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 PRIVATE & CONFIDENTIAL 2 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 PRIVATE & CONFIDENTIAL 3 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. PRIVATE & CONFIDENTIAL 4 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).