The recent election in Turkey could sow the seeds of future growth for private participation banks despite being widely seen as a headwind to the sector as Justice and Development Party (AKP) experienced a defeat in being pushed either into a coalition government for the first time, or call for a fresh round of elections. This could challenge Erdoğan’s plan for a bigger role for government-owned banks in the participation banking sector. Ziraat Bank, the first to launch its participation banking unit, did so days before the election on the anniversary of the Ottoman conquest of Istanbul and will be followed by Vakıfbank and Halkbank.
During 2014 as the (politically motivated) regulatory seizure of Bank Asya became more likely, asset growth at participation banks slowed from 37.1% in 2013 to just 8.9% in 2014. The growth differential relative to the overall banking sector slowed from a +10.2% to (4.6%), a swing of almost 15% in just a year. Asya’s seizure highlighted problems identified by, among others, the World Bank’s departing Country Director Martin Raiser, with “the quality of regulation and the independence of regulatory institutions”.
This drop in growth is likely to keep market share of the private participation banks stagnating even with a pickup in growth this year because the trauma of Asya’s decline damaged confidence at a time when macroeconomic vulnerabilities in the Turkish economy grew. The confidence may take a further hit as the CEO of Türkiye Finans (owned by Saudi-based National Commercial Bank) resigned suddenly. Türkiye Finans is the 2nd largest participation bank and the CEO departure adds distraction when it and the other two private participation banks should be focusing on competition from the state-owned banks.
Participation bank asset and deposit growth returned in Q1 for Albaraka Turk and Kuveyt Turk to a 30% annual rate (Q1 results are not available for Türkiye Finans) while Asya’s asset and deposit outflows abated. However, economic conditions became more difficult with political pressure from elected leaders and foreign investors pushing the central bank in opposite directions creating a standoff that has resulted in a falling Lira. Conventional banks also saw rapid asset growth and both growth at participation and non-participation banks may have more to do with the currency volatility and lots of (now more burdensome) dollar-denominated loans than with underling asset growth.
Market volatility may prove a silver lining for private participation banks’ failure to grow market share relative to a situation where the government was in full advocacy mode for its own banks without the volatility. It may be more difficult for the state-owned participation banks to grow their market share (notwithstanding the likely enthusiasm from the Anatolian Tigers who are staunch AKP supporters). The uncertainty around the direction of monetary policy, and the potential political bent to asset growth with AKP supporters may lead to a deterioration of asset quality, particularly of the new financing which the state-owned participation banks will have to offer in order to grow.
Barring future issues in private participation banks, it may be a better time to sit more on the sidelines and remain well positioned to capture depositors and resume asset growth after political stability returns with less control by AKP alone. The ‘push’ for depositors may be a decline in asset quality causing difficulty for the banks to maintain competitive returns for depositors) or a shifting of the political winds towards less explicit government support for participation banking. That being said, the next year will be equally challenging for the remaining private banks as their market share gets challenged by new government-owned participation banks.
A shift away from governance by Erdoğan’s Islamist AK Party on its own may, however, lead to less governmental involvement in the participation banking market in the future and, in the meantime, by growth which could be captured by the private banks down the road. Whatever market share the state-owned backs capture now may eventually end up benefitting the private participation banks who are all majority-owned by foreign Islamic banks and thus able to provide liquidity in the meantime.
Eskom, the cash-trapped South African state owned utility, faced a public hearing where the acting CEO Brian Molefe said they would go ahead with ‘a lot’ of sukuk issuance. The troubled utility is facing defaults by many municipalities which it has reacted to by rolling black-outs as long as debts remain. With costs running ahead of revenue, it is looking to sukuk follows a failure to get approval for the price hikes it said it needed. The corporate issuance would, following the South African government sukuk, be a rarity: a corporate issuer that enters the market shortly after the sovereign’s debut. South Africa issued a $500 million sukuk which priced at 3.9 percent and has traded higher with a bid yield of 3.63% on June 29 since it was issued in September 2014.
Although sovereign sukuk issuances have grown considerably, it has not spurred rising issuance in the corporate sukuk arena where pricing and legal issues associated with more complex structures remain a concern. The lack of familiarity with sukuk structures outside core MENASA markets translates into higher advisory fees for prospective issuers, which saps momentum in already dormant corporate sukuk markets. The higher fees add onto already higher yields as investors demand compensation for limited trading activity in sukuk secondary markets.
According to a Thomson Reuters Sukuk forecast study, 36% of the survey respondents said that the additional cost of issuing sukuk was at least $50K more than conventional bonds. On the liquidity side, respondents expect that sukuk will move more than 100bps in reaction to a 100bps rise in Treasury yields, supporting the idea that sukuk trade in less liquid secondary market activity which could leads to higher pricing of new issues.
Despite these issues in the market and Eskom’s own financial straits, the company’s choice to pursue sukuk as a financing option makes sukuk look like a ‘lender of last resort’ for Eskom. This points towards an alarming issue of whether there is an adverse selection problem in the corporate sukuk market. Will sukuk become the first choice of only those corporates, due to factors including falling credit ratings, who would otherwise go for conventional issuance. It is imperative for sukuk practitioners to work to structure sukuk in a way that levels the playing grounds globally so that corporate sukuk issuance are just not limited to corporates in dire-straits or those in Muslim-majority hubs.