The medium-term stable to positive outlook for Turkey’s banking system reflects the banks’ developing franchises and strong financial metrics, says Moody’s Investors Service in its new Banking System Outlook for Turkey published this week. The report also takes into consideration financial markets’ turbulence that could disrupt projected franchise development and hurt short-term financial performance, depending on its severity and duration. The Turkish banks’ current financial strength ratings (FSRs) are concentrated in the D and D+ categories. According to Moody’s, the strongest banks, typically the largest private sector banks, have defensible positions in a number of corporate and retail banking businesses, while second-tier banks have also shown their ability to grow with the market. However, the smallest banks, with ratings in the E+ and D- categories, are finding it more difficult to compete profitably. «Throughout 2005 and the early part of 2006, Turkish banks have continued to take advantage of favorable operating conditions to grow their businesses and generate strong profits. Lower interest rates and strong economic growth have been supporting loan demand, and in particular mortgage loans, while smaller companies are also becoming a viable growth avenue,» says George Chrysaphinis, a Moody’s AVP/Analyst and author of the new report. Moody’s current ratings and outlooks for the Turkish banks also reflect improved capital ratios and asset quality. Three years of strong profits have restored capital ratios to levels that can support projected business growth, while healthy loan growth and good provisions have led to improved asset quality indicators. »We followed up a number of FSR upgrades and outlook changes in 2004 with positive outlook changes for Turkiye Garanti Bankasi and Turkiye Is Bankasi and with the upgrades to E+ and D- respectively, for Yapi ve Kredi Bankasi and Turkiye Vakiflar Bankasi, to reflect material improvements in franchise quality and financial condition,» the analyst notes. In addition, the long-term potential of the Turkish banking market has attracted interest from foreign banks, which have made significant investments in the sector, buying controlling stakes in local banks. Moody’s believes that the involvement of foreign banks will give direction to the next phase of Turkish bank franchise development. This is likely to involve further development of distribution networks and the introduction of new products and capabilities. Threat Notwithstanding these characteristics, the considerably higher interest rate environment will likely have a negative impact on both capitalization (through the fair value adjustment of available for sale securities) and in some cases on profitability, depending on how net interest margins adjust. Higher interest rates and currency depreciation and a possible economic slowdown are also likely to hurt business growth and credit quality as both retail and corporate customers face more difficult conditions. «The duration and severity of the financial markets turbulence will ultimately determine the impact on the Turkish banking sector and, to the extent that it materially weakens banks’ financial condition or franchise, we would take negative rating actions,» the analyst cautions. Over the short term, Moody’s will be focusing on how Turkish banks respond to the recent financial market turbulence that has seen interest rates and Treasury yields rise and the Turkish lira depreciate by about 30 percent before regaining some lost ground. «Because the banking sector is now structurally much stronger than it was during previous periods of financial market instability, we expect the effect on individual banks to be milder, with little or moderate systemic impact,» Chrysaphinis says. Moody’s notes in particular Turkish banks’ significant profitability and capital cushion, improved credit risk profile, better funding profiles, low exposure to direct foreign exchange risk and moderate exposure to interest rate risk. The rating agency also notes the substantial ownership stake that strong foreign banks have in the Turkish banking sector and the resources that can be made available to manage short-term volatility.