Moody's maintains negative outlook on the Turkish banking system amid challenging operating conditions

Moody's Investors Service is maintaining its negative outlook on Turkey's banking system, reflecting the rating agency's expectation of weakening financials for the country's banks amid a challenging operating environment.

The outlook expresses Moody's expectation of the Turkish banking system's creditworthiness over the next 12-18 months.

Moody's report, entitled "Banking System Outlook: Turkey", is available on www.moodys.com. Moody's subscribers can access this report via the link provided at the end of this press release. The rating agency's report does not constitute a rating action.

Although Turkish banks' financials remained resilient in 2016 and early 2017, Moody's expects a combination of factors, including domestic political and geopolitical tensions, potential currency depreciation, and weakening investor confidence, to take a toll on these going forward.

As noted in April 2017, Moody's expects economic growth in Turkey to slow to an average of 2.8% in 2016-2018, significantly below the 7.4% average over the previous six years, against a backdrop of lower domestic confidence, potential further lira depreciation and high inflation. Although asset quality has so far proved resilient, aided by non-performing loan sales and regulatory forbearance, the rating agency expects the challenging macro environment to drive problem loans to above 4% over the next 12-18 months from 3.2% at end-2016.

Similarly, profitability will likely decline as higher funding and foreign currency (FX) hedging costs, slower lending growth and higher loan-loss provisioning will weaken the strong 1.8% return on risk-weighted assets recorded in 2016.

Capital will likely remain sound, however. The system's common equity tier 1 (CET1) ratio of 13.2% at end-2016 will decline in 2017 if the Turkish currency continues depreciating, but will remain solid.

Reduced investor confidence could also increase wholesale funding costs over the outlook period. Potential disturbances to the cost and access to FX wholesale funding remain a key risk for Turkish banks, given their high reliance on short-term FX funding, notes Moody's.

Lastly, the Turkish government's capacity to support the banking system if needed is diminishing, in Moody's view. This is particularly the case for FX wholesale funding, given the central bank's modest net FX reserves of USD34 billion as at January 2017, compared to short-term bank wholesale maturities of almost USD80 billion.