Journal of Modern Accounting and Auditing, ISSN 1548-6583 March 2011, Vol. 7, No. 3, 289-304

An Empirical Research of Ethical Banking in Turkey

Basak Turan Icke, Esra Nemli Caliskan, Yusuf Ayturk, Mehmet Akif Icke Istanbul University, Turkey

Ethical banks can be defined as financial institutions providing both social and economic profitability for the society and environment. Placement of assets and avoiding social exclusion are significant factors that differentiate ethical banks and the rest of financial intermediaries. Ethical banking is a new concept in Turkey. This paper analyzes the situation of ethical banking by examining the significant differences in lending behaviors of 49 Turkish banks in terms of their functions and ownership structures. We conducted non-parametric tests of Kruskal Wallis, Jonckheere-Terpstra, Mann-Whitney, Kolmogorov-Smirnov and Wald-Wolfowitz. We found that in terms of ownership structure, state-owned banks are more ethical than private banks when the placement of assets and avoiding social exclusion factors are considered. In terms of function, participation banks locate their funds to social value generating sectors more ethically than deposit and development banks. From the avoiding exclusion aspect, deposit banks are more ethical than other functional banking groups (i.e., participation and development banks).

Keywords: ethical banking, social value added, social exclusion, Turkey

Introduction Banks play very critical roles in national and international economies. They operate the payments system, are a source of credit for large parts of the economy, act as a safe haven for depositors’ funds (Hoepner & Wilson, 2010). If banks’ intermediation between depositors and borrowers is undertaken in an efficient manner, then deposit and credit demands can be met at low cost, benefiting the parties concerned as well as the economy overall. Banks also play an important role in allocating money across sectors of industry thereby indirectly influencing the nature of economic growth (Jeucken, 2001). Therefore, they are crucial in determining whether society-from governments to individual consumers-succeeds in following an environmentally and socially sustainable path. One could easily ask the question “What does a bank have to do with sustainable development? at the beginning of 1990s. The relevance of sustainability for banks has come into recognition by UNEP’s ‘Statement by Banks on the Environment and Sustainable Development’ after the Rio Summit in 1992” (United Nations Environment Programme UNEP, 1992). A large number of banks from around the world signed this statement. This statement was the banking industry’s first reaction to the challenge of sustainability (Weber, Fenchel, &

Basak Turan Icke, assistant professor, Ph.D., Faculty of Political Sciences, Department of Business Administration, Istanbul University. Esra Nemli Caliskan, associate professor, Ph.D., Faculty of Political Sciences, Department of Business Administration, Istanbul University. Yusuf Ayturk, research assistant, Faculty of Political Sciences, Department of Business Administration, Istanbul University. Mehmet Akif Icke, assistant professor, Ph.D., Faculty of Political Sciences, Department of Public Administration, Istanbul University.

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Scholz, 2008). The UNEP Statement recognizes that sustainable development—development that meets the needs of the present without compromising the ability of future generations to meet their own needs—must rank amongst the highest priorities of banks; that the banks are an important contributor towards its achievement. The statement further commits signatories to pursue common principles of environmental protection by using best practices of environmental management in their internal operations and integrating environmental risks into the normal checklist for risk assessment and management (Cowton & Thompson, 2000). Although Cowton and Thompson (2000) could not find firm support that this code has a substantial impact on signatory banks’ practices, UNEP Statement was a major improvement for banking sector to take environmental issues into consideration. Since banks themselves do not produce hazardous chemicals or discharge toxic pollutants into the air, land or water, at first sight they do not appear to be involved with environmental issues beyond those which would normally apply to any office-based service industry–paper recycling, energy efficiency of buildings etc. However, through their lending practices they are inextricably linked to commercial activity that degrades the natural environment (Cowton & Thompson, 2000). Besides the environment, issues such as poverty and human rights have received increasing attention since the end of 1990s. The awareness that sustainable development does not only comprise of environmental sustainability and has two more dimensions has been increasing. Economic and social sustainability have been adopted as additional and interrelated concerns to the natural environment throughout the World (McKenzie, 2004). Johannesburg Summit (2002) had a special contribution to the understanding of this interrelationship. It was a true sustainable development summit in the sense that advocates of all three dimensions of sustainable development—the “triple bottom line” of economy, environment, and society—in the words of Speth (2003). The interrelationship between the environmental, social and economic aspects of sustainability is commonly accepted now. Banks have a special role in promoting sustainability as important actors of the financial system. The environmental burden of bank products do not come from themselves, the users of bank products can have a considerable impact on the environment. Therefore it is very hard to estimate the environmental burden of the activities the banks have funded (Jeucken, 2001). A number of banks provided loans to damaging and highly environmental and social impact projects, including the arms trade and production of big dams, pipelines and others (Baranes, 2009). Infrastructural projects generally require years of planning, engineering, construction and testing, before they go into production. The role of banks and other financial institutions is crucial since a huge financial investment is needed in order to realize those projects. Many of the projects, accused of negatively impacting the local communities and the environment, would not have been possible without the active support of financial institutions. The financial sector, incorporating banks, pension plans and other types of financiers that facilitate development by distributing capital and managing financial risks, has an important role to play for the sustainability of the planet (Richardson, 2009). Sustainability is affecting the financial industry in various additional ways. For example, new ethical investment products such as socially responsible, environmental and sustainable mutual funds are growing rapidly in their size and variety (O’Rourke, 2003). These funds select the portfolio of stocks based on the assessment of stock-listed companies on the triple bottom line of environmental, social and financial performance. This sector is now universally known as socially responsible investment. Financing policies for profit projects that pay attention to social and environmental issues are becoming more

AN EMPIRICAL RESEARCH OF ETHICAL BANKING IN TURKEY 291 and more common in mutual funds (Lanzavecchia & Poletti, 2005). The banks therefore hold a strong responsibility with regard to the use of money, and in deciding to whom and how to provide a loan. In the last few years, more and more networks and organizations from international civil society started to ask the banks to face these responsibilities, and to adopt strong social and environmental standards that would prevent them from financing these projects (Baranes, 2009).

Ethical Banking In recent years, issues related to business ethics are also considered by banks in addition to sustainability. Banking, in common with other areas of finance, is often considered an amoral field focused purely on risk and return. However, ethics does have an important role to play, both traditionally and as business and banking evolve (Cowton, 2002). The fact that banks, as organizations which fulfill investment and saving functions by playing an integrating and intermediary role between the fund-supplying and fund-demanding parties of the society, have also adopted profitability and productivity principles, obliges them to stick to ethical principles during their operations in both professional and corporate domains (The Turkish Banking Association, 2006). The expressions ethical banking, social banking, sustainable finance and alternative banking refer to forms of financial intermediation aimed at evaluating the collective aims of projects, and the implications of these projects for the stakeholders (Lanzavecchia & Poletti, 2005). Different authors define ethical banking from different points of view. For example, San-Jose, Retolaza, and Gutierrez (2009) talked about two accepted characteristics to define the ethical banking: (1) The obtaining of social profitability, understood as funding (placement of the assets) economic activities with social value added and as the absence in any case of investments in speculative projects or in those that fulfill negative criteria; (2) The obtaining of economic profitability, which means benefits. The dimension of obtaining benefit refers to the good management of the bank, because ethical banks do not distribute benefits between stockholders or, if they do so, the distribution is very limited. On the other hand, Cowton (2002) summarized three aspects of ethics in banking as integrity, responsibility and affinity. Integrity is very important in banking, helping to generate the trust vital for a financial system to flourish. Depositors need to trust banks, otherwise they would not lend money. Lending with responsibility, includes first of all, avoiding financial exclusion. Secondly having lent money, the responsibility of banks includes not being too hasty to foreclose. Thirdly, lending too much is potentially as serious a problem in the ethical sense as lending too little. Affinity refers to a way in which depositors and borrowers can be brought closer together than they are in traditional banking. San-Jose and Retolaza (2008) in another study identified four basic different characteristics that would differentiate ethical banking from traditional banking (i.e., the transparency and participation of the savers in the decision about the investment of their savings, and the location of funds in projects with an added social value and the differentiation between them are necessary guarantees to avoid social exclusion even in the groups of the most needy). Barbu and Boitan (2009) explained the basic characteristics of ethical banks which can be seen in Table 1.

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Table 1 Characteristics of Ethical Banks Operate with a clear set of ethical values, known, accepted and respected at all the hierarchical levels. Pursue the obtaining of both financial and social gains. The investment decision belongs, firstly, to customers (depositors, creditors), by choosing the ethical project to be financed with their funds. Publish on a regular basis a list with all the investment projects that received financing. Finance those companies whose projects exert a positive influence on society and environment.

Note. Source: Barbu and Boitan (2009).

The ethical banks consider the non-economic consequences of their operations as important as the economic ones. They base their action on a full disclosure of information towards all the stakeholders. They pay a special attention to the needs of the most vulnerable sectors of the society (Baranes, 2009). More radically still, sustainable business activity could be promoted by the ethical banks by targeting specific types of borrowers, or offering preferential rates of interest to those borrowers which exhibit a high level of environmental awareness and performance and/or are involved in activities that have a clear environmental benefit such as the manufacture of environmentally friendly products (Cowton & Thompson, 2000). Ethical banks may offer alternative financing for socio-environmental projects, including more attractive interest rates, longer terms or even discounts in the principal. The supply of these special products not only helps improve the economic-financial performance of these institutions (by increasing incomes), but also helps improve the environment and communities (Lins & Wajnberg, 2007).

Turkish Banking Sector and Code of Ethics An Overview of Turkish Banking Sector The financial sector in Turkey is traditionally controlled by banking activities. Banking activities have been performed both by state-owned banks and private-sector banks. The majority of the private-sector banks are locally owned. Some are foreign-owned, while a few are jointly owned by domestic and foreign banks. The number of state-owned banks declined following the financial liberalization program of the 1980s. The major domestically owned private banks are closely linked to industrial groups. Currently, banks from various countries including the UK, US, Netherlands, Germany, and Greece operate in Turkey. Turkey faced with two major banking crises, in 1994 and in 2000. The banking sector in Turkey has been improved considerably. Currently, it stands as one of the unusual examples of financial sectors able to withstand the 2007-2009 global financial crises without any bank failures (Baum, Caglayan, & Talavera, 2010). In 1994 banking crises, the Turkish government had to introduce the full deposit insurance scheme. A number of banks reported the decline of assets quality in order to receive capital injections from the government. The second financial crisis ended in 2001. The government and IMF introduced systemic measures to fix up the Turkish economy through the so-called Rehabilitation Program. The Program included the following priorities: to restructure three large state-owned commercial banks; to restructure those banks that were taken over by the Savings and Deposits Insurance Fund; to strengthen the financial position of private banks and lastly to improve the regulatory and supervisory framework. During the 2000-2001 financial crises, several banks managed by the Savings Deposit Insurance Fund (SDIF), which was taking over and restructuring failed banks. In 2002, the Program was revised in order to reflect the current economic issues. The

AN EMPIRICAL RESEARCH OF ETHICAL BANKING IN TURKEY 293 persistent macroeconomic problem was hyperinflation. In 2002, the government had to introduce inflation accounting to reflect severely distorted financial reporting (Fukuyama & Matousek, 2011). Prior to the 1990’s, the Turkish financial sector had an underdeveloped and basic structure. This period could be best characterized by high regulation, limited interest rates, monitored foreign exchange operations, restricted foreign asset holding, lack of competition, barriers to foreign entry and high liquidity, chronic inflation, and a deficit in balance of payments. However, the Turkish financial sector has experienced substantial changes with the liberalization program that came into being during 1980s. The primary aim of this process was to increase the efficiency, strength and competitiveness of the Turkish banking system. The share of private banks rose from 42% to 47% and the share of public banks declined from 44% to 34% in the period of 1980-2000. The banking sector adjusted itself to the changing conditions around the world. With the increasing importance of Turkey in the global arena, the foreign entries into the banking industry gained momentum and the Turkish Banking Industry emerged as a profitable one. Table 2 shows that this fact which began in early 2000s (Gokmen & Hamsioglu, 2009).

Table 2 Banks Purchased by Foreigners Between 2001-2006 Bank % Purchaser Origin Date Amount (million $) Demirbank 100 HSBC England September 2001 350 Sitebank 100 Novabank Portugal December 2001 3 Kocbank 50 Unicredito Italy May 2002 240 TEB 41.2 BNP Paribas France February 2005 217 Disbank 89.3 Fortis Belgium April 2005 1.141 Garanti 25.5 GE Finance USA August 2005 1.556 Yapi Kredi 57.4 Unicredito Italy September 2005 1.395 C Kredi Kalkinma 57.5 Bank Hapoalim Israel December 2005 113 Finansbank 46 National Bank of Greece Greece April 2006 2.323 Tekfenbank 70 EFG Eurobank Greece May 2006 182 Denizbank 75 Dexia France May 2006 2.437 Sekerbank 33.9 Bank Turan Alem Kazakhstan June 2006 254 Note. Source: Gokmen and Hamsioglu (2009).

Table 3 Ownership and Number of Banks in Turkey, 1999-2009 1999 2002 2008 06/2009 Total number of banks (I+II) 81 54 45 45 I. Commercial (deposit) banks 62 40 32 32 (1) State 4 3 3 3 (2) Private 31 20 11 11 (3) Savings deposit Insurance fund (SDIF) 8 2 1 1 (4) Foreign, founded in Turkey 5 4 11 11 (5) Foreign, branches 14 11 6 6 II. Development and investment banks 19 14 13 13 (1) State 13 8 6 6 (2) Private 13 8 6 6 (3) Foreign 3 3 4 4 Note. Source: Uygur (2010).

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In the period between 2002 and 2008, the largest drop was in the number of private commercial banks owned by residents. This resulted from the acquisition of Turkish banks by foreign banks (Uygur, 2010) (see Table 3). In recent years, Turkish banking sector has relatively good performance as compared to the past. It can be concluded that in a mainly two headings. First of all, the banking sector was restricted in the crisis of 2000-2001 and well regulated and supervised afterward. Secondly in recent global financial crisis, there were no toxic financial instruments in Turkish banks’ portfolios. Table 4 shows that development of total assets of banking sector in Turkey in the period of 1999-2009 Q2 (Uygur, 2010).

Table 4 Total Assets of Banking Sector in Turkey: 1999-2009 Q2 1999 2002 2008 03/2009 06/2009 Total bank assets, Billion $ 133.5 129.7 482.2 452.7 503.5 Total bank assets/GDP 67.1 58.6 78.1 79.8 79.1 Total banks (I+II, % Share) 100.0 100.0 100.0 100.0 100.0 I. Commercial (deposit) banks 95.2 95.6 96.9 96.7 96.7 (1) State 34.9 31.9 28.5 29.0 30.2 (2) Private 49.5 56.2 41.0 40.7 40.2 (3) Savings deposit insurance fund (SDIF) 5.6 4.4 0.0 0.0 0.0 (4) Foreign 5.2 3.1 27.4 27.0 26.3 II. Development and investment banks 4.8 4.4 3.1 3.3 3.3 (1) State 3.4 3.2 2.8 3.0 3.0 (2) Private 0.9 0.8 0.2 0.2 0.2 (3) Foreign 0.5 0.4 0.1 0.1 0.1 Note. Source: Uygur and Ercan (2010).

According to Fukuyama and Matousek (2011), the Turkish banking sector positively reacted to consolidation and restructuring process. It is obvious that bank efficiency has increasingly improved and the cost efficiency scores peaked immediately after the Restructuring Program. However, they found a slow decline of bank efficiency from 2004 to 2007. This negative trend could be explained by the strict regulatory rules imposed by Banking Regulation and Supervision Agency (BRSA). They did not find evidence that foreign banks are more efficient than domestic banks. They also obtained interesting results as for the determinants of bank efficiency. Firstly, their results show that the increase in market shares within the deposit market contributes to bank efficiency. Secondly, ROA ratios may be considered as an appropriate proxy indicator that provides information not only about bank performance but also indirectly about its efficiency. When we look at the profitability indicators of the Turkish banking sector we see a very changeable course in the last 20 years. In 1990s, very high profitability ratios were observed but, in general, the ratios were not sustainable. The sector made important losses between 1999 and 2001 generally because of the financial crises. Return on assets (ROA) and return on equity (ROE) ratios have been relatively stable since 2002. ROA and ROE ratios can be seen in Table 5. According to Sayilgan and Yildirim related to macro independent variables; the profitability (ROA and ROE) of the banking sector seems to have increased along with declining inflation rate consistently increasing industrial production index and improving budget balance. On the micro

AN EMPIRICAL RESEARCH OF ETHICAL BANKING IN TURKEY 295 independent variables, profitability seems to have been positively affected by capital adequacy in broad terms and negatively by growing off-balance sheet assets. They conclude that profitability became more stable in the 2002-2007 periods (Sayilgan & Yildirim, 2009).

Table 5 ROA and ROE Ratios in 1987-2001 and in 2002-2007 Average/Standart deviation 1987-2001 2002-2007 ROA 2.8/3.1 2.5/0.5 ROE 29.9/41.3 18.7/4.4 Note. Source: Sayilgan, Guven, Yildirim, and Onur (2009).

In 2010, the strong structure in the banking sector is preserved. Capital adequacy ratio of the sector is highly above legal limit. Liquidity indicator of the sector presents a stable structure. FX position/total owned funds ratio remains very limited which indicates low exchange rate risk. The off-balance sheet transactions to total balance sheet size ratio has increased within first quarter of 2010 compared to the end of previous year. The steady level of the NPL/gross loans ratio of the sector has turned into a decline, which is considered a positive development. BRSA Performance Index (BRSA-PI) has re-entered to an increasing tendency within the first quarter of 2010. The value the index has reached as of March 2010 to the highest level in its history ((The Banking Regulation and Supervision Agency, 2010) (see Table 6).

Table 6 Turkish Banking Sector Performance Index Year PI Liquidity Own funds Exch. rate risk Profitability Asset quality 2003 100.0 100.0 100.0 100.0 100.0 100.0 2004 100.2 100.2 99.5 100.1 99.7 101.3 2005 100.0 100.7 99.3 99.8 98.5 102.2 2006 100.7 100.4 99.4 100.1 100.5 102.9 2007 100.8 101.6 99.4 99.1 101.0 103.2 2008 100.6 101.7 98.9 100.0 99.6 103.3 2009 100.9 102.1 100.1 99.3 100.7 102.8 03/2010 101.2 102.2 100.1 99.3 101.8 103.0 Note. Source: BRSA (2010).

The banking system in Turkey is still relatively small compared with the some EU member states on average. However we can say that the sector is gradually developing. Here are some selected indicators and Turkish banking sector’s data in the year 2009 (The Banks Association of Turkey, 2010): (1) Growth: Balance sheet size of deposit banks recorded an average growth of 13%. Out of 32 deposit banks in the banking sector 10 banks grew at a rate higher than the average of the sector. The balance sheet size of nine deposit banks recorded a growth below 13 percent, while the balance sheet size of 13 deposit banks contracted; (2) Profitability: Return on equity in deposit banks was 19.7% on average as of December 2009. Return on equity in six banks was above the sector average, while two banks reported loss; (3) Capital Adequacy: Capital adequacy of deposit banks was recorded as 19.3%. 17 banks had a capital adequacy ratio higher than the average;

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(4) Non-Performing Loans: The upward trend in the non-performing loans stopped in the last months of the year. Provisions were set aside for 85% of non-performing loans of deposit banks. The Turkish banking sector is still in a developing period and in order to bring the financial system more in line with developed countries, new risk management tools must be introduced to the system. Turkish market has improved in all aspects of macroeconomic performance but financial deepening is still lagging European markets. The coordination between international supervisors and the flexibility of central banks will improve the efficiency of this transformation in the banking sector (Hacihasanoglu & Ozdemir, 2009). Code of Banking Ethics—The Banks Association of Turkey The Banks Association of Turkey (BAT) was founded in 1958. It is a professional organization, which is a legal entity with the status of a public institution, established pursuant to Article 79 of the Banks Act. The purpose of the Association is to preserve the rights and benefits of banks, to carry on studies for the growth of the banking sector, for its robust functioning and the development of banking profession, strengthening of competition power, to take the decisions/ensure that they are taken to prevent unfair competition, to implement and demand implementation of these decisions, in line with the principles of open market economics and perfect competition and the regulations, principles and rules of banking (The Banks Association of Turkey, 2010). All deposit banks, development and investment banks operating in Turkey are obliged to become members of this Association at most a month after they get their permit of operation, and to comply with the provisions of this Statute, and to implement the decisions taken by the authorized bodies of the Association. The Banks Association of Turkey has published the draft version of Code of Banking Ethics in 2001, Banking Regulation and Supervision Agency (BRSA) approved the Code in 2006. The fundamental motive behind the banking ethics to apply to the procedures and transactions of the banks with each other and with their customers and shareholders, and as well as with other organizations is to ensure that the existing respect for the banking profession in the society is set on a permanent footing, to maintain and improve this social respect, called also as professional honor, and to maintain and protect the stability and trust in the banking sector. According to the Code, banks are required to stick to the below-specified general principles in their operations (The Banks Association of Turkey, 2006): (1) Honesty: Banks, during their operations, stick to the honesty principle in their relations with their customers, employees, shareholders, group companies and with other banks, organizations and companies. (2) Impartiality: Motivated by the motto of “At the heart of the success should lie respect to humans”, banks should make no discrimination and should avoid all forms of bias in their attitudes towards their employees as well as to their customers. Banks should not make any discrimination towards their customers based on their nationality, religion, financial and social standing, and gender during their service. (3) Reliability: Banks should offer clear, comprehensible and correct information to their customers within the principle of reciprocal trust during their entire services and transactions; and they should provide the customer services in a timely and complete manner. (4) Transparency: Banks should inform their customers in an open, easily understandable and clear way regarding the underlying rights and responsibilities, benefits and risks attached to the products and services offered to them. (5) Observing Social Benefit and Respect to Environment: Banks should show due diligence to support all

AN EMPIRICAL RESEARCH OF ETHICAL BANKING IN TURKEY 297 kinds of social and cultural activities in the light of the principle of observing, aside from the profitability, the social benefit and respect to the environment. (6) Fighting with Laundering of Crime-Originated Assets: They should adopt the fight against corruption, laundering of crime-originated assets, etc. as a significant principle as stipulated by international norms and the provisions of national laws and regulations, and do their utmost for the due cooperation with each other, with other organizations and institutions related with the subject, as well as with the competent authorities. They should also assume the required measures inside their organizations for this purpose, and device training programs to instruct their personnel on the matter. (7) Insider Trading: Banks should take all measures in order to prevent the use of insider information for the trading purposes. Besides these general principles, the Code also includes provisions related to banks’ relations with public organizations and institutions, relations between banks, relations of banks with their customers, relations of banks with their employees, professional rules and ethical principles the bank employees should comply. The general principle of “Observing Social Benefit and Respect to Environment” stated above is especially appealing for this study. The Code suggests Banks “to show due diligence to support all kinds of social and cultural activities in the light of the principle of observing, aside from the profitability, the social benefit and respect to the environment”. Since the publication of principles, many Turkish banks have adapted these principles to their own Codes. But the impact of the principle “Observing Social Benefit and Respect to Environment” is still not adequately seen in banking practices.

Problem Definition and Research Methodology Social and economic profitability are two accepted characteristics of the ethical banking. Both aspects are necessary: The social dimension makes the banks ethical and the economic profitability makes the banks economically sustainable. Social profitability can be defined as funding (placement of the assets) economic activities with social value added and as the avoiding investments in speculative projects or in those that fulfill negative criteria (San-Jose, Retolaza, & Gutierrez, 2009). According to San-Jose and Retolaza (2008), there are four basic different characteristics differentiating ethical banking from traditional banking, (i.e., transparency; participation of the savers in the decision about the investment of their savings; location of funds in projects with a social value added (the placement of assets) and avoiding social exclusion even in the groups of the most needy). Banks lend their funds responsibly, by considering the risk and return characteristics of the lending funds. In this regard depositors’ interests are broadly aligned with those of shareholders. However, recently it is argued that banks should have many further obligations, including to stakeholders other than depositors and shareholders. There are three aspects of responsible lending in ethical banking. Firstly, ethical banks have a responsibility not to exclude certain groups. Second, after having lent money, the responsibility of ethical banks includes not being too hasty to foreclose. Third, lending too much is potentially as serious a problem in the ethical sense as lending too little (Cowton, 2002). San-Jose, Retolaza, and Gutierrez (2009) found that placement of assets is a significant factor that differentiates ethical banks and the rest of financial intermediaries. In this respect, one of the most important characteristic of ethical banking is giving credits to the companies which have a positive impact on society and environment.

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Ethical banks can describe their own types of investments which generate a social value, according to the principles and interests, first of the shareholders and later of all the stakeholders; however, the main types refer to the positive investment in four aspects–nature and environment, social economy, culture and society, cooperation (San-Jose & Retolaza, 2008). Ethical banks should place their funds in projects with positive social value added and not in speculative projects or in ineligible projects. The concept of social value added generating projects refers to the projects that according to their objectives (ecology, social inclusion, renewable energy) or the people they are addressed to (people who cannot get a loan from traditional banking) create a positive value for the social environment in which they take place (San-Jose et al., 2009). Avoiding social exclusion is also a significant factor that differentiates ethical banks and the rest of financial intermediaries. Ethical banks have a responsibility to lend fairly. If banks’ lending policies are unnecessarily restrictive, this situation will tend to adversely affect certain groups which are denied credits or cannot afford credits on the disadvantageous terms on which it is offered to them. This might prevent these people or companies participating in society in various desirable ways. Excluded or disadvantaged groups can be defined in various ways, for example by income level or geographical location. Certain types of organizations, for example microenterprises or start-ups can face problems about borrowing (Cowton, 2002). In Turkey, banks have an important role in society. Most banks do not integrate social and environmental factors into their lending and credit risk-assessments, although there are a few banks which have started to develop them. For example, Industrial Development Bank of Turkey declares that it always takes sustainable development criteria into consideration when evaluating the investment projects. However, social banking or ethical banking is a new concept in Turkey, and a radical change can be possible towards ethical banking by non-governmental organizations’ pressure, customer awareness and governmental measures. In this paper, we analyze the differences in lending behaviors of traditional banks in terms of their functions and ownership structures. In order to measure ethical banking degrees of Turkish banks, we use two important criteria of ethical banking (i.e., location of assets and avoiding social exclusion). Companies doing business in education, health and culture sectors provide the higher social value added to the society than other companies doing business not in these sectors. In this respect, banks giving more credits to the companies which operate in education, health and culture sectors proportionately with their total credits, can be accepted more ethical than other banks. This assumption is consistent with one of the most important aspects of ethical banking which is the location of funds in projects with a social value added. The credits given to companies operating in environment-related sectors are excluded from the study because of lack of data. The first hypothesis is formulated as follows: Hypothesis 1: There are significant differences in the location of funds between banks in terms of their functions and ownership structures. In Turkey, microenterprises can be defined as businesses which employ at most 10 employees yearly, and have net sales revenues or total assets at least 1 Million Turkish Lira. Compared to medium and large scale enterprises, microenterprises have difficulties in getting enough credits, which means microenterprises are often socially and financially excluded. In this respect, the degree of avoiding social exclusion can be measured as the ratio of given loans to the microenterprises divided by total given loans, and the banks giving more loans to the microenterprises proportionately with their total credits, can be accepted more ethical than other banks. This assumption is also consistent with one of the most important aspects of ethical banking which is avoiding social

AN EMPIRICAL RESEARCH OF ETHICAL BANKING IN TURKEY 299 exclusion even in the groups of the most needy. The second hypothesis is formulated as follows: Hypothesis 2: There are significant differences in avoiding social exclusion towards microenterprises between banks in terms of their functions and ownership structures. In Turkey, there are 49 banks at the end of September 2010. In the Banking Regulation and Supervision Agency (BRSA) database, banks are grouped in terms of their functions and their ownership structures. There are three types of ownership structures, state-owned banks, domestic private banks and foreign private banks. According to functions, banks can be divided into three groups; deposit banks, participation banks, and development banks. Data used in this paper is obtained from the Banking Regulation and Supervision Agency’s (BRSA) web site. In testing of the first hypothesis (i.e., there are significant differences in the location of funds between banks in terms of their functions and ownership structures), we use 94 monthly ratios over the period December 2002-September 2010 in terms of the banks’ ownership structures. Participation banks started to give credits to companies operating in education, health and culture sectors as of January 2005. Because of this reason, 69 monthly ratios are used over the period January 2005–September 2010 in terms of the banks’ functions. The ratio is calculated as the monthly total credits including non-cash credits given by the banks to the companies doing business in social value added creating sectors (i.e., education, health and culture divided by monthly total credits). This ratio is called social value added lending (SVA-L) ratio. SVA-L ratios are calculated for each banking group in terms of functions and ownership structures. Database used in testing of the second hypothesis (i.e., there are significant differences in avoiding social exclusion towards microenterprises between banks in terms of their functions and ownership structures) includes 46 monthly ratios over the period December 2006-September 2010 in terms of the banks’ functions and ownership structures. Our analysis is limited with 46 monthly ratios, because in BRSA database there is no information about credits given by banks to the microenterprises before December 2006. The ratio is calculated as the monthly total credits including non-cash loans given by the banks to microenterprises mostly exposed to social exclusion divided by monthly total given credits. This ratio is called avoiding social exclusion lending (ASE-L) ratio. ASE-L ratios are calculated for each of the banking group in terms of functions and ownership structures. One of the most widely used statistical methods to compare the significant differences between more than two independent samples is one-way ANOVA test. However, the results of one-way ANOVA test can be accepted reliable as long as assumptions of this test are met. These assumptions are equal variances of populations, independent samples and normal distribution of samples. If one of the assumptions is not met, non-parametric tests to compare the significant differences between more than two independent samples can be used. In this paper, firstly we conduct Levene test of homogeneity of variances. Since the basic assumption of equal variances between samples in our dataset is not met, we conduct non-parametric tests—Kruskal Wallis, Jonckheere-Terpstra, Mann-Whitney, Kolmogorov-Smirnov and Wald-Wolfowitz—rather than the one-way ANOVA to test our hypotheses.

Results of Empirical Analysis This study is conducted on Turkish banks. The sample is chosen from BRSA database in terms of the ownership structures and functions of 49 banks in Turkey, and the descriptive statistics of our data is shown in Table 7.

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It seems that mean ratios in each group are different, but we have to test whether the differences are statistically significant or not. Firstly, we conduct Levene test of homogeneity of variances, to test one of the basic assumptions of one-way ANOVA test. Levene test of homogeneity results are stated in Table 8. The results of the test of homogeneity of variances show that with an error of less than 0.01 (p < 0.01) variances of SVA-L ratios (function and ownership) and ASE-L ratios (ownership) between different groups are not equal, which means we cannot conduct one of the most widely used parametric technique, one-way ANOVA test, to compare the significant differences of mean ratios between different groups. Only the ASE-L (function) ratios between different groups have equal variances, but the distributions of ASE-L (function) ratios in each group are deviated significantly from normal, which means we cannot conduct one-way ANOVA test to compare the significant differences of mean ASE-L (function) ratios between these groups.

Table 7 Descriptive Statistics of SVA-L and ASE-L Ratios Panel A: Social value added ratios (Function) Banking function N Mean Std. deviation Std. error Minimum Maximum Deposit banks 69 0.0120 0.0018 0.0002 0.0080 0.0154 Participation banks 69 0.0177 0.0046 0.0006 0.0106 0.0246 Development banks 69 0.0086 0.0013 0.0002 0.0056 0.0112 Total 207 0.0127 0.0048 0.0003 0.0056 0.0246 Panel B: Social value added ratios (Ownership structure) Ownership structure N Mean Std. deviation Std. error Minimum Maximum Domestic private banks 94 0.0099 0.0018 0.0002 0.0072 0.0134 Foreign private banks 94 0.0071 0.0051 0.0005 0.0005 0.0141 State-owned banks 94 0.0172 0.0055 0.0006 0.0067 0.0310 Total 282 0.0114 0.0061 0.0004 0.0005 0.0310 Panel C: Avoiding social exclusion ratios (Function) Banking function N Mean Std. deviation Std. error Minimum Maximum Deposit banks 46 0.0699 0.0071 0.0011 0.0579 0.0827 Participation banks 46 0.0474 0.0133 0.0020 0.0383 0.1313 Development banks 46 0.0086 0.0038 0.0006 0.0027 0.0158 Total 138 0.0420 0.0269 0.0023 0.0027 0.1313 Panel D: Avoiding social exclusion ratios (Ownership structure) Ownership structure N Mean Std. deviation Std. error Minimum Maximum Domestic private banks 46 0.0527 0.0065 0.0010 0.0411 0.0715 Foreign private banks 46 0.0336 0.0108 0.0016 0.0134 0.0480 State-owned banks 46 0.1013 0.0305 0.0045 0.0653 0.1516 Total 138 0.0625 0.0343 0.0029 0.0134 0.1516

Table 8 Test of Homogeneity of Variances Results Levene statistic df1 df2 Sig. SVA-L ratio (Function) 65.817 2 204 0.000 SVA-L ratio (Ownership) 99.605 2 279 0.000 ASE-L ratio (Function) 2.113 2 135 0.125 ASE-L ratio (Ownership) 55.817 2 135 0.000

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The initial empirical analysis is carried out using two different non-parametric tests (i.e., Kruskal-Wallis and Jonckheere-Terpstra tests), to test whether there is a significant difference in mean SVA-L ratios and in ASE-L ratios between different bank types in Turkey. The statistical results of the Kruskal-Wallis and Jonckheere-Terpstra tests are stated in Table 9. The results of Kruskal-Wallis and Jonckheere-Terpstra tests indicate that with an error of less than 0.01 (p < 0.01) there are significant differences in SVA-L ratios between banks in terms of their functions and ownership structures. And also, there are significant differences in ASE-L ratios between traditional banks in terms of their functions and ownership structures. We reject the null hypotheses of mean ratio equalities of the groups with a significant level.

Table 9 Kruskal-Wallis and Jonckheere-Terpstra Non-parametric Tests Results Panel A: Kruskal-Wallis test results SVA-L ratio SVA-L ratio ASE-L ratio ASE-L ratio

(Function) (Ownership) (Function) (Ownership) N 69 94 46 46 Chi-square 135.639 115.473 119.194 116.155 df 2 2 2 2 Asymp. Sig. 0.000 0.000 0.000 0.000 Panel B: Jonckheere-Terpstra test results SAV-L ratio SAV-L ratio ASE-L ratio ASE-L ratio

(Function) (Ownership) (Function) (Ownership) Number of levels in grouping variable 3 3 3 3 N 207 282 138 138 Observed J-T statistic 4,242.000 19,127.000 46.000 4,307.000 Mean J-T statistic 7,141.500 13,254.000 3,174.000 3,174.000 Std. deviation of J-T statistic 469.250 745.608 255.773 255.773 Std. J-T statistic -6.179 7.877 -12.230 4.430 Asymp. sig. (2-tailed) 0.000 0.000 0.000 0.000

Kruskal-Wallis test and Jonckheere-Terpstra test results show that at least one of the groups has a mean ratio which is different from others. In order to identify which banking group has the highest statistically significant mean ratio, we conduct the non-parametric tests which use multiple comparisons between two independent samples. Mann-Whitney, Kolmogorov-Smirnov and Wald-Wolfowitz non-parametric tests are applied to prove differences in social value added lending and avoiding social exclusion lending ratios between one group of bank as opposed to another group of bank. Mann-Whitney, Kolmogorov-Smirnov and Wald-Wolfowitz non-parametric tests results are stated in Table 10. According to Mann-Whitney, Kolmogorov-Smirnov and Wald-Wolfowitz non-parametric tests results, there are significant differences in location of funds towards social value added generating sectors (represented by mean SVA-L ratios) with an error of less than 0.01 (p < 0.01) between deposit banks and participation, deposit banks and development banks, participation banks and development banks (function); and between domestic private banks and foreign private banks, domestic private banks and state-owned banks, state-owned banks and foreign private banks (ownership structure).

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Table 10 Mann-Whitney, Kolmogorov-Smirnov and Wald-Wolfowitz Non-parametric Tests Results Panel A: Three tests results for social value added lending ratios Social value added lending Ratio–Location of Funds Mann-Whitney Kolmogorov-Smirnov Wald-Wolfowitz (Function and ownership structure) Deposit vs. participation -6.126 (0.000) 4.086 (0.000) -6.152 (0.000) Deposit vs. development -8.395 (0.000) 4.862 (0.000) -7.159 (0.000) Participation vs. development -10.077 (0.000) 5.703 (0.000) -10.936 (0.000) Domestic Private vs. state-owned -9.020 (0.000) 4.886 (0.000) -7.313 (0.000) Domestic Private vs. foreign private -2.584 (0.009) 3.428 (0.000) -8.775 (0.000) State-owned vs. foreign private -9.307 (0.000) 4.376 (0.000) -8.629 (0.000) Panel B: Three tests results for avoiding social exclusion lending ratios Avoiding social exclusion lending ratio Mann-Whitney Kolmogorov-Smirnov Wald-Wolfowitz (Function and ownership structure) Deposit vs. participation -7.903 (0.000) 4.962 (0.000) -9.225 (0.000) Deposit vs. development -8.262 (0.000) 4.796 (0.000) -9.435 (0.000) Participation vs. development -8.262 (0.000) 4.796 (0.000) -9.435 (0.000) Domestic private vs. state-owned -8.160 (0.000) 4.587 (0.000) -8.596 (0.000) Domestic private vs. foreign private -7.575 (0.000) 3.649 (0.000) -6.500 (0.000) State-owned vs. foreign private -8.262 (0.000) 4.796 (0.000) -9.435 (0.000)

The results also show that there are significant differences in avoiding social exclusion towards microenterprises (represented by mean ASE-L ratios) with an error of less than 0.01 (p < 0.01) between deposit banks and participation, deposit banks and development banks, participation banks and development banks (function); and between domestic private banks and foreign private banks, domestic private banks and state-owned banks, state-owned banks and foreign private banks (ownership structure). Ethical banks should place their funds in projects with positive social value added and not in speculative projects or in ineligible projects. The results of the empirical analysis show that in terms of functions of the banks in Turkey, participation banks have the highest mean social value added ratio (1.77%) which represents location of funds towards sectors providing higher social value added. Mean differences between types of banks are statistically significant. With the highest mean social value added ratio, participation banks can be accepted more ethical than other banking types (i.e., deposit banks and development banks, when the location of funds criteria is considered in lending behavior of the banks). When we analyze banks from the aspect of ownership structure, stated-owned banks have the highest mean social value added ratio (1.72%) and mean differences are statistically significant. State-owned banks can be accepted more ethical than other banking types (i.e., domestic private banks and foreign private banks, when the location of funds criteria is considered in lending behavior of the banks). Avoiding social exclusion even in the groups of the most needy is one of the most basic characteristics of ethical banking. The results of the empirical analysis show that in terms of functions of the banks in Turkey, deposit banks have the highest mean avoiding social exclusion ratio (6.99%) which represents the degree of avoiding social exclusion towards microenterprises. Mean differences between types of banks are statistically significant. With the highest mean avoiding social exclusion ratio, deposit banks can be accepted more ethical than other banking types (i.e., participation banks and development banks, when the avoiding social exclusion towards microenterprises is considered in lending behavior of the banks).

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When we analyze banks from the aspect of ownership structure, stated-owned banks have the highest mean avoiding social exclusion ratio (10.13%) and mean differences are statistically significant. State-owned banks can be accepted more ethical than other analyzed banking types (i.e., domestic private banks and foreign private banks, when the avoiding social exclusion towards microenterprises is considered in lending behavior of the banks).

Conclusion Ethical banks can be defined as financial institutions providing both social and economic profitability for the society and environment. There are four basic different characteristics differentiating ethical banking from traditional banking (i.e., transparency, participation, location of funds and avoiding social exclusion). Ethical banking is a rising trend in the World and it is also a new concept in Turkey. This paper analyzes the situation of ethical banking in Turkey. According to the results of the empirical analysis, in terms of the functions of the banks, participation banks give more credits to companies in more social value generating sectors as compared to deposit and development banks. Participation banks can be considered as Islamic banks in Turkey. Islamic banks operate under the basic framework of socially responsible investing by considering their customers religious beliefs. Islamic banks are assumed to be more ethical in general due to their religious underpinnings inherent in their working structures. Thus the result is not surprising that participation banks are locating more funds in more social value generating sectors. In terms of ownership structures, state-owned banks give more credits to companies in education, health and culture sectors as compared to domestic private and foreign private banks. At the same time, state-owned banks avoid social exclusion by giving more credits to microenterprises compared to domestic private and foreign private banks. This result shows that government has the leading role in implementation and development of ethical banking in Turkey. Related to social exclusion the results show that deposit banks give more credits to microenterprises as compared to participation and development banks. Since deposit banks are geographically more dispersed than other types of banks in Turkey, microenterprises have more physical access to deposit banks. Total credits given to education, health and culture sectors, and also microenterprises in Turkey are still very low proportionately with total credits. As a conclusion, ethical banking as an important tool in achieving sustainable development is not common practice in Turkey. Private banks with their highest credit potential do not take into account ethical considerations adequately in their credit management process. Although The Banks Association of Turkey’s Code of Ethics has a special provision related to the society and the environment, it seems that Turkish private banks need more time to become more “ethical”. State-owned banks have pioneering role in ethical banking practices in Turkey.

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