OREANDA-NEWS. December 15, 2015. The outlook for Turkey's banking sector is stable, supported by expectations that loss-absorption capacity will remain adequate, says Fitch Ratings. Our base case is that lenders' key financial metrics in 2016 should remain broadly in line with current levels. But downside risks for the sector have increased, and from 2016 banks will also have to meet additional Basel III capital buffers that will underpin quite healthy solvency ratios.

We believe banks may need to raise new capital, either through equity or Tier 2 issuance, to support solvency ratios over the near to medium term. This is because higher minimum capital requirements, increased risk-weights, likely still significant loan growth (which we expect will run ahead of moderate internal capital generation) and potential further lira depreciation could erode capital ratios. These could edge closer to the new Basel III floors.

Now that the election season is over, some Turkish banks are seeking to take advantage of greater market stability to tap international markets. Last week, Yapi ve Kredi Bankasi announced plans to issue Basel III Tier 2-compliant subordinated capital notes. And in November 2015 Kuveyt Turk's specialised issuance vehicle announced plans to issue Basel III-compliant subordinated sukuk. We understand that other banks are also considering Tier 2 issues, seeking to lock in still relatively low interest rates. We expect Turkish banks to retain external market access for new capital issues and to roll over outstanding senior borrowings.

Under the latest Basel III capital requirements to be implemented in Turkey from 2016, by 2019 banks will have to build up a common equity Tier 1 (CET1) capital conservation buffer equal to 2.5% of risk-weighted assets (RWAs). They will also have to hold a buffer, with size dependent on systemic importance. This buffer will range from 1% to 3% of RWAs, but we understand it is set to be capped at 2% for the larger banks. The minimum CET1 ratio will therefore rise to 9% for larger institutions by 2019 from 4.5%, initially stepping up to 5.625% in 2016.

At end-September 2015, the average CET1 ratio for the largest seven banks was 11%, already above the 9% future requirement. But the tighter capital rules could put pressure on these ratios, bringing them closer to minimum levels. We calculate that the proposed 50% risk-weighting on foreign-currency reserves held at the central bank will shave 55bp-85bp off the CET1 ratios of the largest seven banks, with deduction of free provisions from capital resulting in a further 0bp-50bp hit. A countercyclical capital buffer to address the build-up of risks during periods of high credit growth could also be imposed; based on existing Basel III regulations this could reach 2.5%.