Lack of confidence: Declining value of Turkish lira presents challenges for country's banks

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Turkey’s precarious economic position is putting significant strain on its banking sector, which is facing a negative outlook for the second half of 2018 and early 2019, despite an improvement in performance in recent years, analysts say.

Budget and current account deficits are among the causes of intensifying downside risks, along with a more challenging external financing environment, according to Aabid Hanif, senior credit analyst at Indosuez Wealth Management’s Investment Intelligence unit.

Hanif cited a jump in inflation and the plunge in the lira’s exchange rate’s impact on the private sector as factors in the strain on the banking sector, because the private sector holds significant foreign currency-dominated debt in a note published on Sunday.

The Turkish lira has fallen in value by around 44 percent against the US dollar in 2018, and by 40 percent against the euro, according to Thomson Reuters Eikon data. The lira fell to 7.23 per $1 over the weekend, before gradually recovering to around 6.67 per $1 on Monday morning.

“Turkish banks face increased risks to performance, asset-quality, capitalisation, as well as to liquidity and funding profiles, following the recent period of market volatility. Additionally, the increased risk of a hard landing for the economy coupled with reduced investor sentiment are negative for the sector,” said Hanif.

Hanif said one positive factor may be that most larger foreign and state-owned banks in Turkey feature solid domestic franchises, have moderate non-performing loans, reasonable liquidity and capitalisation buffers and often have track records of stable profitability.

Thus far, headline non-performing loans (NPLs) have remained broadly stable at around three percent of gross loans, Hanif said, but at the end of the first half of 2018, asset-quality risks for banks have risen given the weakening growth outlook.

A significant portion of banks’ lending is in foreign currency (equal to about 37 percent of sector loans) and the potential impact of local currency depreciation on weakly hedged borrowers' ability to service debt is negative for the health of banks’ balance sheets, he said.

“Given the increased risk of a hard landing for the economy and reduced investor sentiment, the outlook for the sector for the time being remains negative,” Hanig said.

In a post citing a ‘brutal conclusion to an eventful week’ for emerging market currencies, Jameel Ahmad, global head of currency strategy and market research at FXTM, said the Turkish lira had fallen into a ‘state of crisis’.

“The Turkish lira is in a state of crisis, as a result of investor confidence in Turkish assets remaining at alarmingly low levels. It is astonishing that no matter how punished the lira looks, traders are showing absolutely no indication that they are finished with pricing in “bad news” into the market,” he said.

“The issue that global investors now need to take into consideration is that the recipe for a currency crisis in Turkey is now presenting a risk of a contagion knock-on effect across other markets,” added Ahmad, who also cited the ‘unpredictable nature of the Trump administration’, imposing sanctions on Turkey, Russia and Iran in the space of one week, as another threat that traders must factor in.

According to Reuters, a ‘deepening economic crisis’ in Turkey has impacted bank shares, and triggered a move away from riskier assets. The news agency also reported that Emirates NBD, the Dubai-based bank which agreed a $3.2 billion deal to acquire Turkey’s Denizbank from Russia’s Sberbank in May, said that it was closely monitoring the situation in Turkey, but declined to comment on whether it was looking to renegotiate the terms of its deal following the lira’s decline in value.