The banking sector is enjoying Turkey's economic recovery if the strong third-quarter profits are any guide. Yet much of the better showing was generated from investments and trading in government paper as the treasury and banks helped each other out of the crisis.

'Apparently, the name of the game now in Turkey is to be short in dollars and long in government paper,' says Aykut Demiray, manager of Is Bankasi's treasury division. 'There is at least a 40 per cent margin between these two instruments.' Treasuries are the most important profit centres of large retail banks in Turkey, distracting attention from the provision of basic services to ordinary customers, he adds.

This year banks have borrowed foreign currency externally for conversion into Turkish lira placements in government paper, capitalising on interest and exchange rate differentials that have been made even more lucrative by the overvaluation of the lira.

There is some concern about the banks' accumulation of short-term liabilities in foreign currency, which had reached around $2,500 million at the end of September. A similar spree in 1993 contributed to the foreign exchange crisis early in 1994.

But bankers stress the present situation is different. 'We have learnt our lesson,' says Demiray. Banks are now legally restricted to a 50 per cent ratio of foreign exchange liabilities to total assets, compared with the previous maximum permissible ratio of 80 per cent. In addition, the government in early September imposed a 6 per cent levy on short-term foreign borrowing by private sector banks and corporations to curb potentially destabilising inflows of 'hot money'. The levy is scheduled to be lifted at the end of December, although it may remain in force indefinitely for corporate and other borrowers.

Anxiety about the political outlook is deepening, however. 'Right now, it's not demand, but lack of supply,' says Anjum Iqbal, general manager of Citibank in Istanbul. 'The marginal players have pulled back. For a while, spreads are going to widen,' Iqbal predicts.

The treasury's huge financing needs are likely to weigh heavily on the market in the first half of 1996. 'Obviously, there is a crowding out effect in the domestic markets, especially when we look ahead to the first four months of next year,' says Husnu Akhan, executive vice-president at Garanti Bankasi. The treasury's total internal debt burden is around $20,000 million, of which $6,000 million is held in banks, as both mandatory reserves and financial placements. Ordinary Turks hold around $10,000 million; the remainder is held by the Central Bank and other government institutions.

The treasury's ability to cope with its financial burdens is not in doubt whatever the stamp of the government that emerges from the 24 December general election. The next government will have to introduce stronger austerity measures, Akhan believes.

This preoccupation with meeting the government's financial requirements has not done the banks any service in other respects. 'The treasury's borrowing is risk-free, tax-free, and the return is very profitable,' says Akhan. 'It causes the banks to be lazy, if you like.' The obsession of retail banks is cheap deposits rather than sophisticated instruments. Demand deposits, which account for a quarter of all deposits and pay rates of around 5 per cent, are a cheap source of funds for placing in government paper. 'In today's environment, savings are not being channelled towards investment, but into liquid positions,' says Hayri Culhaci, deputy general manager of Akbank. Even companies find they can earn more on treasury bills than they can from investments in production.

But, says Akhan, lending to corporates has still picked up this year as demand has recovered and this is reflected in bank balance sheets for the third quarter. Corporate credit accounts for around 49 per cent of Garanti's total loan portfolio at present, compared with 36 per cent at the start of 1995.

Consumer credit has also recovered. During the first half, the total extended by the banking sector amounted to TL 18.8 million million, around 77 per cent of the total lent in the whole of 1994, according to the semi- official Union of Turkish Banks. Automobile and durable household goods topped the list of purchases on consumer credit.

Though expanding, the growth in consumer credit is still low by European standards. Consumer loans account for around 10 per cent of the banks' loan portfolios, and carry interest rates of more than 100 per cent on a compounded, annualised basis. 'It is a no-win game for both parties at today's interest rates,' says Akbank's Culhaci. Another deterrent was the central bank's early September package, which raised the levy on consumer credit to 10 per cent to curb the growth in demand.

In contrast, credit cards have witnessed a phenomenal growth in demand. 'For credit card holders, it is still convenient to borrow for a short period, like one week or 10 days,' says Culhaci. 'But if you pay 10 per cent every month on consumer credits, it really hurts.' Credit card transactions also suit the banks as they are not categorised as consumer loans reportable to the central bank. They do not incur taxes and also escape the levy.

Domestic transactions by credit cardholders rose by 51.1 per cent to 16,512,474 in the first half of 1995 compared with January-June 1994, according to the industry's Bankalararasi Kart Merkezi (BKM - Interbank Card Centre). Their value rose by 148.6 per cent to TL 35.2 million million during the period. Annualised retail inflation over the period was 84.4 per cent.

Debit cards lead the growth in the payments industry and will probably expand by around 100 per cent annually in terms of transactions over the next three years. This trend was accentuated by the 1994 economic crisis, since debit cards cut out credit risk, and reduce overheads in merchant commissions.

Having never had a chequing account culture, the Turkish banking sector has skipped decades of evolution to embrace the age of automated banking with relish. More innovations in home, personal computer, remote and telephone banking should arrive in 1996.

The pace of such modernisation means that Turkish banks will be able to compete in terms of technology and human resources once they are inside an EU customs union in 1996, says Akhan. The private sector is also gaining international expertise. 'Ten years ago, many bankers did not know what swaps or options were,' says Demiray.

The biggest handicap for Turkish banks inside the EU will be their small capital bases. Most observers agree the country is grossly overbanked. The total assets of the entire banking sector are at present divided among 62 institutions. The asset total would barely qualify as a single, medium- size institution in Europe. To achieve economies of scale, some banks might be obliged to seek mergers or joint ventures with European institutions, believes Akhan.

Partnerships are unlikely at present, however. 'For the time being, I don't think big European banks have much appetite for the Turkish market,' says Culhaci. Deterred by the high interest rates, they also lack local information and asset management expertise. Turkey still has a far less transparent environment than most Western European countries, other analysts note. 'Securing a good asset quality is an art rather than a science in Turkey,' says Culhaci.

Closer relations with the EU also pose challenges for the 21 foreign banks already established in Turkey. 'The financial services market here is set to grow explosively, particularly along with trade flows,' says Iqbal. 'We have to keep on evolving and adding more value by broadening product bases.'

Citibank plans to start consumer banking operations early next year, emphasising quality of service, says Iqbal. 'Our customers should have the same experience in Istanbul as they would in London or New York,' he stresses.

In August, the authorities also granted registration for a separate brokerage operation. This permits activities, such as equity underwriting, which are denied to a bank branch by various US regulations. Leasing is another area Citibank regards as a growth vehicle for the future in a big emerging market. 'I don't think you can be successful here by just being a niche player,' Iqbal believes. 'What you can bring to the party is the question.'

Exchange rate: $1=TL 56,210 (December 1995)