For years Turkish bankers have talked about - and some have even been preparing for - a low-inflation environment. Since the launch in January of a three-year disinflation programme backed by the International Monetary Fund, a brave new world, in which some will thrive and others wither, has suddenly become a near-term possibility.

The transition to a low-inflation environment poses a stiff challenge to an 81-member banking sector accustomed to living off fat profits from lending to the government. With profit margins set to shrink following a sharp fall in interest rates from 90 per cent in November to around 30 per cent, banks will need to engage much more in real banking - lending to businesses and consumers.

This adjustment is also likely to involve long-awaited consolidation. "For able players, net interest margins will shrink but volumes will increase dramatically," says Ersin Ozince, chief executive of Isbank, the biggest private sector bank which is one of the best placed to thrive in a low-inflation environment.

Gazi Erçel, governor of the central bank, says banks enjoy a cushion from past treasury bill profits to help them adjust. "Large capital gains on T-bill books should secure bottom-line performance until the third quarter of 2000," agrees Salomon Smith Barney, the US investment bank. But it sees return on equity of 18.7 per cent for top-ranked banks this year falling to 11.2 per cent in 2001.

Until demand for loans takes off and consolidation materialises, some banks have tried to square the circle by investing aggressively in non-core assets, prompting Mr Erçel to describe as "enormously wise" Isbank's planned investment in a GSM (mobile telephone operating) licence and chain of petrol stations (see Isbank profile). Even though these businesses have little to do with banking, they can provide a "continuous cash flow" during a transition period, he says.

The route to profitability is consolidation. "The margin and return on equity outlooks are unsatisfactory," Salomon Smith Barney says in a recent report on Turkish banking. "Consolidation would seem a precondition to Turkish banks securing profitability."

The first sign of long-awaited restructuring came in December, with the government's seizure of five troubled banks. Other banks are understood to have taken measures to strengthen their balance sheet and avoid a similar fate. The five - Esbank, Yasarbank, Yurtbank, Egebank and Sümerbank - joined three banks already under the tutelage of the central bank's deposit insurance fund. The cost of recapitalising the five additions to the fund has been estimated at around $6bn.

The sector will take a further step towards consolidation when weaker institutions begin merging with other banks. The government is now preparing the eight banks under its control for sale to other private sector banks. Citibank, the oldest-established foreign bank in Turkey with 900 employees and nine branches, has publicly expressed an interest. But the bank, which paid $1.2bn for a Polish bank earlier this year, has also indicated that it will look at other Turkish banks should it not be able to strike a deal with Ankara.

A similar message has come from Akbank, the most conservative of the big four Turkish private sector banks. Meanwhile there is much talk of the benefits of mergers between even the bigger banks, in line with international trends.

The Sabanci conglomerate has floated the idea of merging its banking flagship - Akbank - with the banking operations owned by the Dogus group. Dogus owns Garanti Bank, another of the big four private sector banks, as well as medium-sized Osmanli and Korfezbank.

Alternatively, Salomon Smith Barney suggests "there would be merit for example in a Yapi Kredi-Garanti Bank marriage - the two conjoined with greater market share in all the main product areas".

r Erçel says the authorities are helping to lay the foundations of a more sound banking sector in two ways. A new independent banking supervisory body due to be in operation by August will "assist timely accurate flows of information" between itself and the central bank. It is to be headed by Zekeriya Temizel, a former finance minister, who has got as far as leasing an Ankara skyscraper to house the new institution. One of the aims of taking bank supervision away from the government is to reduce harmful interference by politicians in the distribution of banking licences and the taking of remedial action when problems are uncovered.

Ankara also wants to encourage mergers and acquisitions in the sector on the grounds that "small is not beautiful".

But the government has much more work to do to create a level playing field by tackling two main sources of unfair competition and moral hazard. It last month announced a timetable for phasing out universal deposit insurance. The scheme's blanket coverage until now has encouraged weaker banks to take undue risks with depositors money in the knowledge the government would pick up the pieces if necessary.

Second, the government has only just begun putting four state-owned banks accounting for 40 per cent of deposits, and responsible for a gross misallocation of capital, on a commercial footing with the ultimate goal, it says, of privatising them.

The World Bank has insisted that Turkey first draw up a clear programme for reorganising and privatising the state-owned banks before it disburses a $750m loan for financial sector reform. "Their lending practices are politically motivated and it is impossible to set international standards in the banking system if large state banks continue business as usual," says Ajay Chhibber, director of the World Bank in Ankara.

"Unless these banks are privatised and restructured into much smaller entities, they will continue to be a drag on the financial system and hold back economic growth."

It was in response to such advice that the government earlier this month announced plans to start privatising Vakifbank, one of the smaller four state banks in question.


Sights are set beyond the core
Sector set to undergo sweeping reforms
Here to stay this time
Target is energy security at affordable cost


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