Islamic finance has a history of more than 30 years in Turkey. At present, out of the 50 banks in Turkey, there are four Islamic banks normally referred to as ‘participation banks’. Ziraat Bank, one of the public banks in Turkey, is also contemplating entering the Islamic finance market in 2015. Conventional banks hold 90.4% of the banking market while the participation banks currently hold 5.5%, although this is expected to reach 15% by 2023.

Sukuk, or lease certificates, are on the ascendant throughout the world, and are expected to grow rapidly in Turkey along with the flexibility and diversity introduced by the Communiqué on Lease Certificates in June 2013. Drafted in consideration of the international practice and with contributions of Capital Market Board (CMB), Treasury, Participation Banks Association of Turkey (PBAT) and other market stakeholders, the new Communiqué introduced new forms of lease certificates, which can be based on the Ownership, Management, Trading, Partnership or Engineering, Procurement and Construction contracts.

Additionally, Special Purpose Vehicles (SPVs), which are established to conduct the transaction between the investors and fund users, are allowed for multiple transactions.At the same time, bureaucratic process is eased and issuance costs are decreased.

As another significant development in the Islamic finance market, the Turkey Export Credit Bank (Turk Eximbank) received approval from Banking Regulation and Supervision Agency (BRSA) to providemurabahah credit for exporters’ international transactions. Export credits, which were granted via only conventional banks, are also available for the participation banks to be granted for their customers as of May 2014.

Hayrettin Kaplan, CEO of Turk Eximbank, clarified that Turk Exim bank acts as an agency between the banks of Gulf countries and Islamic Development Bank together with the participation banks whereby it provides the capital required by the participation banks on interest-free basis.

tur-cur1Analysis of obstacles

One of the long standing problems faced by the Islamic finance market in Turkey is liquidity. Participation banks, before the introduction of lease certificates, had to keep high volume of liquidity reserves in their accounts for risk management purposes, which led to a decrease in profits, thus creating a handicap while competing with conventional banks.

Lease certificates, introduced in 2010, provided a tool for the participation banks to remedy the lack of fund raising methods. In order to increase market liquidity by means of lease certificates, the new Communiqué additionally allows rights as well as assets to be regarded as the source of the lease certificates. In addition, pension investment funds, real-estate investment funds and venture capital investment funds, whichare revised in order to incorporate lease certificates and tax incentives for both individual and corporate incomes generated by interest-free transactions, constitute leverage for the expansion of Islamic finance structure.

Participation banks mostly use lease certificates based on ownership (ijara), in particular on real estate ownership,to increase the liquidity. Participation banks need ownership of real estate among their assets to transfer it to SPVs and lease back within the framework of issuance if they want to continue to issue ijara sukuk. As stated by the Workshop on the Participation Banks and Islamic Finance (Workshop) organised by PBAT and BRSA and released in July of 2014, however, the participation banks’ inventory of real estate is about to be diminished. Therefore,participation banks need to diversify the methods to increase liquidity in the market and offer new instruments for investors.

Recent ventures in the market

Participation banks have begun to look at foreign investors to raise liquidity. Despite the concern among market stakeholders that the potential of Turkey in terms of Islamic finance is not clearly expressed abroad, recent transactions conducted by participation banks as well as private companies are promising for the future. Statistics also indicate that issuances to foreign investors have already reached up to 49% of overall issuances concluded to date.

Turkiye Finans, which has previously concluded two international issuances in 2013 and 2014, concluded another in July of 800 million Malaysian Ringgit (app. US$250 million). This transaction, announced to be the first part of an issuance programme totalling 3 billion Ringgit, took place with the supervision of HSBC andStandard Chartered. Following this, it is on the news that Kuveyt Turk, another participation bank,also plans to issue sukuk in Malaysia. In September, Kuveyt Turk announced that it applied for the approval of lease certificate issuanceto raise as much as 2 billion Ringgit (app. $625.3 million).

Apart from the participation banks, companies are also willing to provide funds by means of international issuance.Last month, conglomerate Dogus Group received regulatory approval to raise $370 million via sukuk in what would be the first dollar-denominated corporate transaction of the kind in the country. Similarly, Agaoglu,one of the significant players in construction sector, is planning to raise up to$300 million from foreign investors.

tur-curInstruments offered to investors

Despite the Communiqué introducingfive types of lease certificates, most of the transactions conducted between the participation banks and investors are based on trading (murabahah – mark-up sale) where an asset or right is purchased through an SPV with funds contributed by the investors and sold to the fund user at a price that is calculated using an agreed profit margin. Approximately 75% of Islamic financial instruments containmurabahah, which concerns short term financing. Mukim Oztekin, president of Banking Regulation and Supervision Agency (BDDK), at the Participating Banks Workshop stated that they should be seeking for the application of other instruments such as lease certificates based on partnerships (mudaraba and musaraka) in order to maintain long-term funds for participation banks as well as the macro-economic projections for the next decade.

At this point, an issuance led by Agaoglu in 2013, together with Aktifbank, an investment bank, drew the attention as the first issuance realised for the financing of the construction of Istanbul International Finance Center. The issuance amounted to TRY 100 million (US$44 million). It is based on mudaraba, an instrument also describedas profit/loss sharing, where the SPV obtains a share in the joint venture by allocating the fund contributed by the investors.

Hasan Rahvaiİ, CEO of Agaoglu, commented on the introduction of this practice and stated that the development of new financial institutions, especially asset based instruments such as lease certificates (sukuk), creates the motivation required to draw the capital accumulated in the Gulf region. In addition, considering investors’ satisfaction in mind, lease certificates based on partnership are expected to be considered as a viable alternative to raise funds for the construction sector.

According to Mr. Oztekin, the reasons why the participation banks mostly tend to usemurabahaharethe customer’s behaviour, i.e. tendency for short-term investments and competition among banks.

On the other hand, Derya Gürerk, new president of PBAT, emphasises another aspect of the issue and points out that regulations concerning partnership-based sukuk need revision. Confirming this latter opinion, the Workshop, takinginto account the high level of risk in partnership-based sukuk and hardship in tracing the activities of the fund user corporations, concluded that new regulations shall be brought in to reduce the risk and new incentives will be introduced. Suggested solutions are tax exemptions for investors and formation of a guarantee fund in order to distribute the risk of the investments, which is borne solely by banks.