Turkey's increasing economic stabilization has given rise to increased activity in the banking and finance market. Turkey's banking and finance sector is now re-positioning itself to better facilitate growth of the private sector, which has been impeded by past macroeconomic instability and fiscal deficits, crowding out credit generation to the private sector. The sector has not reached its potential size and is performing below average in terms of prudently allocating credit in the economy.

Turkey is an emerging market with its own dynamics. Increasing credit to the private sector will not only facilitate capital accumulation, leading to growth and better labour productivity, but it will also improve the allocation of capital leading to total factor productivity (TFP) growth.

Corporate governance and transparency

Turkey's banking and finance sector provides a good payment system and has efficiently mobilized savings, but the mobilized funds have historically not supported private sector investments and have instead been largely invested in a small number of firms and in government securities. So capital has not been allocated to the private sector efficiently and risk has not been diversified for investors.

The EU accession process is a positive force for change, as the acquis outlines a number of effective standards for financial sector supervision and standards for corporate governance and transparency.

The new Banking Law stipulates that the Banking Regulation and Supervision Agency (BDDK) should determine a complete set of corporate governance rules based on similar rules introduced globally, particularly in economically developed countries, to protect the rights of various stakeholders, managers, and creditors of organizations, such as publicly held companies and banks that have a decisive role in the management of the funds of the third parties.

The Regulation of Corporate Governance Principles of Banks defines corporate governance as "the 'style of management' of a bank by the bank top management:

• according to predetermined targets andgoals;
• pursuant to the Banking Law, the regulations issued by virtue of the Banking Law, and other relevant laws and regulations, as well as the bank's articles of association and internal bylaws and regulations, and the general banking ethics rules; and
• in such manner to protect the rights and interests of all stakeholders and shareholders and deposit holders of the bank."

This definition refers to the concept of "regular management of a bank by the bank's board of directors in compliance with the laws and regulations and by protecting the rights and interests of shareholders and deposit holders of the bank".

Open market for financial services

The EU process aims to create an open market for financial services and to create a level playing field by applying consistent governance and supervisory systems across the EU member states. The EU legislation (acquis) lays out standards for supervision of financial institution and governance that will guide banking and finance sector reform in Turkey.

The Turkish government's commitment to EU accession is also stimulating investor confidence. EU accession establishes a medium-term policy anchor, which creates trust among international and European investors that Turkey is on the path towards harmonization with the EU.

In February 2005, the Turkish government successfully marketed a five-year bond with a yield lower than the one-year Treasury bill (T-bill), and international issuers have followed with fixed coupon bond issues with maturities up to ten years. These are positive forces for the development of access to credit, and medium- to long-term credit products in local currency.

The new Banking Law

The stabilization decisions of January 24 1980 have had a significant affect on the Turkish economy over the past 25 years. These decisions have altered the mentality in the Turkish economy. Before 1980, the state played a large role in the economic life, with a state-oriented hybrid economy.

The financial liberalization process sped up in the second half of the 1980s and the Turkish banking system entered into a structural change. The main policy target of the banks became the development of financial tools for asset and liability management. The banks in Turkey are transforming their business models towards better assessing credit risk and providing value-added services for their clients.

The new Banking Law (Law 5411 of November 19 2004) came into force on November 1 2005. It lists, for the first time, the activities that can be carried out by banks. These listed activities will be added to their legal capacities in terms of their activities as joint-stock companies.

World Bank

The World Bank has supported the recovery and development of the banking sector since the financial crisis of 2000/2001, most importantly through a series of adjustment loans, the Programmatic Financial and Public Sector Adjustment Loan (PFPSAL I – III). Between 1997 and 2002, 20 banks were taken over by the BDDK, and all but one have been liquidated, merged or acquired.

The BDDK system has been strengthened, and three large deposit taking public banks have been operationally restructured and recapitalized. In tandem with the economic recovery, the banking sector is now evolving from being a mechanism for funding the Turkish government's borrowing needs into a sector that intermediates finance for the private sector.

Turkey's main challenge is to strengthen the prudential framework and to create institutions that will facilitate effective expansion of credit to the private sector, which in turn will foster competitiveness, growth and employment in the private sector.

EU accession process

The regulatory and supervisory frameworks are constantly being revised, adapting to the EU and International Convergence of Capital Measurement and Capital Standards (Basel II) requirements.

The credit markets, which to a great extent remained dormant during the time of economic volatility, need institutional support in the areas of auditing and accounting, credit information systems, collateral regimes, enforcement of contracts, as well as more sector-specific reforms, for instance in the mortgage market. These institutional underpinnings merited little attention during the time of economic volatility, but they now offer great potential for developing an effective financial market.

Equity, bills, bonds and funds

The equity market has been growing steadily in terms of listed firms, while the market capitalization has been more erratic over the same period, reflecting the volatility in pricing of equity.

The equity market provides an important source of financing for large enterprises and an essential alternative to bank (or debt) financing. Trading in equity has been growing rapidly and the market today is quite liquid compared with other emerging markets.

The traded corporate bond market has been almost non-existent since it dried up in the mid-90s, but even before that, the market was small. The Turkish tax reforms are likely to support the re-emergence of the market.

The reforms of the withholding tax on capital gains and interest designed to level the playing field between government securities and other debt instruments is expected to support the re-emergence of the corporate bond market. A withholding tax of 15% will be applied to all capital gains and interest, including Turkish government securities, starting January 1 2006. This will place deposits, government bonds, and corporate bonds on a level playing field with respect to taxation.

Government securities are still held in large part by banks, but also by Turkish individuals, domestic and foreign investors. The wide distribution of the securities helps sustain liquidity when the market is under stress, and so reduces liquidity risks for banks and other financial institutions.

Mutual funds have become an important savings vehicle in Turkey. The mutual funds market grew rapidly after the crisis in 2001. Offered by the banks, they are a close substitute for time deposits and are more flexible instruments for the investor than directly holding government securities.

The emergence of mutual funds has put a downward pressure on the T-bill to deposit spreads, where the banks used to earn much of their income, but the development has also reduced risk in the financial system.

Securitization

In the last 20 years the main banks in Turkey have securitized their international credit card receivables due from credit card networks, export receivables, cheques and travellers cheque remittances, electronic remittance payments (generated primarily from Turkish workers in the EU countries), and diversified payments, in the international financial markets.

These future-flow transactions provided long-term, lower-cost hard currency financing to banks in Turkey. The Turkish banks that have lower ratings from the credit rating agencies, but have high-quality assets, that is, receivables, could get cheaper funds through securitization than through borrowing from the money markets. The banks involved in international asset securitization have become more liquid, lowering risk and cost.

The Turkish capital market has paid considerable attention to securitization as an alternative tool for funding. The Turkish Capital Market Board (the SPK), the main regulatory body responsible for the supervision and regulation of capital markets, issued a Communiqué on the Registration of Asset Backed Securities with the Board and the Principles of Establishment and Operation of General Finance Companies (Communiqué 1992) on July 31 1992.

In Turkey, securitization has been practised as asset-backed securitization. Other types of securitization, for example, mortgage-backed securitization, is still being regulated. However, Turkish issuers have turned to the international markets and have undertaken considerable securitization deals in the last couple of years.

Legal framework

According to the Communiqué 1992, asset-backed securities are defined as negotiable instruments backed by receivables of the issuer or of a third party assumed by the issuer pursuant to the terms of Communiqué 1992.

The scope of Communiqué 1992 sets out an exhaustive list of issuers: general finance companies; banks, financial institutions, leasing companies; and real estate investment companies.

Apart from general finance companies, other issuers are specifically regulated entities under the laws of Turkey. The general finance companies are introduced to the market through Communiqué 1992.

They are defined as special purpose vehicles formed solely to purchase receivables from a third party and to issue asset-backed securities. According to Communiqué 1992, a general finance company must: (i) be in the form of a joint stock company; (ii) have a paid-in capital of at least NTL10 billion ($7 billion); and (iii) specify in its commercial title the phrase general finance company.

The receivables against which asset-backed securities may be issued are: consumer loans; housing loans; receivables from finance leasing agreements; export receivables; other receivables; agricultural loans; and receivables of real estate investment companies.

Communiqué 1992 introduces two thresholds: the total receivable portfolio of a general finance company cannot be more than 20 times its net worth, that is, paid-in capital plus reserves; and the total value of asset-backed securities cannot be more than 90% of the value of the backing receivables.

Asset-backed securities to be issued are required to be offered to public.

Under Communiqué 1992, receivables must be assigned in accordance with the principles of the Turkish Code of Obligations (the BK), the main code regulating contracts.

The SPK may request that issuers other than banks provide bank guarantees to secure their obligations to investors. Alternatively, the SPK may require such issuers to deposit 10 % of the nominal value of the asset-backed securities to be offered to the public with a bank.

Turkish capital markets have shown much development in the last decade and the Istanbul Stock Exchange (IMKB) showed a similar increase during the same period. In early eighties, there was reluctance among private companies to go public or use alternative funding tools, due to a tendency to keep the management control of the company and not to disclose information relating to the company. Now, Turkish companies have undertaken both domestic and international offerings and apply different funding tools.

Mortgage banking

According to Article 796 of the Turkish Civil Code (the MK), a mortgage can be created as security for any kind of debt, present, future or contingent, by registering a mortgage over real property with the relevant title deed register.

A mortgage securing an existing or future debt is registered as a maximum amount mortgage. Therefore, the amount of the mortgage should be agreed upon by the mortgagor and mortgagee and written in the mortgage agreement. A mortgage can only be registered over real property, which will include the land and all buildings constructed upon it. If construction takes place after the registration of the mortgage, the buildings constructed will automatically and without any amendment to the mortgage agreement or re-registration with the title deed register, become subject to the mortgage.

A mortgage will not apply to movables in the real property, however, they can be included in the mortgage if they are registered as accessories to the real property.

According to Article 751(j) of the Turkish MK, servitude can be created on real property by registering the right with the title deed register in favour of a person who would become the holder of the servitude. This confers the right to construct a building on the real property and to use it for a certain period of time. If the servitude has been registered for a term of at least 20 years, it can be registered as separate real property, which can become the subject of a mortgage.

The housing financing system is poised to play a vital role in providing affordable housing to families and to increase real estate development, construction, real estate finance, secondary markets and related sectors in the Turkish economy. Solving the problems of housing and housing finance through a modernized financial and real property system will have many positive social and economic effects on the country, including an increase in home ownership, the promotion of economic development through planned urbanization, a decrease in unauthorized construction and a steady rise in the market value of real property as it becomes more widely available to the public.

The Law Amending the Laws Related to the Housing Finance System Law (Law 5582 of March 06 2007 (the ML) aims to cure these housing problems by establishing an efficient housing finance system. This goal requires a coordinated effort in several different areas of law. To provide the infrastructure needed to establish this effective housing finance system, the Law is expected to amend the Capital Markets Law 2499, Execution and Bankruptcy Law 2004, various tax laws, Consumer Protection Law 4077, Financial Leasing Law 3226, and Mass Housing Law 2985.

The ML specifies two types of corporations: housing finance corporations and mortgage finance corporations. According to the ML, these two corporations will be defined in the Capital Market Law.

Mortgage-covered bonds are the debt securities that are general obligations of the issuer and secured by asset pools. Mortgage-covered bonds can be issued by banks and mortgage finance corporations.

The ML specifies two types of funds: housing finance funds and asset finance funds. According to the Law, these two types of funds will be defined in the CML.

Under the CML, a housing finance fund is a property established by means of the funds collected in return for mortgage-backed securities issued on behalf of the mortgage-backed security-holders, in accordance with the principle of fiduciary ownership.

An asset finance fund is a property established by means of the funds collected in return for the asset-backed securities issued on behalf of the asset-backed security-holders, in accordance with the principle of fiduciary ownership. The assets to be held by the fund portfolio are determined by the Capital Market Board.

The valuation of real estate not only provides the initial value assessment of the real estate but also plays a crucial role during the foreclosure process and the validity of public auctions, that is, the minimum amount the real estate should be sold for. Under the ML, the real estate valuation must be conducted by the members of the Turkish Real Estate Valuation Experts Association.

The tax benefits that were more generously provided to individuals, as well as to the mortgage banking institutions, have been restricted in the ML, although tax benefits such as exemption from corporate tax and stamp duty were kept.

The payback guarantee obligation of the Undersecreteriat of Treasury has been further detailed under the ML. The prerequisites to obtaining a UT guarantee will be regulated separately. The Capital Market Authority aims to increase the transparency in obtaining the UT Guarantee to make mortgage banking more attractive for financing institutions.

One of the main amendments of the ML relates to the information to be provided to consumers by mortgage banking institutions before execution of any agreements. Accordingly, Information Notice Prior to Sale leaflets must be distributed to consumers, the content and format of which is to be determined by the Turkish Ministry of Industry and Commerce. The ML requires the valuation to be notified to the consumers and the sale to be realized by the mortgage banking institution, which is obliged to act as a prudent merchant.

The ML takes an innovative approach towards the types of interests that may be applied in a financing transaction by the mortgage banking institution. The ML allows a fixed interest and/or a floating interest to be applied in a transaction. Further protection is envisaged on behalf of the consumers, particularly for cases where they contract for floating interests.

Pre-payments, with a pre-payment fee not exceeding 2% of the pre-paid portion of the loan, and a discount in the interest of the loan (the terms of which will be regulated by the Council of Ministers), are still allowed under the ML.

The liability of credit institutions has also been regulated in more detail in the ML. Concerning the defective goods, that is, real estate, the lenders will be liable for the defects jointly with the manufacturer/producer, seller, distributor, agency and the importer, whereby their liability amount will be limited to the credit they have extended.

A reform-oriented policy

Turkey's growing economic stabilization has given rise to increased activity in the financial market. The reduction of interest rates is spurring an increase in demand for both retail and commercial lending and has led investors to move away from government securities into more attractive sources of return.

In recent years, the amount of total loans in Turkey has increased by 25% and is expected to continue growing. Once the appropriate legal framework has been finalized, demand for mortgage housing is also expected to increase.

Turkish banks will need ready and ever-increasing access to capital to meet their domestic demand. International financial players are expected to provide the Turkish financial community with liquidity and it is expected that the presence of foreign banks will increase to 10% this year following more M&A activity.

There is also a need for a change in practice, aligning Turkish practice with that in international and European markets. The two big potential risks to the financial market are: sharp increases in international interest rates, which will probably be combined with capital outflows from emerging markets; and a loss of political commitment to the main policy anchors: the IMF programme and the EU accession process, which could affect the pending reforms in the state banking and regulatory spheres.

The banking and finance market confidence in the Turkish economy is based on trust in a continued reform-oriented policy that will insure fiscal sustainability, as well as financial stability.

Author biography

Hakan Hanli Pekin & Pekin Hakan Hanli is a partner in Pekin & Pekin, which he joined in 2004. Hanli counsels institutions on legislative reforms, onthe EU accession process and comments on legal frameworks. Hanli specializes in multinational project finance, corporate finance, cross-border financings, corporate, commercial and competition law, corporate transactions, securitization, banking finance, structured finance transactions, privatization, arbitration and environment law. Hanli is member of the European & Turkish Competition Associations and has had numerous articles published in English and Turkish on international, European & Turkish law. A highly qualified attorney at law, Hanli is a member of the Ankara (1990) and Brussels Bars (1994) and of the European (CCBE) Bar Councils. Hanli graduated from the University of Ankara Law School (LLB, 1989), University of Catholic Leuven Law School (international and European public and private law) (LLM, 1993) and the University of Free Brussels (LLB-equivalent, 1994). Hanli speaks Turkish, English, French and Dutch.