Turkish Islamic finance industry set to cross $100bn amid government push  

By Puja Sharma

Sukuk is also a key part of the sovereign funding toolkit, as the government has been able to issue these with notable investor demand despite the challenging domestic operating environment and international debt capital market volatilities

The Turkish Islamic finance industry is projected to reach $100 billion over the next few years after crossing $90 billion in September 2023, Fitch Ratings says. This will be underpinned by the sector’s strategic importance to the government, which aims for Islamic banks to reach 15% of sector assets by 2025. Top-down support is also evident by the entry of three swiftly expanding state-owned Islamic banks. Sukuk is also a key part of the sovereign funding toolkit, as the government has been able to issue these with notable investor demand despite the challenging domestic operating environment and international debt capital market volatilities.

We expect strengthening relations between Turkiye and GCC countries to positively affect the Islamic finance market and help the government attract foreign direct investments. In July, the government obtained financing commitments from the UAE totalling $51 billion over three years, including the purchase of an $8 billion sukuk. A number of GCC banks have ownership stakes in Turkish Islamic banks that aim to diversify their investments. Dubai Islamic Bank also recently entered the Turkish digital banking sector.

Islamic banking (known as participation banking in Turkiye) is becoming a significant part of the banking system, with an expanding market share of 8.5% of total sector assets in September 2023 (2018: 5.4%). However, the fast growth should be viewed in the light of high inflation and lira depreciation in Turkiye. Turkiye is the seventh-largest Islamic banking market globally in terms of assets, based on IFSB data.

Fitch rates six Islamic banks in Turkiye, all of which have a Long-Term Foreign Currency Issuer Default Rating of ‘B-’. Some of these banks are owned by highly rated parents, but are capped at ‘B-‘ because of Fitch’s view of government intervention risk. In September, Fitch revised the Outlooks of 16 Turkish banks to Stable from Negative, including a number of Islamic banks, following the revision of the sovereign Outlook.

The Turkish banking system has been resilient to repeated periods of stress. Fitch is not aware of Islamic banks passing on losses or not paying profits on to mudaraba depositors, which are based on profit-and-loss sharing contracts. The regulator grants Islamic banks a 50% “alpha-factor”, which is a discount in the calculation of risk-weighted assets. This provided an uplift of 100bp–450bp to Islamic banks’ capital ratios in 2022–2023.

Outstanding sukuk, known as lease certificates in Turkiye, had grown by 19.7% yoy ($25.9 billion) as of September 2023, and held 6.5% of the debt capital market, with the balance in bonds. So far this year, more than $7 billion of sukuk were issued (all currencies), which was 40.8% lower yoy, with US dollar issuance having a 6.2% share. In contrast, $51 billion of bonds were issued in the same period, up 28.1% higher yoy. Fitch-rated Turkish sukuk reached more than $9 billion as of end-3Q23 – all non-investment-grade – with more than 90% issued by the sovereign.

There is a sizeable untapped potential for the industry as about 26% of Turkiye’s adult population did not have a bank account in 2021, according to the World Bank, with 15% of the unbanked population citing religious reasons as a barrier. However, the limited distribution network and product gaps, along with low awareness, sharia-sensitivity and confidence, are key hurdles. In 2019, the government reported that 60% of the surveyed population in Turkiye did not understand the meaning of “participation banking”.

Islamic banking assets contributed more than 70% to the total Islamic finance industry size as of September 2023, with the balance mostly in outstanding sukuk (28.2%). Takaful had 4% insurance sector share. The Islamic asset-management sector is nascent.