The overall outlook for rated Turkish banks remains stable-to-positive as they benefit from favorable profitability and franchise development dynamics, says Moody’s Investors Service in its new Banking System Outlook for Turkey. At the same time, further upside on the ratings would be halted if risk appetite increases. Moody’s notes that the rapid business growth since 2003 has generally been undertaken within the context of fairly conservative risk policies and a sound regulatory regime. Capitalization and asset quality metrics have improved over this period, contributing to upgrades of one or more notches for most banks. «We believe that within the context of the currently favorable profitability dynamics and the projected growth of the Turkish banking market, banks can continue to prosper without altering their risk profiles,» says George Chrysaphinis, a Moody’s AVP/Analyst and author of the new report. «The operating environment remains risky, however, and banks will need to maintain modest risk appetites if ratings are to rise beyond their current levels,» the analyst cautions. According to Moody’s, the financial markets’ turbulence in Turkey in May and June of last year shows how vulnerable the country is to external financial shocks, and at the same time demonstrates how violently economic and financial parameters (interest rates, exchange rates, equity markets) can respond. Nevertheless, Turkish banks survived the turbulence relatively unscathed. The economic cost of the market shifts was limited to about 10-15 percent of Tier 1 capital for most banks, reflecting healthy capital levels and banks’ moderate exposure to market risk – primarily interest rate risk. The banks benefited from the fact that both the YTL/US$ exchange rate and ISE equity index recovered most of the 20-30 percent declines by the end of the year. Although interest rates have remained high following a sharp 400-basis-point hike in overnight rates to 17.5 percent, and although this led to a pronounced slowdown in consumer spending, overall economic growth remained robust. This has allowed banks to maintain business growth and asset quality metrics, says Moody’s. However, an area of concern remains the large short open position in foreign currency of the Turkish corporate sector that could expose the banks to significant asset quality problems in the event of another sharp devaluation. «Additional factors that we will be monitoring include (i) possible rapid asset growth into products or customer groups that is not matched by banks’ risk management capabilities, (ii) increased reliance on confidence-sensitive market funding, (iii) a buildup of capacity and cost bases that cannot be supported by banks’ systems or that surpass market potential, (iv) taking on more interest rate mismatches than can be effectively hedged, and (v) banks outgrowing their capital resources,» the analyst concludes. Notwithstanding these concerns, Moody’s notes the current financial health of the banking sector, and the strong franchise fundamentals and good management of Turkish banks that can form the basis for further profitable growth. The rating agency holds a positive view of the strategic stakes of strong foreign banks in the capital of Turkish banks, in that they can steer them toward healthier competition, help tide them over market volatility and speed up the process of risk management upgrade. All Turkish bank ratings were reviewed within the context of Moody’s revised BFSR methodology and the introduction of joint default analysis (JDA) in April 2007 and this resulted in a rise in most banks’ BFSRs, with the weighted average now at D+ (up from D).