Turkey: Taking a Risk Weighted Approach in Islamic Finance

By Fawad Butt

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on 21st April, 2010

Turkey is the sixth largest Muslim country by population. Although the country has a secular government, the majority of the population is considered to be devout and practicing Muslims.

There are currently over 70 million Muslims in Turkey, representing a tremendous opportunity for both local and global Islamic financial institutions.

The country’s banking law allows for three different types of institutions. Each is limited to defined activities. The Islamic fi nancial institutions are referred to as “special finance houses” or participation banks. These operate primarily as subsidiaries of foreign banks.

The Banking Act 2005 provides for participation banks (PBs) to be supervised by the Banking Regulatory and Supervision Agency. PBs function similar to commercial banks, but deposit and lending products are structured and regulated differently.

Currently the banking regulators do not require dedicated Shariah boards for oversight and review; instead, an advisory board with limited governance duties is used to fuel product development.

“The Turkish consumer banking market represents a large and currently under-tapped opportunity for local and international Islamic banks”

In terms of asset size, the Kuwait-Turkey bank is considered to be the largest Islamic bank in Turkey. The bank is a joint venture between Kuwait Finance House (KFH), Islamic Development Bank (IDB) and local investors. Turkish investors own 9% of the overall partnership.

The competition for foreign banks entering the Turkish PB market is heating up, the most noticeable example being the acquisition of Turkiye Finans by National Commercial Bank of Saudi Arabia.

NCB paid US$1.08 billion for the acquisition, representing an astounding 5.8 times price to book value.

Participation banks are allowed to collect deposits via either special current accounts or via profit and loss participation accounts. The special current account holders can withdraw money, either partially or fully, without earning interest.

The participation accounts by contrast, offer profit and loss sharing arrangements without a guarantee for the principal amount.

The lending activities are conducted primarily via Murabahah and Ijarah transactions, with support for both personal and corporate finance.

According to the Turkish Participation Banks Association (TKBB), PBs saw 25% deposit growth between 2008 and 2009, totaling TRY32 billion (US$22 billion).

Asset growth was also measured at a healthy 4% over the same time period. Participation banks currently operate over 550 branches with a current and expected average branch growth rate of 10% a year.

The Turkish consumer banking market represents a large and currently under-tapped opportunity for local and international Islamic banks. The existing regulatory framework has laid the foundation for Islamic financial institutions, but leaves room for improvement.

The Islamic banking institutions or PBs currently represent a small segment of the overall banking market. According to TKBB, the Islamic banks collectively represent 4% of the overall banking market in Turkey.

In January 2009 the Turkish Treasury issued Sukuk-like interest-free bond instruments worth an estimated US$1.05 billion.

It is expected that the Income from four state enterprises will pay the bond holders. Although the bonds are described as interest-free, it is not clear if they are true Shariah compliant Sukuk.

In 2001, Turkey saw a major collapse of its financial infrastructure. This event has left a lasting mark on both the government and the business community, and has served as a deterrent towards developing complex risk-based products.

Overall, Turkish Islamic banks are built around asset-based risk mitigation and risk-sharing. Although these principles represent the core of the Islamic finance jurisprudence, additional layers of Shariah governance and supervisory oversight are necessary for the development of internationally accepted fi nancial instruments.

The absence of such structures limits the Turkish Islamic finance industry to a niche status.

Islamic Finance: www.islamicfinancenews.com