Competition in Turkish banking sector

By

Name: Baris Can Mugan ANR No: 314958 Graduation Date: August 27th, 2013 Supervisor: Jose M. Liberti School of Economics and Management Master of Science in Finance (CFA Track)

Table of Contents

I INTRODUCTION ...... 3 II OVERVIEW OF THE COMPETITION IN TURKISH BANKING SECTOR ...... 4 II.I THE MILESTONES AFFECT THE COMPETITION LEVEL IN TURKISH BANKING SECTOR ...... 5 II.II HOW THE COMPETITION LEVEL AFFECT THE CHARACTERISTICS OF TURKISH BANKS ...... 7 III DEVELOPMENT OF HYPOTHESIS ...... 9 III.I MEASURING THE COMPETITION AND CONCENTRATION LEVEL IN TURKISH BANKING INDUSTRY ...... 11 III.I.I Structural Approach ...... 12 III.II MARKET STRUCTURE IN TURKISH BANKING INDUSTRY ...... 14 III.II.I The Concentration Level ...... 14 III.II.II Asset Growth and Concentration ...... 14 III.II.III Loan Size Growth and Concentration...... 15 III.II.IV Deposits Growth and Concentration ...... 16 III.III M&AS AND CONSOLIDATION ...... 16 III.IV REGULATIONS FOR COMPETITION ...... 18 IV DATA AND METHODOLOGY ...... 19 IV.I DATA ...... 19 IV.II METHODOLOGY...... 20 IV.II.I Event Study for the regulation effect...... 20 IV.II.II Panel Data Regression...... 21 IV.II.III Hausman Test in order to determine Fixed Effects or Random Effects ...... 24 V RESULTS ...... 25 V.I RESULTS OF EVENT STUDY ...... 25 V.II RESULTS OF REGRESSION ...... 27 VI CONCLUSION ...... 31 VII WORKS CITED ...... 32 VIII APPENDIX...... 35

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I Introduction Turkish Banking Sector is one of themost developed sectors in still developing Turkish economy. Like any other sector, competition level in the banking sector isdependent on regulatory boards and characteristics of the players in the market. In this paper, I will study the competition level in Turkish banking sector.

Examining competition level in Turkish banking sector needs special treatment becausebanks have many products to serve their customers. Additionally, Turkish banking sector became highly regulated market after the financial crises. These two factors make studying the competition level in Turkish banking sector complex. For this reason, I will investigate the competition level in Turkish banking system with two sides: (i) the regulation effect on the competition level and (ii) the characteristics of the banks affect competition level in the market.

According to recent studies, measuring competition level and its effects in a banking system is not final and conclusive. In this paper, I will use structural approach in order to measure market concentration and competition level in the market. Herfindahl-Hirschman Index is a proxy for market structure and competition level. While using structural approach, I examine the characteristics of the banks in order to understand if competition creates efficient and profitable banks in the market.

Turkish banking system is used for examining competition level because Turkish banking sector gives a chance to see how establishing a regulatory body affects the competition level in the market.Therefore, I use the event study in order to investigate the effect of establishing a regulatory boardin 2000 on the competition level. As a result of the event study, I investigate how the regulator affects the market competition. Additionally, I used a panel data regression not only to extent the event study research and but also to examine which characteristics of banks are drivers for the competition level in the market.

The main goal of this paper is investigating the effect of establishing a regulatory board on the competition level in Turkish banking system and which characteristics of the banks affect market concentration and competition level.

The thesis report proceeds as follows. In Section 2, development of Turkish banking system is explained. In Section 3, current state of literature in competition level in financial markets

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is described. Then the methodology and data resources are outlined in Section 4. In section 5, the results of the event study and the panel data regression will be given and described. Section 6 concludes the main goal of this paper and the findings about the competitio n level in Turkish banking system.

II Overview of the competition in Turkish banking sector The structural change of Turkish banking sector starts with establishing The Republic. From the republic period, the sector evolves and expands time after time even though there were some financial crises in the history.

Turkish financial system is one of the leading sectors in Turkish market. The sector is highly correlated to the outlook of Turkish economy and development. As shown in Figure1, financial system gains more share year after year. It shows that Turkish financial system became stronger and important for Turkish economy after financial crises. After 2001 local financial crisis and 2009 global financial crisis, Turkish financial system recovered itself quickly and gains more sector share from Turkish GDP.

Figure 1 Turkish GDP Growth and Financial System Sector Share

0,15 0,1 0,05 0 -0,05 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 -0,1

Financial System Sector Share GDP Growth

Source: Turkstat, turkstat.org.tr

Turkish economic development is highly correlated with Turkish banking sector. For this reason development of Turkish economy is explained chronologically in Appendix 1.

In order to examine competition level in Turkish banking sector, understanding the milestones, which affect Turkish banking sector structurally and how characteristics ofTurkish banks changed in the event of changing the competition level in the market is so important.

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II.I The milestones affect the competition level in Turkish banking sector Competition level in Turkish banking sector is changed drastically depends on the regulations and the macroeconomic conditions. As a result of this, some turning points in Turkish banking history need to be studied in order to give an opinion what drivers affect competition level in the market. As shown in Figure 2, some key events in Turkish history changed the number of banks and branches in the banking sector. In this section I will explain the turning points and their effects on Turkish banking sector briefly.

Figure 2 Numbers of Banks and Branches in Turkish Banking Sector

40 6000 30 4000 20 10 2000

0 0

Number ofBanks Number Number ofBranches Number

State Owned Privately Owned Foreign State Owned Privately Owned Foreign Source: TBB, tbb.org.tr

The first milestone for Turkish banking sector is establishing Turkish Central Bank (“TCMB”). TCMB was established in June 11, 1930 and is the first regulatory board in the market. Turkish Central Bank is able to set discount rates, monetary policy, perform open market operations in order to achieve its main goal, which was supporting to Turkish economic development (Central Bank of The Republic of Turkey).

Even though Turkish Economy was still immature and had lack of capital accumulation, Turkey suffered from economic crises in 1930s because of “The Great Depression”. For this reason, Turkish economic policy was shift to state socialism and Turkish banking sector changed significantly and state owned banks had higher market power. Another impact of the state socialism policy is that consolidation in the banking sector. In other words, local and small banks were eliminated due to high competition between the big players in the market.

In post Second World War era, the economic development relied on participating of the private sector instead of the public sector (Tokgoz, 2011). Private-owned banks increased in importance. Thus the number of banks and branches increased in this period. Additionally, the way of earning revenues in banking industry was changed because Turkish Central Bank determined commissions and interest rates. That’s why, banks tried to open more branches to

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collect more deposits (TBB, 2009).

This expansion in the banking industry was built on foreign investment and liberalization policy. Turkish economy grew up unsustainable between 1950-1960 in the help of positive inside and outside factors. However, Turkish economy has problems, after the macroeconomic outside and inside factors were gone (Sahin, 2011). It caused high inflation, fiscal deficit and trade deficit so the banking sector suffered the crises in 1958. As a result of these financial crises, some banks went bankrupt and some of them merged with each other to survive (Ankara Sanayi Odasi, 2001).

After 1958 economic crises, Turkish State shifted again the economic policy to planned economy from liberal economy to provide sustainable economic growth (Kepenek & Yenturk, 2012).The numbers of banks’ branches were increased because the government set interest rates and exchange rates and there was no risk about interest rates and exchange rates(Dincer, 2006). For this reason, banks preferred to open new branches to collect more deposits that help banks to finance granted loans. As shown in Figure 2, the number of banks in the market was decreasing steadily while the numbers of branches rose tremendously in between 1960-1980.

Another milestone, which changed Turkish market structure completely, is announcing a liberal economic program in January 24, 1980. The government controlled the market and the entrance to the market was so hard.(TBB, 1990) For this reason, mostly foreign banks entered to Turkish banking sector with the help of lower entry barriers.The competition level increased in parallel with the number of banks in the market between 1980 and 1990.

The structure of Turkish banking sector was changed remarkably after 1990 because there was a significant cash outflow from the market and lack of liquidation problem due to macroeconomic conditions. Then, Turkish lira was devalued and most Turkish banks were in open currency position. Some privately owned deposit banks went bankrupt and the state- owned banks have higher market share in the market because of nationalization of some distressed banks (Acar Boyacioglu, 2003).

The most important and recent turning points, which affect the competition level in the market, is establishing “The Supervision Agency” (“BDDK”) in August 2000. BDDK has wide scope of work as a regulator in the industry. The entry barriers begun to control by

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BDDK so entrance is not as easy as before. Also BDDK always checks capital adequacy ratios of the banks and force them to have ratios in a normal range (Sahin, 2011). These reforms directly affect positively competition level in the industry so the inequality in competition between state-owned banks and privately owned banks was gone (Keskin, 2001).

Even establishing BDDK improved to solvency of banks in the market, Turkish deposit banks had still open currency position in 2001 (TBB, 2002). Then, Turkish Lira devalued again and 8 privately owned deposit banks nationalized. The number of banks in the market was 79 in 2000 and 47 in 2005 and 44 in 2011. However, the reforms, which were introduced by BDDK, helped the banking sector to recover after 2001.

Turkish banking sector became an attractive with profitable indicators in parallel with Turkish economic development. The number of foreign bank increases after 2005.

II.II How the competition level affect the characteristics of Turkish banks According to classical economics, competition level in the market and the number of players in the market are directly related each other. For this reason increasing number of players causes higher competition level in the market. Additionally, not only the numbers of firms but also characteristics of the firms (such as net interest margin, return on equity etc…) affect the competition level significantly.

According to Bikker & Haaf (2002), some financial ratios can be used to have insights about the effectiveness in the banking industry. That’s why, net interest margins, return on assets (“ROA”) and return on equity (“ROE”) can be taken into account as a proxy for effectiveness in the banking industry.

In this section, I will focus on some financial ratios to have an idea about the competition level of Turkish banking industry. In later section, I will analyze the competition level and effectiveness of the industry with empirical model.

The first ratio which I will analyze the competition level is the net interest margin. The net interest margin is the ratio of net interest income to total asset and it shows us how much money the bank earns with its interests. In a competitive market, the net interest margins are expected low because the competition forces banks to reduce their interest income, which is their major operating revenue (Bikker, Competition and Efficiency in a Unified European

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Banking Market, 2004).

Table 1 Some Ratios in Turkish Banking Sector

Return Returns on Loan Size/Total Assets Net Interest Margin on Asset Equity State- Private State- Private Sector Foreign Sector Foreign Sector Sector Owned Owned Owned Owned 1995 42.5 44.2 39.1 27.9 8.4 3.4 11.9 17.8 3.4 55.4 1996 43.1 39.5 43.6 25.3 10.5 6.7 13.0 16.7 3.9 64.3 1997 45.5 45.6 44.7 26.3 10.5 4.5 13.7 21.9 3.4 54.1 1998 38.3 31.9 41.4 25.6 12.3 5.3 15.4 24.6 2.7 44.9 1999 30.1 24.3 33.5 16.5 8.8 4.5 13.1 14.4 -0.6 -14.9 2000 32.9 25.8 37.7 17.1 3.5 3.0 7.0 9.4 -3.6 -89.8 2001 24.6 16.4 26.7 26.8 4.7 8.6 4.5 10.1 -3.8 -69.9 2002 26.5 13.8 30.8 33.9 6.0 7.2 5.0 11.0 1.4 11.2 2003 28.0 15.3 33.0 39.9 4.5 6.2 3.1 9.1 2.2 15.8 2004 33.7 20.1 39.6 46.3 5.8 5.8 5.4 6.5 2.1 14.0 2005 38.6 25.3 43.6 50.6 4.6 4.1 4.6 5.7 1.4 10.6 2006 45.0 32.8 48.1 56.3 4.2 4.4 3.8 5.0 2.3 18.9 2007 50.0 38.6 52.1 62.6 4.6 4.3 4.3 5.6 2.6 19.5 2008 52.0 42.0 54.1 61.8 4.4 3.9 4.0 6.1 1.8 15.4 2009 47.7 52.0 47.6 59.8 5.2 4.4 4.9 7.3 2.4 18.3 2010 52.9 47.7 52.7 60.1 4.0 5.2 3.8 5.5 2.2 16.5 2011 57.2 52.9 57.9 58.9 3.4 4.0 3.1 4.5 1.6 13.8 Source: TBB, tbb.org.tr

As shown in Table 1, the net interest margins in the banking industry dropped after 2000. In other words, this decline on the net interest margin means that the market becomes more competitive after 2000. When focusing on classifications of the banks, the margins of private owned and foreign deposit banks are in decreasing trend since 1999. On the other hand, state owned deposits banks had higher net interest margins after 2000.

While focusing on the net interest margin and analyzing the competition level, I will also consider the loan market. In other words, the banks grant more loans in order to gain more market share in the market. Clearly, the market becomes highly concentrated if the fraction of 퐿표푎푛 푇표푡푎푙 퐴푠푠푒푡푠 is increasing in the banking industry.

Due to risky environment between 1999 and 2001, the banks were more conservative and they granted fewer loans. After 2001, they became more aggressive to attract customers. It shows that the banking industry became more competitive in post financial crises era.

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Obviously, the foreign and private owned deposits banks are more aggressive to grant loan in order to attract more customers and gain more market share.

Competition level in the market has negative impact on returns. For this reason, examining returns of the banks will give an insight about competition level. “Return on Asset” and “Return on Equity” are shown in Table 1 to monitoring the returns of the banks in year by year for the relation with competition.

ROA and ROE ratios are increasing since 2001, so the banking industry becomes more profitable. Put another way, this increasing in the returns concludes that the banks operates more effectively or the competition level is decreasing after 2001. These two possibilities may affect the returns.

The ratios I discussed in this section are not enough to conclude the relationship between competition level and efficiency. Obviously, empirical model, which covers more ratios, can analyze the relation. I will use empirical methods in later section.

III Development of Hypothesis The banking sector is the biggest sector in financial world so the market structure becomes so important. A market structure is based on the number of firms, barriers to entry, demand and supply of products in the market(Artun, 1983). In a competitive financial market, it is expected that the banks become effective financial intermediaries, which provide a wealth transfer from savings to investments(Buchs & Mathisen, 2005).

The main aim of competition in the industry is maximizing the social welfare and efficiency. However, the special characteristic of the banking industry makes the relationship between competition and efficiency unclear. Asymmetric information and existence of entry barriers create a market power for each bank (Carletti, 2007). Another reason of instability in financial markets is the probability of contagion(Allen & Gale, 2004). A shock in a bank may affect the other banks in the market and the market may affect the whole economy.

Due to these attributes, the basic competition theory in economics doesn’t work for banking industry. In other words, the relationship between competition and sustainability is complex. Competition increases sustainability in the market in some cases while highly concentrated

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markets can be better for social welfare. For this reason, the relationship between competition and efficiency is analyzed under two views(OECD, 2010).

According to the “competition-efficiency” hypothesis, increasing in competition creates more efficient banks. In other words, Banks force to minimize the costs and service their products in lower prices. When they try to maximize their profits, effective banks have higher size and market share. Thus, the market becomes highly concentrated. Contrary, banks have “quiet life”in uncompetitive markets. Therefore, banks become less effective because they don’t need to minimize the costs to announce profits. For this reason, the competition causes effectiveness in the market(Schaeck & Čihák , 2008).

Consistent with “competition-efficiency” hypothesis, highly concentrated banking industry has fewer players in the market. Policymaker cares more the concentrated markets with fewer players because the probability of contagion is higher in these kinds of markets. In other words, policymaker concerns the bankruptcy of bigger banks triggers a failure of other banks in the market (“contagion”). Along with these assumptions, these big banks are called as “too-big-to-fail” and they are more risk taker because they know that “they are too big to fail”. In case of bankruptcy, one of the “too-big-to-fail” banks believes that the government will bail them out(Yeyati & Micco, 2007). For this reason, highly concentrated banking industries are more fragile and have higher contagion risk(Beck, 2008).

On the other hand, the “competition-inefficiency” hypothesis suggests that competition causes a less efficient banking industry. Higher competition among banks leads to shorter relationships between customers and their banks. Clearly, customers are more likely to change their banks when the competition is higher. For this reason, information asymmetries that need for monitoring and screening the customers are increased. Additionally, the value of information decreases because the banks cut their customer relationship activities due to shorter expectancy of customer relation. In the light of these two issues, banks need to spend more to attract customers. Put another way, the value of proprietary information held by banks is decreased(Schaeck & Čihák , 2008).

There is no certain view which clarify how the relation between competition and efficiency in banking industry. However, it is a fact that the structure of the market should be balanced with benefit and cost of competition.

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I will primarily focus on “competition-efficiency” hypothesis in this paper. In examining efficiency, I will take financial efficiency into consideration. Financial ratios, which are calculated from the figures in the banks’ annual reports, align with profit maximizing. Considering profit maximizing, banks likely to be more profitable in a competitive market. Additionally, banks begin to gain more market share when they maximize their profits so total assets of banks show their efficiency performance too.

I also investigate the regulation effect on the competition level in consistent with “competition-efficiency” hypothesis. Establishing BDDK as a regulatory board in the market is an exogenous shock that allow “quiet-life” for banks. Put another way, regulated market makes banks less efficient banks and the banks serve highly priced products while they don’t force themselves minimize costs.

III.I Measuring the competition and concentration level in Turkish Banking Industry Two approaches are used in order to measure the competition level in banking industry.

The first approach is based on the effects of concentration level on performance and it tests structure conduct performance (“SCP”) versus efficient structure hypothesis. In this approach, the indicator of competition is the concentration level in the market. When testing to efficiency structure hypothesis, major efficiency ratios are taken into account as proxies.(Maudos & Nagore , 2005)

The second approach is also called New Empirical Industrial Organization (“NEIO”). In this approach, the key point is predicting behaviors of firms and consumers and fitting in an empirical model so it focuses on econometric and game theory models. While determining the market power in this NEIO approach, the difference between market price and marginal cost is taken into account. In other words, any exogenousmarket structure isn’t taken into consider in NEIO approach in order to find concentration or competition level in the market.(Matthews, Murinde, & Zhao , 2007)

Bain (1951 and 1956) worked on market structure with structure conduct performance. Unlike NEIO approach, market structure and concentration level is considered as exogenous variable. Additionally, profitability ratios regress on concentration indexes and other control

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variables. Most results show a positive relation between profitability and concentration.

I will run a regression and use empirical methods in order to see the relation between profitability, efficiency ratios and concentration levelin the market. That’s why; I will focus on structural approach and used Herfindahl-Hirschman as a proxy for concentration level in the market.

III.I.I Structural Approach In Structural approach, the competition level is measured according to SCP assumptions. The origin of theory in structural approach comes from industrial economics. For this reason, the banks become less efficient and less competitive when the concentration level in the market increases. As a result of this, concentration level is a key measurement for structural competition level.(Bikker & Haaf , Measures of Competition and Concentration in the Banking Industry: a Review of the Literature , 2002)

According to SCP paradigm, structure means that concentration level in the market and performance implies that efficiency & profitability in the firms. In the light of SCP paradigm, it is expected that firms, which have higher market power, have higher profitability and lower efficiency ratios. In other words, market structure directly affects performance of firms in the market.(Kocabay, 2009)

In my empirical work, I used market concentration ratios such as Herfindahl-Hirschman Index.

In banking industry, it is really unique in terms of concentration and competition level because banks serve many products and operates in many sub-sectors. For this reason, this multi-layered structure affects banks’ characteristic and efficiency attributes. The concentration indexes areused for banking industry due to multilayered structure. Also the concentration ratios/indexes are really good measurements to monitor entry barriers or consolidation in the sector.(Bikker & Haaf , Measures of Competition and Concentration in the Banking Industry: a Review of the Literature , 2002)

Concentration indices vary according to weighted average methodologies. Weighted average methodologies, which are used in calculation of concentration indexes, change drastically the sensitivity of the effect of fluctuation inthe performance of a firm, which has lowest market

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share in the market. As a result of this sensitivity issue, there are four different categories in concentration indices. (Bikker & Haaf , Measures of Competition and Concentration in the Banking Industry: a Review of the Literature , 2002)

The very general form concentration indices can be written in the following.

푛 퐶퐼 = 푖 =1 푠푖 푤푖 CI: Concentration index ′ 푠푖: 퐵푎푛푘 푠 푚푎푟푘푒푡 푠푕푎푟푒 푤푖 : Weight that the index attaches to the corresponding market share market share (3.1.) The threshold (k) is set and weights of some banks, which have greater than or equal market share to (k) become 1. Weight of other banks becomes zero unless they have less market share than (k).

푤푖 = 1 ∀푖 ≥ 푘 푎푛푑 푤푖 = 0 ∀푖 < 푘 (3.2.) In this category, market shares of the banks in the market are their weight in concentration indices.

푤푖 = 푠푖 ∀푖 Herfindahl-Hirschman index (“HHI”), which will be used in empirical model section, is an example of this category. (3.3.) The indices in this group, the banks weight according to their market share rank.

푤푖 = 푖, ∀푖 (3.4.) Banks weights in the indices with negative logarithmic function of their market share.

푤푖 = −log 푠푖 , ∀푖

(1) Herfindahl-Hirschman Index

Herfindahl-Hirschman Index (“HHI”) is most using concentration index in academic works about industrial economics. In calculation of HHI, every firm in the market is taken into consideration and affects the value of HHI. However, the magnitude of large banks on HHI is higher than small bank because of multiplying the market share of each bank with their market share again.

The calculation formula of HHI is in the following.

푛 2 퐻퐻퐼 = 푠푖 푖

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There are two different expression and calculation methods for HHI. If the market share is putting into equation in terms of percentile, HHI index will be calculated between 0 and 10.000. According to intuition of HHI, there is a monopolistic market and only one firm operates in the market if HHI is 10.000. On the other hand, the index closes to zero if the market is perfectly competitive and the market shares of firms are identically same. In sum up, we can say that(BDDK, 2011)

 The market is competitive if HHI is less than 1.000,  The market is monopolistic if HHI is higher than 1.800,  The market is monopolistic competition market if HHI is between 1.000 and 1.800.

Second expression for HHI is putting the market shares in terms of decimal value. Then HHI index will be range between the constraints in the following.

1 < 퐻퐻퐼 < 1 푛

In this type of expression, HHI index will be close to 1 when the market is highly concentrated.

III.II Market Structure in Turkish Banking Industry Considering there are many aspects to affect market structure, it should be examined the structure in depth. In this paper we will study the market structure in the view of (i) the concentration level, (ii) M&As and consolidation, (iii) regulation.

III.II.I The Concentration Level A bank serves many products to customers so determining the concentration level can be complex and has many dimensions to examine carefully. For this reason, (i) asset size, (ii) loan size, (iii) deposit figures of banks will be studied to understand the current state of Turkish banking market structure.

III.II.II Asset Growth and Concentration The financial crisis in 2001 is a turning point for Turkish Banking sector. First 5 banks and first 10 banks in the market gain more market share between 2001 and 2005 so HHI index increased relatively higher than 2005 - 2011 period (CAGR of HHI between 2001-2005 is 7%). It means that financial crisis triggered consolidation in the market and higher

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concentration in the market.

Even though BDDK established in 2000, the effective regulation policy put into effect in 2005. Also foreign investors and banks became eager to enter Turkish banking industry after 2005. The economic and political sustainability in this period boosted the figures up. In the light of these events, HHI index has decreased till 2011. Besides HHI, asset size has raised up to €891,6 billion and €225,6 billion for large scale and medium scale banks in 2011. It shows that total asset size in Turkish banking industry expanded €1.217,6 billion in 2011 from €106 billion in 2000.

Table 2 Total Asset Size and Concentration Indicators

TL Billion; % 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Asset Size by Scale Large Scale Banks 56,4 128,4 154,4 187,0 213,2 300,9 376,0 430,6 544,3 629,8 752,9 891,6 Medium Scale Banks 28,7 29,5 44,0 43,8 52,3 64,9 74,6 96,0 119,9 135,6 168,8 225,6 Small Scale Banks 18,6 12,7 15,0 19,7 24,2 34,3 41,3 44,6 56,4 55,0 66,9 83,2 Micro Scale Banks 2,3 4,6 3,3 4,4 6,1 6,7 7,8 10,4 11,9 13,5 18,2 17,2 TOTAL 106,0 175,2 216,7 254,9 295,8 406,8 499,7 581,6 732,5 833,9 1.006,8 1.217,6

Concentration Criteria (%) First 5 Banks 47,0 53,8 57,4 59,0 58,1 61,4 60,9 59,8 60,1 60,5 60,1 58,4 First 10 Banks 67,9 78,6 79,3 80,6 82,0 82,9 83,5 82,5 82,8 83,4 83,2 83,1 HHI 623,4 794,9 851,7 904,6 905,9 934,7 911,0 879,1 885,7 913,3 897,0 855,5

Distribution by Scale

Large Scale Banks 53,2 73,3 71,3 73,4 73,7 74,0 75,2 74,0 74,3 75,5 74,8 73,2 Medium Scale Banks 27,1 16,8 20,3 17,2 16,7 16,0 14,9 16,5 16,4 16,3 16,8 18,5 Small Scale Banks 17,5 7,2 6,9 7,7 7,7 8,4 8,3 7,7 7,7 6,6 6,6 6,8 Micro Scale Banks 2,2 2,6 1,5 1,7 1,9 1,6 1,6 1,8 1,6 1,6 1,8 1,4

TOTAL 100,0 100,0 100,0 100,0 100,0 100,0 100,0 100,0 100,0 100,0 100,0 100,0 Banks whose asset size shares in sector total are above 5% are classified as large scale, between 1%-5% are medium scale, between 0,20%- 1% are small scale and below 0,20% are micro scale banks. Source: BDDK Structural Developments in Banking – December 2011

III.II.III Loan Size Growth and Concentration Like the trend of HHI based on total asset, the concentration level in loan lift up in overall Turkish banking market. As shown in Table 3, HHI index increased to 812,9 by 2,9% CAGR yet the big players in the market have granted higher loan. In other words, large-scale banks have dominated the loan market in the market. On the other hand, HHI increased slightly in first five banks and first 10 banks. It means that competition level in the market is changing in favor of big players in the market.In parallel with this trend, the market share of small-

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scale banks in loan volume decreased to 7,5% in 2011 from 19,9% in 2000.

Table 3 Total Loan Volume Concentration Indicators

Loan Size (%) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 First 5 Banks 44,4 54,6 54 52,2 51,6 53 55,9 54,7 55,5 52,7 54,3 55 First 10 Banks 68,9 78,4 73,8 73,4 75,3 76,3 80,4 79,9 81,2 80,1 81,4 82,5 HHI 578,7 761,3 732 710,2 712,6 751 805,8 784,2 811,7 772,9 797,1 812,9 Distribution by Scale

Large Scale Banks 47,2 70,8 62 62,6 63,4 63,9 68,8 68,2 70,4 69,4 71 71,4 Medium Scale Banks 32,9 15,9 24,5 24 23,7 25,9 19,8 21,5 20,1 21,7 20,6 21,1 Small Scale Banks 19,9 13,3 13,5 13,4 12,9 10,2 11,4 10,2 9,5 8,9 8,4 7,5

TOTAL 100 100 100 100 100 100 100 100 100 100 100 100 Source: BDDK - Structural Developments in Banking – December 2011

III.II.IV Deposits Growth and Concentration Concentration level in deposit side is not as high as the levels in total assets. Especially the concentration level (HHI) in deposits dropped significantly in 2011 to 937,8 from 1.042 in 2010. It proves that the competition in deposit market is rising up since 2010. In parallel with the concentration level, the market structure is shifted to medium-scale banks from large- scale banks in 2011.

Table 4 Deposit Concentration Indicators

Deposits (%) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 First 5 Banks 49,7 56,7 60,8 61,4 62,9 63,9 63,2 62,2 62,3 62,6 63,1 59,8 First 10 Banks 70,6 82,8 84,5 85,3 86,8 86,9 87,3 86,3 86,1 86,1 86,9 86,5 HHI 720,7 878,2 969,8 1.027,0 1.090,3 1.056,7 1.034,1 1.003,3 994,9 1.015,3 1.042,0 937,8 Distribution by Scale

Large Scale Banks 78,6 78,6 78,6 78,4 76,6 76,9 79,5 78,3 78,6 78,5 78,8 76,5 Medium Scale Banks 14,6 14,6 14,6 15,0 16,3 15,7 13,8 15,7 15,2 16,6 16,5 19,3 Small Scale Banks 6,8 6,8 6,8 6,6 7,1 7,4 6,7 6,0 6,3 4,9 4,7 4,2 TOTAL 100 100 100 100 100 100 100 100 100 100 100 100 Source: BDDK - Structural Developments in Banking – December 2011

III.III M&As and Consolidation There are 17 successfully closed M&A deals in Turkish banking industry between 2001 and 1H/2012. The shares of the total transactions in post 2001 financial crisis in Turkey are higher than other years. The reason of higher share in 2001 is restructuring the Turkish banking sector after suffering 2001 local financial crises. As shown in Table 5, the financial crises in the market directly stimulate M&A transactions and consolidations positively. For this reason, 2001 local financial crisis and 2011 global economic crisis caused an effective

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M&A deal market in this sector. Therefore, it reflects that M&A transactions trends are related to market structure in post financial crises.

Table 5 Number and Sizes of Mergers and Acquisitions by Years

Year Number of Transactions Total Value (TL billion)* Share (% ) ** 2001 6 13.130,9 7,69 2002 3 3.142,6 1,50 2003 1 45,1 0,02 2004 2 6.249,3 2,04 2005 2 1.738,4 0,45 2006 1 20.028,5 4,23 2011 1 11.877,5 1,16 2012 1 6.470,0 2,96 *It is assumed that total asset value of the bank taken over defines the total value of the merger. **Defines the share in total assets of banking sector. Source: BDDK - Structural Developments in Banking – December 2011

The main aim of M&A deals is based on economies of scale theory. Turkish banking industry focused on returns on equities and efficiency so capital adequacy is a key element for the market. As a result of higher capital adequacy ratios, determined by the regulatory board (BDDK), M&A deals took a place in the light of consolidation and economies of scale theory.

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Table 6Concentration Analysis of Mergers and Acquisitions

Market Market Share Before Share After Date Institutions Merged Title After Merger Merger (%) Merger (%) Jul-01 T. Emlak Bank and Ziraat Bank Ziraat Bank 12,49 15,14 Birlesik Turk Korfez Bank and Osmanli Aug-01 Osmanli Bank 2,20 3,38 Bank Tekfen Yatirim, Finansman Bank and Oct-01 Tekfen Bank 0,15 0,18 Bank Ekspres Dec-01 Osmanli Bank and T. Garanti Bank T. Garanti Bank 6,21 9,08 Dec-01 Demirbank and HSBC Bank HSBC Bank 0,90 1,50 Morgan Guaranty Trust Company and Dec-01 JP Morgan Chase Bank 0,18 0,20 The Chase Manhattan Bank Jan-02 Sumerbank and Oyak Bank Oyak Bank 0,28 1,77 Sinai Yatirim Bank and T. Sinai Mar-02 Kalkinma Bank T. Sinai Kalkinma Bankasi 0,37 0,60 Dec-02 Milli Aydin Bank and Denizbank Denizbank 1,40 1,46 Apr-03 Fibabank and Finansbank Finansbank 2,47 2,49 Credit Lyonnais Turkey Istanbul Credit Agricole Indosuez Turk Mar-04 Branch and Credit Agricole Indosuez 0,13 0,13 Bank Turk Bank Nov-04 Pamukbank and T. Halk Bank T. Halk Bank 7,15 9,19 Sep-05 Ak Uluslar Arasi Bankasi and Akbank Akbank 12,42 12,48 Turkiye Finans Katilim Bank Dec-05 Family Finans and Anadolu Fınans (Islamic Bank) 0,37 0,76 Oct-06 Kocbank and Yapi Kredi Bank Yapi Kredi Bank 5,94 10,16 Feb-11 Fortis Bank and Turk Ekonomi Bankasi Turk Ekonomi Bankasi 1,88 3,05 Source: BDDK - Structural Developments in Banking – December 2011

As shown in Table 6, the banks in the market seek a higher market share after consolidation. The deals between Emlak Bank and Ziraat Bank in 2001, Osmanli Bank and Garanti Bank in 2001, Pamukbank and Halk Bank in 2004, Kocbank and Yapi Kredi Bank in 2006 are most significant deals in terms of increasing market share in post deal period.

After post financial crises, the market shares of the banks, which are involved in deals, increased. It means investors in Turkish banking industry are keen on being a big player in the market even after restructuring process in post financial crisis period.

III.IV Regulations for competition During 2000s, the Turkish banking sector was recovering from local financial crises and Banking regulation. The Supervision Agency (“BDDK”) was established in order to regulate Turkish banking sector. After regulating the market, a high entrance barrier is created for the sector and BDDK regulates the market completely.

An event year should be determined in order to examine the effects of regulation on market structure. Even though BDDK was established in 2000, BDDK became more powerful and put some new legislation to change competition level in the market after 2005. For this

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reason, I will study the HHI index figures in terms of 3 different account balances,

 HHI index, which is calculated with Total Assets  HHI index, which is calculated with Loan Size  HHI index, which is calculated with Deposits.

After 2001 financial crises, some banks went bankrupt or merged with other banks. For this reason, the concentration level in Turkish banking industry increased. Additionally, BDDK did not give any license any investor to open a new bank in Turkish market. Thus, the entry barriers became effective while the number of banks in the market became less due to bankruptcy or consolidation.

Figure 3 Market Concentrations in Turkish Banking Industry

1.200 1.000 800 600 400 200 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

HHI Index (Total Asset) HHI Index (Loan Size) HHI Index (Deposits)

Source: BDDK - Structural Developments in Banking – December 2011

As shown in Figure 3, HHI indexes for all accounts raised steadily until 2004. Then the market structure of the market is pretty stable between 2005 and 2010. After consolidation effect became ineffective and BDDK puts new legislations in 2005 and entry barriers were still active, the market structure was not change significantly. However, 2011 global economic crisis also changed the market structure. In 2011 the concentration level decreased and the market became more competitive.

IV Data and Methodology

IV.I Data Annual solo reports which are retrieved from The Banks Association of Turkish (“TBB”) web site (http://www.tbb.org.tr) for Turkish Deposit Banks which operate between 1994 and

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2012 are used for analysis of competition level in Turkish banking industry.

The sample, used in the empirical model in this thesis only covers survivor Turkish deposits banks, which operate between 1994 and 2012. In other words, I used only survivor Turkish deposit banks during the sample period. The main reason why I chose only survivor deposit banks is having a balanced panel data. 27 survivor Turkish Deposit banks used in the sample can be seen in Table 7.

Table 7 The Banks Used in the Empirical Model

Adabank Fibabanka Turkish Bank Akbank Habib Bank Turkland Bank Alternatif Bank HSBC Bank Turkiye Ekonomi Bankasi Anadolu Bank ING Bank Ziraat Bankasi Arap Turk Bank Portigon AG Garanti Bankasi Bank Mellat Societe Generale Halk Bankasi Birlesik Fon Bankasi Sekerbank Is Bankasi Citibank Tekstil Bank Vakiflar Bankasi Burganbank The Royal Bank of Scotland Yapi ve Kredi Bankasi

IV.II Methodology

IV.II.I Event Study for the regulation effect Event study is used in order to study regulation effect on the competition level in the market. I classified Turkish deposit banks as their owner structures and there are three types of Turkish deposit banks – privately owned Turkish Deposit Banks, Foreign Banks, State- owned Turkish Deposit Banks.

Establishing BDDK is a milestone for Turkish banking sector, because BDDK started to regulate the market completely. After BDDK was established, the entry barriers became higher. Moreover, BDDK had not granted a license to any foreign/domestic investors to establish a bank in Turkish market for 12 years.

It is a fact that as a regulator in the market BDDK completely changes the competition level and market structure. As an exogenous effect, BDDK is expected to be one of the reasons the changing on HHI indices in the market. That’s why; I need to focus on event study to see the effect of BDDK as a regulator in the market.

Establishing of BDDK, when is happened in August 2000, is the event date for the analysis.

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However, determining event window is really key element. Even though BDDK begun to regulate Turkish banking sector just after it was established, the effect of regulations which is forced by BDDK can be seen in a longer horizon.

In my data sample, there are only year-end annual figures, which help to calculate HHI indices. Additionally, HHI index is a lagging indicator, which means that it takes time to see the effect of regulation on the competition level. As a result of this, I determined to look up [- 1 year, +1 year] and [-2 year, +2 year] event windows in the sample data.

IV.II.II Panel Data Regression HHI index for each period will be the proxy and dependent variable to examine market structure and competition. For this reason, panel data regression is used in order to study the factors, which affect HHI index year by year.

Types of data used in empirical analysis are classified under three categories – time series, cross-section and panel. In time series data, the values of one or more variables over a period of time are observed. On the other hand,cross section data contains values of one or more variables for several sample units, or entities, at the same point in time. In panel data the same cross-sectional samples is also observed over time. In other words, panel data havecross sectional as well as time dimensions.(Gujarati, 2004)

According to the definition of panel data, the general form of panel data regression is in the following,

If the number of cross sectional unit equals to the number of time series observation, the panel data can be classified as a balanced panel data. Otherwise the number of cross-sectional units or time series observation is different, it is called unbalanced panel data. (Gujarati, 2004)

In order to examine the relation between competition level in the market and banks account characteristics, I used balanced panel data regression with HHI index as a dependent variable.

i Determining Variables Used in The Model

The two main goals of this study is that understanding (i) how regulation affects competition level in Turkish banking sector and (ii) the relation between competition level and the effect of this competition on banks. For this reason, I chose Herfindahl-Hirschman Index (“HHI”)

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as dependent variable in order to examine market concentration and competition level in the market. On the other hand, the independent variables I expect to affect HHI index are explained in Appendix 2.

The panel data regression, which I run to see the links about the effect of market structure on Turkish deposit banks, is in the following.

퐻퐻퐼푖푡 = 훼푖 + 퐴푓푡푒푟 퐵퐷퐷퐾 푋1푖푡 + 퐵푎푛푘 퐿표푐푎푙 푋2푖푡 + 퐵푎푛푘 퐹표푟푒푖푔푛 푋3푖푡 + 퐴푓푡푒푟 퐵퐷퐷퐾 ∗ 퐵푎푛푘 퐿표푐푎푙 푋4푖푡 + 퐴푓푡푒푟 퐵퐷퐷퐾 퐿표푎푛 푆푖푧푒 퐿표푎푛 푆푖푧푒 푁표푛 − 푖푛푡푒푟푒푠푡 퐼푛푐표푚푒 ∗ 퐵푎푛푘(퐹표푟푒푖푔푛)푋 + 푋 + 푋 + 푋 + 푅푂퐴 푋 5푖푡 푇표푡푎푙 퐴푠푠푒푡푠 6푖푡 퐵푎푛푘 퐷푒푝표푠푖푡푠 7푖푡 푇표푡푎푙 퐴푠푠푒푡푠 8푖푡 9푖푡 푁표푛 − 푎푐푐푢푟푎푙 퐿표푎푛 퐸푞푢푖푡푦 + 푅푂퐸 푋 + log 푇표푡푎푙 퐴푠푠푒푡푠 푋 + 푋 + 푋 10푖푡 11푖푡 푇표푡푎푙 퐿표푎푛푠 12푖푡 푇표푡푎푙 퐴푠푠푒푡푠 13푖푡 푁푒푡 푖푛푡. 푟푒푣푒푛푢푒 푂푝푒푟푎푡푖푛푔 퐸푥푝푒푛푠푒푠 + 푋 + 퐸 + 푢 푇표푡푎푙 퐴푠푠푒푡푠 14푖푡 푂푝푒푟푎푡푖푛푔 푅푒푣푒푛푢푒 15푖푡 푖푡

“After BDDK” variable is a dummy variable to see how establishing BDDK effect the market concentration (HHI index).

ii Descriptive and Summary Statistics

The independent variables, which are explained in Appendix 2,help to investigate the effects of competition level on the banks in terms of size, profitability and efficiency. Therefore, descriptive statistics of those independent variables give an opinion about Turkish deposit banks in my sample.

Table 8 Summary Statistics of The Sample

Variable Name Mean Median Std Dev 10th Pctl 25th Pctl 75th Pctl 90 Pctl N Total Assets (in millions) 13,25 0,84 30,34 0,01 0,11 7,36 46,20 513 Loan Credit (in millions) 6,39 0,23 15,78 0,00 0,02 2,92 20,75 513 Deposits (in millions) 8,67 0,44 19,93 0,00 0,04 4,76 30,14 513 HHI - Total Assets 0,13 0,12 0,01 0,11 0,11 0,14 0,15 513 HHI - Loan Credit 0,13 0,11 0,03 0,10 0,10 0,13 0,18 513 HHI - Deposits 0,14 0,13 0,02 0,11 0,12 0,16 0,17 513 Loan Size/Tot. Assets 34,97% 33,83% 20,03% 7,26% 20,57% 50,56% 62,01% 513 Loan Size/Deposits 86,76% 63,18% 176,83% 16,89% 39,18% 95,25% 133,35% 513 Non-Int. Inc./Total Asset 15,54% 2,08% 41,13% 0,25% 0,53% 12,98% 37,09% 513 ROA (Return on Assets) 0,62% 1,73% 12,28% -1,19% 0,65% 3,51% 6,81% 513 ROE (Return on Equity) 14,00% 14,31% 150,73% -1,27% 5,52% 33,42% 80,40% 513 Log(Tot. Assets) 13,59 13,65 2,98 9,51 11,62 15,81 17,65 513 Non-Acc. Loan/Tot. Assets 63,54% 2,37% 758,09% 0,00% 0,18% 5,97% 15,61% 513 Equity/Total Assets 15,75% 11,46% 17,35% 5,14% 7,92% 16,63% 31,36% 513 Net Int. Rev./Total Assets 8,40% 5,83% 7,70% 2,63% 3,79% 10,62% 16,94% 513 Ope. Exp./ Ope. Rev. -158,92% -62,00% 1324,93% -208,39% -96,67% -42,23% -32,16% 513

In my sample, it clearly shows that there are huge gaps between percentiles especially

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between 75th Percentile and 90th Percentile. It means that some Turkish banks are more successful in efficiency and profitability.

In terms of scale, some banks in 90thpercentile dominate the market. It proves that there are some big players, which have higher total assets, loan credit and deposits than other banks. Even if the sample consists of 27 Turkish deposit banks, some banks dominate the market with their size.

When comparing efficiency and profitability ratios, mean of “non-interest income/total asset”,“loan size/deposits” and“non-accrual loan/total assets” variables are higher than their median. It shows that the banks are not distributed equally and some banks lead the market with their profitability, efficiency and specialization.

Table 9 Descriptive Statistics of the Sample

HHI - Total Assets HHI - Loan Credit HHI - Deposits Low Middle High Low Middle High Low Middle High Loan Size/Tot. Assets 45.4% 27.7% 30.0% 43.3% 30.2% 30.0% 41.4% 32.5% 30.0% Loan Size/Deposits 112.9% 67.1% 76.0% 109.2% 71.4% 76.0% 105.6% 75.5% 76.0% Non-Int. Inc./Total Asset 0.9% 23.8% 24.3% 0.9% 23.8% 24.3% 16.7% 5.3% 24.3% ROA (Return on Assets) 1.8% -3.9% 3.7% 1.6% -3.6% 3.7% -2.3% 0.9% 3.7% ROE (Return on Equity) 10.1% -29.4% 61.9% 9.7% -29.0% 61.9% -26.7% 13.5% 61.9% Log(Tot. Assets) 15.4 14.1 10.9 15.3 14.3 10.9 15.2 14.4 10.9 Non-Acc. Loan/Tot. Assets 48.3% 143.0% 1.8% 61.4% 127.8% 1.8% 39.7% 153.0% 1.8% Equity/Total Assets 20.2% 16.5% 9.8% 20.1% 16.6% 9.8% 19.4% 17.5% 9.8% Net Int. Rev./Total Assets 5.0% 8.2% 12.5% 5.3% 7.9% 12.5% 6.5% 6.5% 12.5% Ope. Exp./ Ope. Rev. -54.8% -134.2% -305.0% -55.3% -133.7% -305.0% -101.5% -79.8% -305.0%

There are three ways to calculate HHI index – based on Total Assets, Loan Credit, and Deposits. I used three of HHI indices as proxies of market concentration and competition level. As shown in Table 9, I calculated 3 quartiles of HHI indices in order to understand how market concentration and competition level changed according to profitability and efficiency ratios, used in the model.

The most important conclusion from Table 9, the figures of all independent variables are same in all HHI indices. It means that the banks in “the high quartile” don’t change according to HHI indices based on total asset, loan credit and deposits. In other words, the banks, which have higher market power, are same banks regardless of types of HHI indices.

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When comparing profitability ratios, the banks who are in less competitive market (=high HHI index) have higher Return on Asset, Return on Equity and Net Interest Revenue/Total Asset. On the side of efficiency ratios, Banks, which have higher market power, are less efficient. These findings show that “competition-efficiency” theory dominates Turkish banking market.

To examine deeply the effect of competition-efficiency, I will test “competition-efficiency” view empirically in this paper.

IV.II.III Hausman Test in order to determine Fixed Effects or Random Effects When using panel data regression, being a cautious is important to analyze panel data regression correctly. For this reason, there are two common approaches to analyze panel data regressions – fixed effects approach and random effects approach.

(1) Fixed Effects Approach

If the assumptions, which are stated in the following, are fit to the panel data regression, fixed effects approach will be better to analyze the panel data.

 The error terms captures time differences and space differences because the intercept and coefficients of variables are constant over time and individuals  The coefficients are constant but the intercept is changing over individuals  The coefficients are constant but the intercept is fluctuating over individuals and time  Every coefficient is fluctuating over individuals  The intercept and coefficients are changing over time and individuals. (Gujarati, 2004)

(2) Random Effects Approach

Fixed Effects approach has issues to analyze panel data regression due to many individuals. Clearly, fixed effects approach fails to analyze the panel data regression because ofcoefficients, which are not changing over time periods (such as dummy variables). As a result of this issue, dummy variables cause loss of explanation in the model and the model doesn’t fit properly. For this reason, random effect approach is introduced and solved this

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issue for panel data regressions.(Kok & Simsek)

Hausman Test is a useful indicator to determine the fixed or random effect approaches in regression models. Put another way, “Hausman Test”tests whether the unique errors are correlated with the regressors. In STATA program, Hausman Test will be run between the regression model with random effects and with fixed effects. If p-value is 푝푟표푏 < 훼, using fixed effect would be better choice for the panel data regression.(Torres-Reyna)

The result of Hausman Test for my panel data regression is in the following.

Test: Ho: difference in coefficients not systematic chi2(14) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 238.87 Prob>chi2 = 0.0000

According to the result of Hausman Test in the box above, prob > 푐푕푖2 is lower than 0.05 so I preferred fixed-effect approach to analyze the panel data regression.

V Results As explained in previous sections, this paper investigates the effect of regulation on the competition level in Turkish banking sector and how Turkish deposit banks are affected by competition level. For this reason, I used two different methodologies, which is explained in Section IV.II., (i) event study in order to examine the regulation effect on competition level and (ii) panel data regression in order to go further to examine the regulation effect and investigate the relationship between characteristics of banks and competition level.

V.I Results of Event Study As mentioned Section IV.II.I before, I did 2 event studies with 2 different event windows for the same event (=establishing BDDK) in order to examine the effect of regulation on the market deeply.

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Table 10 The Result of The Event Study with [-1 year, +1 year] event window

HHI-Total Assets Before (-1 year) Establishing BDDK (in 2000) After (+1 year) t-test Privately-owned Turkish Deposit Banks 0,178 0,180 0,178 0,681 Foreign Banks 0,198 0,222 0,383 -0,071 State-owned Turkish Deposit Banks 0,400 0,390 0,378 0,022 HHI-Loan Credit Before (-1 year) Establishing BDDK (in 2000) After (+1 year) t-test Privately-owned Turkish Deposit Banks 0,196 0,191 0,201 0,353 Foreign Banks 0,217 0,238 0,400 -0,109 State-owned Turkish Deposit Banks 0,391 0,389 0,393 0,045 HHI-Deposits Before (-1 year) Establishing BDDK (in 2000) After (+1 year) t-test Privately-owned Turkish Deposit Banks 0,191 0,187 0,172 0,402 Foreign Banks 0,229 0,251 0,487 -0,303 State-owned Turkish Deposit Banks 0,404 0,390 0,381 -0,018

Firstly, I set the event window as [-1 year, +1 year] in order to see the effect of establishing BDDK on the market competition level (=HHI). As shown in Table 10, none of changing on HHI indices is statistically significant. However, the changing on HHI indices gives us an opinion which way the regulation affects the market competition level and structure.

While there is no clear conclusion about privately-owned Turkish Deposit Banks, HHI values change for foreign banks and state-owned banks. For foreign bank, establishing BDDK has positive impact on market concentration. Therefore, foreign banks gain more market power after BDDK. On the other hand, regulation negatively affects market concentration level for state-owned banks. It means that state-owned banks become more competitive.

To have a clear conclusion about the effect of regulation on the competition level, I changed the event window to -/+ 2 years in Table 11.

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Table 11 The Result of The Event Study with [-2 year, +2 year] event window

HHI-Total Assets Before (-2 year) Establishing BDDK (in 2000) After (+2 year) t-test Privately-owned Turkish Deposit Banks 0,182 0,180 0,183 5,817*** Foreign Banks 0,205 0,222 0,366 0,048 State-owned Turkish Deposit Banks 0,402 0,390 0,373 -0,150 HHI-Loan Credit Before (-2 year) Establishing BDDK (in 2000) After (+2 year) t-test Privately-owned Turkish Deposit Banks 0,200 0,191 0,183 0,753 Foreign Banks 0,236 0,238 0,476 -0,051 State-owned Turkish Deposit Banks 0,380 0,389 0,385 -0,591 HHI-Deposits Before (-2 year) Establishing BDDK (in 2000) After (+2 year) t-test Privately-owned Turkish Deposit Banks 0,189 0,187 0,179 1,982*** Foreign Banks 0,234 0,251 0,449 -0,308 State-owned Turkish Deposit Banks 0,407 0,390 0,404 -0,171

On the side of foreign banks, every HHI figures increased after “the event”. It means that the competition among foreign banks became less. It shows that the regulations, which were forced by BDDK, hurt small foreign banks so the market became highly concentrated.

Privately owned Turkish deposit banks had affected differently according to HHI indices based on total assets, loan credit and bank deposits. After the event, privately owned banks had pretty much same HHI index in terms of total assets. However, HHI-Deposits and HHI- Loan Credits figures decreased in two years after the event. It shows that privately owned Turkish banks lost market power.

When looking t-test results for HHI differences, the changings on HHI – Total Assets and HHI – Deposits for privately owned Turkish Deposit Banks are statistically significant.

V.II Results of Regression

The empirical regression model will not only explain the regulation effect on the competition level but also how the characteristics (characteristics which are explained in Appendix 2) affect market concentration and competition level in the market.

The results of the regressions with fixed effect approach are shown in Table 12.In Table 12,퐴푓푡푒푟(퐵퐷퐷퐾),퐿표푎푛 푆푖푧푒 푇표푡푎푙 퐴푠푠푒푡, 퐿표푎푛 푆푖푧푒 퐵푎푛푘 퐷푒푝표푠푖푡푠, 푅푒푡푢푟푛 푂푛 퐴푠푠푒푡 (ROA) , log푇표푡푎푙 퐴푠푠푒푡푠 , 퐸푞푢푖푡푦 푇표푡푎푙 퐴푠푠푒푡푠 and 푂푝푒푟푎푡푖푛푔 퐸푥푝푒푛푠푒푠 푂푝푒푟푎푡푖푛푔 푅푒푣푒푛푢푒 are mostly statistically significant coefficients in 95% and 90% confidence intervals.

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Table 12 Results of The Regression

(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) VARIABLES HHI-Total HHI-Total HHI-Total HHI-Total HHI-Loan HHI-Loan HHI-Loan HHI-Loan HHI- HHI- HHI- HHI- Assets Assets Assets Assets Credit Credit Credit Credit Deposits Deposits Deposits Deposits

After(BDDK) -0.02824*** -0.02824*** -0.02730*** -0.00716*** -0.05243*** -0.05243*** -0.04886*** -0.00416 -0.04194*** -0.04194*** -0.04137*** -0.01991*** (0.001) (0.001) (0.002) (0.001) (0.002) (0.002) (0.006) (0.004) (0.001) (0.001) (0.002) (0.003) After(BDDK)*Bank(Local) 0.00053 0.00186 -0.00135 -0.00158 0.00123 0.00367 (0.002) (0.001) (0.007) (0.004) (0.003) (0.002) After(BDDK)*Bank(Foreign) -0.00248 0.00126 -0.00716 -0.00288 -0.00201 0.00304 (0.003) (0.002) (0.007) (0.004) (0.003) (0.002) Bank(Local) 0.00311 -0.00430 0.01161 -0.00693 0.00201 -0.00545 (0.003) (0.003) (0.009) (0.007) (0.005) (0.004) Bank(Foreign) 0.00099 -0.00210 0.01466 0.00374 -0.00312 -0.00564 (0.004) (0.003) (0.010) (0.008) (0.006) (0.005) Loan Size/Tot. Assets -0.00305* 0.01446*** -0.01064*** (0.001) (0.004) (0.003) Loan Size/Deposits -0.00021*** 0.00001 -0.00023* (0.000) (0.000) (0.000) Non-Int. Inc./Tot. Assets -0.00084 0.00066 -0.00170 (0.001) (0.002) (0.001) ROA 0.00801** 0.01163 0.01537*** (0.003) (0.007) (0.005) ROE 0.00003 -0.00055* 0.00041 (0.000) (0.000) (0.000) Size -0.00511*** -0.01178*** -0.00511*** (0.000) (0.001) (0.000) Non-acc. Loan/Total Assets -0.00001 0.00001 -0.00001 (0.000) (0.000) (0.000) Equity/Total Assets -0.01820*** -0.02077*** -0.03197*** (0.002) (0.005) (0.004) Net Int. Rev/Total Assets 0.00867* 0.00227 0.01218 (0.004) (0.010) (0.008) Op. Exp./Op. Rev. 0.00003*** 0.00009*** 0.00006*** (0.000) (0.000) (0.000) Constant 0.14466*** 0.14466*** 0.14266*** 0.20518*** 0.16130*** 0.16130*** 0.15009*** 0.28957*** 0.16454*** 0.16454*** 0.16452*** 0.22988*** (0.001) (0.001) (0.003) (0.004) (0.002) (0.002) (0.008) (0.010) (0.000) (0.000) (0.004) (0.006)

Bank Fixed Effect No Yes Yes Yes No Yes Yes Yes No Yes Yes Yes Adjusted R-squared 0.76917 0.75680 0.76101 0.91175 0.71666 0.70147 0.70288 0.88545 0.78921 0.77791 0.78272 0.87048 Observations 513 513 513 513 513 513 513 513 513 513 513 513 Robust standard errors in parentheses *** p<0.001, ** p<0.01, * p<0.05

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For investigate the effect of regulation on the competition level in the market, (1), (5) and (9) regression models are important. According to the results, HHI indices, which based on total assets, loan credit and deposits, decreased after establishing BDDK. It means that there is a negative relation with regulation and market concentration. After establishing BDDK, banks lose their market share and the market became more competitive.

The firm fixed effects are used in (2), (6) and (10) regression models and the results of these models are similar to (1), (5) and (9) models. It proves that the reforms, which are introduced by BDDK, cause more competitive market and less concentrated market.

After finding overall effect of establishing BDDK in Turkish banking sector, I examine how privately-owned, foreign and state-owned deposit banks are affected by establishing BDDK in Turkish banking sector. Additionally, it gives me a chance to compare the results with the event study, which is in previous section. In (3), (7), (11) regression models, there is still negative relation between HHI indices and establishing BDDK. However, other dummy variables in the models are not statistically significant. Even though there is no clear (=statistically significant) finding in the relationship between being a privately owned bank or foreign bank after establishing BDDK and HHI indices, the signs of coefficients for privately owned banks are parallel with the finding of the event study.

Similar to the event study in this thesis, I examine the effect of the regulatory board on competition level for each kind of banks in longer periods. I created dummy variables for +1, +2, +3 years after establishing BDDK (=the regulatory board) in order to see the longer effect on the competition level. Therefore, I study the impact of competition level on privately- owned and foreign deposit banksafter one, two and three year of establishing BDDK with cross product variables. However, there is no statistically significant impact of BDDK in one, two and three year time horizon for privately-owned and foreign deposit banks. Unlike the result of the event study, there are no particularly significant changes on HHI-Total Asset and HHI-Deposit for privately-owned banks in the regression model.

In (4), (8) and (12) regression models, I examine which characteristics of banks affect the market concentration.

As efficient ratios, Loan Size/Total Asset ratio and Operating Expenses/Operating Revenue ratio are positive relation with HHI – Loan Credit. It is clearly shows that the banks, which

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have higher market power in terms of loan credit, become more efficient so it shows “competition-inefficiency” view rules over Turkish Deposit Banks market between 1994 and 2012. However, It is a clear that “competition-inefficiency” view is only effective on HHI, which is based on loan credit. On the other hand, “Loan Size/Total Asset” and “Loan Size/Deposits” ratios are negatively correlated with HHI, which based on total asset and deposits. Therefore, banks become more effective when the competition level in the market decreases. In other words, “competition-efficiency” view dominates Turkish banking sector in terms of total asset and deposit, while “competition-inefficiency” view is effective on the market in terms of loan credit.

On the side of profitability ratios, ROA – Return On Asset, ROE – Return On Equity and Net Interest Revenue/Total Assets are the profitability ratios statistically significant in the regression models. While the coefficient of ROA is positively linked with HHI – Total Asset and HHI – Deposits, the coefficient of Net Interest Revenue/Total Asset is positively correlated with HHI – Total Assets only. It proves that Turkish deposit banks have higher profits when the competition in the market decreases. In other words, they became more profitable banks when the market is highly concentrated. This result is expected because banks, which have already high market power in highly, concentrated market prefer to have higher profit margins. On the other hand, ROE is another profitability ratio in the model but it has negative relation with only HHI – Loan Credit. However, the magnitude of the coefficient is so small even though it is statistically significant in model (8).

As a capitalization ratio, Equity/Total Asset has negative relation with HHI indices in every regression. In normal circumstances, capitalization ratios are expected to have positive relation with market power and HHI index because banks which have higher capitalization ratios are assumed that they are in safe area for bankrupt. As a result of this, Banks, which have higher capitalization ratios, are supposed to have lower financial cost. However, this is not the case for Turkish deposit market because The Supervision Agency (“BDDK”) forced Turkish banks to capital injection due to financial crises. For this reason, Turkish banking industry has a unique characteristic in terms of the relationship between capitalization ratios and HHI indices.

The results show interesting relation between market power and scales of banks, when looking the scale measure in the model, logarithmic function of total assets of each bank.

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There is a negative relation between size of banks and market power. In other words, the banks have higher total asset and higher size when the market becomes more competitive. It brings the questions about economies of scale theory for this market. The only explanation about the negative relation is Turkish deposits banks increased their size in terms of their total assets when the market becomes more competitive.

VI Conclusion In this paper, I study how the competition level in Turkish banking system changes after establishing BDDK as a regulatory board and what are the main attributes of the banks in the market affects competition level.

Turkish banking sector developed significantly and became one of the leading sectors for Turkish economy. After struggling financial crises, Turkish banking system became highly regulated with establishing BDDK. Establishing BDDK is an important and exogenous event for Turkish banking history. In event study, establishing BDDK is not changed market competition level significantly with one-year event window. On the side of two-year event- window,the competition level increased in terms of deposits for privately owned deposits. However, the results of the event study are not so clear and conclusive. For this reason, panel data regression method is used to investigate fully how establishing BDDK changed the market structure and the competition level. Also, it proves that competition makes efficient banks in the terms of total assets and deposits. Unlike total asset and deposit sides of the banking market, banks became inefficient in highly competitive market in terms of loan credit. Besides efficiency, banks have higher profits when they gain market power and market became highly concentrated.

Even though I used two different methodologies - the event study and the panel data regression, the results doesn’t show the relationship between regulation and competition level clearly and conclusively due to complexity of banking system. However, this paper proves that establishing a regulatory body affects the competition level and some traits of banks helps to change market competition. Further research could shed more light on the regulation effect on competition level.

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VII Works Cited

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Gujarati, D. N. (2004). Basic Econometrics (4th Edition ed.). New York: McGraw-Hill Higher Education.

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VIII Appendix

Appendix 1 Development of Turkish Economy

Period Key Points The main goal was having a national banking industry State Turkish Central Bank was established Socialism The State financed pre-determined industries via state owned banks The economic development relied on participating of private sector Banking Liberal industry after Economy The economy grew up unsustainable between 1950 and 1960. establishing The Economy have a problem with high inflation Turkish Republic The economy became closed economy. (1930-1960) Interest Rate and Exchange rates were fixed. Planned Turkish Lira was overvalued to help industries to import required Economy inputs relatively cheaper. Turkish banks were restricted to determine commission ratios and loan rate by the government.

Planned Economy failed due to outside and political factors. (Turkish Invasion of Cyprus, increasing oil prices by OPEC. Liberalization Liberal The free market and openness are the main characteristics of this After 1980 Economy period. Banks increased interest rates to attract deposit holders so this increasing reflects both deposit rates and lending rates. Gulf War affected negatively the global economy as much as Local Turkish Economy and there was a significant cash outflow from the Financial Liberal market. Crises after Economy Turkish government tried to pay budget deficits with loans from 1990 Turkish Central Bank and it triggered an increasing in interest rates and inflation.

Recovery of Local The integration in banking industry to European peers was provided Financial with new reforms and regulations such as establishing "The Crises in Supervision Agency" ("BDDK") in August 2000. Liberal 2000s and Economy The Current State of Banking The inflation rate was decreasing below the expectations so it Sector pressured current account deficit. In late of 2000, Turkish Lira devalued sharply against other foreign currencies because of falling through the economic plan

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Appendix 2 The Variables Used in the Model and Their Explanations

Type Variables Definition Dependent Variable

Market Structure HHI (Herfindahl- Herfindahl-Hirschman Index of the market concentration. It also gives insight about Measure Hirschman Index) the market competition level in the market.

Independent Variables After(BDDK) A dummy variable indicates whether BDDK is established Bank(Local) A dummy variable indicates whether the bank is privately owned A dummy variable indicates whether the bank is foreign deposit banks in Turkish Bank(Foreign) banking sector

Loan Size / Total Asset These three ratios indicate the financial intermediary of the banks. Effective banks Efficiency Ratios would gain more market share so the relation with Herfindahl index should be positive. Loan Size / Bank Deposits Operating Expenses/Operating Revenue Specialization Non-Interest Income / The ratio indicates specialization of the banks. It is expected to have negative Ratios Total Assets relationship with HHI. ROA - Return On Asset

(Net Income/Total Assets) These three ratios measure profitability of the banks. If I assume that competition Profitability Ratios ROE - Return On Equity affect profits adversely, it is expected negative relation with HHI. (Net Income/Equity) Net Interest Revenue/Total Assets

It is logarithmic function of total assets of each bank. It is presumed that bigger Scale Measure LogTotal Assets ("Size") banks have gaining more market share in regard of economies of scale view.

Non-Accrual Loan / Total Risk Measure This ratio measures risk of the banks. It is presumed the negative relation with HHI. Loan Capitalization Equity / Total Assets It indicates capitalization of the banks. It is expected a positive relation with HHI. Ratios

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