Turkey's banking watchdog (BDDK) on June 19th took control of the country's seventh largest bank, Pamukbank, driving the Istanbul Stock Exchange (ISE) into a sharp decline.
The ISE index ended June 19th down 2.05% at 9,378.43, with the banking sector index falling 2.75% on the day.
Nevertheless, the decision was hailed by outside observers of the country's road to economic recovery as a much-needed step towards reforming the beleaguered banking sector.
"This decision is yet another demonstration of the BDDK's strong commitment to placing Turkey's banking sector on a sound footing. It marks a critical step in the recapitalization exercise of the private banking system…" said IMF External Relations Department Director Thomas C. Dawson on June 19th.
The ISE’s downturn came in contrast to a fleeting boost on June 13th following an announcement by the BDDK that a recent audit showed the banking sector to be sound. All of the banks but one, Sekerbank, were shown to have met their capital needs of 1,102tr lira (around $700m) of a total 1,326tr lira in extra capital the BDDK deemed necessary at the end of 2001. The BDDK now requires banks to have a minimum capital adequacy ratio (CAR) of 8%, in line with international standards
Following its seizure of Pamukbank, the BDDK received considerable kudos abroad, with U.S. Treasury Under Secretary for International Affairs John B. Taylor saying on June 19th the BDDK's "forceful actions" were welcomed.
"These actions are critical steps in the plan to recapitalize the private banking system and they demonstrate the on-going commitment of the Turkish authorities to implement the economic program," he said in a press release.
The recapitalization plan, central to Turkey's $16bn IMF-backed reform package, is meant to unburden banks of bad debt incurred when Turkish companies were unable to repay loans following the February 2001 crisis.
It is hoped that the recapitalization will free banks to inject much-needed capital into the economy, with outstanding loans renegotiated at new favourable terms.
"Turkey's reform measures are strengthening the prospects for economic recovery," Taylor said.
Turkey's beleaguered banking sector was at the heart of the February 2001 economic crisis, which saw the lira lose nearly half of its value and the economy contract by 9.4%.
Turkey's Economy Minister Kemal Dervis said on June 20th that reform of the banking sector would shore up the economy and said the BDDK's decision "was a pleasing development."
"Our economy is at a turning point in 2002, as inflation has started to decrease and economic growth has begun again," Dervis said.
"It should not be forgotten that the robust structure and activities of the banking sector … are one of the basic necessities in maintaining this trend and entering into a process of sustainable growth in the medium-term."
The country is currently within reach of its goal of 35% year-end inflation and 3% growth. And the IMF is due to review progress under the loan by the end of June, which would lead to the disbursement of a $1.1bn tranche.
But political infighting in the ruling three-party coalition has razed the shaky façade of unity, and EU-demanded reforms are not likely to be considered before July 1st, when parliament will return briefly from its summer recess to debate the contentious issue of abolishing the death penalty.
The seizure of Pamukbank compounded uncertainties in the market, with shares of Cukurova Holding-owned Turkcell plummeting 17.8% on June 21st.
And with Pamukbank now under state receivership, the future of its sister bank Yapi Kredi - Turkey's fourth largest private lender by assets - now looks uncertain.
The BDDK replaced two of Yapi Kredi's board members, including Cukurova Holding head Mehmet Emin Karamehmet, who was ordered by an Ankara court on June 19th along with several directors of Pamukbank not to leave the country. The court also ordered the freezing of their assets.
Questions are mounting about how to make up for Pamukbank's $2bn capital shortfall. It is unclear whether Cukurova Holding's other concerns, including mobile provider Turkcell and pay TV service Digiturk, can be sold off to reform the lender. There are unresolved issues of cross ownership between Pamukbank and Yapi Kredi, which form the core of the group. Banking and financial services make up 45% of Cukurova's revenue.
With the removal of Karamehmet and his fellow board member, the BDDK now has executive control over 40% of Yapi Kredi shares, as a recent IMF-backed law forbids shareholders in failed banks from holding a majority stake in a failed bank.
Trading of Yapi Kredi shares resumed on June 24th after they were suspended last week, opening down 12.24%. And on June 21st the bank announced $573.2m in losses in 2001.
The banking watchdog said on June 21st that it had revised its original estimate of bad loans by private banks included in an audit of their capital shortfall from 7% to 25%. It said that $1.6bn of loans extended by banks would go down as losses.