Islamic Banking: Case of Turkey

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Islamic Banking: Case of Turkey

Transcript of Islamic Banking: Case of Turkey

Islamic Banking: Case of Turkey

Ahmet ERTRK President of SDIF

6th IADI Annual Conference Malasia, 1-2 Nov 20071

Outline

1 Need for DIS 2 Risks of Participation Banks 3 Challenges and Conclusion

1-2 Nov 2007

6th IADI Annual Conference

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Share of Participation Banks in the Banking Sector3,5 3Percentage Share0,8% of the %1,05 drop due to hlas Finans House

3,14 2,75 2,34 2,44

2,5 2 1,5 11995 2000 2001

2,13 1,87 1,83

2,01

1,082002 2003 Years 2004 2005 2006 2007/63

As of the end of June 2007 total assets of participation banks rose to USD 12.869 million while share of participation banks in terms of total assets rose to %3,14.1-2 Nov 2007 6th IADI Annual Conference

Levels of deposits at participation banksRevoke of the license of IFH

Introduction DIF

of

Source: Ylmaz, Rasim, Bank Failures and Deposit Insurance in Emerging Market Economies: The Case of Turkey, 2007

Concerns due to the revoke of the license of hlas Finans, IFH, caused further withdraw of funds from participation banks. Introduction of Deposit Insurance Fund, DIF, stabilized the market and reduced the withdraw of funds.1-2 Nov 2007 6th IADI Annual Conference 4

Percent decline in deposits at participation banks

Ylmaz, Rasim : Bank Failures and Deposit Insurance in Emerging Market Economies: The Case of Turkey, 2007

Concerns due to hlas Finans caused a decline of 63% in the participation funds in the period between 31/12/2000-30/6/2001.1-2 Nov 2007 6th IADI Annual Conference 5

Deposit insurance for participation banks

Membership Co-insurance Coverage Amount Premium system Ownership and management

Compulsory No Special current account and participation account belonging to real person 50.000 YTL (38.226 USD)

Risk based similar to deposit banks 15-28 bps quarterly on covered deposit The Fund was established in May 2001 among participation banks and managed by The Participation Banks Association of Turkey After December 2005, management was transferred to SDIF6

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6th IADI Annual Conference

Growth of participation funds(Million USD)

12.000 10.000 8.000hlas Finans

6.000 4.000 2.000 01990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007/6

Participation funds have grown %40 annually during 2001 - 2007

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Deposit classification in TurkeyParticipation Banks Deposit Banks

JUNE 2007 Insured Deposit / Total Deposit Time Deposit / Total DepositUp To 1 Month Deposit / Total Deposit Between 1-3 Months Deposit / Total Deposit Between 3+ Months Deposit / Total Deposit

%41 %81%62 %12 %7

%31 %84%28 %46 %10

Since customer base of participation banks is broader, SDIF gives more protection to their customers. 62% of funds in participation banks have less than one month maturity, whereas maturity of deposits in conventional bank is longer.8

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6th IADI Annual Conference

Ratios to total assetsJune 2007 Cash Credit Securities Deposits Capital Capital Adeq. Ratio Participation Banks %13 %81 %0 %76 %12 %16 Deposit Banks %14 %46 %31 %64 %11 %17

Participation Banks are exposed to much higher credit risk relative to deposit banks. Their funding is from mostly short term deposits.9

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6th IADI Annual Conference

Example of profit sharingQuestion: In the case of 10% of credit defaulted, what will be capital adequacy ratios for participation banks and deposit banks? Assumptions: - Same credit portfolio and similar liability portfolio is hold. - Under Basel-I, 100% risk weight applied. No collateral. - Current Capital Adequacy Ratio is %20(=20/100) - For time deposit in participation banks, 20% of return hold by bank for management and 80% paid to customerAsset Liability Deposit banks Participation banks =(20-10)/(100-10) CAR=11,1% =(20-10*20%)/(100-10) CAR=20,0%10

Credit 100 Demand deposit 20 Time deposit 60 Capital 20 Total 100 Total 100

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6th IADI Annual Conference

Risk comparison to deposit banksRisk Category Credit risk Market risk Operational risk Liquidity risk Case Higher Lower Same Higher Reason Credit/asset ratio is 81% Almost no security instrument Similar operations carried out Assets mostly funded by short term participating funds Customer base is less sensitive to interest rates

Interest rate risk Lower

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Challenges for the supervisory authority Due to the differences in the assets and liabilities structure participation banks are subject to higher level of credit risk and liquidity risk. As participation funds holders are less sensitive to interest income, participation banks have a substantially lower level of interest rate risk. Since 62% of participation funds have less than one month maturity, liquidity risk is higher. To give enough confidence to customers, sound supervision and strong deposit insurance systems are required. Deposit banks deduct provisions for non-performing loans (NPL) from banks capital, which causes a decrease in the capital adequacy ratio (CAR), whereas provisions for non-performing loans of participation banks are shared with customers and have limited effect on their CAR.6th IADI Annual Conference 12

1-2 Nov 2007

Challenges for the deposit insurance fund Participation banks and deposit banks are subject to the same risk based premium system. However, their assets and liabilities structure and risks require differentiated risk factors to be identified. Participation banks have a small market share in Turkey and contain high correlation of default risk, which increases the total risk of deposit insurance system. Therefore, insurance funds for participation banks and deposit banks are managed in the same pool. Moreover, as participation funds are the only instrument bearing no interest in Turkish financial system, their deposit insurance funds could not be managed in a different pool. In case participation banks need public funds due to systemic risk and liquidity risk, there are no non-interest financing tools.6th IADI Annual Conference 13

1-2 Nov 2007

Conclusion2. Growth of participation funds is very high in Turkey and fund owners require sound supervision and strong deposit insurance. 4. Ihlas Finans is the first participation bank revoked its license. Concerns on its default became contagious to other participation banks and turned out to be a systemic risk. Establishment of DIS gave confidence to the fund owners. 6. Participation banks are subject to the same supervision and regulations as deposit banks. However, due to significant differences in assets-liabilities structure and risk exposures, supervision and risk based DIS should be differentiated. 8. For development of participation banks, innovation for new instruments needed.1-2 Nov 2007 6th IADI Annual Conference 14