market Intelligence are owned by S&P Global Inc.
