Gulf banks take $950m hit on Turkish economic woes

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• Dubai bank Emirates NBD and Kuwait Finance House worst affected
• GCC banks not expected to exit Turkey, despite challenging conditions 

The exposure of GCC banks to Turkey through their subsidiaries is increasingly credit-negative due to deteriorating operating conditions in the country, according to analysts.

But Gulf-based banks are unlikely to exit Turkey despite the challenging conditions, mainly because of the lack of potential buyers, said Fitch Ratings in a new research note released on Tuesday.

It calculated that GCC banks with Turkish subsidiaries recorded about $950 million of net monetary losses in the first half of 2022 although exposures are decreasing due to Turkish lira depreciation.

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In July, Fitch downgraded 25 Turkish banks to ‘B-’ from ‘B’ following the downgrade of Turkey’s sovereign rating to ‘B’/Negative from ‘B+’/Negative on spiralling inflation and increasing macroeconomic and external risks. The Turkish banks’ ratings all also remain on negative outlook.

GCC banks with Turkish subsidiaries adopted hyperinflation reporting in H1 under the accounting standard IAS29 as cumulative inflation in Turkey exceeded 100 percent over three years. 

IAS29 requires the banks to restate non-monetary assets and liabilities to reflect the impact of hyperinflation, leading to net monetary losses in their income statements.

Fitch said Emirates NBD, Dubai’s largest bank, and Kuwait Finance House (KFH) were worst-affected in terms of the operating profit/risk-weighted assets ratio.

Their ratios fell by about 70 basis points when the net monetary losses were included. Both banks have high Turkish exposure with 16 percent of ENBD assets as at end-2021 and 28 percent of KFH assets.

The net monetary losses at ENBD and KFH, as well as at Kuwait’s Burgan Bank, accounted for over 15 percent of the banks’ operating profit in H1, Fitch data showed. The losses would have been even higher without gains on CPI-linked bonds. 

“We expect further net monetary losses in the second half of 2022 and into 2023, gradually declining as Turkish inflation slowly eases. Fitch expects Turkish CPI to average 71.4 percent in 2022 and 57 percent in 2023,” the ratings agency added.

Fitch said it has always viewed GCC banks’ Turkish exposures as credit-negative and it deducts one notch from Qatar National Bank, ENBD, The Commercial Bank and Burgan’s domestic operating environment scores to reflect their exposures to weaker international markets, particularly Turkey. 

For KFH, it deducts two notches to reflect its higher exposure although its exposure should decrease as a proportion of total assets following the acquisition of Ahli United Bank, agreed in July. 

Turkish exposures are a risk for GCC banks’ capital positions due to currency translation losses from the lira depreciation. The lira has weakened dramatically in recent years, with the US dollar/lira exchange rate now about 18, compared with 2.2 in January 2014. 

Fitch said: “We calculate that GCC banks’ aggregate currency translation losses through ‘other comprehensive income’ were $6.3 billion in 2018–2021, mainly due to lira depreciation.

“The aggregate net income of Turkish subsidiaries was about $3.3 billion over the same period. We expect currency losses to remain high until at least 2024 due to further lira depreciation.”

However, the agency said that it does not expect to downgrade the viability ratings (VRs) of GCC banks with Turkish subsidiaries as a result of the deteriorating operating conditions in Turkey. 

“The exposures are declining due to lira depreciation, and those banks have good loss-absorption capacity. Moreover, the VRs already reflect the high risks associated with the subsidiaries,” it noted.

Fitch added: “We do not expect GCC banks to exit Turkey, despite the challenging conditions. One factor is the lack of potential buyers, even though Turkish banks are trading at 50 percent below their book value.”

The ratings agency believes that GCC banks would be willing and able to provide their Turkish subsidiaries with financial support, if needed, and this is reflected in the ratings of the subsidiaries. 

Turkey’s central bank shocked markets earlier this month by cutting its main interest rate by 100 basis points to 13 percent, saying it needed to keep driving economic growth despite inflation hitting nearly 80 percent and a monetary tightening trend among its peers worldwide.

According to the World Bank, the Russian invasion of Ukraine is amplifying the headwinds facing the Turkish economy. Given Turkey’s close economic ties to both Russia and Ukraine, the war is expected to disrupt its energy and agricultural trade, tourist arrivals and overseas construction activities.

Turkey’s foreign trade deficit surged 147 percent year-on-year to $10.69 billion in July, with imports surging 41.4 percent, data from the Turkish Statistical Institute showed. Imports stood at $29.24 billion, while exports rose 13.4 percent to $18.55 billion.

Under an economic programme unveiled last year, Turkey aims to shift to a current account surplus through stronger exports and low interest rates, despite soaring inflation and a tumbling currency. Soaring global energy and commodity prices have made that target more difficult to attain.