1. From Crisis to Stability: Restructuring of the Turkish Banking Sector “Strong Banking Sector, Strong Economy” “Strong Banking Sector, Strong Economy” A. Teoman Kerman Vice President

2. 1 “Strong Banking Sector, Strong Economy ”Outline Structural problems Structural problems Impact of the crisis Impact of the crisis Restructuring strategy Restructuring strategy Restructuring of the state banks Restructuring of the state banks Resolution of the SDIF banks Resolution of the SDIF banks Strengthening of the private banks Strengthening of the private banks Improving the regulatory and supervisory framework Improving the regulatory and supervisory framework Results of the restructuring Results of the restructuring Remaining challenges and BRSA agenda Remaining challenges and BRSA agenda Lessons learned Lessons learned

3. 2 “Strong Banking Sector, Strong Economy ” Pre-crisis structural problems Small scale and segmented market structure Small scale and segmented market structure 1980 1990 19992000 Commercial Banks 31546261 State8744 Private19253128 Foreign4221918 SDIF--811 Invest. & Dev. Banks 6 101010101918 State4333 Private241312 Foreign-333 TOTAL37648179

4. 3 “Strong Banking Sector, Strong Economy ” Licensing of banks 1980-1999 56 banks were licensed (42 deposit banks and 14 Development and Investment banks) 56 banks were licensed (42 deposit banks and 14 Development and Investment banks) 15 of the 20 intervened banks were licensed in the post-1980 period; of these 13 were licensed in the 1990s. 15 of the 20 intervened banks were licensed in the post-1980 period; of these 13 were licensed in the 1990s. Ownership details of intervened banks: Ownership details of intervened banks: 6 were media groups 6 were media groups 12 were conglomerates 12 were conglomerates Remaining 2 were cooperatives and pension funds Remaining 2 were cooperatives and pension funds Asset size of these banks were about 21 billion USD while their liabilities were about 30 billion USD (shareholders equity excluded) Asset size of these banks were about 21 billion USD while their liabilities were about 30 billion USD (shareholders equity excluded)

5. 4 “Strong Banking Sector, Strong Economy ” Asset growth 1980-2000

6. 5 “Strong Banking Sector, Strong Economy ” Large FX open positions of private banks Crisis

7. 6 “Strong Banking Sector, Strong Economy ” Crowding out by government Note: 2001 and 2002 data reflect the results of the three-stage audit process and are inflation-adjusted.

8. 7 “Strong Banking Sector, Strong Economy ” State banks: pre-crisis conditions Liquidity problems Liquidity problems State banks with over-night liabilities of $14 billion State banks with over-night liabilities of $14 billion Low asset quality Low asset quality Inadequate risk assessment and management systems Inadequate risk assessment and management systems Lack of good corporate governance Lack of good corporate governance

9. 8 “Strong Banking Sector, Strong Economy ” Summing up: Pre-crisis conditions Banks Banks Liquidity problems Liquidity problems State banks with over-night liabilities of $14 billion State banks with over-night liabilities of $14 billion Large open positions of the private banks Large open positions of the private banks Significant share of holdings of government debt Significant share of holdings of government debt Low asset quality Low asset quality Inadequate risk assessment and management systems Inadequate risk assessment and management systems Lack of good corporate governance Lack of good corporate governance Operating Environment Operating Environment Major macroeconomic instability Major macroeconomic instability High public sector deficit High public sector deficit Systemic distortions created by state and weak banks Systemic distortions created by state and weak banks

10. 9 “Strong Banking Sector, Strong Economy ” November and February Crises  Sharp increase in interest rates  Sharp depreciation of the Turkish Lira  Contraction in economic activity  Maturity mismatch  funding losses  Decline in the value of securities portfolio  Short-positions  FX losses  Asset Quality   Credit Risk  Result: Erosion in Capital Base Macroeconomic Shocks Impact on the Banking Sector

11. 10 “Strong Banking Sector, Strong Economy ” The initial fiscal costs of the Turkish crisis have been high In addition, private banks raised $2.4 billion of capital from own resources. In addition, private banks raised $2.4 billion of capital from own resources. Thus, there has been a significant burden-sharing as $7.1 billion of the restructuring costs were borne by the private sector. BillionUSD Ratio to GDP (%) State Banks Duty Losses 19.012.8 Capital Support to State Banks 2.92.0 Resolution of SDIF banks 21.714.9 -Public Resources -Public Resources17.011.7 -Private Resources -Private Resources4.73.2

12. 11 “Strong Banking Sector, Strong Economy ” Banking System Restructuring Program announced on May 15, 2001 Banking System Restructuring Program announced on May 15, 2001 Objective is to eliminate distortions in the financial sector and adopt regulations to promote an efficient, globally competitive and sound banking sector Objective is to eliminate distortions in the financial sector and adopt regulations to promote an efficient, globally competitive and sound banking sector Restructuring of the state banks Restructuring of the state banks Resolution of the SDIF banks Resolution of the SDIF banks Strengthening of the private banks Strengthening of the private banks Improving the regulatory and supervisory framework Improving the regulatory and supervisory framework 4 Main Pillars 4 Main Pillars But crises also provide opportunities for major restructuring

13. Banking Sector Restructuring Program State Bank Reform Strong Capital Base Cost Efficiency Structural Reform Macroeconomic Stability Decline in Public Deficit Efficient Supervision Market Discipline and Transparency Sound Banking  Strong Economy and Sustainable Growth Environment Corporate Restructuring Goal: Sound banking-strong economy

14. 13 “Strong Banking Sector, Strong Economy ” Financial restructuring of the state banks Liquidation of duty losses Liquidation of duty losses ( $19 billion) ( $19 billion) Elimination of the over-night liabilities Elimination of the over-night liabilities ( From $14 billion in March 2001 to zero in 2002) ( From $14 billion in March 2001 to zero in 2002) Strengthening of the capital base Strengthening of the capital base ($2.9 billion) ($2.9 billion) Appropriation in the budget for any subsidies provided through the state banks Appropriation in the budget for any subsidies provided through the state banks Determination of deposit rates uniformly with market rates Determination of deposit rates uniformly with market rates Efficient management of the loan portfolio Efficient management of the loan portfolio

15. 14 “Strong Banking Sector, Strong Economy ” Appointment of a Joint Board of Directors Appointment of a Joint Board of Directors Monitoring program for profitability, liquidity, and interest margins Monitoring program for profitability, liquidity, and interest margins Establishment of internal control, financial control and risk management units Establishment of internal control, financial control and risk management units Improved efficiency and productivity Improved efficiency and productivity As of December 2002, number of branches and personnel were reduced by 32% and 51%, respectively, compared to December 2000. As of December 2002, number of branches and personnel were reduced by 32% and 51%, respectively, compared to December 2000. Operational restructuring of the state banks

16. 15 “Strong Banking Sector, Strong Economy ” Intervention of the insolvent banks by the SDIF November 2000 Crisis The Government’s Declaration to Expand the Scope of the Guarantee covering all liabilities of SDIF banks Internal/external confidence loss to the financial system Bank runs (Indonesian example) Withdrawal of deposits from the banking system (Total deposit $75.5 billion) Liquidation limited by the scope of the existing deposit insurance $ 26 billion cash requirement instead of transferring funds in the form of Government Securities to the SDIF Need for over-borrowing Excessive pressure on interest rates Impossibility of sustaining the debt service Direct liquidation after takeover by the SDIF Legal process has been shortened compared to direct liquidation Resolution process has been facilitated through deposit transfers Some portion of employees were kept employed through branch/bank sales Resolution under the SDIF

17. 16 “Strong Banking Sector, Strong Economy ” Rapid resolution of the intervened banks 20 banks were taken over by the SDIF 20 banks were taken over by the SDIF 1 bank in 1997Law Nr.3182 1 bank in 1998Law Nr.3182 6 banks in 1999Law Nr.3182 (1), 14.3 (1), 14.3/14.4 (4) 3 banks in 200014.3 (1), 14.3/14.4 (2) 8 banks in 200114.3 (3), 14.3/14.4 (5) 1 bank in 200214.3/14.4 The resolution of these banks through merger, transfer, sale or liquidation within 2 years The resolution of these banks through merger, transfer, sale or liquidation within 2 years (As of today only 2 banks remain under SDIF)

18. 17 “Strong Banking Sector, Strong Economy ” Resolution Process of the SDIF Banks Financial Restructuring; Financial Restructuring; Elimination of over-night liabilities Elimination of over-night liabilities Reduction of FX open positions Reduction of FX open positions Determination of deposit rates uniformly with market rates Determination of deposit rates uniformly with market rates Auction of deposits of about $3bn to other banks Auction of deposits of about $3bn to other banks Transfer of liabilies to other banks Transfer of liabilies to other banks With operational restructuring, significant reduction in the number of branches and personnel With operational restructuring, significant reduction in the number of branches and personnel Excluding 2 remaining banks number of branches were reduced to 6, personnel to 583. Excluding 2 remaining banks number of branches were reduced to 6, personnel to 583. With bank sales, a total of 10,337 jobs were kept. With bank sales, a total of 10,337 jobs were kept.

19. 18 “Strong Banking Sector, Strong Economy ” Most of these funds were used for meeting the deposit liabilities (total $26 billion) of the SDIF banks through payments and/or transfer. Initial costs of resolving the intervened banks Billion USD Public Funds (a-b) 17.1 a.Bonds issued by Treasury a.Bonds issued by Treasury 18.5 b.Bonds returned by the SDIF b.Bonds returned by the SDIF 1.51.51.51.5 Funds Provided from Private Sector (c+d) 4.7 c.Deposit support from SDIF revenues c.Deposit support from SDIF revenues 2.6 d.Capital support from SDIF revenues d.Capital support from SDIF revenues 2.2 TOTAL 21.7

20. 19 “Strong Banking Sector, Strong Economy ” Legal obstacles to a rapid collection of assets of intervened banks SDIF has collected a total of $1.7 billion via direct collection, sale of subsidiaries, tangible and intangible assets and bank sales. SDIF has collected a total of $1.7 billion via direct collection, sale of subsidiaries, tangible and intangible assets and bank sales. Dragging legal porcedures and lawsuits are a major impediment to rapid collection. Dragging legal porcedures and lawsuits are a major impediment to rapid collection.

21. 20 “Strong Banking Sector, Strong Economy ” Debt swap operation: Private banks’ FX open position to $1.5 bn in December 2001 from $8.4 bn at end-2000 Debt swap operation: Private banks’ FX open position to $1.5 bn in December 2001 from $8.4 bn at end-2000 Lower interest rate risks: Issuance of floating rate, FX indexed and FX denominated government bonds Lower interest rate risks: Issuance of floating rate, FX indexed and FX denominated government bonds Financial and Real Sector Council: to develop strategies to resolve NPLs and to restructure corporate debts Financial and Real Sector Council: to develop strategies to resolve NPLs and to restructure corporate debts Özel Bankalar Strengthening of the private banks

22. 21 “Strong Banking Sector, Strong Economy ” Increase in potential credit risk Deep-rooted structural problems Deep-rooted structural problems Deeper than expected recession Deeper than expected recession Adverse international environment Adverse international environment Limited possibilities of liquidation of assets in current economic conditions Limited scope for raising new capital from domestic and foreign private investors Vicious cycle of banking crisis-real sector crisis Rationale Rationale Recapitalization scheme for the private banks

23. 22 “Strong Banking Sector, Strong Economy ” To ensure transparency and enhance confidence in banking sector To ensure transparency and enhance confidence in banking sector To maximize capital contributions by banks’ owners To maximize capital contributions by banks’ owners To encourage mergers and acquisitions To encourage mergers and acquisitions To enable banks to start extending credits to real sector To enable banks to start extending credits to real sector To facilitate corporate debt restructuring To facilitate corporate debt restructuring To restore market discipline To restore market discipline Recapitalization scheme for the private banks Objectives

24. 23 “Strong Banking Sector, Strong Economy ” Start of the procedure with the completion of the legal framework 01.02.02 01.04.02 Finalization of the first audit 15.05.02 Announcement of BRSA’s final assessment results to the banks 30.06.02 Realization of capital increases Assessment Phase Phase Assessment Phase Phase Bank Bank Recap. Recap. Phase Phase Bank Bank Recap. Recap. Phase PhaseState Recap. Recap. Phase PhaseState Recap. Recap. Phase Phase Realization of the capital support by Public 30.04.02 22.04.02 Completion of appropriateness control (second audit) Submission of Merger& Acquisition plans (where relevant) to BRSA Meetings of General Assemblies Application to BRSA for support Recapitalisation Program Phases

25. 24 “Strong Banking Sector, Strong Economy ” The transparency of the banking sector has increased. The transparency of the banking sector has increased. The ability of the public sector authority to design and apply sound policies towards the establishment of a healthy and efficient banking sector has been improved. The ability of the public sector authority to design and apply sound policies towards the establishment of a healthy and efficient banking sector has been improved. Statistical Results: The total capital needs of the 25 banks have been determined as 866 mil. $ The total capital needs of the 25 banks have been determined as 866 mil. $ After negotiations, 720 mil. $ of the capital needs has been covered by banks and with other positive developments (e.i. decline in int.rates increased the value of gov’t papers). Remaining capital needs was 146 mil.$. After negotiations, 720 mil. $ of the capital needs has been covered by banks and with other positive developments (e.i. decline in int.rates increased the value of gov’t papers). Remaining capital needs was 146 mil.$. Özel Bankalar Results of the Audit Process

26. 25 “Strong Banking Sector, Strong Economy ” Asset size of the recap banks decreased from 69 bil. $ to 66 bil. $ after auditing. Asset size of the recap banks decreased from 69 bil. $ to 66 bil. $ after auditing. Important revisions in loans and NPL’s Important revisions in loans and NPL’s (loans decreased from 29,2 tril.TL to 24 tril. TL and NPL’s increased from 2,3 tril. TL to 7,8 tril. TL The collaterals of loans have been examined and updated by experts and real estate valuaiton agencies. (declined from 35,8 tril. TL to 30,4 tril. TL) The collaterals of loans have been examined and updated by experts and real estate valuaiton agencies. (declined from 35,8 tril. TL to 30,4 tril. TL) Inflation Accounting: Inflation adjustments for the non- monetary assets realized. Inflation Accounting: Inflation adjustments for the non- monetary assets realized. After the auditing process the own funds increased and the risk weighted assetes decreased. As a result the sector’s average CAR realized as 14,8%. After the auditing process the own funds increased and the risk weighted assetes decreased. As a result the sector’s average CAR realized as 14,8%.

27. 26 “Strong Banking Sector, Strong Economy ” Banks realized capital increase of $2.4 billion from their own resources. Banks realized capital increase of $2.4 billion from their own resources. As a result of the three-stage audit, 3 banks were found to be capital deficient. As a result of the three-stage audit, 3 banks were found to be capital deficient. 1 bank applied for state support and received subordinated debt to reach 9% capital adequacy ratio. 1 bank applied for state support and received subordinated debt to reach 9% capital adequacy ratio. Another bank’s capital need was covered in cash by shareholders. The capital increase process was finalized as of September 2002. Another bank’s capital need was covered in cash by shareholders. The capital increase process was finalized as of September 2002. Pamukbank, with a capital deficiency of about $2 billion, was transferred to the SDIF Pamukbank, with a capital deficiency of about $2 billion, was transferred to the SDIF Özel Bankalar Results of the Recap Scheme

28. 27 “Strong Banking Sector, Strong Economy ” Moving towards international standards Regulations on capital Regulations on capital Regulations on risk management Regulations on risk management Regulations on credit and subsidiaries’ limits and loan loss provisioning Regulations on credit and subsidiaries’ limits and loan loss provisioning Accounting standards and independent auditing Accounting standards and independent auditing Regulations on facilitating mergers and acquisitions Regulations on facilitating mergers and acquisitions Regulations on special finance houses Regulations on special finance houses MoUs with other countries supervisory authorities MoUs with other countries supervisory authorities Yasal ve Kurumsal Düzenlemeler Improving the regulatory and supervisory framework Improving the regulatory and supervisory framework

29. 28 “Strong Banking Sector, Strong Economy ” Consolidation in the banking sector Consolidation in the banking sector Number of banks declined from 81 in 1990 to 53 as of April 2003 Decline in the share of the State and the SDIF banks Decline in the share of the State and the SDIF banks During 2000-2002 the share of these banks in total loans and deposits from 34.2% to 18% and 53.3% to 39.3%, respectively. Increase in mergers and acquisitions Increase in mergers and acquisitions Total asset size of the mergers and acquisitions that took place in the sector is around $26.5 billion Results of operational restructuring

30. 29 “Strong Banking Sector, Strong Economy ” Results of financial restructuring Reduction of financial risks to manageable levels. Reduction of financial risks to manageable levels. Improved transparency Improved transparency Improved profitability Improved profitability In 2002 private banks generated a profit of $1.5 billion, state banks generated a profit of $646 million Strengthened capital structure Strengthened capital structure CAR rose to 27.1% in December 2002 from 9.3% in December 2000.

31. 30 “Strong Banking Sector, Strong Economy ” Effects on the private sector Istanbul Approach A total of $3.8 billion of loans of 135 firms were restructured. Increased credit extension Credits rose to $29.4 billion in 2002 from 23.4 billion in 2001.

32. 31 “Strong Banking Sector, Strong Economy ” Although certain risks have been decreased to more manageable levels... Interest Rate Risk Interest Rate Risk Issuance of bonds with variable interest rates Distortions created by state banks and insolvent banks eliminated Credit Risk Credit Risk Adequate classification of NPLs after the 3-stage audit Realistic assessment of collateral Necessary provisions have been set aside FX Risk FX Risk Issuance of FX-indexed bonds Implementation of floating rate regime Improvements in risk management

33. 32 “Strong Banking Sector, Strong Economy ”...some risks still remain Despite Istanbul Approach share of NPLs are still high Despite Istanbul Approach share of NPLs are still high Total sector Loan Loss Ratio = 17.8% For 25 Re-cap banks this ratio is 10.1% in 2002 compared to 24.7% in 2001 Short-term maturity structure of deposits Short-term maturity structure of deposits More than 90% of the deposits have a maturity of less than 3 months 57% of the deposits are in FX 57% of the deposits are in FX High share of Government bonds in the balance sheet High share of Government bonds in the balance sheet For Private Banks in 2002 Securities /Total Assest= 33.3% Low level of free capital Low level of free capital High level of operational costs High level of operational costs

34. 33 “Strong Banking Sector, Strong Economy ” BRSA’s agenda Rationalization of intermediation costs Rationalization of intermediation costs Establishment of financial holding companies Establishment of financial holding companies Providing a level playing field in the sector Providing a level playing field in the sector Establishment of secondary markets for distressed debt Establishment of secondary markets for distressed debt Incentives for rapid resolution of NPLs Incentives for rapid resolution of NPLs Compliance with BASEL-II Accord Compliance with BASEL-II Accord Risk based supervision Risk based supervision

35. 34 “Strong Banking Sector, Strong Economy ” Challenges faced by the BRSA Legal obstacles Legal obstacles Lack of political backing and consensus Lack of political backing and consensus Intense lobbying by pressure groups Intense lobbying by pressure groups Relationships between media and bank groups Relationships between media and bank groups Public awareness Public awareness Institutional draw-backs Institutional draw-backs BRSA - SDIF relationships BRSA - SDIF relationships Institutional development of BRSA Institutional development of BRSA Lack of secondary markets for distressed debt Lack of secondary markets for distressed debt

36. 35 “Strong Banking Sector, Strong Economy ” Key Lessons: Restructuring instruments utilized by the BRSA Introduction of blanket guarantee Introduction of blanket guarantee Voluntary debt swap (TL to FX indexed) Voluntary debt swap (TL to FX indexed) Tax incentives for merger and acquisitions Tax incentives for merger and acquisitions Tax incentives to lengthen maturity of deposits Tax incentives to lengthen maturity of deposits Merge then resolve (sell or liquidate) strategy Merge then resolve (sell or liquidate) strategy Superpowers granted to the SDIF to accelerate collection Superpowers granted to the SDIF to accelerate collection SDIF deposit auctions SDIF deposit auctions Re-capitalization scheme and provision of Tier-II capital Re-capitalization scheme and provision of Tier-II capital Agree on protocols to accelerate collection process and to minimise costs Agree on protocols to accelerate collection process and to minimise costs Voluntary corporate debt restructuring (Istanbul Approach) Voluntary corporate debt restructuring (Istanbul Approach)