Turkey Banking Crisis Lalit Raina Global Finance Forum June 19 – June 21, 2002

Turkey Banking Crisis Pre-crisis Environment and Recent Developments Pre-crisis Environment and Recent Developments Bank Role until now Bank Role until now Lessons Learnt Lessons Learnt Bank Role in Future Bank Role in Future

Macroeconomic and Political Risks Macroeconomic and Political Risks High Chronic Inflation — nearly 70% in 1998 and 1999, 39% in 2000, 69% in 2001 High Chronic Inflation — nearly 70% in 1998 and 1999, 39% in 2000, 69% in 2001 High and very volatile Nominal (Nearly 100%) and Real Interest Rates — nearly 30% or More High and very volatile Nominal (Nearly 100%) and Real Interest Rates — nearly 30% or More Falling and Unpredictable Exchange Rates Falling and Unpredictable Exchange Rates High and Growing Overall Fiscal Deficit, 15% of GNP in 1998, 24% in 1999, 20% in 2000, 17% in 2001 High and Growing Overall Fiscal Deficit, 15% of GNP in 1998, 24% in 1999, 20% in 2000, 17% in 2001 Pre-crisis Early Indicators

Macroeconomic and Political Risks (Contd.) Macroeconomic and Political Risks (Contd.) Large and Growing Public Debt --57% of GDP in 2000, 91% in 2001 Large and Growing Public Debt --57% of GDP in 2000, 91% in 2001 Uncertain Economic Growth, -6.4% in 1999, 6.3% in 2000, --8.5% in 2001 Uncertain Economic Growth, -6.4% in 1999, 6.3% in 2000, --8.5% in 2001 Lack of clear economic strategy Lack of clear economic strategy Lack of political will and Consensus to undertake serious reforms Lack of political will and Consensus to undertake serious reforms Fragmented Political Coalitions leading to a loss of Public Confidence in the Government Fragmented Political Coalitions leading to a loss of Public Confidence in the Government Pre-crisis Early Indicators

Regulatory and Institutional Framework Regulatory and Institutional Framework Fragmented Banking Regulation and Supervision Authority — Lack of Focus, Coordination and Responsibility Fragmented Banking Regulation and Supervision Authority — Lack of Focus, Coordination and Responsibility Lack of Independence ---Political Interference Lack of Independence ---Political Interference Outdated and Overly Lenient Prudential Regulations Outdated and Overly Lenient Prudential Regulations Enforcement very weak, Widespread Regulatory Forbearance Enforcement very weak, Widespread Regulatory Forbearance Deficient Accounting and Auditing Practices, Poor Public Disclosure Deficient Accounting and Auditing Practices, Poor Public Disclosure Pre-crisis Early Indicators

Private Banks – pre-reform situation Private Banks – pre-reform situation High Forex Exposure High Forex Exposure High Interest Rate Exposure High Interest Rate Exposure High level of NPLs High level of NPLs High Connected Lending High Connected Lending Poor Capital Adequacy Poor Capital Adequacy A number of insolvent banks in the system A number of insolvent banks in the system Pre-crisis Early Indicators

State Banks – pre-reform situation State Banks – pre-reform situation Politically directed subsidized lending in Ziraat and Halk Politically directed subsidized lending in Ziraat and Halk Huge losses (duty losses nearly $21Billion) hidden in the balance sheet as government dues Huge losses (duty losses nearly $21Billion) hidden in the balance sheet as government dues Insolvent Housing bank – Emlak Insolvent Housing bank – Emlak Excessive number of branches in Ziraat and Halk Excessive number of branches in Ziraat and Halk Excessive staff in both State Banks Excessive staff in both State Banks Pre-crisis Early Indicators

Regulatory and Institutional Framework Regulatory and Institutional Framework A new Banking Law was adopted creating an Independent Banking Regulation and Supervision Entity (BRSA), and Strengthening Bank Failure Resolution Provisions. A new Banking Law was adopted creating an Independent Banking Regulation and Supervision Entity (BRSA), and Strengthening Bank Failure Resolution Provisions. Prudential Regulations were Upgraded to EU/BIS Standards Prudential Regulations were Upgraded to EU/BIS Standards Enforcement of New Regulatory Standards was Strengthened. Enforcement of New Regulatory Standards was Strengthened. Banking Discipline was Restored through Broad SDIF Interventions in Insolvent Banks. Banking Discipline was Restored through Broad SDIF Interventions in Insolvent Banks. Recent Developments

Private Banks – present situation Private Banks – present situation Net forex exposure reduced to prudent levels; Net forex exposure reduced to prudent levels; Short-term liabilities reduced; Short-term liabilities reduced; Detailed portfolio audits carried out to reflect NPLs more accurately; Detailed portfolio audits carried out to reflect NPLs more accurately; Connected lending exposure reduced and is being tightly monitored; Connected lending exposure reduced and is being tightly monitored; 20 insolvent private banks have been intervened and taken over. 20 insolvent private banks have been intervened and taken over. Recent Developments

State Banks – present situation State Banks – present situation Ziraat and Halk duty losses eliminated, balance sheet restructured, Short term liabilities reduced; Ziraat and Halk duty losses eliminated, balance sheet restructured, Short term liabilities reduced; EMLAK bank closed down; EMLAK bank closed down; Independent Joint Governance Board Created for Ziraat and Halk; Independent Joint Governance Board Created for Ziraat and Halk; Excess branches (nearly 900) of Ziraat and Halk closed down; Excess branches (nearly 900) of Ziraat and Halk closed down; Excess staff reduced to the tune of nearly 16,000 either retired or transferred to other public entities Excess staff reduced to the tune of nearly 16,000 either retired or transferred to other public entities Recent Developments

Banking Sector Diagnostic Review Nov 1998 EFIL Aug 1999 Comprehensive banking risk management workshop Establishing dialogue with the banking sector, introducing comprehensive risk management to 5 of the largest/strongest private banks, provision of export finance Feb 2000 FSAL Dec 2000 Banking Law; creation of an independent BRSA, Intervention in failed banks, enabling law on Privatization of State banks Corporate Sector Assessment Jan 2002 PFPSAL July 2001 Introduce LLP tax deductibility, consol. connected and forex exposure, institutional strengthening of BRSA; eliminate overnight repos, and re-capitalize SDIF and State Banks; revoke Emlak license and merge with Ziraat; initiate recapitalization of remaining capital deficient private banks PFPSAL II Apr 2002 Implement BRSA institutional development; remove tax & legal hurdles for bank mergers; resolve all 13 SDIF banks, re- capitalization of private banks by owners; Vakif privatized, operational restructuring of Ziraat & Halk 50% completed Bank Role Until Now

Crisis Prevention Measures Create strong and politically independent financial management institutions like Central Bank, Banking Regulation and Supervision authority. Create strong and politically independent financial management institutions like Central Bank, Banking Regulation and Supervision authority. Develop early warning systems based on crisis indicators. Develop early warning systems based on crisis indicators. Contingency planning, including what-if scenarios, should be in place before crisis actually happens. Contingency planning, including what-if scenarios, should be in place before crisis actually happens. Under macroeconomic stress situations the level of capital required should be increased. Under macroeconomic stress situations the level of capital required should be increased. Lessons Learnt

Crisis Prevention Measures (cont.) Risk management regulations should be enforced to assess individual bank exposures and capital requirements. Risk management regulations should be enforced to assess individual bank exposures and capital requirements. Consolidated supervision both vertical and horizontal should be used to assess financial risks on a group basis Consolidated supervision both vertical and horizontal should be used to assess financial risks on a group basis Deposit Insurance premiums to be increased in times of high macro- and sectoral risks Deposit Insurance premiums to be increased in times of high macro- and sectoral risks Lessons Learnt (continued)

Crisis Prevention Measures (cont.) Fit and proper ownership/ management assessment should be made to weed out incompetent/dishonest bank owners Fit and proper ownership/ management assessment should be made to weed out incompetent/dishonest bank owners Accounting/Auditing Standards and Practices Should be Rigorously Enforced to Ensure Disclosure of Reliable Financial Information Accounting/Auditing Standards and Practices Should be Rigorously Enforced to Ensure Disclosure of Reliable Financial Information Insolvency and creditor rights legislation should be strengthened for efficient restructuring of corporate debtors Insolvency and creditor rights legislation should be strengthened for efficient restructuring of corporate debtors Lessons Learnt (continued)

Crisis Management Measures In times of crisis, an economic crisis management team should be urgently formed between the relevant institutions to ensure coordinated rapid response. In times of crisis, an economic crisis management team should be urgently formed between the relevant institutions to ensure coordinated rapid response. In case of a liquidity distress the Central Bank liquidity should be provided early and quickly to avoid a systemic contagion effect. In case of a liquidity distress the Central Bank liquidity should be provided early and quickly to avoid a systemic contagion effect. Urgent intervention should be undertaken to stop further bleeding in loss making banks. Urgent intervention should be undertaken to stop further bleeding in loss making banks. Lessons Learnt (continued)

Crisis Management Measures (cont.) Institutional capacity including financial, human and technical resources should be mobilized to deal with the crisis. Institutional capacity including financial, human and technical resources should be mobilized to deal with the crisis. Prompt restructuring of the banking sector should be initiated to restore confidence in the banking system. Prompt restructuring of the banking sector should be initiated to restore confidence in the banking system. Bad banks should be removed urgently from the system to reduce subsequent overall resolution costs Bad banks should be removed urgently from the system to reduce subsequent overall resolution costs Lessons Learnt (continued)

Non-Bank Financial Institutions Review 2002 PFSAL I Early 2003 Implement SDIF institutional development; resolve remaining insolvent private banks; privatize Halk; new insurance law, full IAS for banks, listing & disclosure reform for ISE PFPSAL II Late 2003 Deposit insurance reform; SDIF autonomy; consolidated supervision; privatization of Ziraat; regulatory reform for NBFI Bank Role in Future