ANKARA – The veil will be lifted on Turkey’s crisis-wracked banking system on Wednesday when its bank watchdog releases an audit designed to assess the damage done to a sector at the heart of two deep financial crises. Analysts expect to find some banks weighed down by non-performing loans and so low on capital that they cannot lend to local firms desperate to make use of a weaker local currency to produce an export-led return to growth. The audit also aims to provide the remedy:a fresh capital injection to those facing capital adequacy ratio problems and a banking system capable of driving recovery from recession. «The best outcome… will be transparency. No one will speculate about banks’ financial health anymore, no matter what the results are,» said Berna Bayazitoglu, an economist at CSFB. The International Monetary Fund (IMF), lending $16 billion to Turkey to help it out of its crisis, requires the audit as a central condition among a swathe of reforms Turkey must take to earn a latest, $1.1 billion slice of its $16 billion reform pact. The Turkish Banking Regulation and Supervision Agency (BDDK) has ordered two-tier independent auditing for banks’ balance sheets to determine the level of non-performing loans and thus the amount of required capital injection by May 15. The auditing and capital injection is part of a plan which aims at enabling banks to restructure loans to viable but troubled companies facing temporary liquidity problems. According to the outcome, bank owners should make necessary capital increases by June 30 and then can make one-off applications to the BDDK for additional recapitalization. The required capital injection will be in the form of treasury papers. The treasury will match the amount injected by the owners of the banks to help them reach 8-percent capital adequacy ratio, the lowest required by law. Analysts believe some may have ratios below 5 percent. At the start of the year, BDDK head Engin Akcakoca said some $4 billion in capital would be needed to raise bank capitalization and allow them to boost lending to the manufacturing industry. Banks must drive growth However, both government officials and banking industry sources said recently the amount would be much less. «We will see losses but I don’t expect anything earthshaking from audit results,» said a senior banker who declined to be named. «I expect further consolidation in the system even after the recapitalization,» he said. A frail and distorted banking system was a major factor in a November 2000 financial crisis and a second crash in February last year that resulted in a 50-percent devaluation of the lira and the collapse of one IMF program. Banks had multiplied rapidly in a 1990s high-inflation environment that enabled quick profits from government paper which carried lucrative returns above inflation. The sector grew to include more than 80 banks, many of them small operations running mainly on trading government debt. The system was not ideal as a motor of investment or growth. Inflation is now falling toward the 35-percent forecast for end-2001 from recent peaks around 80 percent, but growth needed to handle a heavy debt load is slow to come. EU candidate Turkey seized 19 banks during recent financial turmoil and has sold or closed most of them under pledges to the IMF. Restructuring should also include tools to boost profitability and efficiency. «Capital injection is a temporary solution unless acute problems of the banking and corporate sectors are cured,» said Serhan Cevik of MSDW. «Improved profitability is the key to sustainable restructuring in the banking system.» Banking authorities have focused extensively on assessing loan quality and accounting methods to determine banks’ true capital adequacy and whether capital injections are necessary. The majority of the banks will manage to achieve the required capital adequacy ratios because of a new accounting system that introduced an inflation-adjusted mechanism and allowed revaluation of certain assets, some analysts said. «Banks were allowed to revalue some real estate and more importantly equity participations (shareholdings),» said Murat Gulkan, the head of research at Bender Securities. «The second factor appears to be liberal treatment of the various forms of collateral covering non-performing loans which lower the provisions that need to be taken for the loan in question.» Flexibility on bad loans? Banks asked the BDDK to be more flexible over the ratios of provisions to be set aside against non-performing loans. According to a BDDK decree, a bank should write a non-performing loan off as a loss if it cannot be collected in a year following its due payment. The BDDK stands firm, and no steps have been taken so far to sweeten the decree. «The BDDK wants to see the picture clearly first. Then it may provide some flexibility,» the banker said. Some argue the BDDK’s tough stance could deter banks from issuing the new loans needed for post-crisis recovery in the NATO member country. In a slow-growth environment where the likelihood of a loan becoming non-performing is higher, banks would be more likely to limit exposure to the corporate sector, runs the argument. Some bankers said recapitalization might pave the way for extending new loans to companies provided firms establish the same degree of transparency.