Turkey's Back in the Headlines: What This Could Mean for Turkish Banks

Turkey is back in the headlines again. The country launched a military offensive into Syria and is now facing United States sanctions, and one of its largest state-owned banks has been charged with violating US sanctions on Iran. As a result, Turkish equities, bonds and the lira have all come under pressure. Investors’ wounds are still fresh from last year’s currency crisis, which pressured the balance sheets of the country's banks and sent the economy into a tailspin.

In the Turkish banking sector, valuations currently look cheap and macroeconomic conditions have been favorable. Do Turkish banks offer opportunity, or could investors get burned again? Below, I examine what’s going on in the sector and where it could go from here.

The influence of the Turkish Central Bank

The central bank’s rate cuts, largely due to lower inflation expectations and government pressure, have been particularly positive for Turkish banks because their deposits reprice faster than longer-term loans. The market expects the central bank to cut rates again as lower inflation expectations persist and government growth targets have increased.

Typically, I’d expect rate cuts to lead to an improvement in the net interest margins (NIMs) of Turkish banks over the next several quarters. However, the latest crisis has stoked risk aversion, and if the lira continues to depreciate, the central bank may have to pause or even increase rates, which could stall out the recovery in bank profitability.

Central bank policy may have the greatest impact on state-owned banks. These banks suffered the most from interest rate hikes put in place last year to help stabilize the currency, and they could benefit the most from recent and continued rate cuts. But Turkish state-owned banks have a bad reputation for corporate governance; they are viewed as the government’s agent for directed lending at the expense of shareholder profitability. In my view, fundamental profitability drivers, such as an expansion in NIMs, would need to significantly improve to compensate for the corporate governance overhang, especially in light of recent events.