Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No: 51388-TR

PROJECT PAPER

ON A

PROPOSED ADDITIONAL LOAN

IN THE AMOUNT OF US$100 MILLION AND €101.1 MILLION (US$250 MILLION EQUIVALENT)

TO THE

TURKIYE HALK BANKASI A.S. (HALKBANK)

WITH THE GUARANTEE OF THE REPUBLIC OF TURKEY

FOR

THE ACCESS TO FINANCE FOR SMALL AND MEDIUM ENTERPRISES PROJECT

NOVEMBER 17, 2009

Private and Financial Sector Development Department Turkey Country Unit Europe and Central Asia Region

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

(Exchange Rate Effective Oct 31st, 2009)

EURO 1 = US$ 1.485 US$1 = EURO 0.673

FISCAL YEAR January 1 – December 31

ABBREVIATIONS AND ACRONYMS

BEEPS BDDK

Business Environment and Enterprise Performance Survey Banking Regulation and Supervision Agency

CBT Central Bank of Turkey CPS Country Partnership Strategy DC Direct Contracting ECA Europe & Central Asia (Region) EFIL Export Finance Intermediation Loan EU European Union FIL Financial Intermediation Loan FSL FMR FMS

Fixed Spread Loan Financial Monitoring Reports Financial Management System

FX Foreign Exchange GOT Government of Turkey IFRS International Financial Reporting Standards ICA Investment Climate Assessment ICB International Competitive Bidding ICR Implementation Completion Report IFI International Financial Institution ISA International Standards on Auditing ISR Implementation Status Report ISP International Shopping Procedures NCB National Competitive Bidding NS National Shopping OECD Organization for Economic Cooperation and Development OM Operational Manual PIU Project Implementation Unit SME Small and Medium Enterprises SPO State Planning Organization SOE Statement of Expenditure TSKB Türkiye Sınai Kalkınma Bankası

Vice President: Philippe H. Le Houerou

Country Director: Ulrich ZachauSector Director: Fernando Montes-NegretSector Manager: Lalit Raina

Team Leader: Isfandyar Z. Khan

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

FOR OFFICIAL USE ONLY

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.

PROJECT PAPER

Republic of Turkey

ACCESS TO FINANCE FOR SMALL AND MEDIUM ENTERPRISES PROJECT ADDITIONAL FINANCING

TABLE OF CONTENTS

I. Introduction ................................................................................................................ 3 II. Background and Rationale for Additional Financing ............................................... 3 III. Proposed Changes .................................................................................................. 10 IV. Consistency with Country partnership strategy ...................................................... 11 V. Appraisal of Scaled-up Project Activities ............................................................... 11 VI. Expected Outcomes: .............................................................................................. 15 VII. Risks: ..................................................................................................................... 15 VIII. Financial Terms And Conditions For The Additional Financing ....................... 17 Annex I Halkbank Assessment .............................................................................. 18

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REPUBLIC OF TURKEY ACCESS TO FINANCE FOR SMALL AND MEDIUM ENTERPRISES PROJECT

ADDITIONAL FINANCE Europe and Central Asia Region

Private and Financial Sector Development Department PROJECT PAPER DATA SHEET

Date: Dec 15th 2009 Country: Turkey Project Name: Access to Finance for Small and Medium Enterprises Project ID: P108140

Team Leader: Isfandyar Z. Khan Sector Manager: Lalit Raina Country Director: Ulrich Zachau Environmental Category: FI

Borrower: Türkiye Halk Bankasi A.Ş. (Halkbank), Responsible agency for this Loan: Türkiye Halk Bankasi A.Ş. (Halkbank), Guarantor: Republic of Turkey

Revised estimated disbursements (Bank FY/US$)1 FY 09 10 11 12 Annual $400 $110 $120 $70 Cumulative $400 $510 $630 $700

Current closing date: April 30th 2012 Revised closing date: NA

Does the restructured or scaled-up project require any exceptions from Bank policies? Have these been approved by Bank management? Is approval for any policy exception sought from the Board?

○ Yes X No ○ Yes ○ No ○ Yes X No

Revised project development objectives/outcomes Not applicable. The original project objective will remain the same, that is, to increase Turkish SMEs’ access to medium term finance Does the scaled-up or restructured project trigger any new safeguard policies? No

For Additional Financing [X ] Loan [ ] Credit [ ] Grant For Loans/Credits/Grants:

Total Bank financing (US$): US $ 250,000,000 million equivalent (US$100,000,000, € 101,100,000) Proposed terms: IBRD Flexible Loan with an interest rate equal to 6 months Libor, plus fixed spread with final maturity of 14 years including a grace period of 5, commitment linked with level repayment pattern

Financing Plan (US$m.) Source Local Foreign Total

Borrower IBRD Total

0 0 0

0 250 250

0 250 250

1 Disbursement estimates are for the original project and the two additional financings.

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I. INTRODUCTION

1. This Project Paper seeks the approval by the Executive Directors of an additional loan in the amount of US$ 250 million equivalent (US$ 100 million and € 101.1 million) to Halkbank, guaranteed by the Republic of Turkey, for the Access to Finance for Small and Medium Enterprises Project.

2. The Access to Finance for SMEs project, a financial intermediation loan (FIL) in Turkey, is implemented by two borrowers: Halkbank and Türkiye Sınai Kalkınma Bankası (TSKB), each originally supported by a loan of €100 million equivalent approved by the Board of Executive Directors in June 2007. After Halkbank disbursed its original loan amount an additional finance loan in the amount of $ 200 million was approved by the board in December 2008.

3. The Access to Finance for SMEs project is being successfully implemented and has proven effective in achieving its objectives by providing financing for over 435 small and medium firms so. The loans are well dispersed both sectorally and geographically. SMEs representing more than twenty sectors from varied areas such as printing, plastic processing, solar energy, tourism and food processing have utilized funds from the project. The geographical coverage extends to most parts of Turkey with an emphasis on underserved areas. The additional financing for Halkbank is expected to enable further expansion of the sectors covered and broaden the coverage of the project. Such expansion of access to finance for SMEs is especially important during the time of constrained financing due to the impact of the global economic crisis.

II. BACKGROUND AND RATIONALE FOR ADDITIONAL FINANCING

Project Background 4. The existing Access to Finance for SME project is supported by a loan in an amount of €100 million equivalent for TSKB (Loan 7390-TU) and a loan in an amount of €100 million equivalent to Halkbank (Loan 7389/7462-TU). The project was approved by the Board in June 2007 and the loans became effective in July 20072. Loan 7606-TU ($200 million equivalent for Halkbank) was processed as an additional financing loan to scale up the original project. The loan was approved in December 2008 and made effective in January 2009. A second additional financing loan is now sought for Halkbank as Halkbank has completed disbursement of its first additional finance loan funds to sub-borrowers. TSKB has approved disbursements of 56% as of October 1st 2009.

Macroeconomic Background 5. The Turkish economy has entered a phase of gradual recovery. The underlying, systemic strengths have meant that as the worst of the global crisis has receded and

2 The IBRD financing for the project was originally structured to include two loans --€100 million (€ 60 million and $ 48.1 million) for TSKB, and €50 million for Halkbank, and approved by the Board in June 2006. Prior to signing, Halkbank requested an increase of the loan amount to €100, so the project was re-submitted to the Board in June 2007.

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uncertainty fallen, the Turkish economy has stabilized and shown signs of initial recovery. Leading indicators of activity such as industrial capacity utilization and purchaser/manager indices of business confidence point to the recession bottoming out in Turkey in the second quarter of 2009. Capacity utilization has risen from a low of 63.8 percent in January 2009 to 71.8 percent in October 2009. Interviews conducted with IFC clients confirm this picture: investment and business development plans remain in place even if delayed and order books are fuller in the fall than in the spring of 2009.

6. Manufacturing is also picking up slowly. Turkey's manufacturing was particularly affected by the global economic downturn, above all automotive, textile, consumer-durables and capital-goods sectors. Economic activity is now recovering slowly. Nevertheless, fixed capital formation has fared particularly badly, posting a negative growth rate of 24.6 percent in the second quarter of 2009 (y/y). This decline in investment most likely reflects the absence of significant foreign direct investment flows and excess capacity in key sectors. Private consumption growth, at -1.2 percent, represented a significant improvement over the first quarter (-10.2 percent), mostly supported by the tax incentives (on durables and car purchases) introduced by the government.

7. The Government’s new Medium-Term Program (MTP) announced on September 16th 2009, begins the transition from crisis management to renewed growth. The MTP and the more detailed Medium-Term Fiscal Plan (MTFP) announced on September 18th 2009 give aggregate fiscal targets for the period 2009-12 and set the stage for the 2010 budget. The MTP also broadly outlines a post-crisis reform agenda for shared growth. As in previous years, the MTP document includes a wide range of reform areas that follow the development axes established by the Ninth Development Plan for 2007-2013 and in addition the transition from crisis-response policies. Among the key planned reforms are the introduction of a fiscal rule in 2011, further labor-market, tax administration, and local government finance reform, the expansion of education and vocational training, and measures to increase credit access especially for SMEs.

8. Economic activity is forecasted in the MTP to contract by 6.0 percent in 2009, is consistent with Bank staff’s projections. Growth is then projected to recover gradually to 3.5 percent in 2010, 4.0 percent in 2011, and 5.0 percent in 2012. The growth process is expected to be led by the private sector, with an expected pick-up in private gross fixed capital formation to 8 percent in 2010.

9. Overall, the government’s economic framework for 2010-12 represents an appropriate balance between ambition and realism. The program targets ambitious but achievable fiscal goals and the stabilization of public debt as a share of GDP, and has been welcomed by most analysts. Following the announcement of the Program, two rating agencies upgraded their outlook for Turkey.

10. The rollover ratios of Turkish banks and corporations are expected to rise slowly over the next 3 years. The rise in the rollover ratio of corporate medium and long term (MLT) debt from 75 percent in 2009 to 130 percent in 2012 implies a much slower buildup in external debt than before the global crisis (when Turkey’s rollover ratios were above 200 percent).

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Public Debt Sustainability

11. Debt Sustainability is being addressed. Under the Government’s Medium-Term Program (MTP), total gross public debt (EU definition) is projected to peak at 49 percent in 2010, before stabilizing in 2011 and then declining to 47.8 percent in 2012. Stress testing by World Bank staff suggests that even under adverse scenarios the gross public debt to GDP ratio would remain below the EU Maastricht criterion of 60 percent of GDP3. The rise in debt ratios underlines the importance of the measures underpinning Turkey’s fiscal readjustment as well as the return to growth. Turkey has a strong track record in public debt management, mitigating some of the macroeconomic risk. According to the MTP, starting in 2011 public financial management will be conducted in line with a fiscal rule, whereby the public sector deficit will be set in line with a debt sustainability framework over the medium to long term. Strong implementation of the fiscal rule, along with other measures in the MTP, should allow Turkey to reproduce, as the economy gradually recovers in the coming years, its proven track record of reducing the public debt burden during the high economic growth period of 2002-08.

External Debt Sustainability and Financing Sources

12. The economic slowdown has removed the main source of pressure in recent years, the current account deficit on Turkey’s external debt dynamics. The gradual economic recovery assumed in the MTP and the associated external financing requirements pose no threat of a rapid escalation of public or private external debt in the near future.

13. Public external debt is low and is expected to remain so. Since the 2001 crisis the Turkish Treasury has pursued a conservative strategy of financing itself largely using domestic currency debt instruments, removing much of the foreign exchange risk from the public debt portfolio. For example, the Treasury reports4 that in 2001 a 5 percent real depreciation would have added 2.2 points to the public debt-to-GDP ratio; in 2008 this sensitivity was only 0.8 points. Other market risk has likewise diminished, reducing the risk premium on Turkish sovereign debt.

Banking Sector Background

14. The Turkish banking sector has proven resilient to the effects of the global credit crisis. The system remains highly-capitalized and profitable, despite a deterioration in asset quality (Table 1). Unlike in other emerging market economies, the Turkish banking system relies on a strong and stable domestic deposit base for funding, as reflected in relatively low loan/deposit ratios. Wholesale funding, including syndications and securitizations, is relatively low at about 15 percent of non‐equity liabilities. The performance of the banking sector has been supported quite significantly by prompt and effective policy action on the

3 The Maastricht criterion is relevant for Turkey in view of its prospects for EU accession. It is also worth noting that lower public debt to GDP ratios, in the 30-40 percent range or lower, have been shown to provide emerging market economies with a buffer that can help them maintain debt sustainability even in case of external shocks 4 Debt Indicators October 2009 Presentation

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part of the government and the monetary authorities to maintain stability in financial markets. Specifically, profitability has been supported in 2009 by a rapid widening of net interest margins as the policy rate has been cut by 950 basis points since last November, enabling banks to reduce their deposit costs and compensate for higher provisioning charges. Capital adequacy was relatively high at 19 percent as of end‐June 2009.

Table 1: Banking Sector Financial Strength Indicators

Percent 2004 2005 2006 2007 2008 June 2009

Gross Non-performing loans/ Total loans 6.0 4.7 3.7 3.5 3.7 4.8

Provisions/NPL 88.7 88.7 89.7 86.8 79.8 79.7 ROA /1 2.5 2.7 3.3 3.4 2.5 1.8 ROE /1 13.4 12.1 21.0 24.8 18.7 12.7 Loans/deposits 51.0 65.7 74.3 83.2 84.1 82..9 CAR 27.6 23.7 21.9 18.9 18.0 19.2

Source: BRSA, 1/June numbers are not annualized. /1 The elimination of inflation accounting at the end of 2005 makes the income data not comparable across time

15. Nevertheless, as a result of the global credit crisis and the ensuing uncertainty, lending volumes have stalled. Since end‐2008, commercial bank loan volumes have been flat, with only state banks showing some increase in their loan books (Figure 1). Lending to SMEs, a sector that had been growing significantly since 2005, has actually dropped in relative terms, which at TL 80 billion (Figure 2) accounts for less than 22 percent of total lending, compared to almost 24 percent at end-2008. In this connection, while lending rates, after peaking in October 2008, have been on a downward trend, there is anecdotal evidence that there is segmentation in the market, with rates charged to SMEs clients exceeding by far those offered to larger corporate clients. So far, the performance of corporate and commercial loans and mortgages has held up relatively well, whereas NPLs on SMEs, credit cards and unsecured consumer loans has grown considerably. The NPL ratio for the system as a whole was 4.8 percent at end-June 2009.

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Figure 1: Banking Sector Credit

Figure 2: Lending to SME Sector

16. The Government has taken steps to reactivate credit activity and mitigate risk-averse behavior in the banking system. Chief among these actions is the enhancement of the existing credit guarantee fund (KGF) scheme. Through legislative action an additional TL1 billion is going to be made available in the next two years for leveraging additional credit resources for SMEs. The guarantee scheme follows international best practices in that guarantees are limited (not to exceed 65 percent of loan amounts) and leaves credit risk assessment and recovery efforts with the commercial banks originating the credit. An element of burden-sharing has been introduced into the activities of the KGF by requiring beneficiary commercial banks to participate in a subscription of fresh capital for the KFG.

17. Turkey’s domestic financial system, though it is well-capitalized and prudential regulations meet modern standards, is shallow for an economy Turkey’s size, with total banking sector credit accounting for about a third of GDP. After surviving crisis and restructuring in 2001-02, the Turkish banking sector has been understandably conservative, faced with the high uncertainty of late 2008 and early 2009. Therefore, Turkey’s banking sector is clearly sensitive to external developments and may turn out to be reluctant to ease credit conditions without solid improvements in global economic conditions. Steps to enhance confidence and underpin financial intermediation, such as the expansion of the credit guarantee fund, may therefore have a role to play during the anticipated recovery.

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SME Access to Credit Background 18. SMEs are important not only for economic growth in the country, but particularly for employment and development outside the major urban areas. As of end September it is estimated that SMEs account for 76.7 percent of total employment and 50 percent of GDP.

19. Evidence has shown that smaller firms and firms outside the major urban areas have less access to credit. As it is often the case, smaller firms use credit less frequently than larger ones. In addition, regardless of firm size, firms in major cities are more likely to have a loan than others are. Even when grouping firms by size, it remains true that firms in cities with populations of one million or more have loans more frequently than do firms in smaller cities and towns (Figure 3). It is possibly a result of bank branches being concentrated in major urban areas, and this bias may therefore reflect a physical barrier to accessing loans for the firms outside the cities.

20. After being severely underserved SMEs started gaining access to credit around 2004, but the crisis has reversed that trend in both relative and absolute terms. With the stabilization of the financial sector and the economic environment providing credit to SMEs became highly profitable for the financial sector, and many more firms gained access (Figure 4).

Rationale for the Bank Involvement 21. An effective financial sector that provides investment credit to firms supports economic development by enabling firms to invest in technology and capacity. That raises output and productivity thereby fueling growth and employment opportunities.5 In addition, evidence suggests that a well-functioning financial system enables the poor to benefit proportionally more from economic growth (i.e.; growth is pro-poor).6

5 The positive association between employment and credit was established in the Turkey ICA (2007), and the importance of finance for competitiveness was further discussed in the Turkey CEM II (2008). 6 See Beck, Demirgüç-Kunt, and Levine (2007).

Figure 3: Share of Firms with Loans

Source: Turkey Investment Climate Assessment (2007).

0

10

20

30

40

50

60

70

Small Medium Large

Large cities (>1 million people) Smaller cities and towns

Per

cen

t

Figure 4: Share of firms using banks to finance investments by firm size

Source: Turkey Investment Climate Surveys.

0

10

20

30

40

50

60

Small Medium

Perc

ent

2002 2004 2005 2008

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22. SMEs remain underserved in terms of credit and in addition, there is evidence of spatial inequality in the provision of credit. The project has been successful in addressing these issues. As a result of the global credit crisis, lending volumes have stalled and the loan/asset ratio is declining at the expense of growing exposure to government securities. Since end‐2008, total loan volumes have been flat, whereas securities holdings increased by 14 percent (31 percent of total assets). A World Bank enterprise survey conducted in early 2009 found that access to finance was the biggest obstacle to growth. In the long run domestic banks are expected to expand lending business to SMEs. The project is designed to develop this market and to maintain credit flows to the sector.

23. Most of the funding for the corporate sector especially to SMEs is short term in nature. For example, deposits, which constitute about two thirds of total liabilities, have the average maturity as of end-July 2009 of 2.2 months for TL and 2.7 months for foreign currency deposits (2.4 months on average), thus restricting the ability of Turkish firms to invest in productivity enhancements. This project enables firms to have access to a stable and longer term funding, making them more competitive. The project has already proven effective in generating longer term credits to SMEs by providing long term funding for the companies, with the average maturity being greater than five years.

24. Halkbank’s financial condition is strong. As explained in detail in Annex I, Halkbank remains in strong condition. It attains the position of strength due to a mix of core deposits that buffers against adverse market movements, limited market exposure and a high capital adequacy ratio. In the current financial crisis where highly leveraged financial institutions are finding it difficult to lend, Halkbank’s past risk averseness has placed it in a strong position to remain active in the SME sector whilst other banks are restricting lending due to liquidity constrains.

Rationale for Additional Financing

25. The additional financing is expected to increase the development impact of the project and continues to support the project's development objective "to increase Turkish small and medium enterprises (SME) access to medium-term finance". It will scale-up SME financing not only during the implementation period (2008-2012), but also beyond that period as the Borrower will use the reflows repaid from the initial sub-borrowers to finance new investments before the funds are returned to the World Bank. Such expanded financing responds in particular to the financing constrains due to the impact of the global crisis.

26. The project has achieved impressive results to date with a broad spectrum of SMEs using the funds as investment loans to improve their productivity and working capital loans to complement their investments and scale-up their operations. 42 percent of the loans made by Halkbank have been for investment purposes. Given the current financial crisis the trend has been shifting towards more working capital loans. The geographical dispersion of the borrowers and the wide range of industries included confirm Halkbank’s ability to reach SMEs. Commitments and disbursements since effectiveness have proceeded at a rapid pace. As of October 2009, Halkbank disbursed € 100 million (original loan) and US$ 200 million to over 400 SMEs, confirming both the demand for credit by

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SMEs and Halkbank’s ability to implement the project. The average loan size for Halkbank is $ 780,000 and average maturity over 5 years. TSKB has disbursed $ 34 million and € 27 million (out of a loan amount $48 million and €60 million) to 35 SMEs. The average loan size for TSKB is $ 2.5 million and the average maturity is also over 5 years.

27. The implementation performance of the existing project is strong. The implementation performance ratings for all categories are either highly satisfactory or satisfactory in the last ISR. Halkbank and TSKB are in compliance with all legal covenants including prudential and eligibility requirements. There are no outstanding fiduciary or safeguards issues. The project is currently rated satisfactory on financial management and procurement aspects as well as on social and environmental aspects.

III. PROPOSED CHANGES

There are no proposed changes to the project design.

28. The additional loan will finance a credit line intermediated by Halkbank. The SMEs will be the final beneficiaries of the credit line. For purposes of this additional financing, SMEs will continue to be defined as firms employing fewer than 250 people and having annual sales of less than US$20 million. To ensure that the project covers geographical regions in which SMEs are particularly underserved, Halkbank plans to allocate a portion of the loan to the areas as defined in the Loan Agreement. The credit line will finance medium-term working capital (e.g. raw materials, overheads, inventories, labor) and investment loans (e.g., machinery, equipment, and civil works) with no sector restrictions. Sub-loans will be provided on the same terms and conditions as stipulated in the original Loan Agreement. The lending rates would be approximate to what sub borrowers would pay in the market for similar money, taking into account, as relevant, maturities, risks, and scarcity of capital.

Institutional and implementation management

29. The project has a current closing date of April 30, 2012. The implementation period for the additional loan will not require an extension, and the closing date will remain unchanged.

30. For purposes of the project, there is an existing operational manual which will continue to be used and will reflect the additional amount. Implementation shall be carried out through the existing Project Implementation Unit (PIU). The PIU at Halkbank is fully staffed and operates under the overall supervision of an Assistant General Manager. The PIU includes experienced management and staff including representatives of the financial analysis, financial control, credit, administrative, and operational departments. Annex I provides a summary evaluation of Halkbank including an analysis of the Bank’s financial soundness, its implementation capacity and specific considerations on the bank’s ability to meet the World Bank requirement including OP 8.30 on Financial Intermediation

Monitoring and evaluation of outcomes/results

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31. Halkbank will evaluate progress on the proposed indicators with supervision from the Bank through regular reporting and through implementation missions. Halkbank has agreed to submit yearly reports including output and outcome indicators and semi-annual financial management reports to the World Bank. The financial monitoring reports (FMRs) are included in the operational manuals. The data will come from internal Halkbank reports and the PIU has sufficient capacity to ensure provision of the monitoring data. The World Bank will also carry out physical inspection of sub-loans and projects financed out of the loan.

IV. CONSISTENCY WITH COUNTRY PARTNERSHIP STRATEGY

32. The additional financing is well aligned with the CPS, which calls for improving access to finance to improve competitiveness and employment opportunities. The CPS suggests a new credit line for SME productivity and competitiveness in FY10/11 while also mentioning that the timing of projects will be flexible.

V. APPRAISAL OF SCALED-UP PROJECT ACTIVITIES

Economic and financial analyses 33. SME sub-projects to be funded are not pre-identified and project costs not defined thus, a traditional economic/financial analysis cannot be conducted. The approach taken is to measure the development results in relation to the amounts intermediated.

Technical 34. Provisions are included in the project to ensure that lending rates reflect the cost of intermediating the funds including an appropriate credit risk margin as required by OP8.30. The final lending rate and the margin charged will be in line with market rates.The financial condition of Halkbank is good, it has proven its ability to maintain low non-performing loans ratios, and the capacity to implement the project is viewed as strong.

Fiduciary 35. Halkbank has satisfactory financial management (FM) arrangements for the Access to Finance for SMEs Project. The FM arrangements were assessed during the October 2009 FM supervision mission and rated as satisfactory. The supervision included the examination of project accounting and reporting arrangements, staffing, internal control procedures, planning and budgeting, financial manual and external audits.

36. Halkbank is in compliance with the FM provisions of the legal documents of the Access to Finance for SMEs Project. The semi-annual FMRs have been submitted on a timely basis in the agreed content and format. Halkbank also submitted the entity audit report for the year-ended December 31, 2008, and the project audit report for loan no. 7389-TU and 7462-TU for the period from effectiveness until July 31, 2008. The audit report on entity financial statements prepared in accordance with the International Financial Reporting Standards (IFRS) is unqualified (clean). The project audit report has two qualifications on exceptions to compliance with loan covenants relating to the

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eligibility criteria, for which the Bank has granted waivers. Both audit reports were assessed as satisfactory by the project’s FM specialist.

37. After Halkbank disbursed its original loan amount, which was covered by the project audit report mentioned above, an additional finance (AF) loan in the amount of $ 200 million equivalent was approved by the board in December 2008. Halbank started to withdraw from the AF account in April 2009 and fully disbursed as of September 30, 2009. The amounts remaining in their EUR and USD designated accounts will be disbursed to SMEs by mid-November 2009. Halkbank will provide an audit report for the Additional Financing by June 30, 2010.

38. Halkbank will continue to use its existing systems and staff for the financial management of this second additional financing. The same accounting, reporting and internal control procedures will apply. The financial monitoring report templates will be used unless additional information is requested from the task team. FMRs will be prepared semesterly and will be submitted to the Bank no later than 45 days after the end of the semester. The entity IFRS financial statements and project financial statements will be audited by private external auditors when disbursement ratio reaches 50% or on an annual basis. The terms of reference of the audit have to be acceptable to the Bank. The annual reports will be submitted to the World Bank no later than six months after the closing of the year. The interim reports, if any, will be submitted within a month after the date disbursements reach the above mentioned ratio. The disbursement procedures, as followed under the original project, would continue to be used for the additional loan.

Procurement

39. Procurement for the proposed additional financing will continue to be carried out in accordance with the World Bank’s “Guidelines: Procurement under IBRD Loans and IDA Credits” dated May 2004 revised in October 2006 (Procurement Guidelines); and the provisions stipulated in the original Loan Agreement. “Guidelines on Preventing and Combating Fraud and Corruption in Projects Financed by IBRD Loans and IDA Credits and Grants, dated October 15, 2006” (Anti-Corruption Guidelines) will apply to this additional financing. The additional financing will not finance any consultancy contracts.

40. For goods and works contracts at €2.5 million and below, established acceptable local private sector commercial practices may be followed in accordance with paragraph 3.12 of the Procurement Guidelines. International Competitive Bidding (ICB) would be required for individual contracts above €2.5 million for goods and works in accordance with Section II of the World Bank’s Procurement Guidelines

41. The Ankara based procurement specialist carried out an assessment of the capacity of the Halkbank to implement procurement actions for the project in October 2009 as well as assessment of the local private sector practices. The Halkbank assessment reviewed the organizational structure for implementing the existing project and the interaction between the project’s staff responsible from the procurement activities. Specialists assigned for the procurement arrangements within Halkbank’s PIU, established in the existing SME project, will continue to be responsible for all procurement oversight for the management

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of the additional financing. The overall risk for procurement is moderate in Halkbank. In order to reduce the procurement risk, Halkbank will support the PIU with 25 Engineers from the Project Evaluation Department. Considering that all contracts were procured through commercial practices in the current Loan, these Engineers basically will review (i) the appropriateness of prices relative to market prices; (ii) the appropriate use of funds for intended eligible purposes, with due considerations of economy and efficiency; (iii) technical compliance, physical completion and price competitiveness of the contracts and (iv) quality control measures to be put in place in terms of productivity and functionality of procured goods and works. As a result of the experience gained in the implementation of the existing Loan and given the fast speed of disbursement enhanced procedures will be applied in documentation and review procedures of the proposed Loan to improve the quality and efficiency in the procurement arrangements.

42. Sub-loan agreements of Halkbank will refer to the Bank’s Anti-Corruption Guidelines as well as the Procurement Guidelines. Halkbank will check the contracts from sub-borrowers so that the contracted firms are not in the Bank lists of debarment or suspended firms.

43. Halkbank branches will agree with each sub-borrower on procurement packages and methods exclusively during the sub-loan approval process. Halkbank branches will keep the records of procurements handled by the sub-borrowers including working capital expenditures. Updated procurement plans of all sub-loans (including working capital expenditures) will be kept in Halkbank PIU, and they will be furnished to the Bank along with other procurement documents whenever requested. The Bank will disclose the procurement plans of all International Competitive Bids (ICBs) on the Bank’s external web-site.

44. The World Bank will conduct semi annually post reviews and physical inspections of the contracts not requiring a prior review on a random basis. Considering the nature of the project, high number of contracts is expected, and therefore one in ten contracts for the contract size above € 50,000 equivalent; one in twenty contracts for the contract size between € 50,000-€ 10,000 equivalent; and one in hundred contracts for the contracts below € 10,000 will be post reviewed. The procurement arrangements including sampling ratio will be reviewed at least semi annually. Due to expected high disbursement rate of the Loan, the first post review will be conducted when the disbursement from the Loan reaches to 25% of the Loan amount, even if it happens earlier than the completion of the first six months of the Project. Bank’s team will include experienced consultants for the physical inspection of the procured goods and works. All post reviewed contracts will also be subject to physical inspection. All sub-project and contract information and sites will be available to Bank’s staff, auditors and consultants from Halkbank and sub-borrowers for its review. Procurement arrangements defined in the Operational Manual will be updated in agreement with the Bank before the Loan effectiveness.

Social 45. The project does not have any potentially negative social implications. By increasing access to finance and growth of SMEs, it is expected that the operation will

14

have a positive impact on employment. Furthermore, the project will not support any investment requiring land acquisition or associated involuntary resettlement (OP/BP 4.12).

Environment 46. Halkbank was found to be in compliance with the environment procedures described in the loan agreement based on the review done in April 2009. It was confirmed that (i) the sub-projects files of Halkbank’s branch and beneficiaries’ were conducted with respect to defined methods and environmental screening forms’ specified issues in the loan agreement and, (ii) provisions related to environment management (waste management, hygiene, personal protective materials, etc.) have been satisfactory from supply of raw materials to the final products in visited sites.

47. Halkbank will continue to use its existing systems for the environmental screening procedures. The project has been assigned “Category FI” in accordance with World Bank safeguard policy OP/BP/GP 4.01 (Environmental Assessment).

48. Halkbank has prepared environmental review procedures documents, which is a part of its Operational Manual. The Environmental Review Procedure, which serves as the Environmental Assessment Framework (EAF), provides guidance for the environmental analysis for the Bank’s team and documentation required and screening of the sub-projects. The procedures outline the requirements of World Bank and related environmental regulations of Turkey. These procedures have been accepted by World Bank. The EAF has been updated for the proposed additional financing and disclosed on Halkbank’s websites and in infoshop in November and is included as separate chapters in the bank’s operations manual.

49. Halkbank has decided to include the possibility of financing sub-projects that may, by Turkish environmental regulations, require an Environmental Impact Assessment (EIA) report. The environmental review procedures defined by Halkbank are consistent with Government of Turkey Environmental Assessment requirements, World Bank Environmental Assessment policies, and procedures utilized in previous Financial Intermediary operations in Turkey.

Safeguard policies 50. Environmental Assessment Policies (OP/BP 4.01) and Cultural Property Polices (OP 4.11) will apply to the proposed project. Halkbank and sub-borrowers will have to comply with these policies. No other policy is expected to be triggered by the project. The possibility of other policies being triggered by specific sub-loans made to SMEs will be assessed when conducting the loans’ environmental assessments.

15

Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP 4.01) X Natural Habitats (OP/BP 4.04) X Forests (OP/BP 4.36) X Pest Management (OP 4.09) X Physical Cultural Resources (OP/BP 4.11) X Indigenous Peoples (OP/BP 4.10) X Involuntary Resettlement (OP/BP 4.12) X Safety of Dams (OP/BP 4.37) X Projects on International Waterways (OP/BP 7.50) X Projects in Disputed Areas (OP/BP 7.60) X

Policy Exceptions and Readiness 51. The project complies with all applicable World Bank policies. There is no specific policy exception. The project is being implemented and the additional finance loan is ready for implementation. Specific conditions that have been met and that are sufficient to start with project implementation include:

Fiduciary (financial management and procurement) arrangements are satisfactory

Outcome and output indicators and monitoring and evaluation procedures have been agreed upon with the counterparts and are in place.

VI. EXPECTED OUTCOMES:

52. Enhanced access to medium-term finance for SMEs is the expected outcome. The projects outcomes are expected to be scaled-up proportionally to the already achieved outcomes. Specifically,

• an additional US$ 250 million equivalent worth of sub-loans will be disbursed; • sub-loan maturity will exceed 1 year for 90 percent of the loans; and • non-performing loans will be less than 7 percent of the disbursed amount.

VII. RISKS:

Risk Mitigating Measures Country and External Risks (To Project Development Objective)

Economic Risks: Fiscal and other macroeconomic policies face particular challenges in the context of ongoing global financial turmoil and the economic downturn.

Turkey's macroeconomic planning for the recovery is anchored in the recently announced medium term fiscal program. The program foresees a gradual economic recovery, which mirrors the projected performance of the world economy and Turkey’s major trading partners, projecting a return to potential growth of 5 percent only in 2012. This is associated with a decline in the unemployment rate by 1.5 percentage points from the peak

16

of 14.8 percent projected for 2009. The program envisages public debt as a share of GDP to rise until 2010, before stabilizing in 2011 and then beginning to decline in 2012, supported by a gradual improvement in fiscal balances..

Political stability: Political key risks to the reform program relate to continuing domestic political differences and the possibility of declining public support for reforms due to the impact of the crisis. There is also a risk that a focus of legislative and policy activity on the political agenda could delay ambitious and controversial reforms during the

remainder of the CPS period .

Turkey has had a stable government since 2002 under the Justice and Development Party (AKP), facilitating the implementation of major reforms. The EU accession anchor continues to mitigate political risks.

Ongoing global financial sector developments may have adverse effects on the banking sector in Turkey.

The Turkish banking sector has proven resilient to the effects of the global credit crisis. The system remains highly-capitalized and profitable, despite a deterioration in asset quality. The performance of the banking sector has been supported quite significantly by prompt and effective policy action on the part of the Government and the monetary authorities to maintain stability in financial markets. Specifically, profitability has been supported in 2009 by a rapid widening of net interest margins as the Central Bank of Turkey (CBT) has aggressively lowered interest rates (by 950 points since November 2008), enabling banks to reduce their deposit costs and compensate

for higher provisioning charges. Project-Specific Risks Improved financing conditions for Turkish financial intermediaries and a loss of competitiveness of the credit line.

The project would be crowded out if the market failure it attempts to address diminishes, i.e. if medium and long term financing became available at competitive costs to Turkish SME. In this case, the development objective would already be served by the private sector, and it is therefore not a risk to the development objective, but only a risk to project implementation. Considering the current appetite for credit in the SME sector this risk is low.

Credit risk of SMEs. The SME sector is a risky segment of the credit market, and care must be taken in selecting SMEs and managing the risk.

Halkbank has well developed credit appraisal procedure, which has been reviewed in detail by the team. Total NPLs under the existing project have been low (2.3 % in original loan and 0 in the additional finance loan). However NPLs in the SME sector are increasing, the NPL ratio reached 6.5 percent at end-June 2009 (compared to 2.5 percent at end-2007). The NPL ratio for the system as a whole was 4.8 percent at end-June 2009. Given that Halkbank is a bank that is focused on the SMEs it has developed expertise in managing risk in this segment and its NPLs are much lower than those of the banking sector.

Political influence on Halkbank’s lending decisions. As a state owned and controlled bank, Halkbank could be prone to

The team has reviewed the lending procedures and monitored the lending under the project and is fully satisfied that lending decisions in the project are made on a commercial basis and based on sound credit evaluation. The

17

political influence.

team also visited a number of branches in various locations and found the credit approval process satisfactory.

Lack of proper implementation of World Bank fiduciary and safeguard requirements

The procedures have been streamlined based on experience and Halkbank has proven its ability to effectively implement them while successfully disbursing the loan. Through the life of the project all reviews of fiduciary and safeguard requirements have rated the implementation by Halkbank as satisfactory

VIII. FINANCIAL TERMS AND CONDITIONS FOR THE ADDITIONAL FINANCING

53. The loan to Halkbank is in the amount of US$ 250 million equivalent (US$ 100 million and € 101.1 million). The loan is a flexible Loan (partly in US Dollar and partly in Euro) with an interest rate equal to 6 months Libor, plus fixed spread with final maturity of 14 years including a grace period of 5, commitment linked with level repayment pattern. The loans will be guaranteed by the republic of Turkey.

54. The conditions of the original project will continue to prevail for the additional financing.

Terms and Conditions between Halkbank and the Sub-Borrower SMEs

55. SMEs must meet the eligibility criteria identified in the original project in addition:

• At least $ 75 million equivalent worth of sub-loans shall be in the priority regions for development as defined in the Council of Ministers Decree 2009/15513, dated October 12, 2009.

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Annex I Halkbank Assessment7

Overview of Halkbank 1.1 Halkbank is a large deposit-taking state bank primarily serving SME customers

throughout Turkey. It is the 7th largest bank in Turkey by assets and has the 6th largest branch network (see Table 1.1 for key indicators). The bank currently has the Turkish Government as its main stakeholder with a 75% share. With 25% of its shares now quoted, Halkbank has strengthened its corporate governance policies, with the creation of an audit committee and other locally recommended guidelines. Following IPO process, the strategic and operational decisions are increasingly made on a commercial basis.

1.2 Substantial financial and operational restructuring over the past few years have contributed to the bank now being financially sound as well as profitable. The board approves policies, strategies, and principles for the bank. In line with industry practice, the bank has a risk management unit reporting directly to the board. An organizational chart for the bank is included in Figure 1.1 at the end of this Appendix.

Table 1.1: Halkbank key indicators

June 2009 Billion US$

Share of System/ percent

Assets 36.6 7.5 Deposits 26.9 8.8 Loans 18.5 7.8 Securities 13.3 8.9 Branches (number) 645 7.3

Source: Independent Auditors, BAT and staff calculations.

Suitability of Halkbank as Counterpart 1.3 Halkbank has been selected as counterpart for the Project, which will provide credit

to SMEs all over the country. One of Halkbank’s key strategic objectives is to expand its SME business. Halkbank’s vision reads, “Becoming the leading SME bank of the country….” In fact, Halkbank’s portfolio is already dominated by commercial credit (with a significant share of SMEs slightly over 39.4%), while the bank extends less consumer credit (21 percent of loans).

1.4 Halkbank has a relatively strong presence in the East and Center of the Country where credit is less developed. While the Turkish banking system only has 10 percent of its loan portfolio in the eastern and central region, Halkbank has 17 percent of its loan portfolio (or US$ 3.278 billion) in this area. Details on the loans in the two relevant parts of the country are provided in Table 1.2.

7 Unless otherwise noted, data in this section reflect end-December 2008 and are from the The Banks Association of Turkey.

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1.5 Halkbank’s sustaining participation in the project is thus well aligned with its strategy. Halkbank is seeking to further strengthen its position as an SME bank by increasing its product range and growing its portfolio to that segment. Halkbank’s portfolio of non-tradable investment securities shifts towards tradable securities and loans in the recent years. However a change made by the BRSA in October, 2008 increased this figure to (79.5% of total securities) USD 10,638 billion as of end-June 2009 like in other Turkish banks’ security structure. Halkbank has a low but inreasing loans-to-deposit ratio in Turkey, at 68.8 %, compared to an average loans-to-deposit ratio of 83 % in the banking system. This suggests that Halkbank has a large customer base that is currently not exploited in terms of extending credit. While the loan to asset ratio of the sector is 49.2%, Halkbank’s ratio is slightly over the average with 51.2%. By taking into consideration the loan to deposit ratio, loan to asset ratio displays the strong deposit structure of Halkbank.

Table 1.2: Halkbank loan portfolio by region Million US$ end-year, 2008

Western region

Targeted region

Total

Total credits 15,872 3,278 19,150

NPLs 856 132 988

Source: Halkbank. Financial Soundness and Risk Exposures 1.6 Halkbank is a well-capitalized and profitable bank with relatively small market risk

exposures. The bank’s liquidity is strong enough to protect it against adverse market movements. Furthermore, since the great portion of Bank’s liabilities is composed of deposit which is the stickiest liability item in crisis, strengthens the liquidity structure of the Bank. The loan portfolio has performed well in the past four years, and the bank is run in a sound manner. Table 1.3 includes Halkbank’s financial statements compared with those of the Turkish banking system. The section below includes a detailed evaluation of Halkbank’s financial and operational performance.

1.7 Solvency. With a capital adequacy ratio of 14.7 % (see Table 1.4), the bank is solvent when measured against risk-weighted assets. The much lower capital-to-assets ratio of 8.76 % reflects the bank’s large holding of government debt securities with 0 % risk weighting.

Table 1.4 Solvency Banking System Halkbank Percent

Jun 2009 Jun 2009 Dec 2008 Jun 2008

Tier 1/risk weighted assets 19.23 16.05 14.51 14.54 Capital adequacy ratio 19.4 14.69 14.49 14.08 Capital/total assets 12.70 8.76 8.39 8.31 Source: BRSA and staff calculations.

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1.8 Credit risk and loan portfolio performance. The bank’s gross NPL-to-total loans ratio is at 5.06 % (see Table 1.5). However, it largely reflects old non-performing loans that have been fully provisioned for but not written off. Current portfolio performance is sound. A substantial portion of the NPLs are carried over from Emlak Bank, which failed during the crisis and was merged with Halkbank. Specific provisions are made for 80.13 % of gross NPLs, and no loans have been written off in the past five years. New non-performing loans (including sub-standard) net of collections during the period 2005 to 2007 amounted to less than 2 % of the bank’s current loan portfolio. The recent performance of Halk’s loan portfolio is thus sound. Halkbank’s borrowers are widely dispersed, and concentrations are not a concern. In contrast to private banks, Halkbank extends 83.5 percent of loans in local currency and therefore does not expose itself to indirect currency depreciation risk such as is otherwise common in Turkey.

21

Table 1.3: Summary balance sheet and income statement for Halkbank and the banking system

Source: Banking Regulation and Supervision Agency and Staff Calculations.

1.9 Halkbank has a well diversified portfolio in respect of sectors and regions. Current developments are testing the creditworthiness of SME clients however separate rating systems are used for corporate and SME loan portfolio of the Bank and the loan customers are subject to internal rating process, so the firms’ credibility is assessed correctly. Given Halkbank’s experience with the SME sector it has adequate in house procedures and expertise to ensure good health of the SME portfolio. The bank has been generating default statistics in house and the PD rates are lower than the other banks (peer group) in the Turkish banking sector, for the last 3 years. The internal rating system is validated and the economic capital

22

requirement of the Bank is measured periodically, thus the credit risks are managed effectively, by the department of Risk Management.

Table 1.5: Credit risk Banking System Halkbank

Percent Jun

2009 Jun

2009 Dec 2008

Gross NPLs/gross loans 4.85 5.06 4.65 Gross NPLs/capital 18.7 30.7 29.18 Loan provisions/NPLs (incl. substandard) 81.5 80.1 82.94 Loan provisions/capital 15.3 24.6 24.2

Source: BAT and staff calculations.

1.10 Profitability. The bank is profitable by both Turkish and international standards, with real ROA of 1.4 and real ROE of 16.1 (see Table 1.6). As the Turkish banking market evolves, new sources of profits must be developed. Halkbank’s non-marketable securities are currently being remunerated above would-be-market prices, and as they mature they will be partially replaced with lower yielding assets. Halkbank has a greater portion of its assets invested in Government securities than private Turkish banks, and return on this position is declining. Halkbank’s ability to sustain its current high level of profitability will depend on its ability to shift its portfolio in response to changing profit opportunities. However, even a lower level of profitability would not endanger Halkbank’s financial soundness.

Table 1.6: Profitability Banking System Halkbank

Percent Jun

2009 Jun

2009 Dec 2008

Return on average assets 1.4 1.4 3.2 Return on average equity 11.4 16.1 30.6 Net interest income less provisions/average assets 2.1 2.2 5.2 Operating expenses/average assets 1.83 2.1 2.1

Source: BAT and staff calculations

1.11 Liquidity. Liquidity is monitored both by the ratios defined by the BRSA and the ratios set by the Bank within the context of Liquidity Contingency planning. This plan also includes early warning indicator ratios that enables bank to define organization and the procedures to provide commensurate liquidity on time. The Bank’s strong core deposit base has been a good liquidity buffer against adverse market movements. As it can be understood the tables below (see table 1.7) Halkbank’s liquidity ratios are far above the limits defined by BRSA.

23

Table 1.7: Liquidity

Source: BRSA Liquidity Adequacy Reports.

1.12 Market risk exposures. Halkbank’s market risk exposures are very moderate. The bank hedged it’s on balance sheet foreign currency position with off balance sheet items.(See Table 1.8). The amount of net foreign currency position is negligible when we compared it with the amount of total assets. Due to the fact that 78 percent of the TRY denominated securities held by Halkbank is composed of floating rate, the Bank carries low interest rate risk on it’s balance sheet. Furthermore, the Bank measures the effects of interest rate movements on its P/L and net economic value by using periodical stress tests and scenario analysis.

Table 1.8: Exchange rate risk Banking System Halkbank

Percent Jun

2009 Jun

2009 Dec 2008

Net foreign exchange position on bs/capital (0.10) (12.96) (29.20) Net foreign exchange position on and off bs/capital 0.76 (1.5) (4.1) Foreign currency denominated loans/total loans 26.9 25.97 25.52 Foreign currency denominated assets/total assets 28.9 25.32 26.02 Foreign currency denominated liabilities/total liabilities 33.6 27.32 30.1

Source: BAT and staff calculations.

Subsidized Credits 1.13 Halkbank extends two types of subsidized credits; “IFI credits” and “cooperative

credits,” that account for 22 % of total loans (see Table 4.9 for an overview of loans by type and region). The subsidy elements are fully financed by sponsors outside Halkbank, and the subsidized credits are structured in a way that does not distort Halkbank’s credit decision or interest rate setting for other loans.

Table 1.9: Halkbank loan portfolio by loan type and region, end-June 2009

Million US$ Western region

Targeted region

Total

Coop credits 2,359 1,110 3,470

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IFI loans 608 117 725

Other loans 12,903 2,050 14,954

Total credits 15,871 3,278 19,150 Source: Halkbank.

1.14 Directly subsidized “cooperative credits”: Cooperative credits are extended to small individual borrowers under credit cooperatives, and only borrowers organized under these credit cooperatives are eligible. The borrowers are small, and the scheme is akin to microfinance schemes seen in many other places. Halkbank receives a 50 % subsidy of the interest rate from the Government in order to reduce interest on the loans. Credit risk is reduced by the joint liability of the cooperative and the borrower. When payment from a borrower is late, the amount is charged directly from the cooperative’s account. This program is only offered by Halkbank, and it is expected to be phased out over time. The loans are carried on Halkbank’s balance sheet. These programs are no way related to the lending done by Halkbank under the current World Bank Access to Finance for SMEs project.

Indirectly subsidized “IFI loans” 1.15 Fund loans are financed by below market rate liabilities provided in the form of

loans from, for instance, IFIs including EIB, CEB, AFD, IBRD, etc. Halkbank is required to lend the funds according to certain criteria, such as location in specific zones or to special groups of borrowers such as SMEs. The proposed World Bank credit line will also fall in this category. The loans are priced fairly close to market prices, and Halkbank earns a normal spread, carries the credit risk for these loans, and has the loans recorded on its balance sheet. Some of the fund loans are available to other banks in the market, including private banks, and Halkbank does not enjoy a favorable position vis-à-vis other banks with respect to these loans.

Other loans 1.16 The remaining balance of the total loans also includes another type of subsidized

loans such as EXIM and KOSGEB. The sum of these loans is USD 377 million.

1.17 Operational Policy 8.30 (OP 8.30) Considerations

OP 8.30 applies to Halkbank for the proposed operation. In summary, the conditions are viewed as being met for Halkbank as an intermediary. Regarding the specific issues for financial intermediaries under OP 8.30:

(a) Adequate profitability, capital, and portfolio quality, as confirmed by financial statements prepared and audited in accordance with accounting and auditing principles acceptable to the Bank

Halkbank is profitable, well capitalized, and its loan portfolio has performed well over the past four years-sees the section on financial soundness and risk exposures. Halkbank prepares statements in accordance with regulations, and the statements are viewed as adequate.

25

(b) Acceptable levels of loan collections

Although Halkbank used to carry a large stock of old non-performing loans, current loan collections are good—see the section on credit risk and loan portfolio performance under the section on financial soundness and risk exposures.

(c) Appropriate capacity, including staffing, for carrying out sub-project appraisal (including environmental assessment) and for supervising sub-project implementation

On appropriate capacity, including staffing, see section (Implementation Capacity).

Halkbank has a relatively strong presence in the East and Center of the Country where credit is less developed. While the Turkish banking system only has 10 % of its loan portfolio in the eastern and central region, Halkbank has 17 % of its loan portfolio (or US$ 3.278 billion) in this area. NPLs in the targeted region are small. This evidence suggests that Halkbank is able to extend sound credit in the targeted region.

(d) Capacity to mobilize domestic resources

Halkbank has US$26.9 billion worth of domestic deposits, proving its ability to mobilize domestic resources.

(e) Adequate managerial autonomy and commercially oriented governance

Halkbank is mainly owned by the Government by 75% of shares and about 25% of shares are privatized through an IPO. The Government will retain control until a private sector partner takes a majority stake in the bank. Since the Government still owns and controls the bank, it is clearly not totally autonomous and commercially oriented in its decision making. However, the team’s assessment indicates that decisions are made sufficiently autonomously and that they are commercially oriented, as also evidenced by the sound financials of the bank.

(f) Appropriate prudential policies, administrative structure, and business procedures.

Halkbank complies with the regulations, and its balance sheet has a low risk profile. Credit decisions are made on a commercial basis (see section on subsidized credits for details), and the bank has a risk management unit reporting to the bank’s board of directors, according to international practice.

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