Turkish banks’ capital headroom could erode as full Basel III rules come into play: Moody's

LONDON

Some Turkish banks will likely need to issue additional capital to avoid a shortfall before the full implementation of Basel III in 2019, said Moody’s Investors Service in a report April 7.

“Turkish banks’ lending growth is outpacing their capital creation and we expect capital levels to decline over the next three to five years,” said Arif Bekiroğlu, an Assistant Vice President at Moody’s. 

“This means that headroom above the regulatory minimum will narrow just as the full breadth of the new Basel III capital demands come into force.”

To meet the full Basel III requirements, banks in Turkey must phase in a capital conservation buffer requiring another 2.5 percent of risk-weighted assets (RWAs) in capital by 2019. The country’s largest and systematically important banks must also hold a systemic risk buffer, additional capital equal to a further 2 percent of RWAs, by the same date, said the report. 

With Turkish banks’ profitability at historic lows, Moody’s estimated that the banking sector can only support lending growth of around 9 percent without depleting capital, assuming a 20 percent dividend payout ratio, as per the average trend in the recent past (or 11 percent-12 percent growth with full retention of earnings), added the statement. 

Moody’s noted that upon full implementation of the Basel III capital framework, the banks’ ability to maintain headroom above their minimum capital requirements will depend on the growth rate of their balance sheets.

A higher rate of growth, for example, would start to erode capital ratios, since RWAs will outgrow capital.

Any additional pressure on profitability could also accelerate the decline in capital; such pressures could include higher funding costs, narrowing interest margins, or a rise in loan-loss provisions as large volumes of new loans are tested, said Moody’s. 

In addition, further depreciation of the local currency against the U.S. dollar would also consume capital, as the local currency-equivalent risk weights for foreign currency loans will be magnified, in Moody’s view.

Declining capital headroom, though, could enhance the banks’ risk discipline, according to the rating agency.

The need to meet the full breadth of Basel III standards by 2019 will encourage banks to optimize their capital composition and tighten their underwriting practices to protect their margins and so enhance internal capital generation.

As a result, banks with the strongest core capital (currently the country’s four largest banks), will have a competitive advantage to extend more credit, increase their market share and improve their economies of scale, according to the rating agency.