TURKEY'S ISLAMIC BANKS UNDER PRESURE.

Jon Gorvett reports from Istanbul on a proposed new law that has led to controversy in Turkey's financial sector.

To be criticised for investing in your own country is most unfortunate, remarks Candan Karlitekin, the general co-ordinator of one of Turkey's largest Islamic industrial conglomerates, Kombassan Holdings. He is speaking on one of the latest developments in the Turkish Republic's long standing internal conflict -- that between its Islamic roots and its Western aspirations.

It is a conflict that has recently led to controversy over a proposed new law on Islamic finance -- the repercussions of which could be dramatic for the country's Islamic banking sector.

Founded via a governmental decree in 1984, the non-interest bearing banking sector in Turkey now comprises of six main establishments -- or Special Finance Houses (OFKs) --with 155 branches and around $1.25 billion of deposits between them. In addition to this, banking sector observers suggest a further $10 billion plus currently remains outside of the sector due to religious concerns.

However, since the election of the pro-Islamic Welfare Party (RP) to the leading role in a coalition government in December 1995, the secularist establishment in Turkey has been increasingly concerned over the rise of what they characterise as fundamentalist ideas and influence in the country.

This concern led to the soft coup of July last year, when the RP was ejected from power by a coalition of opposition parties, the media and the all-important military.

Since then, the country has been run by another coalition, but recently the Turkish armed forces have expressed their disapproval of Prime Minister Mesut Yilmaz's approach to tackling the perceived threat of fundamentalism. Through the military dominated National Security Council (MGK) they have pushed the government into taking stronger measures on a variety of issues -- from the wearing of headscarves by female students through purging public institutions of suspected Islamist sympathisers to investigating the growing Islamic business and financial sector.

In this context, a new financial reform bill has made its way onto parliament's order of business. The law's main change in current practice will be to bring the OFKs under the same body of legislation as interest-bearing commercial banks.

"There are three basic disadvantages that we see with this," says Fawaz Al Issa of the Kuveyt Turk Bankasi. "First of all, this law will require an additional percentage of liquidity to be reserved with the Central Bank. Right now, we are required by law to maintain six per cent of our capital with the central authority, but with the new law, there will be an additional six per cent ... The disadvantage with this is that a commercial bank maintains this additional six per cent in the form of Treasury bills. For us, we cannot do this. Why? because we are an interest free bank and T-bills give interest."

The fear is that such a practice would create serious problems for the OFKs with their depositors, or, as the Turkish saying goes, "they won't eat steak from a kitchen that has cooked pork".

A second disadvantage is that under the new legislation the OFKs will be required to invest an additional 50 per cent from their own capital over and above what is returned to them in the end-of-year revaluation fund - a financial instrument that takes into account Turkey's rocketing 98 per cent inflation. This means more of the OFKs capital being tied up in meeting regulatory demands and less in investment.

Finally, bringing the OFKs under normal banking laws means that investors deposits will have to be insured. However, part of the whole basis of non-interest banking is that deposits are profit and loss sharing accounts. Insuring these breaks another important principle.

The new law will also allow interest charging commercial banks to provide interest free facilities for their clients. In Turkey, the banking sector is characterised by a large number of different outfits -- 72 at the last count. Removing the difference between these and the OFKs will expose the Islamic banking sector to much fiercer competition. Most of the OFKs are also smaller operations than the commercial banks.

"Today, in Turkey, to buy even the smallest commercial bank would cost you at least $120 million," says Fawaz, "but if you look at our book value, it is much less ... It also costs around $100 million to get a banking license -- and they probably won't give you one anyway as the feeling is that the market is saturated with banks."

The change in law may also bring with it substantial take-overs and a shaking out of the smaller operations.

This may well be the aim of the military. After last March's meeting of the MGK, which came after widespread speculation of another soft coup to remove the current coalition, military spokesmen talked of a five year campaign against pro-Islamic influence, of which only the first year had been completed. Measures involving the Islamic finance sector were also stressed as a major focus of the military's attention.

The Arab links of the OFKs are also a source of concern for those pushing the current legislation. Many of the OFKs, such as Kuveyt Turk and Al Baraka, have a close association with Islamic banks in the Gulf. The staunchly secularist military, claiming to protect the state from any deviation from the principles of the republic's founder, Ataturk, see this as sinister -- despite the legitimacy of these links under existing legislation. However, in an atmosphere where fundamentalism has been declared the greatest threat to the Turkish state by the armed forces -- surpassing any external concerns -- even entirely legal transactions by the Islamic sector have been portrayed as suspect.

Another example of this is the extending of incentives to Islamic businesses and OFKs. The newspapers now publish lists of companies the OFKs have undertaken finance leasing operations with and from which they have been able to take advantage of tax allowances transferred from investment incentive plans, suggesting that these have also been illegitimate.

"The subject on which the soldiers are sensitive is that we should all live under the principles of the republic forever," says Kombassan's Kartekin. "On this we are all behind them." Yet the move to legislate on Islamic finance and stress its Arab connections suggests once again that Islamic ideas are seen as incompatible with that self same republic -- the basis of the Constitutional Court's recent decision to ban the RE

"We are bankers," says Fawaz. "We try to stay away from politics ... The authorities have every right to be concerned about whatever it is they want to be concerned about but this should not be at the expense of a certain group of people or financial entities. If we are all under one umbrella law, we should be sure that this is not there to harm or to drive someone out of the market. There is no country in the world that would accept a law that would drive banks out of business."

It may well be that Turkey's log-jammed parliament will prove unable to pass the finance bill -- particularly as elections in the Autumn are being widely mooted. Nonetheless, with opinion polls suggesting that any election would largely reproduce the 1995 result, the issue, and the conflict behind it, seems unlikely to go away.

TURKEY'S PRICIPLE SPECIAL FINANCE HOUSES (OFKs)

                           Equity Capital    No. of
                             ($ million)     Branches

Albaraka Turk                   8.62            22
Anadulo Finans Kurumu           8.62            20
Asya Finans                     8.62            16
Faisal Finans                   8.62            12
Ihlas Finans                    43.1            35
Kuveyt Turk                     9.06            16