CAMELS Journal

International Research Journal of Finance and Economics ISSN 1450-2887 Issue 32 (2009) © EuroJournals Publishing, Inc. 2009 http://www.eurojournals.com/finance.htm

An Analysis of the Northern Cyprus Banking Sector in the

Post – 2001 Period Through the CAMELS Approach

Mustafa Atikoğulları Department of Banking and Finance, Eastern Mediterranean University

Gazimağusa, North Cyprus

Abstract

The article aims at analyzing the Turkish Republic of Northern Cyprus (TRNC) banking sector in the post-2001 period to assess the performance of the sector after the TRNC Banking Crisis of 2000-2001 through the CAMELS approach. According to this approach, the financial statements of the top five banks with the largest asset sizes have been analyzed in terms of capital adequacy, asset and management quality, earnings ability, liquidity and asset size. JEL Classification Codes: E45, 012, A13

1. Introduction Banking constitutes the most important and the largest part of the financial sector in TRNC. In addition to the Development Bank and the Central Bank, there are now 24 commercial banks and 14 off-shore banks operating under the new Banking Law, which has been implemented since November 2001. The current Banking Law includes major amendments in its content when compared to the previous 1976 Law and was introduced as a result of “economic and financial crisis” causing a banking sector distress period from late 1999 through 2000 and until 20011. The aim of the current Banking Law is to protect the banking system against future possible crises.

As can be seen from Table 1, as of May 2009, more than half of the banks under commercial status in TRNC consists of local banks and most of the rest by the foreign branch banks. In addition to these banks, there are also two cooperative banks and a state bank, which provide state guarantee for the transactions. The aforementioned commercial banks give service through 138 branches. The distribution of the banks by the sectors is shown in Table 1 below: Table 1: Distribution of Commercial Banks by Sectors

Sector Number State Banks 1 Cooperative Banks (operating under the Banking Law) 2 Foreign Branch Banks 7 Local Banks 14 Total 24

Source: The Central Bank of the TRNC - www.kktcmb.trnc.net

Table 2 lists the commercial banks according to their distribution by the sectors:

1 See Safakli (2003).

International Research Journal of Finance and Economics - Issue 32 (2009) 213

Table 2: Names of the Commercial Banks by Sectors Sector Banks State Bank Kıbrıs Vakıflar Bankası Ltd. Cooperative Bank K.T. Kooperatif Merkez Bankası Ltd. Cooperative Bank Limasol Türk Kooperatif Bankası Ltd. Local Bank Türk Bankası Ltd. Local Bank Asbank Ltd. Local Bank Kıbrıs İktisat Bankası Ltd. Local Bank Artam Bank Ltd. Local Bank Creditwest Bank Ltd. Local Bank Denizbank Ltd. Local Bank Yakın Doğu Bank Ltd. Local Bank Şekerbank (Kıbrıs) Ltd. Local Bank Akfinans Bank Ltd. Local Bank Yeşilada Bank Ltd. Local Bank Universal Bank Ltd. Local Bank Kıbrıs Continental Bank Ltd. Local Bank Viyabank Ltd. Local Bank Kıbrıs Faisal İslam Bankası Ltd. Foreign Branch Bank T.C. Ziraat Bankası A.Ş. Foreign Branch Bank Türkiye Halk Bankası A.Ş. Foreign Branch Bank HSBC Bank A.Ş. Foreign Branch Bank Türkiye İş Bankası A.Ş. Foreign Branch Bank Oyak Bank A.Ş. (acquired by ING Bank A. Ş. in 2007) Foreign Branch Bank Türkiye Garanti Bankası A.Ş. Foreign Branch Bank Türk Ekonomi Bankası A.Ş.


Apart from these commercial banks, there are also 14 off-shore banks called “International Banking Units” operating in TRNC which are mostly owned and operated by their parent banking corporations located in Turkey2.

Table 3 shows the International Banking Units (Off-shore banks) located in TRNC: Table 3: Operating International Banking Units in TRNC Off-Shore Banks The Euro Textile International Banking Unit Ltd. Atlasbank UBB Ltd. World Vakıf UBB Ltd. Optima Uluslararası Bankacılık Birimi Ltd. Mondial Private Bank (IBU) Ltd. Şekerbank International Banking Unit Ltd. Cleveland Off-Shore Bank Ltd. Euro Deniz International Banking Unit Ltd. Renfrew Security Bank & Trust Off-Shore Ltd. Cardinal Bank of Ottoman Off-Shore Ltd. Ekonomi Bank IBU Ltd. Rahim International Banking Unit Ltd. Anadolubank International Banking Unit Ltd. Allied Turkish Bank IBU Ltd.


2 International Banking Units Law (41/2008) was put into force at 5th August 2008 and it has replaced the existing

Offshore Banking Law (46/2000). With this new law all off-shore banks are required to change their extension names from off-shore to International Banking Unit (IBU, UBB) – the Central Bank of the TRNC.

214 International Research Journal of Finance and Economics - Issue 32 (2009)

Beside the types and number of banks, distribution of the asset sizes in a country is an important characteristic to assess the banking sector structure. As can be seen from Table 4, as of December 2007, Kıbrıs Türk Kooperatif Merkez Bankası Ltd. has the largest asset size, constituting one fourth of the total asset size among the commercial banks in the TRNC banking sector.

The second and the third banks with the largest asset sizes are two foreign branch banks: “Türkiye İş Bankası A.Ş.” and “HSBC Bank A.Ş.”, together constituting nearly a quarter of the total asset size.

In terms of asset sizes, the first five largest banks own approximately 66% of the total assets of the commercial banking sector, which indicates that there is an oligopoly structure in the TRNC banking sector3.

Table 4 shows the asset sizes of the five largest banks in terms of asset sizes, as a percentage of the total assets of the commercial banks in TRNC: Table 4: Asset Size Distribution of Commercial Banks in TRNC (except the Central Bank, Development

Bank and Off-shore Banks) Banks Asset Size as a percentage of total assets of commercial banks K.T. Kooperatif Merkez Bankası Ltd. 25% Türkiye İş Bankası A.Ş. 12% HSBC Bank A.Ş. 12% Kıbrıs Vakıflar Bankası Ltd. 9% Türk Bankası Ltd. 8% Others 34%

1.1. TRNC Banking Crisis of 2000-2001

The TRNC banking sector has encountered two periods of distress throughout its short history. The first one was a result of continuing devaluation of the TL and economic contraction in Turkey in early 1994. Therefore, a currency crisis started to threat banks in TRNC, especially the ones facing a high currency risk. Consequently, two banks were put under the control of the TRNC Ministry of Finance in the year 19944.

The second distress period of the banking sector in TRNC was much more serious and damaging compared to the one in 1994, starting from late 1999 and continuing through 2000 and until 2001.

The spark that leads to an explosion of banks collapsing was panic, due to a period of very high interest rates, fierce competition, devaluation and mismanagement of financial institutions culminated with depositor's losing their confidence in the financial market of Northern Cyprus5.

Insecurity felt by the depositors and bankruptcy rumors, caused bank-runs by the depositors to quickly withdraw their deposits, thereby put banks under the pressure for liquidity, and pushed them to insolvency. As a result, government decided to liquidate five banks in the year 2000 and five more banks in 2001, thus put them under the Saving Deposit Insurance Fund (SDIF)6, 7. In addition to the failure of ten banks, three banks were taken-over in years 2000, 2001 and 20028.

3 See Safakli (2006). 4 The Everest Bank Ltd. and Mediterranean Guarantee Bank Ltd. The Everest Bank was closed in 2000 and the

Mediterranean Guarantee Bank Ltd. was transferred to Kıbrıs Vakıflar Bankası Ltd. in 2005. 5 See Safakli (2007). 6 The Asya Bank, Tilmo Bank, Yasa Bank, Ticaret Bank and the Endustri Bank. 7 The Everest Bank, Kıbrıs Finans Bank, Kıbrıs Hürbank, Kıbrıs Kredi Bank and the Kıbrıs Yurt Bank which were closed

in the year 2001. 8 The Finba Ltd. was taken over by Artam Bank Ltd. in 2000 and Med Bank Ltd. and Hamza Bank Ltd. was taken over by Şeker Bank Ltd. in the years 2001 and 2002, respectively.


Main results of the crisis were the failure of the one third of the banks in the banking sector, leaving behind hundreds of bankers unemployed and approximately $200,000,000 cost to TRNC economy9, 10. The cost was nearly half of the GNP in the year 199911.

After the 2000-2001 crisis, a new Banking Law was introduced in November 2001 to protect the banking system against future possible crises and construct a sound banking structure. Positive changes regarding Cyprus issue and developments in Turkish Economy also helped TRNC banking sector to stand on its feet again.

The aim of this article is to analyze the TRNC banking sector in the post-2001 period by using the CAMELS approach in order to assess the performance of the sector after the TRNC Banking Crisis of 2000-2001.

For this purpose, secondary data from the web-site12 of the TRNC Central Bank and primary data created from the financial statements of the banks were used. These were the annual reports of the five largest banks in terms of asset sizes which constitute approximately the two third of the total assets of the commercial banks in TRNC.

2. Methodology: The CAMELS Approach The CAMELS approach is a type of financial analysis used to evaluate the managerial and financial performance of banks to determine their soundness and safeness, originally adopted by North American Bank Regulators to assess U.S commercial lending institutions13. According to this approach, the financial and managerial performance of a bank is a function of six elements: capital adequacy (C), asset quality (A), management quality (M), earnings ability (E), liquidity (L) and asset size (S). These elements are predicted by employing certain ratios.

In this study, CAMELS analysis was used to emphasize the weaknesses and possible failure risks in TRNC banking sector, since the period of the TRNC Banking Crisis of 2000-2001 until today. The five banks with the largest asset sizes of the sector were used as proxy to conduct this analysis. The six critical CAMELS elements of these banks were calculated by using the ratios that are tabulated in Table 5. Table 5: Ratios to Predict the Six Critical Elements of CAMELS Analysis Element Ratio Explanation

Capital / Assets Total Capital as a share of Total Assets Capital Adequacy Loans / Capital Total Loans as a share of Total Capital Asset Quality Loans / Assets Total Loans as a share of Total Assets

Operating expenses / Assets Operating Expenses as a share of Total Assets Management Quality Interest expenses / Deposits Deposit Interest Expenses as a share of Total Deposits

Net income / Assets Net Income as a share of Total Assets Earnings Ability Interest income / Assets Net-Interest Income as a share of Total Assets Liquid Assets / Assets Total Liquid Assets as a share of Total Assets Liquid Assets / Deposits Total Liquid Assets as a share of Total Deposits Liquidity Deposits / Loans Total Deposits as a share of Total Loans

Asset Size Assets / Sector Assets Total Assets as a share of Total Banking Sector Assets Source: Gunsel, N. (2007).

9 There were 36 commercial banks operating in the banking sector at the time when crisis took place. 10 See Bektas (2005). 11 See Safakli (2003). 12 www.kktcmb.trnc.net 13 See Sarker (2006).


2.1. Capital Adequacy (C)

Capital adequacy is a measure of the financial strength of a bank. The ratio of total capital as a share of total assets (Capital/Assets) reflects the ability of a bank to absorb the unanticipated losses. This ratio is positively related to the financial soundness of the bank, thus, it is negatively related with a possible failure. In other words, as this ratio gets higher, it means there is more capital to absorb unanticipated losses such as immediate deposit withdrawals caused by a bank-run.

The second function of the capital adequacy is total loans as a share of total capital (Loans/Capital). This ratio indicates the resistability of a bank to loan losses. Loan losses more than expected may cause a serious deterioration of the equity capital. Unlike the first ratio, this one has a positive relation with the risk of failure. 2.2. Asset Quality (A)

Asset quality indicates the risk level of assets and degree of financial strength within a bank. Thus, this element plays a major role in the assessment of the present condition and viability in the future.

The ratio of total loans to the total assets (Loans/Assets) was utilized to measure the asset quality. Loans are the riskiest assets and usually account for the majority of a bank’s assets. A high share of loans to total assets ratio reflects a more sensitive structure to loan losses and may be a result of underestimating the possible loan losses. The higher the value of the non-performing loans means a lower asset quality, which is a threat to the bank’s profitability and future viability. 2.3. Management Quality (M)

An evaluation of the management quality is the most forward-looking element when compared to others. Also, it is the hardest one to measure, since it is not solely dependent on the current financial performance. This component includes a large range of issues such as the education level and expertise of the management.

From the financial data available, the most appropriate measures to predict the management quality are operating efficiency and cost management over deposits. In this manner, operating expenses as a share of total assets (Operating Expenses/Assets) and deposit interest expenses as a share of total deposits (Interest Expenses/Deposits) were used to predict the management quality. These measures are both negatively related with the management quality, thereby positively related to a possible failure as a result of mismanagement of the bank. 2.4. Earnings Ability (E)

The future viability of a bank depends on its ability to earn an adequate level of return on its assets. Earnings ability provides the means to a bank to expand its funds, maintain its competitive position and increase its capital (or at least stabilize). It is the most important determinant of performance.

In this model, two ratios were used to assess the earnings ability of banks. The first ratio is the net income as a share of total assets (Net Income/Assets) which is also known as “return on assets” or “ROA”. The second measure is the net-interest income as a share of total assets (Interest Income/Assets). Both measures are positively related with the financial performance of the bank and negatively related to the failure of possibility. 2.5. Liquidity (L)

Liquidity of a bank can simply be explained as the ability to meet its short-term obligations as well as maintaining its solvency. Hence, a bank should be able to remain solvent in case of an unanticipated drain on deposits or new loan demands. On the other side, a liquidity level over the amount needed has an adverse effect on the profitability level of the bank, as a result of inefficient financial investment activities.


Three ratios were employed to assess the liquidity level of the banks. The first one is total liquid assets to total assets (Liquid Assets/Assets) which reflects the ability of the bank to payoff its liabilities. The second ratio that was used to measure liquidity is total liquid assets as a share of total deposits (Liquid Assets/Deposits). This ratio indicates the capacity of the bank to cover unanticipated deposit drains. The ratio of total deposits to total loans (Deposits/Loans) that measures the deposit drains was the last ratio used to determine the liquidity. All three ratios are positively related to the liquidity level of the bank, but can be both negatively and positively related to the performance or the risk of failure. The reason beyond this is that, the liquidity over needed level can seriously damage the profitability, hence increase the possibility of a failure. 2.6. Asset Size (S)

As the asset size of a bank increases, its sensitivity to market risk decreases, which is the risk of a failure due to bad market conditions, measured as the ratio of total assets as a share of total banking sector assets (Asset/Sector Assets). Consequently, a bank with a larger asset size relative to the sector is less sensitive to the market risk and therefore is less likely to fail.

3. Results of the CAMELS Analysis 3.1. Capital Adequacy (C)

The graphs of the Capital/Assets ratios of the banks are shown in Figure 1. Trends in these graphs provide a deep insight into the financial strength of the banks, revealing their resistability against unanticipated losses between years 2001 and 2007. In general, the trends of all the banks are downwards until 2006 and upwards between 2006 and 2007. Nevertheless, the banks are in a worse condition in terms of capital adequacy to cover unexpected losses, when all of the ratios in 2007 are compared to those in 2001, except that of Kıbrıs Vakıflar Bankası Ltd., which increases slightly from 4% to 5%.

As can be seen in Figure 1, it is obvious that K.T. Kooperatif Merkez Bankası Ltd. and Türkiye İş Bankası A.Ş. have similar and stable Capital/Assets ratios compared to others with a very slight continuous decrease from around 3% to below 2% between the years 2001 and 2006, followed again by a smooth increase to near 2% in 2007. In general, both of these banks have lower ratios compared to others indicating that they are less prone to possible unexpected losses than the others.

Kıbrıs Vakıflar Bankası Ltd. also follows a similar trend until 2003, decreasing slightly from 4% to 2%, and then increasing steadily until 2007 and, finally, reaching 5%. This suggests a stable decrease in the probability of a failure due to unexpected losses between 2003 and 2007.

The Capital/Assets ratio shows greater variations for Türk Bankası Ltd. and, especially, HSBC Bank A.Ş. The ratio for Türk Bankası Ltd. declines quickly from 20% to 12% between 2001 and 2004, continuing to decrease gradually until 2006 to 11%, and increasing back to around 12%. This trend shows that the bank was having a serious problem with a decreasing capital adequacy for a long time and only recently managing to stop this decline. The most varying Capital/Assets ratio belongs to HSBC Bank A.Ş., which took over Demirbank T.A.Ş. at the end of 2001. As can be seen in Figure 1, after the acquisition, the ratio declined from 32% to 12% in just one year and continued to decrease in a slower rate until 2005. With the success of the bank in the sector, the bank became able to take control of its capital adequacy within a few years, increasing its Capital/Assets ratio up to 20% in 2007.


Figure 1: Total Capital as a share of Total Assets

CAPITAL / ASSETS

0,000,050,100,150,200,250,300,35

2001 2002 2003 2004 2005 2006 2007

Years

K.T. KooperatifMerkez Bankası Ltd.Türkiye İş BankasıA.Ş.HSBC Bank A.Ş.

Kıbrıs VakıflarBankası Ltd.Türk Bankası Ltd.

Figure 2 shows the graphs of the Loans/Capital ratios of the banks, which is another measure used to assess the capital adequacy. The results show that the sector, in general, was deteriorating from 2001 to 2006 in terms of capital adequacy, from the viewpoint of resistance to loan losses.

According to the results, the bank with the largest asset size, K.T. Kooperatif Merkez Bankası Ltd., varies widely along the trend and maintains its position as the weakest bank against possible loan losses during the period under investigation. The bank’s strength against loan losses decreases tremendously until 2006 with an increase in the size of the total loans from 14 to 46 times of the capital, then decreasing to 38 times in 2007.

The Loans/Capital ratio for Kıbrıs Vakıflar Bankası Ltd. also shows a similar trend through the sample period with total loans increasing steadily from 3 to 12 times of the capital between 2001 and 2006, and decreasing to 9 times in 2007.

Unlike all other banks, the capital adequacy of Türkiye İş Bankası A.Ş. has continued to deteriorate after 2006, at an increasing rate between 2006 and 2007. The ratio evolves in an increasing manner from 2 to 13 in 6 years, rising from 7 to 13 between 2006 and 2007 alone.

On the other hand, Türk Bankası Ltd. and HSBC Bank A.Ş. seem to have a strong position against possible loan losses compared to others. There is generally a very slight continuous deterioration from 0.1 to 1.7 and from 0.2 to 1.8, respectively, until year 2005. However, after 2005, ratios for the both banks have generally decreased to a better level than that in 2001.


Figure 2: Total Loans as a share of Total Capital

LOANS / CAPITAL

0

10

20

30

40

50

2001 2002 2003 2004 2005 2006 2007

Years



3.2. Asset Quality (A)

Figure 3 plots the series for the Loans/Assets ratios in order to assess the banks’ asset quality. As can be seen in the figure, the asset quality of the banks in the sector diminished compared to the years immediately following the TRNC banking crisis of 2000-2001.

The trend of the K.T. Kooperatif Merkez Bankası Ltd. indicates that the bank has the lowest quality of assets in the whole sample period. As can be seen in Figure 3, the loan to total assets ratio decreases from year 2001 to 2002 from 0.50 to 0.42, indicating an increase in asset quality. Nevertheless, the ratio has continuously increased every year since 2002, reaching a level of 0.66 in the year 2007.

The trend for Kıbrıs Vakıflar Bankası Ltd. also follows a similar trend, albeit at a lower level, except the period between 2006 and 2007. As can be seen in the figure, there is an increase again in the asset quality between 2001 and 2002. The ratio nearly doubles in 2007 compared to 2001, increasing from 0.28 to 0.52.

Türkiye İş Bankası A.Ş. and HSBC Bank A.Ş. have both similar trends and also maintain a higher quality of assets except the years 2001 and 2007. The asset quality of Türkiye İş Bankası A.Ş. and HSBC Bank A.Ş. decrease very slightly between 2002 and 2006 and very sharply between 2006 and 2007, to a level of 0.28 and 0.16, respectively.

Following Türkiye İş Bankası A.Ş. and HSBC Bank A.Ş., Türk Bankası Ltd. is in the third position of maintaining the highest asset quality between the years 2002 and 2006. However, after 2005, the Loans/Assets ratio of the Türk Bankası Ltd. decreases from 0.20 to 0.13 in just two years. Consequently, the bank reaches the lowest Loans/Assets ratio, indicating that the bank has the highest quality assets among these five banks in the period under investigation.


Figure 3: Total Loans as a share of Total Assets

LOANS / ASSETS

0,000,100,200,300,400,500,600,70

2001 2002 2003 2004 2005 2006 2007

Years



3.3. Management Quality (M)

The efficiency of the banks’ operations measured by Operating Expenses/Assets ratio is presented in Figure 4. Although this measure provides information about the managerial quality, it also sheds light on the future financial performance of a bank, helping to predict any failures. In general, the operating efficiency is stable and does not vary vastly across local banks when compared to foreign branch banks such as Türkiye İş Bankası A.Ş. and HSBC Bank A.Ş.. This implies that management quality of the local banks in TRNC is sufficient to maintain a stable operating efficiency, indicating good signs regarding the future of the banking sector.

The HSBC Bank A.Ş. has the most eye-catching trend. The ratio before the take-over of the Demirbank T.A.Ş. by HSBC Bank A.Ş. at the end of 2001 is 0.6, then, it declines rapidly to 0.2 in 2002, continuing to decline until 2005, and recording only a slight increase thereafter. This reflects a very effective management as a consequence of increased operational efficiency.

On the other hand, the other foreign branch bank, Türkiye İş Bankası A.Ş. follows an upward trend after 2004. The Operating Expenses/Assets ratio increases steadily and quickly from 0.03 to 0.26 between 2004 and 2007. This shows that there is a deficiency in the management quality, which may lead to trouble in the future.

K.T. Kooperatif Merkez Bankası Ltd. maintains a slightly decreasing trend since the TRNC Banking Crisis of 2000-2001. The ratio has declined from 0.14 to 0.05 in the six years following the crisis indicating that the management quality of the bank with respect to operating efficiency is showing improvement every year, decreasing the possibility of a management-related failure in the future.

The two other local banks Kıbrıs Vakıflar Bankası Ltd. and Türk Bankası Ltd. have more stable and lower trends varying between 0.02 and 0.09. This implies that management quality of these banks are sufficient to maintain an effective and a stable operating efficiency, indicating sustainability and viability for the future.


Figure 4: Operating Expenses as a share of Total Assets

OPERATING EXPENSES / ASSETS

0,000,100,200,300,400,500,600,700,80

2001 2002 2003 2004 2005 2006 2007

Years



The managerial quality concerning the cost management of the banks over deposits is presented in Figure 5. Although this measure provides information about the cost management over deposits, it also gives a clue about the performance of a bank in the future, and also may help to predict any failures. Overall picture of the trends depicts that the cost management of the banks over deposits has improved after 2001. Especially between 2006 and 2007, this can be attributed to the unusual decrease in deposits in the banks except K.T. Kooperatif Merkez Bankası Ltd.. However, in general, the trends still look good when compared to the years following immediately after the crisis, reflecting a sectoral improvement of cost management over deposits, which is one of the most important determinants of the management quality.

The trend that varied most belongs to HSBC Bank A.Ş. which took over the Demirbank T.A.Ş. at the end of 2001. After the acquisition, the ratio declined from 31% to 7% in just one year and then to 4% in the year 2003. This major change in just two years reflects the effectiveness of the management in cost management issues, compared to Demirbank T.A.Ş.. After 2003, the trend increased continuously in a slight manner reaching 6% in 2007. This suggests that the bank’s effectiveness in cost management is still not well enough to allow it to maintain a decreasing or a more stable trend.

The four other banks have very similar trends, decreasing steadily from 2001 to 2005 and increasing slightly in the last 2 years. Trends of K.T. Kooperatif Merkez Bankası Ltd. and Kıbrıs Vakıflar Bankası Ltd. have decreased more significantly compared to the other banks, decreasing from 22% to 12% and from 20% to 9%, respectively, in a six-year period. Nevertheless, although they have decreased further compared to the other two, they still have the highest ratios in 2007. This leads us to the conclusion that they still have more way to go in terms of managerial efficiency in cost management.

During the sample period, trends of Türk Bankası Ltd. and Türkiye İş Bankası A.Ş. have decreased less compared to the other banks, decreasing from 4% to 3% and from 10% to 4%, respectively. However, they still have the lowest ratios in 2007, as in 2001. This reveals that these banks, in general, have more stability and better quality of management compared to others.


Figure 5: Deposit Interest Expenses as a share of Total Assets

INTEREST EXPENSES / DEPOSITS

0,000,050,100,150,200,250,300,35

2001 2002 2003 2004 2005 2006 2007

Years



3.4. Earnings Ability (E)

One of the two trends used to assess the earnings ability of the banks is Return on Assets (ROA), measured as Net Income/Assets, which is presented in Figure 6. Although trends of the banks have lots of ups and downs between the years 2001 and 2007, all of the ratios are noticeably higher in 2007 compared to 2001, with the exception of K.T. Kooperatif Merkez Bankası Ltd., which has remained the same, and in general, the ups are more than downs during these years. Accordingly, it can be concluded that banks are more profitable as of 2007 based on ROA, when compared to the years just after the crisis.

Similar to previous results, ROA also shows that HSBC Bank A.Ş. achieved a great success in its first year right after taking over Demirbank T.A.Ş., by increasing the earnings ability from -0.003 to 0.038 in just one year. However, after 2002, the ratio steadily decreased until 2005 to a level of 0.008 followed by a positive trend in the last two years, reaching 0.017 in 2007. As of 2007, it is the second highest profitable bank among the five banks studied in the present analysis.

Kıbrıs Vakıflar Bankası Ltd. also follows a similar trend by increasing its profitability level rapidly from 0.004 to 0.045 between the years 2002 and 2004. It is also the most profitable bank between those two years according to the ROA ratio. Nonetheless, this success did not last long, when ratio decreased to 0.003 at the end of 2006. In spite of this decrease, the slight increase to 0.01 in 2007 can be considered as a hope for the future financial performance of the bank.

According to the results, Türkiye İş Bankası A.Ş. is the most profitable bank as of 2007 with a considerable increase from 0.006 to 0.037 in just one year, after little ups and downs between 0.002 and 0.012 until 2006. On the other hand, K.T. Kooperatif Merkez Bankası Ltd. experienced a big fall from 0.02 to 0.01 between 2006 and 2007, after a steady increase in its trend in the period following 2003. This decline changed its position from the most profitable bank to the third, in one year.

Türk Bankası Ltd. is the most stable bank in terms of return on its assets, not varying much throughout the years. In spite of this, its ROA ratio is low in general when compared to the other four banks. In 2007, it seems to be the bank with the lowest earnings ability with a ratio of 0.007.


Figure 6: Net Income as a share of Total Assets

NET INCOME / ASSETS

-0,01

0,00

0,01

0,02

0,03

0,04

0,05

2001 2002 2003 2004 2005 2006 2007

Years



Another ratio used to assess the earnings ability of the banks is interest margin which is calculated as Interest Income/Assets. Lending support to the previous earnings ability measure, trends of the banks’ Interest Income/Asset ratio have lots of ups and downs during the sample period as can be seen in Figure 7. The ratios of all banks are higher in 2007 compared to 2001 and, in general, ups are more than downs during these years. As can be seen in the figure, the results for Interest Income/Assets ratio reveals that banks are more profitable in 2007, when compared to the years immediately following the crisis, supporting the results for the previous profitability measure.

According to Interest Income/Assets ratio, HSBC Bank A.Ş. achieved a great improvement in its profitability in the year following the take over of the Demirbank T.A.Ş.. The earnings ability of the bank increased from -6% to 9% in just one year. However, after 2002, the ratio decreased to 1% in 2003 and continued to increase for the rest of the years in the sample period, and reached 3% in 2007. As of 2007, it is the least profitable bank among these five banks according to the Interest Income/Assets ratio.

Kıbrıs Vakıflar Bankası Ltd. also achieved a great success through the years between 2001 and 2004 by increasing its profitability level rapidly from 0.2% to 10%. Although this increase was followed by a serious decrease in 2005 and continued with a slight increase for the rest of the sample period, it has been the most profitable bank in the years 2004, 2006 and 2007 according to the Interest Income/Assets ratio.

The trend of K.T. Kooperatif Merkez Bankası Ltd. experienced a downward trend in most of the years except between 2001 and 2002 and between 2006 and 2007. In spite of this, the bank seems to have more earnings ability in 2007 when compared to 2001 due to the 7% increase of the Interest Income/Assets ratio in 2002. The bank always maintained its position of profitability as the first or the second among these five banks during the sample period, hence it proves its competitiveness and success in terms of financial performance.

Türkiye İş Bankası A.Ş. and Türk Bankası Ltd. have similar trends through the sample period, and, in general, are more stable with a lower Interest Income/Assets ratio compared to others. The ratios for these banks varied around 2-3%, however, the ratio of Türkiye İş Bankası A.Ş. increased surprisingly to 6% in 2007, thus becoming the most profitable bank with Kıbrıs Vakıflar Bankası Ltd..


Figure 7: Net-Interest Income as a share of Total Assets

INTEREST INCOME / ASSETS

-0,08-0,06-0,04-0,020,000,020,040,060,080,100,12

2001 2002 2003 2004 2005 2006 2007

Years



3.5. Liquidity (L)

Figure 8 plots the series for the Liquid Assets/Assets ratios to assess the banks’ ability to payoff their liabilities, i.e. their liquidity. As can be seen in the figure, the ratios for the foreign branch banks are relatively more stable and lower compared to the local banks. This discrepancy between the local banks and the foreign branch banks is due to the fact that the size of the securities portfolio, which is a component of liquid assets, held by foreign branch banks is much smaller and more stable relative to local banks since the major part of their portfolio is kept in Turkey. Consequently, it would be pointless to comment on the trends of foreign branch banks. In general, local banks have maintained a more liquid position in recent years, compared to 2001 when crisis took place. However, the trend of liquidity, in general has been decreasing in recent years, which may be considered as a threat in the future for the banks.

The Liquid Assets/Assets ratios show the greatest variation in the case of Kıbrıs Vakıflar Bankası Ltd., increasing remarkably in 2003 to 37% owing to a huge increase in securities portfolio following a decline between 2001 and 2002 from 2% to 1%. The trend declines rapidly from 2003 to 2007, from 37% to 4%, indicating the possibility of a threat for the upcoming years in terms of the ability of the bank to payoff its liabilities. However, the ratio in 2007 is still greater than that in 2001, which reveals that the bank is in a better position of liquidity, than it was at the time when the crisis took place.

Similar to the ratios of the Kıbrıs Vakıflar Bankası Ltd., K.T. Kooperatif Merkez Bankası Ltd. also has a greater ratio in 2007 when compared to 2001 and also has a declining trend, after a year of significant increase in the ratio. The ratio increased rapidly in 2002 from 2% to 9%, again due to an increase in the bank’s securities portfolio, and continued to decrease gradually between 2002 and 2007, from 9% to 3%. Although the bank is in a better position relative to 2001, the persistent decline in the trend increases the probability of a liquidity crunch in the future.

Türk Bankası Ltd. has the highest ratio of liquidity in 2007 and has generally followed a high and upward trend throughout the sample period. The trend shows that the bank has kept a more stable liquidity position relative to other local banks, maintaining ratios between 5% and 11%.


Figure 8: Total Liquid Assets as a share of Total Assets

LIQUID ASSETS / ASSETS

0,000,050,100,150,200,250,300,350,40

2001 2002 2003 2004 2005 2006 2007

Years



Figure 9 shows the trends for the Liquid Assets/Deposits ratios to assess the banks’ capacity to cover unanticipated deposit withdrawals. The figure is almost the same as Figure 8 due to the change in the total deposits. As can be seen in the figure, the size of their securities portfolio caused the ratios for the foreign branch banks to be similar, relatively more stable and lower compared to the local banks. Similar to the previous ratio, it would be again pointless to comment on the trends of foreign branch banks. In general, local banks have a more liquid position in the recent years relative to 2001. However, the liquidity trend has been decreasing in recent years, which may lead to liquidity problems in the future.

Similar to the Liquid Assets/Assets ratio, Liquid Asset/Deposit ratio shows the greatest variation in the case of Kıbrıs Vakıflar Bankası Ltd., increasing suddenly in 2003 to 44%, after following a decline between 2001 and 2002 from 2% to 1%. The trend declines quickly after 2003 to 2007 from 44% to 5%, indicating an increasing likelihood of a threat for the upcoming years in terms of the bank’s capacity to cover unanticipated deposit drains. Nevertheless, the ratio in 2007 is still greater than that of 2001, which may infer that the bank is less likely to have a liquidity problem due to unexpected deposit drains.

K.T. Kooperatif Merkez Bankası Ltd. also has a greater ratio in 2007 when compared to 2001, and a declining trend following a year of rapid increase. The ratio increases rapidly in 2002 from 2% in the previous year to 11%, and continues to decrease steadily between the years 2002 and 2007. Although the bank is in a better position relative to 2001, the continuous decline in the trend increases the possibility of a liquidity problem in the future stemming from unanticipated deposit drains.

Türk Bankası Ltd. has the highest ratio of liquidity in 2007 and has generally followed a high and upwards trend throughout the sample period. The trend shows that the bank has kept a relatively stable liquidity position compared to other local banks, maintaining ratios between 5% and 13%. Thus, it can be argued that the bank has maintained its ability to cover any unanticipated deposit drains.


Figure 9: Total Liquid Assets as a share of Total Deposits

LIQUID ASSETS / DEPOSITS

0,00

0,10

0,20

0,30

0,40

0,50

2001 2002 2003 2004 2005 2006 2007

Years



The most important ratio used to assess the liquidity of the banks is Deposits/Loans ratio which is presented in Figure 10. As can be seen in the figure, the banks have generally followed a decreasing trend during the sample period, reaching a significantly low level in 2007. Thus, it can be concluded that the banking sector has become less liquid which indicates an increased likelihood of a banking crisis. On the other hand, the decline in the liquidity level has a positive impact on the profitability level of the banks.

Similar to most of the other ratios, the Deposits/Loans ratio that varies most belongs to HSBC Bank A.Ş.. After the acquisition, the ratio of deposits to loans increased from 10 to 51 times in just one year and has generally followed a decreasing trend for the rest of the sample period. The results show that the bank has had a decreasing liquidity level after a boom of liquidity in 2002 following the take-over, and has become even less liquid relative to 2001, indicating an increase in liquidity risk.

Türkiye İş Bankası A.Ş. and Türk Bankası Ltd. have a similar and decreasing trend through the sample period, with the ratio of deposits to loans decreasing from 23 to 3 and 23 to 6, respectively. This indicates an increase in the likelihood of a failure due to liquidity shortage, at the expense of a positive impact on profitability as discussed earlier.

The ratio of deposits to loans of Kıbrıs Vakıflar Bankası Ltd. increased between 2001 and 2002 from 2 to 9, then decreased steadily to 2 in 2005 and has stabilized for the rest of the sample period. In general, during the sample period, liquidity level of the bank seems to be the second lowest following the K.T. Kooperatif Merkez Bankası Ltd., indicating a higher liquidity risk relative to other three banks.

K.T. Kooperatif Merkez Bankası Ltd. has maintained the most stable and the lowest trend in terms of the ratio of deposits to loans, which has varied between 1 and 2 for the period under investigation. The bank has the riskiest liquidity position throughout the sample period.


Figure 10: Total Deposits as a share of Total Loans

DEPOSITS / LOANS

0

10

20

30

40

50

60

2001 2002 2003 2004 2005 2006 2007

Years



3.6. Asset Size (S)

Figure 11 shows the total asset as a share of total banking sector assets for the five largest banks in the sector in terms of asset sizes. During the period under investigation, K.T. Kooperatif Merkez Bankası Ltd. is the largest bank in terms of asset size. The ratio increased steadily from 17% to 27% between the years 2001 and 2003, then decreased steadily to 24% in 2006, followed by a slight increase to 25% in 2007. As a result, the bank has become less sensitive to market risk in 2007, by increasing its share of assets 8% in the sector during the period under investigation.

HSBC Bank A.Ş. has the most increasing trend which increases steadily from 1% to 12%, between the years 2001 and 2007. As of 2007, the bank seems to be the third largest bank in terms of asset sizes. As a result, the bank has become less sensitive to market risk, by increasing its share of assets in the sector 11% throughout the sample period.

Kıbrıs Vakıflar Bankası Ltd. has also become less sensitive to market risk, by increasing its share of assets in the sector from 6% to 9%, between the years 2001 and 2007, although there is a slight decrease in the trend between the years in 2005 and 2007.

Unlike other banks, Türkiye İş Bankası A.Ş. and Türk Bankası Ltd. have similar trends which decreased from 17% to 12% and from 12% to 8% between 2001 and 2007, respectively. As a result, in general, the sensitivity to market risk is increasing for both banks, during the sample period.


Figure 11: Total Assets as a share of Total Banking Sector Assets

ASSETS / SECTOR ASSETS

0,00

0,05

0,10

0,15

0,20

0,25

0,30

2001 2002 2003 2004 2005 2006 2007

Years



4. Conclusion This article has analyzed the TRNC banking sector in the post-2001 period to assess the performance of the sector after the TRNC Banking Crisis of 2000-2001 through the CAMELS approach. According to this approach, the balance sheets of the top five banks with the largest asset sizes have been analyzed in terms of capital adequacy, asset and management quality, earnings ability, liquidity and asset size. As a result of this analysis, a number of conclusions have been obtained.

First of all, in terms of capital adequacy, results showed that the TRNC banking sector is in a less adequate position as of 2007, compared to the time when the crisis took place in 2001. This result is due to the deterioration in the balance sheets of the sector during the period between 2001 and 2006, which was followed by an improvement between 2006 and 2007. Overall, K.T. Kooperatif Merkez Bankası Ltd. seems to be the least adequate bank in terms of capital structure, especially from the viewpoint of resistance to loan losses, during the sample period.

Secondly, it can be concluded that the asset quality of the banks in the sector, to some extent, has diminished relatively to the years immediately following the TRNC banking crisis of 2000-2001. According to the results, K.T. Kooperatif Merkez Bankası Ltd. stands as the bank with the lowest quality of assets during the period under investigation.

Thirdly, the overall continuous increase in cost management and stable operating efficiency of the local banks reveals an improving management quality in the TRNC banking sector, indicating good signs regarding the future of the banking sector.

Fourthly, in terms of profitability, trends of the banks have shown lots of fluctuations during the period investigated. However, in general, the profitability of the banks are noticeably higher in 2007 than in 2001, which indicates an overall increase in the profitability of the sector since the time when crisis took place.

Finally, in general, liquidity level of the banks in the TRNC banking sector is deteriorating since 2002-2003, after a sharp and immediate increase following the banking crisis of 2000-2001. In 2007, the liquidity level of the banks decreased to a level near to that at the time of the crisis in 2001, indicating an increased possibility of a distress period stemming from a liquidity shortage. On the other hand, the decline in the liquidity level seems to have had a positive impact on the profitability level of the banks.

As a result of the CAMELS analysis, it can be argued that the components of profitability and the management quality of the banks have improved in the TRNC banking sector since the crisis


whereas capital adequacy, asset quality and liquidity level, have deteriorated which has raised concerns regarding the future of the banking sector. Acknowledgement The author would like to express his sincere gratitude to Assist. Prof. Dr. Mete Feridun for his continuous support and useful suggestions throughout this project, and to Assoc. Prof. Dr. Hatice Jenkins and Assist. Prof. Dr. Mustafa Besim for their encouragement. References [1] Bektas, E. (2005), “Structure and Performance Analysis of the TRNC Banking System”.

Wolfson Cyprus Group Conference on “Sustainable Economic Development in Cyprus: Towards Economic Convergence and Reunification: The Case of The Northern Cyprus, 27-28 May 2005, Nicosia.

[2] Gunsel, N. (2007), “Financial Ratios and the Probabilistic Prediction of Bank Failure in North Cyprus”. European Journal of Scientific Research, pp: 191-200

[3] Safakli, O. (2003), “Basic Problems of the Banking Sector in the TRNC with Partial Emphasis on the Proactive and Reactive Strategies Applied”. Dogus Universitesi Dergisi, pp: 217-232

[4] Safakli, O. (2006), “A Research on the Usage of Credit Cards in TRNC”. Journal of Applied Sciences, pp: 400-405

[5] Safakli, O. (2007), “Credit Risk Assessment for the Banking Sector of Northern Cyprus”. Journal of Yasar University, pp: 615-630

[6] Sarker, A.A (2006), “CAMELS Rating System in the Context of Islamic Banking: A Proposed ‘S’ for Shariah Framework”. Journal of Islamic Economics, Banking and Finance, vol. 2, no. 2, July-December 2006.

CAMELS Journal

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