Regulatory regime change in Turkish banks: Reactive or proactive?

Accounting Forum 36 (2012) 62–80

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Regulatory regime change in Turkish banks: Reactive or proactive? Istemi Demirag ∗ Queen’s University Belfast, Management School, Belfast, Northern Ireland, UK

a r t i c l e

i n f o

Article history: Received 13 October 2011 Received in revised form 26 October 2011 Accepted 26 October 2011 Keywords: Financial crisis Turkey Financial reforms Accounting regulation External pressures

a b s t r a c t This paper examines the positive contributions made toward restructuring the regulatory framework of Turkey’s banking and financial sectors prior to and post the 2000–2001 financial crisis. Drawing on a framework initially developed by Onis and Senses (2007, 2009) and further referred to by Onis (2009, 2010) it argues that financial reforms undertaken by the Turkish government would not have been successful without the strong support of domestic coalitions. While the external pressures put on the Turkish government from the International Monetary Fund, The World Bank and the European Union for financial reforms were necessary to kick start the reforms as a reactive process, these pressures on their own may have served only the interests of financial business elites at the expense of the broader stakeholders. Empirical data for the study was collected from documentary analysis of key financial institutions and interviews with twenty major Turkish regulatory agents and other stakeholders. The paper then discusses how the perceptions of these stakeholders are embodied into, and have influenced, regulatory regime change in Turkey from a reactive state to a more proactive one. © 2011 Elsevier Ltd. All rights reserved.

1. Introduction The purpose of this paper is to examine the legislative and policy responses to global corporate governance scandals in Turkey and to evaluate their potential impact on the Turkish domestic regulatory landscape through in-depth interviews with a wide range of stakeholders in the Turkish banking sector and other sectors affected by the changes in the regulatory regime. Prior research has paid inadequate attention to capturing the roles of institutional and regulatory factors in the Turkish regulatory framework. Twenty in-depth interviews with key regulatory actors in Turkey provide political and economic imperatives for successful institutional reforms in Turkey. It is suggested that the regulatory functions of the Turkish state have improved since the financial crisis of 2000–2001. Prior to the crisis, the Turkish regulatory framework had reacted to external pressures imposed by the International Monetary Fund (IMF), the European Union and the World Bank. However, since the financial crisis, it is argued that a domestic coalition of regulatory agents, banks and public companies that have become increasingly dependent on foreign capital has contributed significantly to the development of a more sustainable regulatory framework in Turkey. The paper examines regulatory change in Turkey during a transition period when Turkey was harmonizing its regulatory framework with the European Union following the financial crisis of 2000–2001. Crises often demonstrate that the existing regulatory system is not sustainable and that policy and structural changes are needed. The first section of the paper therefore highlights the background of the Turkish political landscape and economy leading up to the financial crisis of 2000–2001. Section 2 is concerned with regulatory reforms in terms of the provision of financial reporting, capital market reforms and especially reform of the banks. Some of the pertinent outcomes of these reforms are also discussed in this section. Section 3

∗ Tel.: +44 0 289097 4588. E-mail address: [email protected] 0155-9982/$ – see front matter © 2011 Elsevier Ltd. All rights reserved. doi:10.1016/j.accfor.2011.10.002

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Table 1 The cabinets and ruling parties (1993–2003). Political parties

Ruling period

DYP-SHP DYP-SHP The minority government was not approved by the Parliament DYP-CHP ANAP-DYP (minority government with support from DSP) RP-DYP ANAP-DSP-DTP (minority government with support from DSP) DSP DSP-MHP-ANAP AKP AKP

21.11.1991–25.06.1993 25.06.1993–05.10.1995 05.10.1995–30.10.1995 30.10.1995–06.03.1996 06.03.1996–28.06.1996 28.06.1996–30.06.1997 30.06.1997–25.11.1998 11.01.1999–28.05.1999 28.05.1999–18.11.2002 28.11.2002–23.03.2003 23.03.2003 onward

Source: The official website of the Turkish Grand National Assembly, 2011 (http://tbmm.gov.tr). Notes: DYP, Dogru Yol Partisi; SHP, Sosyal Halk Partisi; CHP, Cumhuriyet Halk Partisi; RP, Refah Partisi; ANAP, Ana Vatan Partisi; DSP, Demokratik Sol Partisi; DTP, Demokratik Toplum Partisi; MHP, Milliyetci Harekat Partisi; AKP, Adalet ve Kalkinma Partisi.

describes the banking reform in Turkey, addresses its processes and nature and provides insights into key regulatory actors. Section 4 reports the results of reforms and ends with some concluding remarks. 2. The background of the Turkish political landscape and economy From 1993 to 2002, Turkey experienced political and financial instability. Since November 2002, Adalet ve Kalkinma Partisi (the AK party) has been in power, and the government has remained relatively stable. This section highlights some of the main political and economic characteristics of this period, together with some significant macroeconomic indicators. 2.1. Cabinets and ruling parties From 1993 to 2003 the Turkish political system was characterized by frequent changes of political parties participating in coalition governments with other minority parties. A full list of governing cabinets and political parties from 1993 to 2003 is shown in Table 1. Notably, during this period, no Turkish government served for more than 3.5 years, even in instances when they were elected for a 5-year term. One of the possible results of this instability was chronic inflation during the 1990s. Fiscal dominance, composed mainly of a budget deficit and unsustainable debt stock, was believed to be the main determinant of this high inflation. The economy became unstable and suffered from crises as a result of its unsustainable debt dynamic and the unhealthy structure of the financial sector. Sporadic state intervention, chronic inflation and high public deficits were the main factors that repressed the development of Turkish financial markets. However, it was also argued that the corporate and banking sectors might be forced to choose external foreign funding over domestic funding with higher interest rates, which would have increased the need for fair reporting, transparency and improved corporate governance (World Bank, 2003). Table 2 depicts the dramatic changes in debt dynamics during the last decade. In 1994, the ratios of domestic and external debt to gross national product (GNP) were 15.62% and 49.59%, respectively. By the end of 2002, these ratios had increased to 50.96% and 72.92%, respectively. We now turn to some of the unsuccessful economic policies pursued by the Turkish government prior to the financial crisis in 2000–2001. In December 1999, the government introduced an exchange rate-based stability program with the Table 2 Debt stock in Comparison with GNP.

Sources: The Under Secretariat of the Treasury, 2011 and the State Institute of Statistics.

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aim of decreasing the inflation rate and managing public debt. However, this program was abolished after the serious depreciation of the Turkish Lira and a high volume of capital outflows, and a free-floating exchange rate regime was then adopted (Serdengecti, 2003). High inflation caused real interest rates to increase above the GNP growth rate. In this respect, it is interesting to compare GNP growth rates and real interest rates paid on domestic debt stock by the Treasury. In 2001, 2003 and 2006, GNP growth rates were −9.5%, 11.5% and 3.7%, respectively, and compounded real interest rates were 5.6%, 25.2% and 12.7%, respectively (Main Economic Indicators, State Planning Organization, September, 2003). The cumbersome public deficit and increased public sector borrowing requirement exerted pressure on Turkish financial markets and led to a vicious cycle of borrowing and high real interest rate payments. However, Yeldan (2002) argues that the failure of the public sector to achieve macroeconomic targets and “excessive fiscal deficits” were not the reasons for the “economic-cumpolitical” crisis. The real problem was the pressure to integrate Turkish financial markets with global markets, which led the economy into instability, and the disinflation program supervised by the IMF, which increased the vulnerability of the financial system (see also Akyuz & Boratav, 2001). The Turkish economy lost US Dollars 23.9 billion of foreign capital during the 2000–2001 crisis (Yeldan, 2002). The ratio of the short-term foreign debt to Central Bank (CB) international reserves, which had been over 100% since 1989, was further evidence of fragility in the financial markets. Dependence on speculative foreign capital for liquidity made the CB lose control of macroeconomic targets, especially the interest rates. Notably, the ratio of interest payments to tax revenues reached 103.3% in 2001 from 77.1% in 2000. Yeldan (2002) indicates that Turkey received a total payment of $20.6 billion from the IMF during the financial crisis in 2000–2001 and allocated $11.9 billion of this amount to domestic debt management. The Turkish government then decided to issue approximately $4 billion of government debt instruments for the banks acquired by the Saving Deposit Insurance Fund (SDIF) and approximately $25 billion of government debt instruments for the state banks to cover their duty losses. The aim of ensuring sustainability of the short-term debt stock of the banking sector was achieved. However, the decrease of the short-term foreign debt stock in the banking sector did not relieve the economy of the burden of debt servicing costs. Even in 2003, 73.2% of the total debt was due within one year, and, more importantly, 49.3% of it was still denominated in foreign currency or indexed to inflation. Akyuz and Boratav (2001) posit that the main problem with implementing the disinflation program was the dependency of the banking sector on earnings on T-bills, which benefit from high inflation. There were some initial problems with the implementation of the program caused by a failure to ensure inflation targets and by widening current account deficits. Arguably, the most important development in the Turkish economy since the regulatory reforms has been the decrease in inflation and borrowing rates. Therefore, financial reforms, if successfully implemented, may also help to stabilize economic performance, at least in the short term. The decline in inflation rates is shown in Table 3. Table 3 Inflation Rates Realized in Turkey Between 1994-2003 (1994 = 100) (% Change Over Previous Year End).

Source: State Institute of Statistics,2004.

The government’s unsuccessful economic policies prior to the financial crisis also manifested in the figures relating to trading halts by the Istanbul Stock Exchange (ISE). Trading halts are governed by regulations approved by the Capital Markets Board (CMB) and applied by ISE. The provisions of these regulations grant the ISE the power to make decisions on trading halts.1 Between 1999 and 2002, the ISE halted trading 32 times (Kirali, 2002). Table 4 lists the trading halts experienced by Turkish companies between 1985 and 2002. Between 1999 and 2002, fourteen companies with their own banks were transferred to a SDIF because they were considered to be undercapitalized by the Banking Regulation and Supervision Agency (BRSA), which was established in 1999. The banks and special finance companies experienced financial difficulty and insolvencies, which led ISE to take action by halting transactions on the shares of these institutions and their affiliated firms and, where necessary, removing the shares from the stock exchange permanently. A further nine banks were acquired by SDIF and two were banned from making transactions in 1999–2000. In 2001–2002, seven banks were acquired by SDIF, and four were banned from making transactions. The

1

Regulation on Istanbul Stock Exchange and Regulation on Istanbul Stock Exchange Equity Market published in Official Gazette on 19 February 1996.

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Table 4 Trading halts between 1985 and 2002. Number of halts by period

Number of actions

1985–2002 1985–1998 1999–2002 1999–2002 1999 2000 2001 2002 Company shares permanently halted from trading Company shares temporarily halted from trading Companies allowed to resume trading upon fulfillment of disclosure requirements Reasons for halts between 1999 and 2002 Company is in the same group with the banks whose shares were acquired by the Savings Deposit Insurance Fund (SDIF) Bank was acquired by SDIF Company is in the same group with the special finance companies liquidated by BRSA Special finance company was liquidated by BRSA Others

48 16 32 32 7 9 14 2 30 13 5 14 4 2 1 11

Source: Istanbul Stock Exchange.

effectiveness of these initial reforms and more stringent regulations became clear when only one bank was banned from making transactions in 2003. According to a Fitch report (May 2002) on Turkey’s banks and banking sector reform prior to the 2000–2001 financial crisis, SDIFs and private banks were considered undercapitalized, which could have resulted in the total collapse of the Turkish banking system had non-performing loans increased. In 2002, after the reforms, the bank capital-to-asset ratio stood at 8% (see Table 5). The equity of the private commercial banks was just over half of the entire Turkish financial system’s capital. Thus the financial crisis, prior to 2001 seems to have contributed to the necessary regulatory regime change of the Turkish bank system in terms of both reporting and financial restructuring, especially because the capital-to-assets ratio was low and loan write-offs large by 2000–2001. After the crisis, in 2002, banks’ ratio of nonperforming loans to total gross loans stood at approximately 29% (see Table 6). Crucially, the structure of the Turkish financial sector based on industrial-financial conglomerates increased the vulnerability of all companies in a family group that were exposed to the same risks. Because the banks’ contingent liabilities and off-balance-sheet transactions could not be verified easily at the time, the trading halts were lengthened. In total, 66% of the trading halt cases resulted from enforcement activities of BRSA, most of which took place in 2001, when the crisis was at its most severe. Other reasons for the trading halts included investigations by CMB and ISE for cases of inadequate capital, inability to engage in trading for legal reasons, litigation against a company that has declared bankruptcy, failure to fulfill disclosure requirements, leasing of the company’s trademark and production facilities to another company, failure to report financial statements to ISE and opinions of external auditors. A picture emerged of a financial sector at odds with newly empowered agencies, signifying its fragmented nature and deep-rooted structural problems.

Table 5 Turkey- Bank Capital to Assets Ratio (%).

Source: Trading Economics (2011a, 2011b) http://www.tradingeconomics.com/turkey/bank-capital-to-assetsratio-percent-wb-data.html.

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I. Demirag / Accounting Forum 36 (2012) 62–80 Table 6 Turkey-Bank Nonperforming Loans to Total Gross Loans (%).

Source: Trading Economics (2011a, 2011b). http://www.tradingeconomics.com/turkey/bank-capital-to-assetsratio-percent-wb-data.html.

One such problem that underscored the need for a more proactive approach to reform was the structure of Turkey’s banks. Demirag and Serter (2003) found that the majority of the listed companies in Turkey are owned and controlled by families and organized under a pyramid ownership structure or through inter-corporate shareholdings with a large number of companies. Families directly or indirectly owned more than 70% of all the shares of traded companies. Demirag and Serter posited that Turkey can be classified as an “insider system” country and indicated that almost every private bank is part of such a pyramidal structure. The structure of the Turkish corporate sector is formed by industrial-financial conglomerates, which arguably results in opportunities to exercise transfer pricing and off-balance-sheet transactions. Ulusoy (1999) found that related party transactions and creative accounting practices were frequent in applications for initial public offerings. Similar conclusions were uncovered in the context of reports prepared to fulfill enforcement requirements – 67% of the listed companies examined in 30 reports used transfer pricing. In summary, one of the main reasons for the Turkish financial crisis in 2000–2001 was arguably the financial vulnerability of its banking system. Some Turkish banks were unable to meet their short-term liabilities and were either suspended from trading or barred from operating permanently by the newly formed BRSA. The real interest rates, inflation and external debt burden in Turkey were at record highs. Because most banks were part of family business conglomerates, the crisis that began with banks soon spread to Turkey’s industrial sector and eventually had a significant negative impact on the real economy. This effect was followed by considerable unrest and growing pressure among ordinary citizens, whose savings were disappearing from the books of some disreputable banks as prices for essential food and fuel escalated beyond their reach. The government was also concerned about Turkey’s external credibility, and the labor unions and opposition parties vociferously criticized the government’s handling of the economic situation on the front pages of daily newspapers. The government had no choice but to react by proactively entering into an agreement with the IMF and the World Bank to restructure Turkey’s financial institutions and to enact the long-awaited financial reforms. Importantly, throughout this period, all Turkish governments maintained their commitment to joining the European Union (EU) and continued to participate in negotiations to attain an officially recognized EU applicant member status. This situation placed more power in the hands of the EU negotiators, who demanded that Turkey reform its financial sector and its regulation to bring them in line with EU standards. Government officials2 had to acknowledge external pressures and react immediately to the pressures from the IMF, the EU and the World Bank. These pressures manifested in the thengovernment’s efforts to enact a range of legal and institutional reactive reforms that enhanced the regulatory powers of the financial system (see also Curuk, 2009; Demirag & O’Brien, 2004). Pressures for institutional reform came from both internal and external sources. One of the most surprising factors that helped to internalize the external pressures and underpin regulatory reform in Turkey was the contribution and cooperation of the business sector with the new regulations created by the reform process. In an era of global liberalization of capital, foreign investors and hedge funds were attracted to high real interest rates on treasury bonds offered by the central government and to lending to private businesses. As a result of this interest, during the crisis period, the inadequate and weak financial structures of banks and some conglomerate businesses became exposed and were made the focus of foreign media. The possibility that foreign investors would not continue lending money to Turkish companies and banks, even at very attractive local interest rates, unless they improved their “corporate

2 Kemal Dervis, who was serving as a vice president at the World Bank at the time of the 2000–2001 crisis and was asked to step in and advise the government on how to steer the economy out of the crisis.

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governance” practices and adapted the government’s financial reforms resulted in the creation of a domestic coalition between state and local businesses to strengthen the country’s position on the world economic stage (Onis & Keyman, 2007; Onis & Senses, 2009). 3. The nature of regulatory reform We now turn our attention to the role of regulatory agencies and their reforms in the context of the financial crisis in Turkey. In this section, the duties and the authorities of the regulatory institutions, namely the Ministry of Finance (MOF), CMB and BRSA, are examined for their roles in the reforms. The scope of regulatory authority of each institution is evaluated in separate subsections, and two tables in Appendices A and B describe the current regulatory framework in Turkish capital markets and the structure of the regulatory institutions. The structures of the independent regulatory agencies are summarized in Appendix C. 3.1. The ministry of finance The main responsibility of the MOF is to determine the procedures for establishing companies’ taxable income under the provisions of Tax Procedure Law. In the 1992 communiqué issued by the MOF (Application of Accounting System, 1992), it is specified that publicly traded companies should adopt internationally accepted accounting principles. Section IV of this communiqué specifies that banks and other financial institutions, including financial leasing and factoring companies, must comply with rules governing basic principles of accounting, explanation of accounting policies and principles of financial statements. The basic requirements relating to bookkeeping and the responsibility of the board of auditors were introduced in the Turkish Commercial Code. Comprehensive rules and principles regarding the format of the financial statements, valuation principles and the code of accounts were established in the Tax Procedures Code, the Communiqué on Application of Accounting System and the Uniform Chart of Accounts introduced by MOF. However, the Commercial Code and the regulations published by MOF did not provide a uniform financial reporting framework because the former contained no provision regarding the preparation and disclosure of financial statements, and the latter did not govern the procedures for publishing financial statements or the external audit process. This arrangement was problematic for companies trying to satisfy both requirements in the same financial report. Turkish companies are required to report their financial statements and tax declarations, certified by Sworn Certified Public Accountants, to the MOF for tax purposes. These requirements were not consistent with the concept of external audits and obviously were not in line with the international financial reporting and disclosure standards for the stakeholders. In December 2003, MOF issued a regulation whereby taxable income would be determined in the context of inflation-adjusted financial statements (see also Arsoy & Gucenme, 2009). 3.2. The Capital Markets Board (CMB) Capital market law (CML) affords the CMB the authority to regulate and supervise the activities of publicly held companies and financial institutions such as brokerage firms, mutual funds and investment companies. The CMB fulfills these responsibilities by publishing communiqués and making case-specific decisions. These rules and principles do not contradict tax regulations but are complementary to those enforced to ensure fair reporting of taxable income. The CMB introduced International Accounting Standards with communiqué Serial XI, No: 1, in 1989. All public companies except financial ones, which are subject to special laws, must comply with the principles and rules regarding preparation, submission and disclosure of financial statements. However, Article 18, about the scope of the standards, states that the companies should record their transactions and keep their accounts in line with tax regulations. Once again, the regulations introduced by the CMB did not specify the requirements to be fulfilled for bookkeeping and tax purposes, which posed problems for companies trying to meet both requirements. The provisions of CML No. 2499 Article 16 clearly indicate that issuers and capital market institutions shall prepare financial statements, including consolidated financial statements, financial reports and other information required by the Board, in compliance with the form and principles to be determined and with Generally Accepted Accounting Principles. Financial statements are subject to independent audits, and the reports of the independent auditors shall be provided to the Board and disclosed in accordance with the principles and procedures established by the Board. Article 22 of CML empowered the CMB with authority to make general and specific decisions to ensure adequate and timely enlightening of the public and to issue communiqués about the standards and principles for the publication of the financial reports and for the external audit process. Turkish banks are subject to the provisions of their special laws with respect to matters such as establishment, auditing, supervision, accounting and standards of financial statements and reports (Article 50). All public Turkish companies, including financial companies, carry out all of the required procedures to report their financial statements to CMB and ISE (Mugan, 1995). After the financial crisis of 2001, CMB introduced a communiqué on consolidation and inflation accounting for public companies effective 31 December, 2003. In January 2005, International Financial Reporting Standards (IFRSs) were finally introduced in Turkey. Both Turkey and the EU member states adopted IFRSs almost at the same date. These standards eliminated some of the conflicting requirements imposed by the CMB and the

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Uniform Charts of Accounts introduced by MOF (see also Alp & Ustundag, 2009, on the development of accounting standards in Turkey). One of the responsibilities of the CMB is to ensure fair disclosure of financial results of public companies with the aim of protecting investor rights. The CMB have enforcement and supervisory powers. The CMB requires that the annual financial statements of ISE-quoted companies undergo an external audit twice a year. It also regulates the audit companies that approve the financial statements of publicly held companies and publishes lists of auditors who are authorized and of auditors who have lost their authorization. Audited financial statements of publicly held companies are filed with the CMB, and all quarterly financial statements of listed companies are filed with the CMB and ISE and disclosed to the public through the ISE website (Mugan, 1995). Annual results are also published in daily newspapers with documents related to annual shareholder meetings. CMB specialists also review annual and semi-annual financial statements of listed companies, but they rely heavily on audit reports. The CMB is authorized to request amendments of financial information and the re-publication of financial statements, which provides some control over the amount and quality of information disclosed by the public companies. Thus, some problems between regulatory agents surfaced in the form of conflicting objectives and perceived responsibilities. These conflicts of interest were inherent in the Turkish accounting system, which was driven by raising tax revenues and not by broader stakeholder considerations (see Demirag, 1992, 1995). The reforms that CML introduced after the financial crisis, first in 2003 and again in 2005, by adopting IFRSs were seen as significant in terms of resolving the conflicts between the regulatory agents. 3.3. The Banking Regulation and Supervision Agency (BRSA) The regulatory reform in Turkey started before the financial crisis in 2000–2001 with the creation of the BRSA in June 1999 under Banks Act 4389. The BRSA regulates and supervises the banking sector in Turkey with financial and administrative autonomy. The BRSA is authorized by the Banks Act to regulate the format and reporting of financial statements and the codes of accounts of the banks. Article (13-1.a) of the Banks Act states that banks shall keep, publish and present to relevant authorities their annual balance sheets and profit and loss statements in accordance with the principles and procedures to be laid down by the Banking Regulation and Supervision Board in consultation with the Banks Association of Turkey (Banking Regulation and Supervision Agency, 2002). The BRSA is also authorized to request an amendment of financial information and republishing of financial statements after in-depth reviews. BRSA adopted IFRSs for the banking sector in July 2002. In May 2001, BRSA developed the “Banking Sector Restructuring Program,” the first step of which involved a three-stage audit process to determine banks’ financial positions. Inflation accounting was also required for banks’ financial statements as of 31 December, 2001 to detect the inflationary effects on financial statements of all twenty-five banks. The audit process reduced the “total capital” of the banks from $866 million to $146 million, and the gross value of the non-performing loans and special provisions for the loans increased from $1.525 million to $5.109 million and from $711 million to $1.687 million, respectively, between the pre-audit and post-audit periods. Banking and financial market reform required not only changes to the reporting process but also direct interventions to modify ownership, control and capital adequacy of Turkish private banking. As part of the recapitalization of the Turkish banking sector, BRSA described several options that a bank may select if it chooses to participate in the program. Fitch (2002, p. 5) outlines these as follows: Banks with risk-adjusted capital ratios of less than 5 percent but greater than zero whose market share in the banking system as of September 30, 2001 is at least one percent, will receive a cash capital infusion from the Savings Deposit Insurance Fund (SDIF). The cash injection will bring the ratio to 5 percent, provided that the injection does not exceed the amount paid up by shareholders (including that paid in cash in 2001). A bank whose capital ratio is between 0 percent and 4 percent that does not receive any capital injection from its parent will be transferred to the SDIF. Banks with risk-adjusted capital ratios of more than 5 percent but less than 8 percent will receive loans from the SDIF with seven-year maturities (convertible into shares) to bring the capital ratio to 9 percent. Thus, banks will be able to receive both cash (if they meet the market share criteria) and loans from the government (Fitch report, 2002, p. 5). These methods will either help banks to improve their capital ratios or lead them to be transferred to the SDIF. In the same report, Fitch (2002, p. 5) outlines that the BRSA will determine a bank’s capital position and methods that can be used to improve it. Accordingly, all banks would need to have their accounts audited by an independent auditor to verify that their 2001 financial statements meet the minimum standard capital ratio of 8% and to determine if they qualify for participation in the program. In addition, the audit report will be reviewed by a second independent audit firm and finally by BRSA. If the capital ratio is found to be lower than 8%, action will be taken to assure compliance as outlined above (Fitch, 2002, pp. 4–5). All of these actions would help to improve confidence and transparency in the banking system. 4. The outcome of the reforms The reforms mentioned in the previous sections have resulted in the consolidation of the Turkish banking sector with substantially increased capital adequacy ratios. Table 7 shows that the capital adequacy of 32 banks in 2009 averaged 19%, which is well above the 8% lower limit set by BRSA in 2002.

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Table 7 Capital Adequacy (percentage).

Source: ). http://www.tbb.org.tr/Dosyalar eng/Yayinlar/Dokumanlar/2Bankalarimiz2009ING.pdf.

Between 2008 and 2009, the capital adequacy ratio of Turkish banks increased by 2.8% points and reached 20.9% at the end of 2009. The increase was the result of both a slowdown in the increase of loan volume and growth in profit volume, enabling the banks to set aside a high rate of provisions for non-performing loans. In addition, the average non-performing loans ratio decreased to 0.9% of all loans, which compares extremely well with the comparable figure of 2.8% for US banks for the same period in 2009 (see Table 8). These figures suggest that the measures taken have been effective. The reforms also had positive effects on the overall performance of the Turkish economy. For example, in 2009, the ratio of public sector outstanding debt to gross domestic product was 47%, and the ratio of outstanding domestic debt to gross domestic product increased by 6% points to 35%, while the ratio of outstanding external debt to gross domestic product increased by 2% points to 12%. At the same time, the annual rate of inflation fell to 6.5%, its lowest level since 1968. The decline in inflation levels enabled CB to lower short-term interest rates by 8.5% points in 2009, placing them in the single digits for the first time since they were regulated by the market. All of these economic indicators suggested a substantial turnaround and strengthening of the financial and economic structure of the economy, and particularly the banking sector, positioning it well to withstand the crisis that is happening now in 2011 (Onis & Bakir, 2010; The Banks Association of Turkey, 2010). Table 9 summarizes the regulatory risks, mechanisms and drivers of the Turkish financial market after the restructuring of its regulatory framework. What is most striking about the table is the emerging of the “proactive state,” with the domestic policy coalitions of the bureaucratic agencies in the neo-liberal state apparatus working to develop policy with global actors such as the IMF, the EU and the World Bank. Within this regulatory framework, market failures enhanced the role of new regulatory mechanisms, such as the Competition Board and BRSA (Demirag & Clark, 2006; Onis & Senses, 2009). Table 9 also maps out some of the responsibilities and responses to malfeasance by the main regulatory players in Turkish financial markets. This portion of the table is based on some of the interviews with representatives of the institutions and on information from their websites. Appendices A–C at the end of this paper help to explain some of the responsibilities Table 8 Non performing Loans(Net)/Total Loans(percentage).

Source: The Banks Association of Turkey (2010, p. 10). http://www.tbb.org.tr/Dosyalar eng/ Yayinlar/Dokumanlar/2Bankalarimiz2009ING.pdf.

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Table 9 Responsibilities and responses to malfeasance by the main regulatory players in Turkish financial markets. Regulatory Risk

Conflicts of interest Mechanism Drivers Structured Finance Mechanism

Drivers Insider Trading Mechanism Drivers Board failure Mechanism

Drivers

SPK

BDK

MBT

IMKB

MB

AB

Sermaye Piyasasi Kurulu (Securities and Exchange Commission)

Turkiye Merkez Bankasi (Central Bank of Turkey)

Istanbul Menkul Kiymetler Borsasi (Istanbul Stock Exchange)

Maliye Bakanligi (Ministry of Finance)

Adalet Bakanligi (Ministry of Justice)

YES

Bankalar Denetleme Kurulu (Banking Regulation and Supervision Agency) YES

PARTIAL

YES

PARTIAL

YES

Civil and criminal Reactive YES

Civil and criminal Reactive YES

Civil and criminal Reactive NO

Civil and criminal Reactive YES

Criminal

Criminal

Reactive YES

Reactive NO

Rule proposal; Rule adoption

Civil and criminal

–

Litigation

–

Reactive YES Self-initiated legal action Reactive YES Criminal, coalition with BDK, IMKB, MB and AB Reactive

Reactive NO Institutional investigative Reactive YES Cease and liaison with SPK, IMKB, MB, AB Reactive

Reactive NO –

Hearing; single or conjoined litigation Reactive YES Self-initiated legal action Reactive YES Coalition with BDK, SPK, MB and AB

Reactive NO Institutional investigative Reactive NO Coalition with BDK, SPK, IMKB and AB

Reactive YES Investigative Reactive NO Threatened or actual criminal prosecution

Reactive

Reactive

Reactive

Reactive NO Coalition with MB and AB

Reactive

in more detail. What is interesting about this table is that most of the government’s regulatory agencies acted in a reactive manner when the Turkish financial crisis began in 2000. Onis and Senses (2007, p. 4) note that reactive behaviors contrast sharply with the proactive behaviors of major powers in Latin America. They point out that reactive states also have handson interventions for correcting market failures. These states are characterized by less relative autonomy from the main industrial conglomerates. They point out that (2007, p. 4): “Hence their ability to overcome sectional conflicts and concentrate their attention on longer-term strategic goals such as developing internationally competitive export industries tends to be more limited. Moreover, reactive states tend to move closely with the dominant norms in policy behaviour accepted in major centres of international decision making. Reactive state behaviour by definition means going along with acceptable line of policy thinking as opposed to deviating from such norms in certain critical respects”. 5. Banking reform in Turkey: empirical support for a proactive approach The scope of the study is restricted to the impact of regulatory changes on Turkish public companies whose shares are traded on the ISE and with banks. It excludes state enterprises and privately owned family businesses. In all, twenty key regulatory agents and other stakeholders were interviewed between March 2006 and July 2008. Table 10 shows the institutions and key stakeholders involved in the Turkish regulatory framework. There may of course be other stakeholders, and the list of agents and stakeholders included in the study is not exhaustive. Our selection of the key stakeholders was based on their involvement in the 2000–2001 financial crisis. For the purpose of the research questions, the views of MOF, CMB and BRSA are more important than those of other stakeholders because these organizations were more directly involved with the 2000–2001 financial crisis (which was, after all, mainly a banking crisis; see also Appendices A–C for their detailed organizational structures and responsibilities). A further limitation of this paper is that time and cost constraints prevented the views of politicians and ordinary citizens from being sought. The interviews with the key stakeholders lasted from one and one half to two and one half hours and were conducted between March 2006 and July 2008. All interviews (with the exception of two interviews with members of the CB3 ) were carried out in English and tape recorded (see Tables 10 and 11). All interviews were transcribed and coded to aid content analysis of references to regulatory change. In the next section, we explore key stakeholders’ views, as presented in Table 5, on the importance of regulatory change in Turkey following the financial crisis in 2000–2001.

3

These interviews were carried out in Turkish, and the interviewer made notes immediately afterwards.

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In the interviews, we tried to identify the causes of policy shifts in Turkey. We asked the interviewees about their perceptions of Onis and Senses’ (2007) argument that external actors and influences played a disproportionately important role in the regulatory change in Turkey after the 2000–2001 crisis. In the context of neo-liberalism, Onis and Senses (2007, p. 6) argues that strict conditionality of IMF stabilization policies and structural adjustment loans from the World Bank have been the most effective mechanisms for transmitting these ideas to the developing country context. Table 12 shows the interviewees’ responses to this question. Notably, just half of the interviewees agreed that disproportional external pressures were put on the government to reform. This result, of course, does not exclude the possibility that there were also some domestic factors that led to the reforms after the 2000–2001 crisis in Turkey. There is also an interesting distinction between responses of the interviewees from the government and quasi-government and those from the private sector and academia. Whereas most of the central government and quasi-government interviewees disagreed with this statement, the majority of the interviewees from the private sector and academia agreed that the pressures from external sources such as the IMF, EU and the World Bank has been disproportionally excessive compared to pressures from internal sources. The state system does not appear to recognize the role of external influences in domestic reforms. The shift from a reactive to a proactive state could be inherently flawed until these influences are fully integrated into policy making. Some of the non-government stakeholders agreed that external pressures played a disproportionate role in the financial reforms that followed the crisis in Turkey in 2000–2001, as the following quotation from an academic interviewee indicates: Table 10 Key Actors of the regulatory framework in Turkey. Public sector regulatory agents Central government Quasi-government regulatory institutions

Academy Private-sector institutions

Key actors Turkish Central Bank Ministry of Finance Ministry of Justice Securities and Exchange Commission Banking Regulation and Supervision Agency State Auditing Authority Istanbul Stock Exchange Turkish Internal Auditors Turkish Universities Accounting and Audit Firms Private Banks Consultants/Advisors

Ministers, board members, Senior Government Officers Heads of Departments, Senior Members.

Professors, Senior Academics Partners, Senior Auditors and Systems Controllers Chief Executives, Heads of Risk Analysis Finance and Legal Consultants

Table 11 Interview schedule. Interest Group

Job descriptions of interviewees

Central government

1. Two Central Bank senior staff (Note 1) 2. Project director of the new Turkish Commercial Code 3. Treasury, Department of Turkish Foreign Trade 4. State Planning Organization, planning manager

Quasi-government

1. Member of Corporate Governance Group, Turkish Business Association 2. Two senior members of the Capital Market Board 3. Two senior members of the Istanbul Stock Exchange 4. One senior member of the Banking Regulation and Supervision Agency

Private sector

1. Head of Risk Management of a major Turkish Bank and a senior group member 2. Two Turkish partners of a major international accounting firm 3. Assistant manager of a major Turkish bank 4. Head of the corporate risk management group of an international accounting firm.

Academy

1. One Professor of Finance and two Professors of Political Science

My perception of the period is that the pressure for change in Turkey came primarily from the top. Meaning, from external sources and the pressure for change from the bottom if you like, from below, from civil society and the media has been quite weak. So, if you want to understand the push for regulatory reform post 2001, I think two elements are critical. One is the pressure from the IMF, but also the incentive provided by the EU membership. These two external elements became linked. One other response to your question, I think the process did not start with the present government, the process started under the coalition government in which Kemal Dervis a key figure broke from the World Bank as a minister of the economy and he played a very important role. But, then following the November 2002 elections the present government has essentially continued. Thus, in addition to the promise of EU membership, external pressures from the IMF were particularly significant in light of the powerful banking lobbies before the crisis (Ararat & Ugur, 2003). However the crisis strengthened the IMF’s power to enforce banking regulations in Turkey, as another academic explained:

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Table 12 Key agents’ level of agreement with disproportional external pressures for regulatory reforms. Disproportional external pressures

Central government Frequency (%)

Quasi-government Frequency (%)

Private sector Frequency (%)

Academics Frequency (%)

Total Frequency (%)

Overall agree Overall disagree Uncommitted Total key agents interviewed

2 (10%) 2 (10%) 1 (5%) 5 (25%)

1 (5%) 4 (20%) 1 (5%) 6 (30%)

4 (20%) 1 (5%) 1 (5%) 6 (30%)

3 (15%) 0 (0%) 0 (0%) 3 (15%)

10 (50%) 7 (35%) 3 (15%) 20 (100%)

I think one of the interesting features of Turkey is that change has been externally driven and one of the problems here is that if change is excessively externally driven then there may be difficulties in internalizing this process, suppose I give you an example: take the case of BDDK (Banking Regulation and Supervision Agency). If BDDK functioning depends crucially on the presence of IMF as an external factor what will happen if IMF withdraws its support for the reforms? It would have been difficult to discipline. The powerful banking lobbies have resisted for change but then IMF stepped in and made it a condition. This explanation reveals that Turkey encountered a problem with making policy fast enough to keep pace with external pressures. This result indicates that Turkey was in a reactive state in which it was not yet able to sufficiently internalize external factors into the workings of its financial structure, thus creating a situation where its financial system remained vulnerable to potential external shocks. For example, although institutions were established, the reforms were ineffective as they had not yet fully addressed the ongoing pressures from the EU and the IMF. This point is underscored by a leading Turkish academic interviewee: I would agree that this government has shown much more willingness and commitment to reform and especially regulatory reform. Regulatory reform is an ongoing process in the banking sector, financial system, and also other areas like competition policy. I think the previous governments in Turkey had a big commitment to reform in the 1990s. They were under pressure, for example, from the customs union in 1995 to use regulatory reforms in a number of areas. But I don’t think those reforms were firmly internalized by the government at that time. Yes, the institution is formed, for example, the competition board is formed, but in terms of effectiveness of implementation I think there are major question marks. Similarly, the bank regulatory and supervisory authority was formed in Turkey in 1999 under the auspices of IMF program prior to the crisis. This passage clearly illustrates Turkey’s willingness and commitment to reform as well as its inability to fully internalize pressures external to it. This willingness and commitment, however, led the Turkish government to begin to take control of its internal problems in an effort to comply with external regulations and compete on the EU, and world, stage. Despite the government’s slow shift, it is interesting to note that the pace of reforms in the banking sector began to differ from that of reforms taking place in the corporate sector as a whole. Some have argued that the banking sector, although it had been under pressure from the IMF and EU to initiate reforms, had the necessary organization to internalize the pressures and form coalitions. In the corporate sector, the professional associations were not as well organized. This disparity is illustrated in the reaction of the banks to external pressures compared to that of the government, as one academic interviewee explained: Because so much top-down driven, the involvement of professional associations in Turkey has been quite a weakening spot. I think BBDK (BRSA) is possibly moving from a situation and getting a certain kind of recognition. The change in Turkey in the banking sector was probably more influenced by internal factors like the crisis and so on as opposed to the regulatory framework. The banking sector is somewhat different from the other and therefore maybe that is more likely to succeed because of its internal involvement. I think it’s a mixture of internal and external in a sense that you can call the crisis an internal dynamic but then after the crisis the IMF was in a much stronger position to put pressure on the Turkish government to implement banking sector reform. The coalition government between 1999 and 2001 were essentially resisting IMF reforms but with the major crisis what happens is they become much more dependent on the IMF and as a result IMF’s power to push for change increases considerably on the same government. It would seem that the banking sector responded to internal pressures fairly quickly, whereas the government became increasingly reactive to external pressures. This in itself is not too concerning as it suggests the emergence of a more holistic system whereby external pressures force change within the government and, in turn, these changes are internalized domestically at varying speeds. Had the banks, for example, responded to pressure independently of the state, confusion could have resulted rather than a deep-seated harmonized approach to reform. Furthermore, a private sector consultant introduced the idea that the Sarbanes-Oxley Act had some impact on the post2001 reforms in Turkey, albeit indirectly. EU countries were themselves trying to establish similar acts, so Turkey, influenced by the EU reforms, had to incorporate some aspects of the Sarbanes-Oxley Act in a different manner as indicated by one of the interviewees: I think it has made some impact on these new regulations. What Sarbanes-Oxley brings is to certify everything before something goes wrong. That was not present at all in the banks before. Some corporate governance rules were also

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Table 13 Key agents’ level of agreement with the influence of domestic coalitions. Extent of influence by domestic coalitions

Central government Frequency (%)

Quasi-government Frequency (%)

Private sector Frequency (%)

Academia Frequency (%)

Total Frequency (%)

Overall agree Overall disagree Uncommitted Total key agents interviewed

3 (15%) 1 (10%) 1 (5%) 5 (30%)

5 (25%) 0 (0%) 1 (5%) 6 (30%)

4 (20%) 1 (5%) 1 (5%) 6 (30%)

3 (15%) 0 (0%) 0 (0%) 3 (15%)

15 (75%) 2 (10%) 3 (15%) 20 (100%)*

*

Note: Percentages add to over 100 due to rounding.

established such as audit committees, but it’s not only Sarbanes-Oxley. There is the effect of the EU-Turkey trying to become a member of the EU. EU countries are trying to establish Sarbanes-Oxley-like regulation, not exactly like Sarbanes-Oxley but similar to Sarbanes-Oxley, and of course corporate governance rules and also internal control systems are important in these regulations. There are of course effects of Basel Two; like I said, it’s not correct to tie it on to Sarbanes-Oxley. It’s a lot of development which are relating to internal control systems, corporate governance, and risk management. I mean these are all related to Sarbanes-Oxley, the EU directives, Basel Two. During the post-crisis period, the government began to respond to changes occurring outside of its borders. This change represents a shift of thinking as we see a more proactive element to pressures that have not yet been forced into the system. The change denotes a state of ambition to join a larger system with an approach of compliance to a greater whole. Some of the private sector interviewees argued that the regulations were simply imported and translated from AngloSaxon corporate governance rules or the Sarbanes-Oxley Act and that these regulations had a significant impact on their audit procedures: Well, the banking authorities’ regulations based on Sarbanes-Oxley, nothing else as we understand. These are the translations from such American-based regulations, and capital market board is doing the same thing. They are working very closely with the European Union team because we are going to be the member of the European Union and they are giving some consultant work to us. Either it is Sarbanes-Oxley or the European version of Sarbanes-Oxley; these acts dramatically changed our procedures and approach, especially, I would say that the audit sector is dramatically affected by the Sarbanes-Oxley or from US through European Union and also direct from US to countries like us. Before Sarbanes-Oxley our procedures were not as heavy as the current requirements, and for all internal control systems we have to check at least design and implementation as to whether any entities designing and internal control activities in all the business processes plus whether it is implemented. Whether these regulations were adapted or simply translated to Turkish is, in many ways, not as significant as the fact that they were introduced at all. The fact that they were internalized into the Turkish system at all further adds to the suggestion that the Turkish state had undergone a significant shift in its policy thinking. When the BRSA was set up, initially staff were transferred there from the central bank, treasury and state planning organizations. However, quasi-governmental organizations expressed doubts in terms of the disproportionate impact of external factors on the recent reforms in Turkey, as one of the interviewees explained: You cannot find such idea from the reports, especially from IMF reports, but in reality I cannot say about their impact. Somehow we think there would be a reason to presume that they suggested that the government should set up a regulatory institution for the banking sector. At the beginning, supervision came from the treasury, and supervisory capacity was transferred from central bank and also research people especially they came from the state planning organization. Three main organizations combined under the BRSA umbrella, they did the same functions in this agency, but in terms of pure tasks there isn’t any difference whether state planning organization, or treasury, or central bank, they did the same tasks after the BRSA set up. What is interesting here is that the quasi-governmental agencies responded to regulatory form in a somewhat ignorant manner, without fully understanding the pressures that led to these changes. The important point here is the integration of these changes without too much internal resistance, which again supports the idea that the state’s regulatory system was functioning more coherently. Table 13 indicates the interviewees’ perceptions on the level of agreement and shows that there were also some domestic coalitions within the regulatory reform process in Turkey. These data do not exclude the possibility that there may have been external pressure, and these external pressures may have been disproportionate to other sources of pressure, including the domestic coalitions. Notably, a significant majority of the respondents (75%) agreed with the suggestion that reforms were also influenced by some of the domestic coalitions. None of the quasi-governmental respondents disagreed with this suggestion, and only one central government interviewee disagreed. It is worth noting that all of the academics who were interviewed agreed that some local coalitions contributed to the reforms in Turkey. A similar level of agreement was obtained from the private sector respondents.

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Some private sector interviewees suggested that the pressures were also coming through their US-based parent firms as some of their work involved auditing the subsidiaries of the US- and European-based multinational companies located in Turkey: Well, we didn’t have direct pressure for the Sarbanes-Oxley, but of course the effects of Sarbanes-Oxley was the change in audit procedures and audit approach, and of course our audit firm is now following the change in the audit approach, therefore indirect, that through the change in audit approach, yes, of course, we would have pressures from our international firm, maybe we should call it the pressure for quality control. Of course, we’ve been through all international training, we brought two experts from US to teach us all these Sarbanes-Oxley procedures and effects of Sarbanes-Oxley (SOX), we sent out our partners and managers to certain training programs, seminars, conferences, internal or external, and also there is this standard in our firm; if you do not have that training you cannot do SOX-related work. This excerpt strongly suggests that external pressures had begun to be felt within the domestic economy. However, it would only have been possible to comply with these external corporate pressures if the greater state regulatory system accommodated them, which was becoming possible due to the reform program. It was suggested that Sarbanes-Oxley has not yet had a major impact on the Turkish financial system. As one of the private sector interviewees explained: As I was saying, you will not see an individual legislation named SOX or anything related. You will see the items or bits and pieces with the different things like Banking Act, or other decrees, Risk Management Decrees, so it is scattered around. You will not see one item dedicated to Sarbanes-Oxley. SOX is not a thing on the agenda, I would agree with that. It has not entered into our lives because we are waiting for EU to come up with something on SOX. This is my personal view. We are currently concerned with Basel Two directives, Corporate Governance directives, etc. Some interviewees suggested that there were some pressures from the domestic coalitions that merged after the financial crisis, as one quasi-government interviewee explained: TSFM (Savings Deposit Insurance Fund, SDIF) is not a new agency for Turkish banking system. TSFM was set up under the central bank after the BRSA establishment. TSFM was first transferred to BRSA but then separated in 2004. When I look at the new banking reforms, I see that TSFM is like a coalition agency, just collecting insurance premium from the banks. They are managing them and selling them as well. In terms of the regulatory side, TSFM has not any power. They’re acting as an insurance agent, they’re collecting the premiums but they’re also managing the assets. I think we can take it as an institution that has been very, very successful for what they were set up for, for what they done. Because nobody had thought really that some of those assets were actually worth as much. Approximately, of the $30 billion lost assets, $5 or $7 billion has been recovered by TSFM. Underlying these comments is the argument that new domestic innovations, such as the TSFM, produced positive results of policy reforms generated by the increasingly proactive system. Other interviewees explained some successful domestic coalitions and reforms as outcomes of the 2001 financial crisis. For example, one such area is competitiveness. The competition board is much more involved, and more cooperation takes place between the competition board and privatization agents. In addition, the foreign investment regime has been liberalized so that the bureaucratic obstacles to foreign investment have been considerably reduced, and the new regulations are still being discussed between BDDK and the audit firms. The cooperation between the banking associations and the BDDK was illustrated by one of the quasi-government officials: Our approach with the bankers’ association as a group was like, okay, you are banks, so you are subject to several regulations from several sources. So, we have decided not to include corporate governance rules in our work. We waited for the Basel Two committee to come up with their update version of the banking corporate governance rules, so we have included the new ones. So, we have come up with one solid report now working in coalition with the banking association. The implication of these remarks is that, instead of acting independently, outside influences had begun to affect the decisions of the state agencies. There appears to be a better understanding emerging of a new way of functioning within a state that is more externally focused but internally more collaborative. A quasi-government interviewee pointed out that some of the corporate governance rules were watered down, indicating that they were only recommended: One thing, though, for some articles in the Corporate Governance rules, they would put a letter of T against it, which is Turkish letter for recommendation. So it is only recommended and not compulsory. When it is ‘T’ then you don’t have to comply with it or disclose; you can ignore it. In other words, if you don’t comply with it you will not be criticized. In choosing to “ignore” certain recommendations, it seems that the Turkish state was not developing a copycat approach to regulation. For whatever reason, this decision could be seen in a positive light as it suggests that a new confidence emerged that allowed for some flexibility within the newly forming system.

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A quasi-government interviewee argued that, on a local level, some attempts were made to cooperate and provide some domestic support for the government’s reforms: In every six months, the organizations which are responsible for the capital markets and the banks and other type of financial institutions, such as the Capital Market Board, State Planning Organization, Istanbul Stock Exchange, Forward, Futures and Options market, Turkish Banking Association, Central Bank, BRSA, Treasury, we come together. These organizations and their representatives come together and discuss some issues. Integrating cooperation between agencies seems to be another outcome of the internal changes. The discussion of issues, and thus the recognition of shared responsibility in tackling them, indicates that the agents comprising a once fragmented financial sector were starting to collaborate in a coherent system. These types of domestic support for the reforms were further increased by competition among banks. Some of the private sector interviewees suggested that competition among the foreign and local banks was driving the corporate sector to adopt reforms and to cooperate with the regulators: I don’t know if you are familiar with the developments here in the banking market, foreigners are buying out the Turkish banks. We are the banks that survived the crisis. So we have to improve our processes, including risk management, everything. We have to do this. Immediately after the crisis, the banks began to recognize their part in an almost Darwinian environment in which only the fittest would survive. External pressures wrought on the government had filtered down through regulatory reform, creating a need for the banking system to reform or face takeover. For others, cooperation at the local level was simply not happening prior to the 2001 crisis as there was a lack of cooperation and accountability and too much autonomy, but this coordination could have been improved by a state institution, as one of the academics explained: . . . and at policy cooperation. This also creates a problem in the sense that one to one logic, one institution trying to solve one problem. This works up to a certain point. It doesn’t work and then you have resistance because there is no comprehensive network. I think this seems to be a problem. What is interesting is that perhaps they have more interaction with corresponding bodies outside the country, for example, Central Bank or IMF in a narrow perspective. Perhaps there is a need for an organization, like state planning organization, to play elite organization. Although this excerpt may indicate frustration, it also demonstrates a shift in thinking brought about by the change of policy. The idea of networks that work within a more global context shows the speed at which many financial institutions have embraced a new state of existence.

6. Conclusion The 2000–2001 financial crisis in Turkey made explicit the relations between the financial and non-financial sectors and the fragility of the real economy caused by ownership structures and macroeconomic shocks. The unique structure of the Turkish banks and industrial-financial conglomerates is controlled by families and organizations under a pyramid ownership structure or inter-corporate shareholdings and low ratios of traded shares to paid capital, which made it relatively difficult to respond to external influences. Since the financial crisis of 2000–2001, however, Turkish financial markets have undergone a significant transformation. The results of state-imposed reforms helped to provide much-needed price stability and growth in Turkey. In 2009, Turkey was operating with a robust banking system, which cushioned the economy from the 2008–2009 global banking crisis with stronger capital adequacy and low loan write-downs than most of the advanced economies. Since the 2000–2001 financial crisis, there have been significant external pressures to integrate Turkish financial markets with global markets, which arguably led the economy into instability with its liberal investment and import policies. Initially, the disinflation program, supervised by IMF, increased the vulnerability of the financial system, which presented new challenges to regulators in financial markets and regulatory agencies in Turkey (Onis & Senses, 2007). Without underestimating the significant external forces for change, it is recognized that external actors and external forces have a limited ability to engineer complete policy transformation. Eliminating the vulnerability of the Turkish banking and corporate sectors to financial crisis required more than just the exertion of pressure. It also required a radical shift in thinking about how the state responded to these pressures given its desire to join the EU and its function within an increasingly globalized financial system that resulted in the development of a regulatory framework. In the development of this framework, the Turkish state initially responded reactively to the underlying external pressures from the IMF, the EU and the World Bank. However, a policy shift took place following the financial crisis in 2001, and the evidence presented in this paper demonstrates that the Turkish state has shifted from reactive to proactive as a result of this shift. External pressures for regulatory reforms are not enough for a successful transformation of the economy; domestic support of the reforms is also necessary. Growing domestic support and an alignment to the state’s shifting approach to its place within a more global economy, albeit at a slightly slower pace at times, were observed. These changes provide further evidence in support of the view that the Turkish state developed a more proactive approach to the governance of its financial controls after the initially reactive reforms it implemented prior to the 2000–2001 financial crisis.

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A domestic coalition of regulatory agents, public companies and banks that became increasingly dependent on foreign capital also significantly contributed to this new and more sustainable regulatory framework. Without a domestic coalition of actors and support for reform, external forces for change alone may not be sustainable or even sufficient to drive coherent and integrated reform. However, a crisis also increases the power and ability of external actors to exercise domestic change, which resulted, as can be seen here, in the creation of mechanisms for sustainable change in the status quo of domestic coalitions. In this change process, the BRSA, which began as one of the few proactive regulatory institutions in Turkey, was able to introduce fully consolidated and International Accounting Standards (IAS)-based financial reporting. In addition, the BRSA took steps toward reducing risk in the banking sector based on Basel Two. As of yet, little or no direct impact of SOX on the Turkish financial markets has been mentioned, at least not since the financial crisis in 2000–2001, when Basel Two-related risk management issues within the banking sector were the major force for change. This evidence further illustrates the emergence of a confident Turkish state, proactive in its ability to respond flexibly to external pressures at its own pace, rather than one that reacts hastily to an increasingly demanding global system. Acknowledgements I would like to acknowledge the helpful comments from Ismail Erturk, Ziya Onis and all the participants in the study. I am particularly grateful to Jane Levy, Ozlem Ozdemir and Victoria Carol Maier for their research assistantship and to an anonymous reviewer. All remaining errors are mine. I would also like to acknowledge generous financial support from the Economic and Social Research Council of the United Kingdom (ESRC) under the funding scheme “The Globalisation of Corporate Governance? Reform Pressures and Processes in an Era of Financial Crisis,” – Regulatory Regime Change in World Financial Markets (Award Res-156-25-0033).

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Appendix A. Current regulatory framework of Turkish capital markets. Ministry of finance (Maliye Bakanligi)

Control of accounts for tax purposes Establishment of tax rules related to taxable income Establishment of tax rates Collection of taxable income Publication of accounting standards for tax purposes

Capital Markets Board (Sermaye Piyasasi Kurulu) (Established in 1982)

Development and publication of accounting standards for non-financial public companies Determination of the format and publication of financial statements for non-financial public companies Approval of the amendments to the articles of association of non-financial public companies Approval of the mergers, acquisitions and spin-offs of the companies if at least one part of the transaction involves a public company, taking into account the decisions of the other authorities, i.e., the Competition Board and the courts Review of price-sensitive information for publication to ensure that relevant accounting standards and legal rules are followed in financial statements Monitoring of unauthorized publication of financial and related information Publication rules of interim and annual statements Authorization of capital increases and IPOs Authorization of independent auditing firms Determination of rules for proxy voting and minority rights Regulation of capital market instruments and derivative markets and products Regulation of brokerage firms and pension and mutual funds Determination of the qualifications of real estate valuers and issuing of licenses to personnel working for brokerage firms

Banking Regulation and Supervision Agency (Bankacilik Duzenleme ve Denetleme Kurumu) (Established in 1999)

Development of the rules regarding the establishment and activities of the banks and special finance companies Establishment of the rules about procedures to keep and publish the financial statements of the banks Determination of the principles and minimum ratios related to capital requirements and financial structures of the banks Permission for the establishment of a bank in Turkey and for the opening of the first branch of a bank founded in a foreign country Approval of the amendments to the articles of association of the banks Granting permission for the acquisition of the shares of a bank, which represents a certain ratio of its capital or voting rights Authorization of the assignment of preferential shares with the right to promote a member to the board of auditors and of the shares that are granted a usufruct Authorization of the assignment of the shares of the legal entities who own 10% or more of a bank Introduction of the regulations related to banks’ internal audit and risk management procedures Determination of the principles regarding the provisions for the credits and other receivables of the banks To regulate the mergers and acquisitions of the banks

Sources: Capital Market Law No.: 2499, Banks Act No.: 4389, Turkish Official Gazette 1981, 1999, Ankara, Turkey, Regulations on the structure and duties of the Ministry of Finance, the Capital Market Board and the Banking Regulatory and Supervisory Authority.

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Appendix B. The Structure of the Turkish Regulatory Institutions

Duration of Service Chairman and Board members (Minister for Finance Ministry)

Appointment

Other simultaneous employment Termination of service

The Extent of State Influence

Financial and Administrative Independence

Reappointment Are board members required to relinquish interests in other organizations? Is the independence of the entity recognized by law? Can the decisions made by the entity be overruled by an institution other than a court? To whom are they directly accountable? Sources of Income

The authority that approves its budget

Ministry of Finance

Capital Markets Board

Banking Regulation and Supervision Agency

The cabinet is elected for 5 years, but the governments change frequently before the termination of the service Cabinet upon the proposal of Minister of State.

6 years (one third of the members other than the chairman shall be selected every two years)

6 years

Seven board members are selected by the Cabinet from the nominees of three relevant Ministers: BRSA, the Union of Chambers of Commerce and Commodity Exchanges, and the Association of Capital Market Intermediary Institutions of Turkey. Chairman selected from among the seven board members by the Cabinet.

Cabinet upon the proposal of Minister of State. Chairman and vice chairman selected from among the seven board members by the Cabinet.

Not forbidden

Forbidden

Forbidden

Same procedure as appointment and upon the decision of a Grand National Assembly

In cases of violation of the provisions of the Capital Markets Law 1981 with the approval of the Prime Minister Possible Yes

In cases of violation of the provisions of the Banks Act 1999 with the approval of the Prime Minister Possible Yes

Yes

Yes

No

No

Minister of State and the Cabinet The issuers of securities pay 0.3% of the value of their securities. Any shortage is made up by the Ministry of Finance

Minister of State and the Cabinet The expenditures of the Agency shall be authorized by an annual budget, which shall be approved by The Board. The expenses shall be met from the fund paid by the banks to the Agency depending on their financial results. The Cabinet shall ratify the annual financial report and the final budget account related to results of the application of the budget.

Possible No

Ministry is not an independent institution No

Prime Minister Central Budget (The Ministry is responsible for collecting incomes and allocation of transfers to government institutions.)

Grand National Assembly

The expenditures are paid from its own fund.

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Appendix B (Continued ) Financial and Administrative Independence

Who determines its administrative structure

The administrative structure is regulated by decree law.

The administrative structure is governed by a regulation published by the Council of Ministers.

Who determines its human resource management?

Minister

The institutions with which the regulatory power over related sectors is shared

CMB, BRSA, The Under secretariat of Treasury

The provisions of the Law on the Retirement Fund of the Republic of Turkey shall apply to the personnel of the Board. The wages and other financial rights of the personnel shall be determined by the Cabinet upon the recommendation of the Board and the proposal of the Minister of State. The Ministry of Finance, BRSA, The Under secretariat of Treasury

The service units of the Agency and their respective duties and responsibilities shall be defined in a regulation to be issued by the Council of Ministers upon the Board’s proposal. The provisions of the Law on the Retirement Fund of the Republic of Turkey shall apply to the personnel of the Board. The wages and other financial rights of the personnel shall be determined by the Cabinet.

The Ministry of Finance, CMB

Sources: Turkish Industrialists’ and Businessmen’s Association (2002), Capital Market Law No.: 2499, Banks Act No.: 4389, Turkish Official Gazette 1981, 1999, Ankara, Turkey, Regulations on the structure and duties of the Ministry of Finance, the Capital Market Board and the Banking Regulatory and Supervisory Authority.

Appendix C. The proposed structure of the independent administrative authorities. Duration of Service Appointment Chairman and the board members Other simultaneous employment Termination of service

The Extent of State Influence

Financial and Administrative Independence

Re-appointment Are the board members required to relinquish interests in other organizations? Is the independence of the entity recognized by law? Can the decisions made by the entity be overruled by another institution other than a court? To whom are they directly accountable? Sources of income

The authority that approves its budget

Who determines its administrative structure? Who determines its human resource management?

Source: Draft Law On the Establishment and the Duties of the Independent Administrative Authorities.

6 years Cabinet Chairman and vice chairman selected from among the seven board members by the Cabinet Not allowed In cases of violation of the provisions of the law with the approval of the Prime Minister Not possible Yes

Yes No

Grand National Assembly and the Cabinet

The expenditures of the Agency shall be authorized by an annual budget, which shall be approved by The Board The Board approves the budget. However, annual results are subject to audit by the Turkish Court of Accounts The administrative structure is governed by a regulation published by the Council of Ministers The provisions of the Law on the Retirement Fund of the Republic of Turkey shall apply to the personnel of the Board. The wages of the personnel shall be determined by the Cabinet. Other financial rights of the personnel are determined by the Board

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The following documents and websites were consulted: (1) Turkish Industrialists’ and Businessmen’s Association-TIBA (2002), Ba˘gımsız Düzenleyici Kurumlar ve Türkiye Uygulaması, December 2002. (2) Turkish Industrialists’ and Businessmen’s Association-TIBA (2003), Finansal Raporlama Uygulamalarında Uluslararası Standartlara Gec¸is¸, July 2003. (3) Web page: http://www.die.gov.tr (4) Web page: http://www.tcmb.gov.tr (5) Web page: http://www.treasury.gov.tr (6) Web page: http://www.spk.gov.tr (7) Web page: http://www.bddk.org.tr (8) Web page: http://www.tbmm.gov.tr (9) The State Institute of Statistics (Turkiye Istatistiks Kurumu) http://www.tuik.gov.tr Regulations mentioned in this paper are: Capital Market Law; Banking Act; Commercial Code; Tax Procedures Code; International Accounting Standards (2003); Capital Markets Board; Communiqué Serial XI, Number 25, “Accounting Standards”, Banking Regulation and Supervision Agency; Communiqué (14), Financial Reporting in Hyperinflationary Economies, Banking Regulation and Supervision Agency; Communiqué (15), Consolidated Financial Statements and Accounting for Subsidiaries; Regulations on structures and duties of the Ministry of Finance; the Capital Markets Board; Banking Regulation and Supervision Agency and Istanbul Stock Exchange; The Law On the Establishment and the Duties of the Independent Administrative Authorities (Draft).