Islamic financial houses in Turkey.

ABSTRACT

Islamic banking activities started in Turkey with the opening of two Islamic finance houses at 1985. At the end of 1996 four more finance houses has founded. Initially a special rule was passed to regulate these houses. The politicians were skeptical about these institutions claiming that these institutions were not financially sound and their objectives were increasing Islamic awareness.

Although the number of Islamic institutions and their assets grew approximately at an average annual rate of 15% in the world, Turkish Islamic houses have not experienced significant growth. In the last two decades the percentage of deposits and loans of these institutions among the traditional banks has been at most 3%. After the 2001 financial crisis at Turkey, one finance houses was declared bankruptcy, two of them have been sold to new owners. As of the beginning of year 2003 there are five Islamic finance companies (special finance companies) in Turkey. Their total deposit amount is only 1 billion 958 million Turkish Liras.

1. INTRODUCTION

In the last decade, importance of the Islamic banking institutions has increased not only in the Islamic countries, but also throughout the world. Initially banking specialists thought these institutions can not compete with the traditional banks. However these institutions have survived and have experienced high growth during 1980s. In 1990s this high growth rates have reduced, but still new institutions are formed and institutions have started to enter into new countries and new markets. Turkey is one of these new markets. The so called specific finance companies have begun operations in mid 1980s. Although their number has increased to 6 institutions in 1996, after 2001 this number has reduced to five.

In this paper we study the performance of these companies and examine their importance in Turkish economy. The plan of the paper is as follows: the next section examines the Islamic Banking in other countries. While the third section introduces the financial instruments used by Islamic institutions, the fourth section examines the performance of six Turkish Islamic financial institutions and compares their position within the financial system with other banks.

2. ISLAMIC BANKS IN THE WORLD

Islamic banking and finance started in 1963 when Mit Ghambr Savings Bank began offering interest free banking in Egypt (El-Ashker, 1987). This bank and its branches were forced to close down in 1971 due to perceived threat by the administration. The Islamic Summit of Lahore, Pakistan at 1974 recommended the creation of Islamic banks and an Islamic Development Bank.

Starting from 1980s various Islamic banks and Islamic financial institutions have begun their operations in mainly Islamic countries. While the countries of Iran and Pakistan has decided to implement Islamic banking in the whole banking sector, other countries have permitted Islamic banking institutions operate with the other traditional banks. Malaysia is the first country to issue bonds on Islamic basis. Malaysian government allowed conventional banks to offer Islamic instruments as well if they want.

Examination of the progress of these institutions in Iran and Pakistan reveals that in Pakistan this process is a gradual one. On the other in Iran the conversion of traditional banks and financial institutions into Islamic ones was very rapid (Nienhaus, 1988).

The government of Iran has nationalized all the banks during the period of 1979-1982 after the Islamic revolution. In August 1983 the government has passed the law for riba free banking and asked all banks to convert their deposits and finish Islamization of all their operations within three years. After this period government has started to exert control on the banks so that the banks provide interest free loans to public for housing and for small scale projects. The banks have also provided funds for government projects. The six commercial banks and three specialized banks are mainly engaged in short term projects and profit sharing agreements are only small percentage of their activities.

According to Mirakhor (1988) conversion of deposits from interest bearing to non interest bearing modes happened very quickly in Pakistan. Majority of the funds have been channeled to short term projects. In both of these countries, the governments set regulations and control the banking industry very closely. Since these institutions cannot make decisions in a competitive environment it is not appropriate to compare their performances with those in other countries.

In other Islamic countries Islamic finance institutions and banks started operations in 1980s and worked in competition with traditional banks. According to the Institute of Islamic Banking and Insurance today there are more than two hundred and fifty Islamic financial institutions in the world. These institutions are working in the following countries: Albania, Algeria, Australia, Bahamas, Bahrain, Bangladesh, British Virgin Islands, Brunei, Canada, Cayman Islands, Cyprus, Djibouti, Egypt, France, Gambia, Germany, Guinea, India, Indonesia, Iran, Iraq, Italy, Ivory Coast, Jordan, Kazakhstan, Kuwait, Lebanon, Luxembourg, Malaysia, Mauritania, Morocco, The Netherlands, Niger, Nigeria, Oman, Pakistan, Palestine, Philippines, Qatar, Russia, Saudi Arabia, Senegal, South Africa, Sri Lanka, Sudan, Switzerland, Tunisia, Turkey, Trinidad and Tobago, United Arab Emirates, United Kingdom, United States, Yemen.

Over the last two decades the number of Islamic financial institutions have grown with approximately 15% annual rate and the funds managed by these institutions have reached to $200 billion. The largest Islamic institutions are located in Bahrain, Kuwait, Saudi Arabia and Iran.

The next section will introduce specific instruments used by interest (riba) free Islamic institutions.

3. FINANCIAL INSTRUMENTS USED BY ISLAMIC BANKS

The religion of Islam forbids the believers to receive and pay interest in their daily lives. All of the financial instruments of the classical banking system involves some sort of interest payment. In order to attract devout Muslims to the banks, Islamic banks have invented new financial instruments and started to use some traditional Arabic financial instruments. In the following paragraphs we briefly introduce these new forms of Islamic financing.

Mudaraba is a profit sharing agreement between a bank and an entrepreneur or a company. Bank provides capital and the entrepreneur or the company provides the labor. The company uses the capital provided by the bank either in production or in marketing. The parties share the resulting profit or loss from the project according to pre-specified terms of the contract. Musharaka is an agreement between two parties to provide capital jointly for a project and share resulting profit and loss. Agreement to undertake a project can be made between a financial institution and a company or an entrepreneur or between two financial institutions. If one party actually manages the project then that party receives compensation for the management plus shares of profit. Murabaha is basically a re-sale agreement between a financial institution and a customer. The financial institution buys the assets on behalf of the customer and then puts a mark up on the cost and resells the assets to the customer. Until the customer pays all of the financing given by the bank, bank retains the ownership of the assets. Salaf agreement involves lending by a bank to a company in exchange of buying the products of the company at a cheap price. The bank later sells these products in the market at higher prices and obtains profit. Joalha is a service contract. Banks receive a service fee for providing various banking services to customers. These services include money transfer, cashing checks and notes and others. Quard al Hasanah, involves interest free lending by banks to individuals to promote agriculture or small scale manufacturing projects. Banks only charge service fees of these loans. Islamic banks sometimes provide direct investment in certain projects using long term funds invested by the public. When we examine the Islamic banks in different countries we observe that the long term profit sharing instruments Mudaraba and Musharaka is not very popular among investors. On the other hand medium and short term financial agreements are popular among the customers of Islamic institutions.

4. ISLAMIC FINANCIAL INSTITUTIONS IN TURKEY

On December 16 1983 the administration signed the Decree number 83/7506 and gave permission for Islamic financial institutions to start operations in Turkey and abroad. Since that date six such companies have been established. Initially foreign Islamic banks have formed partnerships with Turkish investors and created joint companies of Al Baraka Turkish Special Finance Company, Faisal Finance Company and Kuwait Turkish Evkaf Finance Company. Later three institutions with only Turkish investors have been formed. The names of these companies are as follows: Anadolu Finance Company, Ihlas Finance Company and Asya Finance Company.

4.1 Al Baraka Turkish Finance Company (ABAT)

ABAT has started its financial operations in 1985 with a capital of 5 billion Turkish Liras. Al Baraka Turk has increased its operations and profits throughout the last decade. Between 1990 and 1993 the profits of Al Baraka Turk have increased more than 50% every year. Turkey has experienced a financial crisis at 1994. The Turkish administration devalued the currency for 50% against US dollar. At that year Al Baraka Turk's profits reduced by 47.15%. The institution increased its profits 458.61% at 1995. During 1995-1998 profits increased by triple digits. However in 2000 profits reduced by 6% and in 2001 the institution got a loss.

Al Baraka Turk is the most successful among the six institutions formed. The Turkish economy has experienced one of the worst economic crisis in her history at year 2001. Many companies and banks declared bankruptcy and more than one million employees have been laid off that year. Although the Al Baraka Turk experienced the effects of this crisis, and got a big loss, the institution continued its operations and ownership structure didn't change after the crisis.

4.2 Faysal Finance Turk (FFK)

FFK has started its financial operations at the same time with Al Baraka in 1985 with a capital of 5 billion Turkish Liras. Ninety percent of the ownership belonged to the non Turkish parties at foundation. Originally Turkish Citizens owned 9.87% of the Faysal Finans company. In 1998 a Turkish corporation called Kombassan purchased the institution by paying $40,000,000. At 2001 this corporation has sold the company shares to an American joint venture group and a Turkish food company called Ulker holding. The new owners decided to increase the capital and change the name of the institution to "Family Finans" at 2002. However at September 2002, the Turkish Securities and Exchange commission started an inquiry about the acquisition and sale of some assets of the old company to the family members of new owners at very low prices.

4.3 Kuwait Turkish Evkaf Finance Company (KTEFK)

KTEFK began its operations in 1989 with 68% non-Turkish ownership. It has increased its capital many times since then. Over the years Kuwait Finance Company has increased its ownership percentage to 62% by contributing additional capital to the institution. At the beginning Kuwait Finance company had a capital of 15 billion Turkish Liras, now this number has increased to approximately 95.3 trillion Turkish Liras. The institution has supported textile investments by providing long-term funds for new textile companies.

Although Kuwait Turk was very successful in terms of increasing its profits till 2000, after this date the profits started to decrease because of the economic crisis Turkey has suffered. However unlike Al Baraka Turk the institution has obtained profits at 2001.

4.4 Anadolu Finance Company

A group of Turkish entrepreneurs combined their capitals and formed this company in 1991. All of the investors are Turkish citizens. The initial capital was 30 billion Turkish Liras.

The first all Turkish owned company was sold at 1999 to a new Turkish family called Boydak. The capital has been increased to 60 Billion Turkish Liras. The company has collected approximately 300 billion Turkish Lira deposits.

4.5 Ihlas Finance Company

The owners of this company were the Ihlas Holding and the Turkish Religion Fund. The company was established in 1995 with 1 trillion Turkish Lira capital. The company has followed an aggressive growth policy and increased its number of branches to 35 in 1997. The institution has issued an initial public offering for 15% of its shares and afterwards has been listed on the Istanbul Stock Exchange. Ihlas Finance at the beginning has increased its assets at an annual rate of 150% and obtained 40% market share. Ihlas Finance's financial problems started as early as 2000. They couldn't collect their receivables and couldn't pay profit shares to the investors. Finally at 2001 the Turkish Banking Association declared Ihlas Finance bankrupt and transfered the ownership to the association. The association will first pay the claims of the lenders and government, afterwards employees will be paid. The account owners will be paid next, however it is uncertain whether or not equity owners will get their claims.

4.6 Asya Finance Company

Asya Finance company was established at 24 October 1996 with 20 trillion Turkish Lira capital. Asya Finance is a public company with 254 small shareholders. Asya Finance's net profit has decreased from 5,316,244 million Turkish Liras in 2000 to 1,916,309 million Turkish Liras in 2001.

Table 1 shows the net profits and the total deposits of the six Islamic finance Houses at the end of 1997. Al Baraka Finance had the highest net profit. However Ihlas Finance had more branches and slightly higher deposits. Kuwait Finance was at the third position.

Today Ihlas Finance declared bankruptcy and ceased its operations. Faisal Finance was sold and became Family Finance. Anadolu Finance was also sold to new owners. During 1988-2002, the Islamic Houses could obtain at most 3% of the Turkish Lira deposits and between 3-4% of foreign currency deposits in Turkey.

TABLE 1
PROFITS AND DEPOSITS OF ISLAMIC FINANCE HOUSES AT 1997

            NUMBER OF   1997 PROFIT    TOTAL DEPOSITS
COMPANY     BRANCHES    (BILLION TL)   (BILLION TL)

AL BARAKA   21                  2300       100000
FAISAL      12                   613        33000
KUWAIT      14                   800        55000
ANADOLU     20                  1900        28000
IHLAS       35                  2100       105000
ASYA        13                    --        18000

REFERENCES

El-Ashker, Ahmed., The Islamic Business Enterprise, Croom Helm Ltd Publishing, 1987

Choudhury, M.A.., "VentureCapital in Islam: A Critical Examination", Journal of Economic Studies, Vol 28, 2001, 1-10

Mirakhor, Abbas., "The Progress of Islamic Banking: The Case of Iran and Pakistan", Islamic Law and Finance, 1988, 91-114

Nienhaus, Volker., "The Performance of Islamic Banking: Trends and Cases" Islamic Law and Finance, 1988, 129-170

Roy, Delwin A., "Islamic Banking; rapid growth and moral dilemma", Middle East Executive Reports, Vol 9-4, 1986, 8-13

Dr Ayse Yuce earned her Ph.D at Louisiana State University in 1994. Currently she is an Associate professor of finance at Ryerson University, Toronto, Canada.