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The governance of banks in transition economies Turkey country report

2012

TURKEY COUNTRY REPORT –2012 PAGE 2 of 69

Table of content

Foreword ......................................................................................................................................... 3 A. Methodology and overview of the banking system in Turkey ................................................. 4

1) Methodology ....................................................................................................................... 4 2) Overview of the corporate governance of banks in Turkey ............................................... 5

B. Executive summary ................................................................................................................... 9 1) Legal framework ................................................................................................................. 9 2) Supervisory practice .......................................................................................................... 10 3) Bank practice ..................................................................................................................... 10 4) Key recommendations ...................................................................................................... 11 5) Overall assessment of bank governance quality in Turkey .............................................. 13

C. Analysis of the strengths and weaknesses of the corporate governance of banks in Turkey 16 1) The strategic and governance role of the board .............................................................. 16 2) Composition and functioning of the board ...................................................................... 18 3) Risk governance ................................................................................................................ 22 4) Internal control ................................................................................................................. 25 5) Incentives and compensation ........................................................................................... 27 6) Transparency to the market and regulators ..................................................................... 29

Annex 1 – Overview of the corporate governance of banks in Turkey ........................................ 31

This Report does not constitute legal advice. Readers are advised to seek appropriate legal advice before entering into any transaction, making any determination or taking any action related to matters discussed herein. The contents of this Report are copyrighted. The assessments and views expressed in the Report are not necessarily those of the EBRD. All assessments and data in the Report are based on information gathered in the course of 2011.

For information or comments please contact Gian Piero Cigna at [email protected]

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The team is grateful for the assistance provided by all parties interviewed. In particular, the team would like to acknowledge the precious assistance offered by the law firms Pekin & Pekin (http://www.pekin-pekin.com) and Hergüner Bilgen Özeke Attorney Partnership (http://www.herguner.av.tr ).

mailto:[email protected]

http://www.pekin-pekin.com/

http://www.pekin-pekin.com/

http://www.herguner.av.tr/


Foreword

In July 2010, the Legal Transition Team of the EBRD launched a comparative assessment of the corporate governance of banks in its countries of operations. The overall objective of the assessment is to inform and support the EBRD’s policy dialogue with authorities with a view to generating further commitment to improve the corporate governance of banks in EBRD countries of operations. The assessment aims at providing the EBRD with an overview of the legal and regulatory framework governing the corporate governance of banks and how diligently the various rules and best practice guidelines are implemented.

The assessment focuses mostly on internal corporate governance arrangements in banks, particularly the role and composition of boards. It analyses the legal and regulatory framework; its implementation by supervisors; and the practices developed by the systemically important banks in each country. The transparency of governance arrangements to the supervisory authority and the markets is also reviewed. While the assessment analyses banks and their boards, and considers ownership structure and patterns in the banking sector, broader governance issues covered in the OECD principles such as shareholder and stakeholder rights and responsibilities as well as equity market issues are not dealt with in any detail.

To enhance the EBRD’s understanding of the corporate governance of banks in countries of operations, countries reviewed are subjectively rated. For this purpose, the legal framework, supervisory practice and banking practice are given an overall score in the executive summary section of each country report. In addition, the performance of countries in the key areas mapped out in the EBRD checklist is also rated and included in the executive summary section of each country report. The rating approach is detailed in the box below.

Rating

“Strong to very strong” - The corporate governance framework / practices of supervisory authorities /

practices of banks are fit for purpose and are close to best practice. “Moderately strong” - Most parts of the corporate governance framework / practices of supervisory

authorities / practices of banks are adequate but further reform is needed

“Weak” - The corporate governance framework / practices of supervisory authorities / practices of banks

contain some elements of good practice but overall the system is in need of reform

“Very weak” - The corporate governance framework / practices of supervisory authorities / practices of banks

contain significant risks and are in need of significant reform

Each Country Report is divided into three Sections: (A) Methodology and overview of the banking system; (B) Executive summary; (C) Analysis of key strengths and weaknesses of the corporate governance of banks and policy recommendations where appropriate.


A. Methodology and overview of the banking system in Turkey

1) Methodology

1. The analysis and recommendations contained in this report are based on research carried out by the EBRD and responses to written questionnaires sent to two Turkish law firms; the Turkish Banking Regulation and Supervision Agency (hereafter the ‘BRSA’); and four of the six largest banks of the country. Responses to the questionnaires were complemented by face-to-face interviews carried out in Ankara and Istanbul in 2011 during which the EBRD assessment team met with respondents to the questionnaires.

2. Based on a best practice assessment check list, the questionnaires and interviews inquired about the legal and regulatory framework with regards to bank governance, supervisory practice and the practice of some of the largest banks in Turkey measured by their share of the total assets of the country’s banking system (‘the banks reviewed’). According to information published on the BRSA website, as of December 2011, the ten largest banks in Turkey controlled together 87.34 percent of the total assets of the Turkish banking system.1. The total assets of banking sector reached TL 1,162 billion at the end of 2011.2

Exhibit 1: The ten largest banks in Turkey by share of total banking assets

Bank name (10 largest banks) Total assets in’000 TL* Share of total asset of banking

system **

1. Türkiye Garanti Bankasi 162,138,835 13.95%

2. Türkiye İş Bankası 160,558,319 13.82%

3. Akbank 139,257,181 11.98%

4. Türkiye Cumhuriyeti Ziraat Bankası 135,117,877 11.63%

5. Yapı ve Kredi Bankası 116,056,718 9.99%

6. Türkiye Vakıflar Bankası 93,469,882 8.04%

7. Turkiye Halk Bankasi 92,214,758 7.94%

8. Finansbank 47,397,796 4.08%

9. Türk Ekonomi Bankası 40,184,864 3.46%

10. DenizBank 28,494,794 2.45%

Total 10 largest banks 1,014,891,024 87.34%

* Source: Banks IFRS financial statements as of 31 December 2011 (from banks websites) **(Total Assets of Bank/Total Asset of sector)*100

1Banking Regulation and Supervisory Agency, 2011. Financial Markets Report, [Internet] December 2011. Available

at: http://www.bddk.org.tr/WebSitesi/english/Reports/Financial_Markets_Report/109642012_fpr_dec_11eng.pdf 2 Banks in Turkey 2011, The Banks’ Association of Turkey:

http://www.tbb.org.tr/Dosyalar_eng/Yayinlar/Dokumanlar/Banks2011.pdf

http://www.bddk.org.tr/WebSitesi/english/Reports/Financial_Markets_Report/109642012_fpr_dec_11eng.pdf

http://www.tbb.org.tr/Dosyalar_eng/Yayinlar/Dokumanlar/Banks2011.pdf


2) Overview of the corporate governance of banks in Turkey

3. The Turkish banking sector showed a fair degree of resilience to the global financial crisis. This was in large part due to the strength of prudential regulation and supervision established in response to the financial and economic crisis that swept Turkey between 2000 and 2002. According to the IMF, the disappointing performance of the Turkish economy leading to the 2000 crisis was rooted in pervasive structural rigidities, weak public finances and low policy credibility. Despite structural reforms implemented at the beginning of 2000 and attempts to control inflation, a worsening current account and fragile banking system led to a liquidity crisis that initially affected only a few domestic banks but turned into a full-blown crisis with a massive loss of reserves in late 2000. A speculative attack early 2001 forced the government to float the currency amidst rocketing interest rates and renewed acceleration in inflation3.

4. In response, the government initiated reforms aimed at restoring investor confidence including a fundamental restructuring of the banking sector and enhanced role for the private sector. The BRSA was established in June 1999 according to the Banks Act No. 4389 and took over banking supervision from the Central Bank of Turkey and Undersecretariat of Treasury4. It was given extensive supervisory and regulatory powers and began to operate in August 2000. A Savings Deposit Insurance Fund (‘SDIF’)5 was also established for the resolution of failing banks. In 2002 the crisis ended and banks returned to profitability. In addition to these regulatory and supervisory changes, the counter cyclical capital buffers required by the BRSA enabled Turkish bank to face the 2007 crisis with levels of Tier 1 capital that exceed the minimum capital adequacy ratio (CAR) of 8 per cent. Since November 2006, the BRSA requires banks to hold a target ratio of 12%, which is stipulated as a prerequisite to opening new branches.

5. According to the BRSA, as of March 2010 the banking sector in Turkey consisted of 49 banks6. In its July 2009 report, the EBRD found that the Turkish financial sector remained relatively small in size, shallow in terms of financial intermediation and narrowly based. The banking sector, whose assets in 2008 corresponded to 63.4 per cent of GDP (compared with 260 per cent in the Euro area), is highly concentrated. State-owned banks account for about 30 percent of total assets. The share of foreign banks was increasing but still rather limited. In general, banks have a relatively underdeveloped branch network although the larger banks had engaged in significant branch expansion programmes in recent years. Domestic lending to the private sector was limited: private sector credit amounted to only to about 32 per cent of GDP, a level comparable to Georgia or Tajikistan7.

3 International Monetary Fund, 2002. Article IV Consultation and First Review Under the Stand-By Arrangement,

[Internet] July 05, 2002. Available at: http://www.imf.org/external/pubs/cat/longres.aspx?sk=15925.0 4 The Undersecretariat of Treasury was responsible for issuing banking regulations, carrying out on-site supervision

and enforcement, while the Central Bank of Turkey was responsible for off-site supervision and was managing Savings Deposit Insurance Fund (SDIF), which gave insurance to saving deposits. 5 Saving deposit Insurance Funds (SDIF). See http://www.tmsf.org.tr

6 Banking Regulation and Supervisory Agency, 2010. Financial Markets Report, [Internet] March 2010. Available at:

http://www.bddk.org.tr/websitesi/english/Reports/Financial_Markets_Report/8368fmr_march_2010_eng.pdf 7 European Bank for Reconstruction and Development, 2009. Strategy for Turkey, [Internet] July 2009. Available at:

http://www.ebrd.com/downloads/country/strategy/turkey.pdf

http://www.imf.org/external/pubs/cat/longres.aspx?sk=15925.0

http://www.tmsf.org.tr/

http://www.bddk.org.tr/websitesi/english/Reports/Financial_Markets_Report/8368fmr_march_2010_eng.pdf

http://www.ebrd.com/downloads/country/strategy/turkey.pdf


6. The relatively low penetration of the banking sector combined with supervisory pressure enables Turkish banks, including the banks reviewed, to be in an enviable position in which they combine high capital adequacy ratio (‘CAR’) and high return on equity (‘RoE’). Return on equity in deposit banks was recorded as 14.8 percent on average by December 2011. Nine banks had return on equity above the sector average, while 2 banks recorded loss. Capital adequacy of deposit banks was recorded as 15.5 percent. Capital adequacy ratio of 23 banks was above the average (see Exbit 2, below).

7. The Turkish banking sector maintained strong volume growth, robust profitability and solid capitalisation despite impacts of the challenging global environment, increasing regulation and intense competition. Return on average equity of the banking sector was 15.4% in 2011.

8. A brief overview of the performance of the Turkish banking sector in 2011 demonstrates that the sector’s total assets grew by 21.0% over 2010 (end of the year), and reached to TL 1,217.6 billion as of December 2011. Total loans rose by 30.3% (TL 163.0 billion) to TL 700.2 billion. As of December 2011, the sector’s capital adequacy ratio was 16.6%. Shareholders’ equity climbed by 7.5% to TL 144.6 billion. Sector profitability became TL 19.9 billion by the end of 2011.8

8 From Finansbank Annual Report 2011 (http://www.finansbank.com.tr/en/investor-

relations/media/552/report.aspx)

http://www.finansbank.com.tr/en/investor-relations/media/552/report.aspx

http://www.finansbank.com.tr/en/investor-relations/media/552/report.aspx


Exhibit 2: Return on Average Equity and Capital adequacy as of31/12/2011

Bank name (10 largest banks) CAR (%)* ROAE (%)

1. Türkiye Garanti Bankasi 15.8 20

2. Türkiye İş Bankası 14.1 15.3

3. Akbank 16.8 14.3

4. Türkiye Cumhuriyeti Ziraat Bankası 15.61 16.1

5. Yapı ve Kredi Bankası 14.88 21.7

6. Türkiye Vakıflar Bankası 13.4 13.7

7. Turkiye Halk Bankasi 25.4 14.3

8. Finansbank 17.18 15.3

9. Türk Ekonomi Bankası 14.23 5.36

10. DenizBank 14.72 26

Source: Banks’ annual reports 2011

Source: Banks in Turkey 2011.

Source: Banks in Turkey 2011.


9. The box below briefly describes the key documents regulating the corporate governance of banks in Turkey9.

Exhibit 3: Laws and regulation on the corporate governance of banks

The Turkish Commercial Code: (Law No. 6762 as amended) dated July 9, 1956. The Law regulates the formation, organisation and dissolution of joint stock companies.

Banking Act: (Law No.5411 as amended) dated November 1, 2005. The Law regulates the principles and procedures for ensuring confidence and stability in financial markets, the efficient functioning of the credit system and the protection of the rights and interests of depositors.

Regulation on the Internal Systems of Banks: published in November 2006 sets out the procedures and principles concerning the internal control, internal audit and risk management systems to be established by banks and the functioning of these systems.

Regulation on Banks’ Corporate Management Principles: published in November 2006 regulates the structures and processes relating to the corporate management of banks. The Regulation includes an Annex, which sets out the principles for banks’ corporate management.

Capital Markets Act: (Law No. 2499 as amended) dated on July 30, 1981. The Law regulates and controls the secure, transparent and stable functioning of the capital market and protects the rights and benefits of investors. The Law applies to companies admitted to trading on the Istanbul Stock Exchange.

Communiqué Regarding Independent Auditing in Capital Markets: dated December 13, 1987. The Communiqué provides for the independence of external auditors.

Corporate Governance Principles: The Governance Principles were issued by the Capital Markets Board in June 2003 and amended in February 2005.

9 For more information please refer to Annex 1.


B. Executive summary

1) Legal framework

Overall scoring: Strong

Key strengths

10. Banking regulation and the corporate governance framework for banks in Turkey has undergone significant modernisation in the last decade following the 2001 crisis. The BRSA was given extensive power to regulate the internal systems and governance of banks and aggressively drive implementation from banks. As they stand, the various communiqués and regulations of the BRSA on corporate governance and internal systems provide banks with a comprehensive regulatory framework on governance, internal control and risk management.

11. According to our interlocutors, the corporate governance framework will be further overhauled with recent amendments to the Turkish Commercial Code and the Turkish Code on Obligations that will affect all joint stock companies.

12. In many ways the legal framework and banking regulation established after the crisis seem to have anticipated current discussions within the EU on the role and professionalism of bank boards. The best example of this is the role ascribed to audit committees by the Regulation on the Internal Systems of Banks. The regulation creates a system of checks and balances at the head of banking institutions in which responsibilities for the business and responsibilities for controls are divided between the general manager and a fully non-executive audit committee under the general oversight of the board. In practice, this means that internal audit, internal control, compliance and to a lesser but significant extent risk functions report to the board via the audit committees. The scope of the responsibilities of the audit committee has led to a highly idiosyncratic governance characteristic of the Turkish banking system: the appointment of “full-time” non-executive directors.

Key weaknesses

13. The Corporate Governance Principles of the CMB used by Turkish listed banks as a code or reference are based on the OECD principles and follow the structure of the OECD principles. The OECD Principles were originally established as a benchmark for countries to assess the quality of their corporate governance framework. As such they do not easily lend themselves to serving as guidance to companies, least of all banks, on how best to organise their internal governance. It seems that this fact has been recognised by the BRSA since it has issued additional mandatory requirements and “soft” guidance on corporate governance.


2) Supervisory practice


Key strengths

14. The BRSA is a hands-on and well-respected supervisory authority, largely credited for its role in restoring the stability of the Turkish banking system following the 2001 crisis and steering Turkish banks through the more recent global financial crisis.

15. The supervisory philosophy of the BRSA is much more interventionist than normally seen within the EU, even if one takes into account current trend within the EU towards a more intrusive supervisory approach. For example, at the onset of the 2007 global crisis, BRSA auditors were dispatched to the head offices of all 49 Turkish banks and given offices from which they have since been carrying out a continuous, day-to-day audit of the banks. It seems from responses to interviews that they have vast powers to request documentation and ask questions from managers and board directors. The scope of their audit covers all aspect of banks’ activities and organisation including corporate governance. This continuous audit is in addition to the distant periodic audits carried out by the BRSA from Ankara.

Key weaknesses

16. While the majority of interviewees have acknowledged the effectiveness of the BRSA’s approach in modernising and maintaining the stability of the banking system, a number of interviewees were concerned by the intrusion of the BRSA and the risk of regulatory creep. In two of the four banks reviewed, when asked to describe their key governance challenges interlocutors identified regulatory risk and changing supervisory expectations.

3) Bank practice


Key strengths

17. Probably as a result of the increasing responsibilities ascribed to bank boards by banking regulation and the pressure from supervisory authorities, the boards of the four banks reviewed are strikingly similar, both in their composition and functioning. All four boards are relatively small, less than 10 members, and composed of a majority of non-executive directors with a background in banking or in the financial industry. In three of the four banks reviewed the chairman has financial industry expertise. In addition, these boards meet very often: in three of the four banks reviewed, boards meet at least every month and in the fourth bank the board meets at least twice per month.

18. In addition to supervisory pressure, the corporate governance framework of the four banks reviewed is strongly influenced by their ownership structure. Three of the four banks reviewed have as shareholders large private Turkish groups along with foreign banking groups combined with a non-negligible free float (see Exhibit 4). This “three-in one” ownership structure is quite unique and creates specific governance advantages: it seems that the presence of two large private interests is enough to ensure that one majority


shareholder does not act to the detriment of all others. The fourth bank is controlled by the government (which represents by law a multitude of charitable foundations) but also has a significant free float.

Key weaknesses

19. The separation between business and control was well understood and endorsed by a large majority of interviewees. In the word of one interviewee:

“Assigning responsibility for the business to the general manager and responsibility for controls to the audit committee creates additional element of stability within banks. This institutionalised checks-and-balances helps prevent that the general manager becomes too strong or does not put adequate focus on controls.”

20. However, the extent to which banks can effectively be run through two parallel command strands is questionable. First, this may reduce the accountability of senior management: how can general managers be effectively held accountable for the performance of the bank they are heading if they have no responsibility for the controls? In addition, this dual structure at the head of Turkish banks can only work if there is effective and continuous communication between control functions and business functions. Responses to questionnaires and interviews indicate that this happens via management committees but this also places further responsibilities on the members of the audit committees. In at least two of the four banks reviewed, non-executive audit committee members attend weekly management committees.

21. Responses to questionnaires and interviews indicate that public shareholders are not very active. For example they do not insist on the presence of independent directors even when the free float of the bank is non-negligible. Two of the four banks reviewed do not have independent directors that are both independent from management and majority shareholders. In the two banks that have independent members, they account for no more than one third of the board.

4) Key recommendations

22. The following box is a summary of the recommendations contained in Section (C) below which aim to address some of the weaknesses identified in this Report. The purpose of these recommendations is to assist the EBRD in identifying priority areas for policy dialogue.

Legal framework

1. The adequacy of the CMB corporate governance code as the main comply-or-explain governance code should be reviewed.

Supervisory practice

2. The BRSA should consider reviewing the need for permanent auditors in all 49 banks and the scope of their responsibilities in banks.


3. While it appears that remuneration is not a key issue in the Turkish banking system, the BRSA should have full access to information on the amount and structure of senior executive remuneration, including the remuneration of heads of key control functions.

Bank practice

4. Bank boards should develop a clearer definition of their risk appetite, possibly in co-operation with supervisory authorities.

5. Banks boards should review the extent to which they are involved in credit decisions.

6. Chief risk officers should have two reporting lines: one to the board/audit committee and one to the general manager/management committee.

7. Bank boards should have a more formal role in approving the structure and amount of senior executive remuneration.


5) Overall assessment of bank governance quality in Turkey

23. The following table provides a rating of Turkey’s performance in the key governance areas mapped out in the EBRD best practice assessment checklist. Rating in this table is subjective and based on the overall assessment of the strengths and weaknesses of the legal framework, supervisory practice and the practice of banks as discussed in section C below.

Issues Score10

The strategic and governance role of the board

Strategic role of the board

Do boards have a sufficiently active role in developing and approving the strategic objectives and the budget of their banks?

Strong

Do boards effectively review and evaluate management performance against agreed budgetary targets?

Moderately Strong

Do boards effectively shape the governance framework and corporate values throughout their organisation?

Strong

Are boards of subsidiaries in a position to effectively control the operation of their banks? n/a

Is there adequate transfer of good practice between parents and subsidiaries? n/a

Board composition and functioning

Size, composition and qualification

Is the size of boards adequate to meet the requirements of their business? Strong

Are directors qualified for their position? Strong

Is the board sufficiently independent from management and controlling shareholders? Moderately

Strong

Are the duties of directors to their banks, shareholders and stakeholders clearly set out? Weak

Is there adequate balance of power between individuals within boards and are there adequate checks to maintain the balance?

Moderately Strong

Do board chairs possess relevant banking and/or financial industry experience and a track record of successful leadership?

Strong

Do current tenure patterns of board directors suggest a high level of engagement and independence? Moderately

Strong

Do boards provide adequate induction and professional development to their members? Moderately

Strong

10

Where: “Strong to very strong” - The corporate governance framework / practices of supervisory authorities / practices of banks are fit for purpose and are close to best practice. “Moderately strong” - Most parts of the corporate governance framework / practices of supervisory authorities / practices of banks are adequate but further reform is needed “Weak” - The corporate governance framework / practices of supervisory authorities / practices of banks contain some elements of good practice but overall the system is in need of reform “Very weak” - The corporate governance framework / practices of supervisory authorities / practices of banks contain significant risks and are in need of significant reform.


Issues Score10

Nomination committees

Is the process for director succession and nomination sufficiently transparent? Weak

Functioning and evaluation

Are the responsibilities, authorities, and terms of reference of boards and board committees clearly defined and documented?

Moderately Strong

Do boards function in ways that encourage informed contribution and constructive challenge by all directors?

Moderately Strong

Do boards meet regularly? Strong

Are boards and board committees supported by a senior company secretary? Moderately

Strong

Do boards evaluate their performance and discuss the outcome of such evaluation? Weak

Risk governance

Risk governance framework

Are boards and their risk committees sufficiently involved in setting the risk appetite and monitoring the risk profile of banks?

Moderately Strong

Do banks appoint and empower senior chief risk officers? Moderately

Strong

Do senior executives have a sufficiently integrated firm-wide perspective on risk? Moderately

Strong

Risk committees

Are boards in a position to effectively review risk management? Moderately

Strong

Internal Control

Internal control framework

Does the organisational structure of banks include clearly defined and segregated duties for key officers and effective delegation of authority?

Moderately Strong

Are there enough check s and balances to ensure the independence and integrity of financial reporting?

Moderately Strong

Are conflicts of interest including related party transactions effectively managed? Strong

Is external auditor independence upheld by boards and their audit committees? Strong

Have banks established effective internal audit departments? Strong

Do banks establish effective compliance departments to ensure that they comply with regulatory obligations?

Moderately Strong

Do boards and their audit committees effectively oversee and regularly review the effectiveness of the internal control systems?

Strong

Audit committee

Do boards establish audit committees? Strong

Are audit committees fully independent? Weak

Do audit committees include at least one member with substantial auditing or accounting experience?

Strong


Issues Score10

Incentives and compensation

Remuneration policy

Do boards and their remuneration committees have a sufficient role in shaping the compensation system of their banks?

Weak

Is remuneration meritocratic and linked to firm and individual performance? Moderately

Strong

Is senior executive compensation aligned with prudent risk management? Moderately

Strong

Remuneration committee

Do boards establish remuneration committees? n/a

Are remuneration committees independent from management? n/a

Transparency to the market and regulators

Financial statements

Is IFRS required by law or regulation? Strong

Corporate governance

Do banks report regularly on corporate governance matters? Strong

Do banks publish key governance information on their website? Strong

Is disclosure proportionate to size, complexity, ownership structure and risk profile of banks? Strong

Transparency to regulators

Can the supervisory authority obtain information about ultimate ownership and other corporate governance matters?

Strong


C. Analysis of the strengths and weaknesses of the corporate governance of banks in Turkey

1) The strategic and governance role of the board

Key strengths

Legal framework

24. The Regulation on Bank’s Corporate Management Principles explicitly ascribes to bank boards responsibility for approving the mission and strategies of their banks. The regulation also makes bank boards explicitly responsible for monitoring the performance of management. Bank boards are required to clearly articulate the corporate values and ethical rules of their banks and ensure that non-compliant behaviour is adequately identified and dealt with.

25. The Regulation on Bank’s Corporate Management Principles is not mandatory. It is flexible enough to allow boards to establish the governance arrangements that best fit “the size of their activities and their organisation types”.


26. It appears from responses to questionnaires and interviews that the BRSA closely monitors the corporate governance and “internal systems” of banks11. BRSA has access to all governance documents and has the power to address material corporate governance deficiencies of banks, including the authority to compel appropriate remedial action and impose fines.

Bank practice

27. Responses to questionnaires and interviews indicate that in compliance with banking regulation, the boards of the four banks reviewed are in control of the strategy of their banks. In practice, the boards of the four banks discuss and approve the three- or five-year business plans of their banks. In at least two of the four banks reviewed the board has adopted a written policy for strategy development. Responses to questionnaires and interviews indicate that bank strategies are well communicated within their organisation and externally to the market.

28. It is notable that even in the three banks that have a significant foreign shareholding, strategic initiative remains at the level of the local Turkish board. Foreign strategic partners have a “hands-of” approach as regards the management of the strategy cycle in their Turkish investments. Instead they monitor their investment by relying on the participation of directors they have appointed to the board, the review of financial statements, occasional audits and sporadic discussions between functions in Turkish banks and heads of functions in their banking groups. As described by one interlocutor:

11

Pursuant to Art. 29-32 of the Banking Law, the “internal system” includes the Internal Control System (Art. 30), the Risk Management System (Art. 31) and the Internal Audit System (Art. 32).


“Strategy is developed by the strategy department of our bank and discussed and approved by the board. We get general objectives from the main shareholders but it is very much a bottom-up process.”

29. The boards of the four banks reviewed seem to participate in the annual budget setting process. However, the extent of boards’ involvement varies significantly. In one respondent bank the board does not approve the budget but reviews and discusses budget variance. In another bank the board is extensively involved in the budgetary process: it approves the budget, reviews budgetary variances and revises the budget for non-budgeted revenues or expenses. In the remaining two banks responses to questionnaires and interviews indication that boards are at least responsible for approving the budget.

30. With regards to the governance role of the board, responses to questionnaires and interviews indicate that all four banks reviewed have based their corporate governance framework on the Corporate Governance Principles of the Capital Markets Board. All four banks publish a corporate governance compliance report on their website. The four banks reviewed have also adopted codes of conduct and ethics “ethical principles” in compliance with banking regulation.

31. Responses to questionnaires indicate that the body responsible for selecting and replacing senior managers varies. In at least two of the four bank reviewed this is carried out by the board of directors. In one respondent bank the controlling shareholders or a restricted group of shareholders carries out this responsibility which seems adequate given the ownership structure of the banks.

Key weaknesses

Legal framework

32. The Corporate Governance Principles of the CMB used by Turkish listed banks as a code or reference are based on the OECD principles and follow the structure of the OECD principles. The OECD Principles were originally established as a benchmark for countries to assess the quality of their corporate governance framework. As such they do not easily lend themselves to serving as guidance to companies, least of all banks, on how best to organise their internal governance. It seems that this fact has been recognised by the BRSA since it has issued additional mandatory requirements and “soft” guidance on corporate governance. But the adequacy of the CMB principles as a comply-or-explain governance code should be reviewed.


33. Responses to questionnaires and interviews indicate that the supervision of the BRSA as regards the governance and internal systems of banks may be too intrusive. Before the 2001 crisis the supervisory authority was pretty hands-off. Banks could organise their governance the way they saw fit as long as they were not making a loss or posing a risk to the stability of the system. Following the crisis the BRSA was keen to avoid past failings in the banking sector and governance was viewed as an area that needed to be strengthened, including through the presence of permanent auditors in banks. While this approach might


have been necessary to steer banks through the crisis, responses to questionnaires and interviews indicate that the BRSA may be “overdoing it”. In the words of interviewees:

“The BRSA has permanent auditors in all 49 Turkish banks, responsible for the continuous auditing of the banks. This audit covers corporate governance issues. They do not hesitate to question the board and management on governance arrangements”.

“The presence of the BRSA auditors can be too much. For example we have quarterly audit committee meetings at the moment which we consider adequate for the needs of our bank. However, the BRSA considers that the audit committee should meet more and we are still arguing the point with them.”

34. The continuous meddling of the regulator in the governance of banks may in effect drive a number of important decisions “underground” and in the end weaken the control environment. This also undermines management responsibility as on-site BRSA auditors may substitute management in key governance and internal control decisions.

Recommendations


1. The BRSA should review the need for permanent auditors in all 49 banks and the scope of their responsibilities in banks.

2) Composition and functioning of the board

Key strengths

Legal framework

35. Banking regulation includes fit and proper requirements for board directors, the general manager, the deputy general manager, and the senior officers of the internal systems. The fit and proper requirements are comprehensive and cover the probity, reputation, and competence of approved persons. As regards director competence, banking regulation requires that a majority of board members “have at least undergraduate degrees in the disciplines of law, economics, finance, banking, business administration, public administration and related fields and those that have undergraduate degrees in engineering fields must have a graduate degree in the aforementioned fields, and they must have at least ten years of professional experience in the field of banking or business administration.”12

12

Art. 25 of the Banking Law (General Manager and Deputy General Managers). This provision should be read together with Art. 23 which states that “The qualifications required for the general manager in this Law shall also be required for majority of the board of directors. Managing directors shall satisfy the same conditions as the general manager”.


36. The CMB corporate governance code requires that one third of directors be independent and provides a definition of independence which includes independence from management and controlling shareholders.

37. The banking act requires that the general manager, and, in his absence, the deputy general manager be a “natural” member of the board of directors. This requirement has the double advantage of strengthening the accountability of general managers to boards and shareholders and encouraging the flow of information between the board and management. Banking regulation also prohibits that one person combine the function of general manager and chairman of the board.


38. Responses to questionnaires indicate that the fit and proper regime is effectively implemented by the BRSA. Instances of refusal by the BRSA are reportedly quite rare.

Bank practice

39. The boards of the four banks reviewed look fairly similar and highly professionalised. As illustrated in the graphs below, all four bank boards have less than 10 members which seems adequate for the size and complexity of their businesses and reflects the ownership structure of their banks.

40. In compliance with banking regulation they all include at least one executive director, the general manager.

41. The majority of non-executive directors on these boards have a banking or financial industry experience. Non-executive directors with an academic background or political background are sometimes appointed to the board. In addition, in three of the four banks reviewed the board is headed by chairmen with a background in banking or the financial sector. Only one of the four banks reviewed did not have a board chairman with financial industry expertise. However, in this case the board chair is also the founder of the bank.


Exhibit 4: Board sizes in the four banks reviewed

42. The boards of the four banks reviewed are also fairly similar in their committee structures. All four banks have established audit committees in accordance with banking regulation. All four banks have in addition established board level credit committees. Two of the four banks reviewed have in addition established a governance committee.

Exhibit 5: Board committees in the four banks reviewed

Board Committees

Audit & Risk Credit Corporate

Governance

Bank 1 X

Bank 2 X

Bank 3

Bank 4


Key weaknesses

Legal framework

43. Responses to questionnaires and interviews indicate that the legal framework contains the general director duties of diligence, care and loyalty, but company law and the courts have not developed clear, robust standards for director duties. In addition it is not entirely clear that there is a business judgement rule as relevant court decisions have reportedly been contradictory. These areas may be further developed in the recently approved Commercial Code which the EBRD team did not have a chance to review.

Bank practice

44. All four banks reviewed are listed on the Istanbul Stock Exchange and three of the four banks combine their listing in the national stock exchange with a foreign listing (on the London Stock Exchange or the OTC in New York). Despite their non-negligible free float, the proportion of non-executive directors that are independent from senior management and controlling shareholders falls below the minimum recommended by the CMB Corporate Governance Code for listed companies. The Code recommends that board of directors include at least two independent members, and that at least one third of the members fulfil the criteria for independence which include independence from management and controlling shareholders. As shown in Exhibit 8, only one bank meets that threshold. Two of the banks reviewed have not appointed independent directors that match the independence criteria of the CMB governance code. It seems that when respondent referred to their “independent” board members they referred in fact to non-executive directors as provided for by Banking Law and banking regulation. The remaining bank has appointed one independent director.

45. With regards to the functioning of boards, responses to questionnaires and interviews indicate that board chairmen do not always have full control of the board’s agenda. In at least one of the four banks reviewed this is done exclusively by the CEO. In another the agenda is developed by the board chairman, the CEO and the COO.

46. As stated above all four banks have established board level credit committees. While banking regulation requires the establishment of a credit committee, it seems that there is no requirement to establish the committee at board level. From responses to questionnaires and interviews it seems that this is a legacy of the 2001 crisis. The SDIF instituted legal actions against boards for past credit decisions and as a result bank established credit committees at board level to ensure that credit decisions are controlled by the board. While we understand the legacy, we consider that credit decisions are best left to management in order to avoid influence by shareholders or people close to them—such as the appointees of large corporate groups that control three of the four banks.

47. None of the four bank boards reviewed seem to carry out a regular evaluation of their performance on a regular basis.


3) Risk governance

Key strengths

Legal framework

48. The regulatory framework on risk management, contained in the Regulation on the Internal Systems of Banks appears to be strong. Banking regulation ascribes to boards extensive responsibilities as regards the risk governance of their banks. These include determining the risk strategy of their banks as well as setting for each type of risk the level of risk that can be taken by their banks. Bank boards are also responsible for monitoring and allocating maximum risk limits to the units and their managers or the staff employed in those units.

49. Banking regulation requires that bank boards approve adequate policies on the taking, monitoring, management and reporting of key risks, supervise the implementation of risk policies and approve changes to these policies. Bank boards are explicitly responsible for monitoring the effectiveness of the risk management systems.

50. The Regulation on the Internal Systems of Banks also require the establishment of independent risk management functions headed by a chief risk officer with a direct reporting line to the board.


51. Responses to questionnaires and interviews indicate that the BRSA carefully monitors bank boards’ compliance with the Regulation on the Internal Systems of Banks. In addition, the appointment of senior and independent chief risk officers as well and their remit and responsibilities are reviewed as part of the supervisory process.

Bank practice

52. In practice, responses to questionnaires and interviews indicate that bank boards comply with banking regulation. In two of the four banks reviewed, respondents indicated that their boards approve the risk appetite and risk limits. However, very often “risk appetite”13 is used to describe the various risk limits approved by the board.

53. In all four respondent banks, boards closely monitor the risk profile of their banks and receive quarterly reports from chief risk officers and risk managers. Practice differs with regards to stress testing. In one of the four banks reviewed the board is involved in approving stress testing rules, while in one other the board is merely informed.

54. In accordance with banking regulation, most banks have appointed a senior chief risk officer with direct reporting to the board either directly or through the audit committee. One of the four banks reviewed has not appointed a chief risk officer, however its risk manager reports to the audit committee.

13

There is no single definition of risk appetite. The Institute of Internal Auditors defines it as "The level of risk that an organization is willing to accept." The Banking Code of the Netherlands Bankers’ Association states that it “refers to the amount of reasonably foreseeable risk that the bank – given its proposed activities – is prepared to accept in the pursuit of its objectives”.


55. Boards and senior management teams are also supported by asset and liability committees, and senior credit committees. At least one of the four banks reviewed has in addition a management level risk committee and an investment committee.

Key weaknesses

Legal framework

56. Banking regulation does not require banks to define a forward looking statement on risk appetite.

Bank practice

57. Responses to questionnaires and interviews indicate that there is confusion as to what is risk appetite. As stated above, two respondent banks seem to consider that their boards approve the risk appetite of their banks when their boards set all the limits required by banking regulation. Another interviewee associated risk appetite with strategy:

“We discuss risk appetite implicitly when the board discusses the three year business plan. But we have it in our agenda to start having a more explicit statement on the risk appetite.”

58. But approving a whole set of limits is not approving risk appetite. Ideally the risk appetite approved by boards should begin with the determination of the bank’s risk capacity followed by the definition of high level boundaries within the risk capacity for well distinguished but fairly high-level categories of credit and market risk. This should providing clear top-down guidance to risk originators within the bank’s management as to how far they can go in using the bank’s capital within a determined period of time. In the absence of such top down process, the risk profile of the bank risks being determined by bottom-up pressures.

59. With regards to credit approval, despite the creation of credit committees at board level, responses to questionnaires indicate that boards still spend significant time on credit decisions. Within the EU, boards have acknowledged that they are bound to have less understanding than management of the complexities of individual credit decisions and the trend has been toward delegating credit decisions to senior managers with the time and expertise necessary to make these decisions. While Turkish banks have adapted the composition and functioning of their boards to respond to the significant responsibilities piled on the board, the value and need for such extensive board involvement in credit decisions is questionable.

“Our board approves all large credit decisions that represent 5 percent or more of equity. Board meetings last between four to five hours. Out of this time one hour is dedicated to the approval of credit decisions.”

“Our board meets at least twice a month, sometimes more. One reason for that is the fact that the board has retained a lot of credit authority. The maximum loan that can be approved by the general manager is 10 million TLR. We have a credit committee but it cannot approve loans. Its main responsibility is to review loan


requests by the general manager then add the request to the agenda of the board meeting”.

60. Responses to questionnaires indicate that in all four banks reviewed chief risk officers or head of risk departments do not report to the general manager or a management committee. There seems to be a perception that the risk function is not an integral part of the business but rather an additional “control”. In one bank, the chief risk officer reports directly to the board, and is hired and fired by the board. In the three other banks the chief risk officer reports directly to the audit committee or to the audit committee via the vice-chairman of the board who is a member of the committee.

Recommendations

Banking practice

1. Banks and their boards should review the extent to which the latter are involved in credit decisions.

2. Boards should develop a clearer definition of what is risk appetite, possibly in co-operation with supervisory authorities.

3. Chief risk officers should have two reporting lines: one to the board/audit committee and one to the general manager/management committee.


4) Internal control

Key strengths

Legal framework

4. Banking regulation with regards to banks’ internal control, or “internal systems” as referred to in Turkey, has a number of specificities not usually seen within banks in the EU.

5. To begin with banking regulation favours a strict separation between management functions and control functions. This means that control functions – internal audit, internal control, and to a lesser extent, risk management – report to the board via the audit committee. In practice, this creates a twin authority structure within each bank: the general manager responsible for the business and the audit committee responsible for all control functions. Such strict separation is not common in other jurisdictions, but seems to be well understood and accepted by a majority of interviewees. In the words of one of our interviewee:

“From a cultural and historical perspective, it is good to have two separate pillars on which banks rest.”

6. The Regulation on the internal systems requires the appointment of at least two non-executive board members in audit committees to head the control functions and provides a list of criteria for audit committee members: members of the audit committee should not be shareholders and should not in the two years preceding their appointment have held any executive function in the bank; they should not be or have been employees of the bank and its subsidiaries except in the internal system, financial control and accounting departments; and they should not have been shareholders or employees of the external auditor or of a firm providing consultancy services to the bank.

7. In addition to their responsibilities at the head of internal systems, audit committees members are also responsible for reviewing and monitoring the independence and effectiveness of the external audit process and ensuring the integrity of financial statements.

8. The other specificity regards the distinction and separation between internal control and internal audit functions. According to banking regulation, internal control is responsible for designing and implementing internal controls and ensuring that they are adequately executed by persons carrying out the activity. Banking regulation views internal control activities as an integral part of the daily activities of the bank, and internal control personnel should be located in “the units or branches where the operational activities are executed and in the head office”. The compliance function can be performed by the internal control department or a separate department independent from the other activities of the bank.

9. The internal audit function in Turkish banking regulation engages in the periodic, risk based audit of all activities of the bank aimed at giving senior management assurance that the activities of the bank are conducted in accordance with laws and regulations as well as with internal policies, principles and targets of banks. Internal audit also provides assurance that that the internal control and risk management systems are effective and adequate.



10. Responses to questionnaires and interviews indicate that the BRSA carefully monitors banks’ compliance with the Regulation on the Internal Systems of Banks. It seems that there are regular meetings between the BRSA and control functions as well as direct contact between the BRSA and members of the audit committee. The effectiveness of boards’ oversight of control functions is also regularly assessed as part of the supervisory process.

Bank practice

11. In compliance with banking regulation heads of internal audit functions, heads of internal control functions and external auditors report to boards directly or via audit committees.

12. All four banks reviewed have established internal control departments distinct from the internal audit departments. In at least two respondent banks, the compliance function is part of internal control departments.

13. As regards related party transactions, responses to questionnaires and interviews indicate that they are not considered a significant issue in Turkey. Responses to questionnaires and interviews indicate that shareholders are careful to avoid related party transactions and when in doubt seek the advice of the BRSA.

Key weaknesses

Bank practice

14. In three of the banks reviewed audit committees have two members, and in the fourth bank three members. Audit committees are probably too small to meet the extensive responsibilities ascribed by banking regulation. In effect, the role of audit committee member has evolved to the point where it is now a full time non-executive position. As described by our interviewees:

“The role of audit committee members is a full time position, especially for the head of the audit committee. We are practically executives but we do not have any management responsibility.”

“The audit committee meets at least 8 times per year, and more if needed. I have an office in the bank. I also attend weekly senior management meetings. I do not have to attend senior management meetings and the idea is not to second-guess management but I find it useful to learn and share information.”

“The BRSA aims to ensure that in all banks there is at least one “full-time” non-executive director.”

15. The extent to which non-executive directors in the audit committee are able to shoulder the significant responsibilities placed on the audit committee is questionable. As noted above, boards and audit committees have adapted to regulatory expectations by professionalising their boards and increasing the number of audit committee and board meetings. Still responses to interviews and questionnaires reveal that there may be a gap between supervisory expectations and what two non-executive directors can achieve. For instance it


seems that there is constant pressure from the BRSA for audit committees to increase the number of meetings they hold each year and their involvement in the banks they supervise.

16. With regards to the transparency of accountability lines, responses to questionnaires and interviews indicate that while banks have clearly specified terms of reference and authority for the board of directors and heads of businesses and functions, none of the boards of the four banks reviewed have adopted a document describing the structure of high level authorities and decision-making within the bank. Such document makes high-level decision making authorities transparent to the board and help strengthen the control environment within banks.

5) Incentives and compensation

Key strengths

Legal framework

17. Principle 6 of the Regulation on Banks’ Corporate Management Principles provides general guidance on the remuneration of board members, senior executives and other authorised personnel. The general principle is that remuneration policies should comply with ethical values and strategic targets of banks. There is also a requirement to attach performance based remuneration to objective criteria and ensure that remuneration is not linked to the short-term performance of the bank. It should be noted however that the principles of this regulation are not mandatory provisions.

Bank practice

18. Due to the ownership structure of the four banks reviewed, local management does not control its own compensation process which seems to be driven by shareholders and the board.

19. Responses to our questionnaire and interviews indicate that more than half of the total compensation of senior executives seems to be fixed. This is an arrangement that, in principle, should mitigate excessive risk taking.

Key weaknesses

Legal framework

20. According to respondents, the new Commercial Code shall contain mandatory rules on executive remuneration. While the final wording of the Commercial Code was not known to most of our interlocutors at the time of interviews, the provisions on executive remuneration were cause for concern as they may include an obligation for all joint stock companies to disclose executive compensation. If this is confirmed, the need for such drastic provision in the Turkish context is questionable.



21. There seems to be little transparency as regards executive remuneration, even to the supervisory authority. Responses to questionnaires and interviews indicate that boards’ involvement in setting compensation policies and practices is not reviewed as part of the supervisory process. In addition it does not appear that remuneration reports are part of the information that is filed with the supervisory authority each year. In the words of one of our interviewees:

“The BRSA is not likely to have more information than what is in financial statements”.

Bank practice

22. Responses to questionnaires and interviews indicate differing practices as regards boards’ role in setting executive remuneration. In at least one of the four banks reviewed, the board has no role at all. Responsibility for setting executive remuneration lies with the two major shareholders. While executive remuneration does not appear to be an issue in Turkey, the board representing all shareholders, should approve remuneration in a more transparent way.

Recommendations


1. While it appears that remuneration is not a key issue in the Turkish banking system, the BRSA should have access to information regarding the amount and structure of senior executive remuneration, including the remuneration of heads of control functions.

Bank practice

2. Boards should have a more formal role in approving the structure and amount of senior executive remuneration.


6) Transparency to the market and regulators

Key strengths

Legal framework

3. Responses to questionnaires and interviews indicate that Turkish accounting standards are a translation of IFRS into Turkish and are fully in line with IFRS. Banks are required to prepare their financial statements in compliance with Turkish accounting standards.

4. The Regulation on Authorization and Activities of Institutions to Perform External Audit in Banks ensure external audit independence by prohibiting the provisions of certain non-audit services by external auditors. The prohibited services include: the design and implementation of financial information system, the preparation of expert’s report, the rendering actuarial services, the rendering of services related with management or human resources management, the of rendering investment advisory services. In addition, the Regulation on Independent External Auditing in Capital Markets requires the rotation of external auditors every five years.

5. Under Banking Law, the BRSA has the power to request any information they need to carry out their supervisory activities including those classified as confidential.


6. The BRSA has extensive access to non-public information including full access to bank books and records and information on ownership structure. In addition, to the financial statements and regular reports from internal systems functions, the information filed with the BRSA each year include: an operating and financial review; a report on risk along the lines required by Basel pillar III enabling a better assessment of banks’ risk profile; a report on the ownership structure of the bank; and a report on the effectiveness of risk management and internal controls.

Bank practice

7. The standard of disclosure on the website of the four banks reviewed mirrors the standards expected from listed companies in the EU. The websites of all four banks contain the following information: the strategy and mission of the bank; the ethical principles; the financial statements; the ownership structure; the composition and structure of the board; and a corporate governance report.

Key weaknesses

Bank practice

8. Due the general nature of the CMB code, based on the OECD principles, the compliance reports of banks are more general corporate governane statements than systematic report on compliance with the code. Only two of the four banks reviewed have published comply or explain statements in the sense understood in the EU.


Recommendations

Legal framework

9. The adequacy of the CMB corporate governance code as the main comply-or-explain code should be reviewed.


Annex 1 – Overview of the corporate governance of banks in Turkey

Regulation and Supervision

The banking sector in Turkey is regulated and supervised by the Banking Regulation and Supervision Agency (the “BRSA” or the “Agency”) which was established in 1999 as a response to the financial and economic crisis. According to the Banking Act No.5411 (the “Banking Act”), adopted in October 2005,14 the role of the BRSA is to (i) take necessary decisions and measures in order to protect the rights of depositors and ensure sound operating of the credit system and to implement them; and (ii) monitor and supervise the establishment, activities, management and organisational structure, merger, disintegration, change of shares and liquidation of banks and financial holding companies as well as leasing, factoring and financing companies.

In the Turkish system, financially weakened banks which are not able to fulfil their liabilities will have their banking licence cancelled and would be taken over by the Savings Deposit Insurance Fund (the “SDIF”). The Banking Act indicates that the role of the SDIF is to (i) insure the savings deposits and participation funds in the credit institutions; (ii) pay the insured deposits and participation funds from its resources in the credit institutions whose operating permission has been revoked; (iii) fulfil the necessary operations regarding partial or full transfer, sale and merger of banks whose shareholder rights are transferred to the SDIF by BRSA; and (iv) take management and supervision of the banks whose operating permission has been revoked and fulfil the necessary operations regarding the bankruptcy and liquidation.

The Capital Markets Board of Turkey (the “CMB”) is the regulatory and supervisory authority in charge of the securities markets in Turkey. Established by the Capital Market Act No. 2499 (as amended) (the “Capital Markets Act”), adopted in 1981,15 the CMB adopts secondary legislation related to public companies (which under Turkish law refers either to a company listed on the Istanbul Stock Exchange (the “ISE”) or an unlisted company with more than 250 shareholders), investors, financial institutions and external auditors. The CMB is mainly responsible for: (i) enhancing investor protection and promoting transparency and fairness; (ii) adopting the norms of the international capital markets and integrating them into regulations; and (iii) promoting and enhancing the effectiveness of the markets.

The Central Bank of Turkey was established on 3 October 1931 and opened officially on 1 January 1932. The primary objective of the Central Bank is to achieve and maintain price stability. The Central Bank must determine in its own discretion the monetary policy that it implements and the monetary policy instruments that it is going to use in order to achieve and maintain price stability. Among others, the fundamental duties of the Central Bank are to: (i) carry out open market operations; (ii) protect the value of Turkish Lira and to establish the exchange rate policy; (iii) determine reserve and liquidity requirements; and (iv) ensure stability in the financial system and monitor the financial markets.

14

English translation dated October 2008 is available at http://www.tbb.org.tr/english/5411.doc. 15

English translation available online at the time of writing is dated March 2007.

http://www.tbb.org.tr/english/5411.doc


Corporate Governance – General

The main law regulating companies and corporate governance in Turkey is the Commercial Code, which has been amended several times since its enactment in 1956.16 A draft commercial code has been prepared by the Turkish authorities and is pending before the Turkish Grand National Assembly since 2007.

The corporate governance framework in Turkey is also determined by the Capital Markets Act, which introduced a market regulator, the CMB. The CMB’s secondary legislation is called “Communiqués”.

Apart from the statutory requirements, listed companies are also required to report their compliance with a voluntary code, the Corporate Governance Principles (the “CGP”) launched in 2003 and updated in 2005 by the CMB. The CGP, modelled on the Principles of Corporate Governance issued by the Organisation for Economic Co-operation and Development, are to be implemented by public companies on a “comply or explain” basis.

The main corporate forms allowed under Turkish law are joint stock company (“JSC”) and limited company (“LC”). Only JSCs can be listed in Istanbul Stock Exchange. The Banking Act stipulates that a bank must be established as a JSC.17

JSCs are managed and represented by a board of directors of at least three members (whereas LCs are managed and represented by at least one director). The shareholder's meeting is the only body authorized to elect/appoint and dismiss members of the board.

JSCs are obliged to have at least one statutory auditor. The right to elect/appoint and dismiss statutory auditors is an exclusive power of the shareholder's meeting.

Listed companies should also have independent auditors who are elected (and can be dismissed) by the board of directors (in cooperation with the audit committee which is mandatory for listed companies) and approved by the shareholder's meeting.

JSCs are managed under compulsory one-tier system with no supervisory board.

The Commercial Code, the Turkish Accounting Standards and the Communiqué Serial IV No: 41 (the “Communiqué”) regulate related party transactions.

According to the Communiqué, if the value of a related party18 transaction is equal to or greater than 10% of company's assets or gross sales as of most recently disclosed annual financial

16

An English translation of the Turkish Commercial Code could not be located. The information in this section 0 Corporate Governance – General is based on the kind translation of the relevant law by Ms. Barut Ozlem. 17

See I.A.1 Bank establishment on p.38 below. 18

For listed companies, a related party to an enterprise (A) is a person or an enterprise directly or indirectly through one or more intermediaries, (i) has control, or is under the control of, or is under joint control with such enterprise(including affiliates and subsidiaries), (ii) has an ownership providing material effect on such an enterprise, (iii) has joint control over such enterprise, (B) is an enterprise having a material effect on such enterprise, (C) is a person or an enterprise having joint control over a joint venture with such enterprise, (D)is a key executive of such enterprise or the parent company, (E) is a close family member of any person described under (A) or (D), (F) is a person or an enterprise over which the persons described under (D) or (E) have substantial voting rights, (G) is a


statements (this is 5% for cash loans granted in favour of group companies and 20% for non-cash loans), listed companies are required to prepare a valuation report for such a transaction. This report must include the opinion of an independent “reporter” as to fairness of price. The board of directors decides as to whether to carry out such a transaction and must take the report into consideration in its decision. Shareholders must be informed of such transactions at least 15 days prior to the date of the forthcoming general meeting.

The approval of the general meeting is necessary in order for a board member to carry out transactions with the company.

Board members have an obligation to reveal their conflicts of interest19 to the company and must not participate in meetings where issues relating to their own interests or the interests of their relatives up to the 3rd degree are being discussed.

If board members and corporate shareholders represented in board are permitted by the general meeting to enter into transactions with the company or to compete with the company, then they are required to disclose such transactions once they reach a significant level. A shareholder cannot vote in any matter relating to a transaction between himself or his family and the company.

Shareholders, directors, officers and auditors and their affiliates cannot buy/sell any assets or services to the company (no threshold applied) for a price considerably different than the market price. Violation of this provision results in criminal liability.

The board members are required to act in the best interest of the company.

The board is responsible of reviewing and guiding corporate strategy, major plans of action, risk policy, annual budgets and business plans; setting performance objectives; monitoring implementation and corporate performance; and overseeing major capital expenditures, acquisitions and divestitures; electing, compensating, monitoring and, when necessary, replacing key executives; monitoring and managing potential conflicts of interest of management, board members and shareholders, including misuse of corporate assets and abuse in related party transactions; ensuring the integrity of the corporation’s accounting and financial reporting systems, including independent audit, and that appropriate systems of control are in place, in particular, systems for monitoring risk, financial control, and compliance with the law; monitoring person or an enterprise which has benefit plans for the employees of such enterprise or a related party of such enterprise, upon their leave (Turkish Accounting Standards No: 17, 28 and 31). For the purposes of the related party definition, if a shareholder has at least 20% voting rights of a company, it is deemed (unless proven otherwise) that such shareholder has material effect over the company. In addition, a shareholder is deemed to have a material effect over the company, if such shareholder (i) has the right to be represented on the company board, (ii) has an involvement to the policy decisions of the company (including dividend decisions), (iii) is doing major transactions with the company, (iv) exchanges its management with the company or (v) transfers know-how to the company. By reference to Article 349 of the Turkish Commercial Code, a family member means up to 3

rd degree blood or

affinitive relatives, and a descendent or an antecedent. 19

For public and private companies, conflict of interest of a board member of a company is deemed to exist (A) on a matter if a board member or any of its family members have any interest in such matter, (B) if a board member or any of its family members, is a board member or shareholder of another company which is (i) in the same business line with the company or (ii) a supplier of the company (Article 334 of the Commercial Code). Conflict of interest of a shareholder of a company is deemed to exist in a general meeting, if such meeting votes on a matter which is related to such shareholder or any of its family members (Article 374 of the Commercial Code).


the effectiveness of the governance practices under which it operates and making changes as needed; overseeing the process of disclosure and communications.

There is no personal liability20 of the board members other than in exceptional cases listed under the Commercial Code (even then, if this case has already been delegated to a specific board member or manager, there would be no personal liability).

Overview of banking sector

According to the December 2009 Financial Markets Report published by BRSA (the “Report”), at the end of 2009, there were 49 banks21 operating in Turkey. 22 Their aggregate total assets stood at TL 834.0 bn. “The banking sector kept its share of 80% in financial sector [in Turkey]”.23

According to the Report, at the end of 2009, the largest banks in Turkey by value of their assets were: T.C. ZİRAAT BANKASI A.Ş. (14.9%);24 Türkiye Iş Bankasi A.Ş. (13.6%); and Türkiye Garanti Bankasi A.Ş. (12.6%).25 Their combined market share by aggregate assets was 41.1%. The Report also appears to provide data on State/foreign ownership of banks and market float. T.C. Ziraat Bankasi A.Ş. appears to be have been fully State-owned; Türkiye Iş Bankasi A.Ş. appears to have been in private ownership with approximately 20% of share capital floated in the market; and for Türkiye Garanti Bankasi A.Ş. 39.7% of share capital appears to have been privately held; 20.8% – in foreign ownership; and 39.5% – floated in the market.

Türkiye Vakiflar Bankasi T.A.O. was the fifth largest bank in Turkey by value of total assets and held 7.8% of assets in the banking system. According to the Report, 73.6% of the bank’s share capital was State-owned; 2.9% was privately held; and 23.5% was floating in the market.

The stock market capitalization of the “National Market” segment of ISE in October 2010 was TL 468,417 mn.26 Comparable historical data on individual bank capitalization was not readily available (neither was available aggregate data for the financial sector); however, it appears that the combined capitalization27 of the second and third largest banks (which were listed, inter alia, on the Istanbul Stock Exchange) was approximately 13.7% of ISE stock market capitalization as of October 2010.

20

But see Duties and liability of the Corporate Governance Principles on p.69 below. 21

Banks in Turkey are apparently classified into: public banks; private banks; banks under the SDIF; deposit banks with global capital; development and investment banks; participation banks. It is not clear under which legal instrument this classification is created. 22

http://www.bddk.org.tr/WebSitesi/english/Reports/Financial_Markets_Report/8127FMR_Dec_2009.pdf, p.31. 23

Ibid, p.32. Apparently, for the purpose of this classification, the financial sector was considered to also include: financial leasing, factoring; consumer financing; asset management companies; insurance companies; pension companies; securities intermediary companies; securities investment trust; securities investment funds; real estate investment trusts; enterprise capital investment trusts. 24

Annual report 2009, http://www.ziraat.com.tr/pdf/ZIRAAT_ENG%202009.pdf. 25

Ibid, p.42. 26

It appears that the ISE does not have a readily accessible set of current/historical information on market capitalization. 27

Information on the financial figures in this report is generally stated as of 23 November 2010.

http://www.bddk.org.tr/WebSitesi/english/Reports/Financial_Markets_Report/8127FMR_Dec_2009.pdf


I. Laws and Regulations

This section covers selected laws and secondary legislation adopted by the BRSA and CMB as related to the banking system in Turkey. In particular, the following documents relating to the BRSA are covered:

– Banking Act;

– Regulation on Internal Systems of Banks; and

– Regulation on Banks’ Corporate Management Principles;

and the following documents relating to the CMB:

– Capital Market Act;

– Communiqué Amending the Communique Regarding Independent Auditing in Capital

Markets;

– Communiqué on Principles Regarding Cumulative Voting at Shareholders Meetings of

Joint Stock Corporations Subject to Capital Market Law; and

– Corporate Governance Principles.

I.A. Banking Act

The objective of the Banking Act is to regulate the principles and procedures of ensuring confidence and stability in financial markets, the efficient functioning of the credit system and the protection of the rights and interests of depositors (Article 1).

1. Bank establishment

The Banking Act stipulates that a bank must be set up as a joint stock company; a bank’s shares must be registered and paid in cash.

At the time when a bank is established, there must be a “transparent and open partnership structure and organizational chart that will not constitute an obstacle for the efficient supervision of the institution” (Article 7).

According to Article 6, the establishment of a bank in Turkey or the opening up of the first branch in Turkey by a bank established abroad can be permitted upon affirmative votes of at least five members of the Banking Regulation and Supervision Board (the “Board” 28).29

28

According to http://www.bddk.org.tr/websitesi/english/About_Us/About_Us.aspx, “Board … is the highest decision-making body of the BRSA”. 29

It is not clear whether this in fact allows the Board an unconditional discretion in issuing such permits.

http://www.bddk.org.tr/websitesi/english/About_Us/About_Us.aspx


2. Bank’s founders

The Banking Act provides for a number of requirements to the “founders” of a bank. Such requirements generally include: no insolvency proceedings against the founders, no previous ownership of a failed bank or a bank where an operating permission has been revoked, no convictions with certain types of sentences (where the penalty included heavy imprisonment or imprisonment of more than five years (even though pardoned), with the exception of negligent offenses), no convictions under the provisions, which provide for imprisonment, of the repealed Banking Laws No. 3182 and 4389, the Capital Market Law No. 2499 and of the legislation on lending transactions, and some other economic crimes and crimes against the State.

The founders must have the necessary financial strength and respect and honesty and competence required for the business. For founders, who are legal persons, a transparent and open partnership structure “together with the risk group”30 is required.

3. Board permission

According to Article 10, in order to establish a bank (or open branches) in Turkey, an establishment permission must be granted by the Board. From the text of the Banking Act it appears that such a permission covers all activities that are treated in the Banking Act as “banking activities”, unless otherwise decided by the Board.

A bank that has received the establishment permission must meet, among others, the following criteria in order to commence its operations:

– its activities should be in compliance with corporate governance provisions and it should

have the required personnel and technical infrastructure;

– its managers should bear the qualifications set out in the corporate governance provisions

[of the Banking Act]; and

– the Board should announce that “they”31 bear the qualifications required for executing

the activities.

4. Articles of association

According to Article 16, any amendment to the articles of association of a bank requires a prior approval of the Agency; a proposed amendment must not be put to the general meeting before such an approval is received.

Banks must keep their up-to-date articles of association on their websites. In case of any amendments, the articles of associations must be updated within ten working days following the date of amendments.

30

“Risk group” is defined in the Banking Act, this concept appears to be similar to a “group of affiliated persons”. 31

It is not clear from the translation whether “they” refers to managers or the Board.


5. Acquisition and transfer of shares

According to Article 18, any acquisition of ten or more percent of a bank’s shares, or an acquisition, which results in a shareholder exceeding ten percent, twenty percent, thirty-three percent or fifty percent of the [share] capital (or a disposition as a result of which share ownership falling below these percentages), requires the permission of the Board.

Further, any disposition or transfer of preferential shares with the right of promoting a member to the board of directors or audit committee or issue of new shares with “privilege”32 shall be subject to the Board's authorization irrespective of limits defined above.33

It also appears that the Banking Act sets a minimum number for a bank’s shareholders, since it provides that “transactions resulting in the number of shareholders falling below five, and transferring of shares affected without permission, shall not be recorded in the book of shares”. Any records made in the book of shares in breach of the foregoing provision are null and void.

Indirect transfer of a bank’s shares is also controlled under the Banking Act.

In cases where the shares are transferred without the permission of the Board, the shareholder rights of the legal person stemming from these shares, other than dividends, will be exercised by the SDIF.

6. Principles of corporate governance

According to Article 22, the Board, upon consulting the CMB and associations of institutions, determines the “structures and processes of corporate governance and the applicable principles”.34

7. Board of directors

According to Article 23, the board of directors of a bank must have at least five members including the general manager. The general manager35 of the bank and, in his absence, his deputy must be a “natural” member of the board of directors.36

The Banking Act states that the responsibilities of the board of directors include ensuring the establishment, functionality, appropriateness and adequacy of internal control, risk management and internal audit systems; “securing” financial reporting systems; and “specification” of the powers and responsibilities within the bank.

32

It is not clear from the text of the law what “privilege” means in the context. 33

Interestingly, there appears to be a fee for such permissions: “For granting these permission, a transfer fee valued at one percent of the nominal value of the transferred shares of the bank shall be paid to the Fund by the transferee.” 34

See I.C Regulation on Banks’ Corporate Management Principles on p.59 below. 35

See I.A.9 General manager and deputy general managers on p.43 below. 36

The language of the law is not entirely clear: it seems that this should mean that the general manager must sit on the board by virtue of his position.


The Banking Act provides for some of the requirements to the founders of the bank to also apply to board members, in particular: no insolvency proceedings; no control over a failed bank or a bank with a revoked permission; and no convictions of specified types.

The qualifications required for the general manager37 in the Banking Act are also required for majority of the board of directors.38 Managing directors must satisfy the same conditions as the general manager. However, a person cannot be appointed/elected the general manager and the chairman of board of directors at the same time.

The Banking Act appears39 to require that at least three members of the board of managers (including the “manager of the main branch office and having the authority and responsibilities of a board of directors”) are located in the “main branch office in Turkey” of a bank established abroad and operating in Turkey through branches. Further, the Banking Act treats the three-member board of managers of such a bank as equivalent to the board of directors and applies the same qualification requirements to such managers as to the members of the board of directors.

The Agency must be notified of any persons elected/appointed to the board of directors (together with the documents supporting their qualification) within seven working days.40

8. Audit committee

According to Article 24, a bank’s board of directors must establish an audit committee “for the execution of the audit and monitoring functions”.

According to the Banking Act, the duties and responsibilities of the audit committee include the supervision of the efficiency and adequacy of the bank’s internal control, risk management and internal audit systems, functioning of these systems and the accounting and reporting systems within the framework of the act and other relevant legislation, and the integrity of the information produced; conducting the necessary preliminary evaluations for the selection of independent audit firms by the board of directors; regularly monitoring the activities of independent audit firms selected by the board of directors; and in case of parent undertakings covered by the Banking Act, ensuring that the internal audit functions of the institutions that are subject to consolidated supervision are performed in a consolidated and coordinated manner, on behalf of the board of directors.

An audit committee is responsible for ensuring that units established within the scope of internal control, risk management and internal audit systems and the independent audit firms regularly provide reports regarding the execution of their tasks and promptly notify the board of directors of the factors that could hinder uninterrupted and reliable execution of the banks’ activities or of the violations of the Banking Act and other applicable legislation.

An audit committee must include at least two members. These members must be non-executives from the board of directors. For banks operating in Turkey as branches, a member of the board of managers to whom no executive unit is attached must be appointed to the audit committee.

37

SeeI.A.9 General manager and deputy general managers on p. 43 below. 38

Those generally include requirements to education. 39

The language is not clear. 40

On the face of it the Banking Act requires neither the approval of an appointment by the Agency, nor specific fit and proper checks.


According to the Banking Act, the qualifications of the members of the audit committee must be such as set by the Board. Further, the audit committee’s duties, powers and responsibilities as well as working principles and procedures must also be set by the board of directors.

The BRSA website includes a link to Board Resolution on Qualifications to be Sought in Audit Committee Members.41 However, the text of the Resolution refers to “the members of board of management to be elected to the supervisory committees to be formed by the board of management to help the board to conduct supervision and surveillance activities”. It is not clear whether the text of the Resolution in fact provides for the relevant qualifications of the members of an audit committee. In any case, the Resolution requires that members must:

a) Including the two years before appointment:

1) Not be one of the board of management members having administrative functions in

the bank;

2) Not be personnel of the bank or its partners subject to consolidation, excluding the

personnel employed in internal audit, internal control, risk management, financial

control and accounting units;

3) Not be partner or personnel of the institutions conducting the external audit of the

bank or its partners subject to consolidation or shall not be participate to the external

audit process; and

4) Not be partner of personnel of institutions supplying consultancy or support services

to the bank or its partners subject to consolidation or shall not be one of the persons

giving these services;

b) Not be owner of qualified shares42 in the bank or its partners subject to consolidation;

c) Not be spouse or second-degree relatives by blood or by marriage of the main partner or

general manager;

d) Not held position within the same bank’s supervision committee for a period longer than

9 years at intervals or constantly;

e) Not accept any payments or any similar incomes under any names from the bank or its

partners subject to consolidation, relating to their profitability, excluding the payments

made to all the personnel from the profit according to the provision of main contract or

board of management resolution;

f) “Be undergraduate” and have experience within the fields of banking or finance for at

least ten years,

41

http://www.bddk.org.tr/websitesi/english/Legislation/8804boardresolution.pdf. 42

Generally, ten percent of share capital.

http://www.bddk.org.tr/websitesi/english/Legislation/8804boardresolution.pdf


g) His/her spouse and children shall not hold positions of general manager, assistant general

manager and any equivalent position in the bank or its partners subject to consolidation

and shall carry the qualifications determined within the paragraphs (a) (excluding item 1)

and (b) above.

According to the Resolution, at least one member must have education at undergraduate level in the fields of law, economy, finance, banking, business administration, public management or equivalent branches; and if such a member has an undergraduate degree from an engineering program, he/she must also have “graduated”43 from the mentioned fields.

The Banking Act generally provides that the information and documents evidencing appropriate qualifications of the members of the audit committee must be submitted to the Agency within seven working days.

An audit committee must, at least once in six months, report to the board of directors the results of its activities; the measures to be taken in the bank; the practices that need to be introduced; as well as other matters that it deems necessary for the sound operation of the bank. The audit committee must have the authority to “receive” documents and information from all units of the bank and the contracted outsourcing institutions and independent audit firms and to procure consulting services from expert persons, as subject to the approval of the board of directors and financing by the bank.

9. General manager and deputy general managers

According to Article 25, the general manager of a bank must have at least an “undergraduate” degree in law, economics, finance, banking, business administration, public administration and related fields. A general manager, who has an undergraduate degree in engineering must have a graduate degree in the aforementioned fields and must have at least ten years of professional experience in the field of banking or business administration.44

Deputy general managers must have at least seven years of professional experience and a minimum of two thirds of [deputy general managers] must have at least an undergraduate degree in the disciplines listed above. Further, even if certain persons are employed with different titles, but with duties which are comparable to a deputy general manager or who occupy higher executive positions are also subject to the provisions of the Banking Act applicable to deputy general managers.

Persons to be appointed as the general manager or a deputy general manager must submit documents to the Agency evidencing that they in fact meet the required qualifications. Such persons may proceed with their positions only if the Agency does not communicate its negative view within seven days following the notification.45

43

The language is not clear; it appears that this should be read to mean a post-graduate degree. 44

From the text of the translation it appears that the requirement of 10 years’ experience applies only to those who have a degree related to engineering, which is not very logical. 45

The manager of a head office in Turkey of a bank established abroad is considered to be the general manager for the purposes of the Banking Act.


In case of a resignation of the general manager or a deputy general manager, the reasons for such resignation must also be reported to the Agency.

General managers and deputy general managers must not take any full- or part-time positions within commercial undertakings other than undertakings subject to consolidated audit.

According to Article 26, persons who do not bear certain qualifications specified for the founders of the bank (i.e., no insolvency proceedings; no control over a failed bank or a bank with a revoked permission; and no convictions of specified types) cannot act as the general manager, a deputy general manager, or in a position wherein they have signing authority. Banks must immediately revoke the signing authorities of these persons.

Further, the signing authority of any bank employee, who was found to have infringed provisions of the Banking Act other applicable laws and put the bank's safe operation into danger and legal proceedings have been commenced must be temporarily revoked upon the Board's decision. Such persons may not be employed by any bank as an employee vested with signing authorities unless permitted by the Board.

10. Oath and declaration of property

According to Article 27, the chairman and the members of the board of directors or board of managers must take an oath after their appointment or election. Such persons, the general manager, deputy general managers and the managers with signing authority, including regional managers, branch managers and the managers of the units within the head office such as departments, sections, groups, etc., are also subject to the provisions of the Declaration of Personal Property and Elimination of Bribery and Embezzlement Law No. 3628.

The Board set out the principles and procedures applicable to oath-taking and declaration of property in the Regulation on the Principles and Procedures for Notification of and Taking Oath and Declaration of Assets by Executives to be Appointed to Top Management of Banks and Maintenance of the Book of Resolutions. The Resolution, for example, provides that within seven business days from election or appointment of the members of the Executive Boards of banks, among other things, detailed CVs containing professional experience and education received and notarized copies of graduate diplomas and post-graduate diplomas, if required, and ID cards or passports must be sent to the Agency.

According to the Resolution, the chairman and members of banks’ Executive Boards and Boards of Directors must take oaths after election or appointment prior to commencement of their duties. An oath is administered before a commercial court with the person in question officially pronouncing the following statement: “I do solemnly swear that I will perform my duties in __________ Bank with utmost care and honesty, that I will never act contrary to the provisions of the legislation and neither will I let any such action.”

11. Internal systems

According to Article 29, banks are obliged to establish and maintain adequate and efficient internal control, risk management and internal audit systems which are appropriate to the scope and structure of their activities, and which can respond to the changing conditions and cover all


their branches and undertakings subject to consolidation in order to monitor and control the risks.

The principles and procedures applicable to the establishment, functioning and adequacy of internal control, risk management and internal audit systems; the units to be established; the activities to be performed; the duties and obligations of senior management; and the reporting to be made to the Agency are set by the Board.46

Internal control system

According to Article 30, within the internal control system, banks must: (i) ensure the execution of their activities in compliance with legislation, internal regulations and banking ethics; (ii) secure the integrity and reliability of accounting and reporting systems and timely accessibility of information through continuous control activities to be complied with and performed by the personnel at any level; (iii) ensure the functional distribution of the duties and the “sharing of powers and responsibilities the fund payments”,47 the reconciliation of bank’s transactions, protection of assets and control of liabilities; (iv) identify and evaluate any risk encountered and prepare the infrastructure required for managing such risks; and (v) establish an adequate information exchange network.

Internal control activities must be carried out by an internal control department and the internal control personnel working “under” the board of directors.

Risk management system

According to Article 31, within the risk management system, banks must establish, implement and “report” risk policies within the framework of the principles set by the Board.

Risk management activities must be performed by the risk management department and “personnel [working] under the board of directors”.

Internal audit system

According to Article 32, banks must establish internal audit systems that cover all their units, branches and undertakings subject to consolidation. Bank auditors must investigate the conformity of the banking activities to the legislation, articles of association, internal regulations and banking principles.

Internal audit activities must be performed in an impartial and independent manner and exercising due professional care by the adequate number of auditors.

Persons in charge of the internal audit of the parent banks may carry out internal audits of undertakings subject to consolidation.

An internal audit report prepared by the internal audit unit and “the authorized inspector” must be submitted to the board of directors through the audit committee at least in each three-month’ period.

46

See I.B Regulation on Internal Systems of Banks on p.50 below. 47

Perhaps, the translation omitted the words “related to” before “fund payments”.


12. Financial reporting

According to Article 37, banks must, in line with the principles and procedures to be established by the Board upon consulting the associations of institutions and the Turkish Accounting Standards Board taking into consideration international standards, ensure uniformity in their accounting systems and timely and prepare their financial reports.

According to Article 38, a parent undertaking must prepare consolidated financial reports. Undertakings subject to consolidation are obliged to provide any requested information and documents during the preparation of consolidated financial reports.

According to Article 39, financial reports must be signed by the chairman of the board of directors, the members of the audit committee, the general manager, deputy general manager responsible for financial reporting as well as the relevant unit manager or equivalent authorities, declaring that the financial report is in compliance with the legislation on financial reporting and with the accounting records. The signing responsibility must be fulfiled by the members of the board of managers of branches in Turkey of banks established abroad.

Annual financial reports presented by banks to their general meeting must be approved by independent audit firms.

According to Article 40, banks must prepare an annual activity report that includes information about their status, management and organization structures, human resources, activities, financial situations, assessment of the management and expectations from the future; together with financial statements, summary of board of directors’ report and independent auditing report.

According to Article 41, the board of directors is responsible for setting the basic policies, duties, powers and responsibilities related to the financial reporting system.

13. Loans

Loans to related parties

According to Article 50, banks must not grant loans, purchase bonds or similar securities of:

a) their board of directors’ members, general manager, deputy general managers and

employees that are authorized to extend loans; their spouses and children under their

custody; and the undertakings where they individually or jointly own twenty-five

percent or more of the capital;

b) their (other) employees and their spouses and children under their guardianship; and

c) funds, associations, unions or foundations established by or for their employees.


The above provisions do not apply to shareholders who are original members of the board of directors or have representative in the board of directors and directly or indirectly own qualified shares48 in the bank’s capital.

However, there is an exception for transactions within a group: the Banking Act states that if persons in the board of directors and audit boards of [subsidiary] undertakings of a bank are at the same time the employees of the relevant bank, this should not preclude the undertakings from entering into transactions with that bank.

In cases where loans are made to persons which belong to the bank’s risk group,49 the relevant decision must be taken by two thirds majority of the board of directors’ and that the terms and conditions of the loan do not vary from the market conditions in favor of the borrower.

An exception is made for certain loans below a threshold: for example, loans made to the members of the board of directors and their spouses and children under their custody, which do not exceed the five times their monthly net total remunerations do not require the special approval of the board of directors.

Banks must regularly report to the Agency the loans extended to persons who are in their risk groups. Loans that violated the respective rules must be repaid within six months.

Risk group

According to Article 49, an individual and his spouse and children, the undertakings where they are members of board of directors or the general manager or the undertakings which they or a legal person control individually or jointly, directly or indirectly or participate with unlimited responsibility, constitute a “risk group”.

A bank and its qualified shareholders,50 board of directors’ members and general manager as well as the undertakings they control individually or jointly, directly or indirectly or participate with unlimited responsibility or where they are members of board of directors or general manager constitute a risk group including the bank.

Jointly-controlled undertakings are included in the risk group of each shareholder that controls together these undertakings. Risk groups also include individuals and legal persons who have surety, guarantee or similar relationships where the insolvency of one will lead to the insolvency of the other.

Extending loans

According to Article 51, the power to extend loans is vested with the board of directors. The board of directors is responsible for ensuring the establishment, implementation and monitoring of policies for extending and approving loans and other administrative matters and for taking the necessary measures.

48

See footnote 50 above. 49

See Risk group below. 50

Strictly speaking, the Banking Act does not define a “qualified shareholder”; however, it does include a definition of “qualified shares”. Qualified shares refer to shares that represent, directly or indirectly, ten per cent or more of the capital or voting rights of an undertaking or that give the right to appoint members to board of directors.


However, the board of directors may assign its power to extend loans to the credit committee or “head office”.

Persons authorized to extend loans cannot take part in the evaluation and decision-taking stages for the loan transactions involving themselves, their spouses and children under their guardianship and the real and legal persons that constitute a risk group with them, and shall inform the relevant authorities of this fact in writing.

According to Article 53, banks must make, implement and regularly review policies regarding compensating for the damages that have arisen or are likely to arise in connection with the loans and other receivables and reserve adequate level of provisions against impairment in the value of other than those assets, for the quality and classification of assets; receiving of guarantees; measurement of value and reliability of them, monitoring the loans under follow-up and the repayment of overdue loans, and establish and operate the structures that could execute all these issues. The principles and procedures applicable to the implementation of the above measures are set by the Board.

Loan limits

The Banking Act sets out loan limits for certain categories of borrower. For example, according to Article 54, the total amount of loans to a risk group must not be more than twenty-five percent of its own funds. For the bank’s own risk group, this ratio is generally set as twenty percent (unless increase by the Board to twenty-five percent or lowered by it). Aggregate loans to all shareholders (excluding those that have less than one percent share in the capital of a bank), and to persons who have indirect loan relations with such persons, must not exceed fifty percent of own funds. Certain transactions, e.g., transactions against cash, cash-like assets and accounts as well as precious metal are excluded from the loan limit rules.

14. Restrictions related to shares

According to Article 56, a bank must not acquire shares of a undertaking other than credit institutions and financial institutions at an amount that exceeds fifteen percent of its own funds, and the total amount of its shares in these undertakings shall not be more than sixty percent of its own funds.

In case the limits mentioned in the first paragraph are exceeded, the exceeded amount shall be taken into account as an item of reduction from core capital in the calculation of own funds.

There is also a restriction on cross-shareholdings: banks must not directly or indirectly own shares in undertakings or institutions that directly or indirectly own shares within themselves, and must not admit their shares as pledge and must not give advance payments in return for [such shares].

15. Ethical principles

According to Article 75, a bank and its employees must ensure that the bank’s activities are performed in compliance with the Banking Act, applicable regulations and the bank’s objectives and policies and also comply with ethical principles that consider justice, fairness, honesty and social responsibility as a foundation in their management.


Ethical principles must be established by the associations of [financial] institutions upon the approval of the Board.

16. Banks Association of Turkey and Participation Banks Association of Turkey

According to Article 79, deposit banks and development and investment banks must become members of the Banks Association of Turkey – a professional organization. Participation banks shall become members of the Participation Banks Association of Turkey. The associations, inter alia:

a) ensure the development of the banking profession;

b) ensure that members function in a dignified and well-disciplined manner as required

by the banking profession and in line with the needs of the economy, by setting

professional principles;

c) set the ethical professional principles and standards that the personnel of member

banks will have to abide by, upon receiving the approval of the Agency;

d) monitor the enforcement of the decisions taken pursuant to the applicable legislation

as well as the measures required to be taken by the Agency;

e) take and implement any measure required for preventing unfair competition among

members; and

f) set the principles and conditions for announcements and advertisements in terms of

type, format, qualitative and quantitative elements to be complied by the members,

upon receiving the approval of the Agency.

I.B. Regulation on Internal Systems of Banks

The Regulation on the Internal Systems of Banks (as amended), published in the Official Gazette dated 1 November 2006 (in this section – the “Regulation”)51 sets out the procedures and principles concerning the internal control, internal audit and risk management systems to be established by banks and the functioning of these systems (Article 1).

1. Board of directors

According to Article 4, units included within the scope of the internal systems must be established “under” the board of directors.

The board of directors may transfer all or part of its duties and responsibilities concerning the internal systems to the officer in charge of these systems. Several officers in charge of the internal systems may be appointed on condition that their duties and responsibilities are segregated on the basis of the units included within the scope of the internal systems. The

51

http://www.bddk.org.tr/websitesi/english/Legislation/8839ic_sistemler.pdf.

http://www.bddk.org.tr/websitesi/english/Legislation/8839ic_sistemler.pdf


responsibility for the internal systems may only be assigned to one of the non-executive directors or to committees composed of such directors or to the audit committee.

According to Article 5, the board of directors has the ultimate responsibility for establishing the internal systems in accordance with the procedures and principles specified in the Regulation, and operating them in an effective, adequate and suitable manner, securing the information provided from the accounting and financial reporting system, and determining the powers and responsibilities within the bank.

The board of directors of has, inter alia, the following powers and responsibilities:

– to establish the institutional structure and human resources policy of the bank and to

determine the criteria for the appointment of top-level management;52

– to determine clearly in writing the duties and responsibilities of the officer in charge of

the internal systems and to monitor his activities;

– to determine in writing the strategies and policies and the procedures of implementation

concerning the activities of the units included within the scope of the internal systems and

to ensure that they are implemented and maintained effectively and coordinated with

each other;

– to determine the duties, powers and responsibilities of the units included within the

scope of the internal systems and of their managers clearly and without duplication, to

approve the working procedures and principles for the staff employed in these units, and

to ensure that the necessary resources are allocated;

– to decide the selection and removal of the managers of the units included within the

scope of the internal systems;

– to determine in writing the risk management policies and strategies of the bank generally

and for each type of risk, the level of risk it can take, and the related procedures of

implementation, and to allocate maximum risk limits for the units and their managers or

the staff employed in those units;

– to approve the policies concerning the taking, monitoring, management and reporting of

such risks as would considerably affect the incomes and expenses of the bank, and

changes to these policies, and to supervise their implementation;

– to ensure that the bank has a process whereby the level of equity in relation to the level

of risk assumed by the bank is determined and equity management strategies; and

52

Top-level management is defined as including the general manager and assistant general managers of a bank, the managers of the units included within the scope of the internal systems, and those managers of the non-advisory units who serve in positions equivalent or superior to the position of assistant general manager in terms of their powers and duties even if they are employed with other titles.


– to ensure that the top-level management submits to it timely and reliable reports

concerning the important risks to which the bank is exposed.

2. Audit committee

According to Article 6, the board of directors must appoint at least two non-executive directors from among itself as members of the bank audit committee to assist the board of directors in carrying out its audit and supervision activities. These members must, inter alia:

a) including for the last two years before the date of appointment:

1) not have been executive directors of the bank;

2) not have been employees of the bank or its partnerships subject to consolidation,

excluding those employed in the internal systems or in the financial control and

accounting units;

3) not have been partners or employees of the institutions performing independent

audit or rating or valuation of the bank or its partnerships subject to consolidation

or of entities abroad which are legally affiliated with the said institutions, and not

have taken part in the process of independent audit, rating or valuation;

4) not have been partners or employees of the institutions providing consultancy or

support services to the bank or its partnerships subject to consolidation, or among

persons providing such services;

b) not hold a qualified interest in the bank or in its partnerships subject to consolidation;

c) not be spouses, or relatives by blood or marriage of up to (and including) the second

degree, of the controlling partner, the executive directors or the general manager;

d) not have served on the audit committee of the same bank for a period in excess of nine

years with or without interruption;

e) not receive any remuneration or similar income under any name whatsoever from the

bank or its partnerships subject to consolidation, based on its or their profitability, except

for payments made to all personnel out of profit under the articles of association or a

resolution of the general assembly;

f) have education at the undergraduate level as a minimum and possess a minimum of ten

years’ experience in banking or finance; and

g) have their spouses and children not being managers in the position of general manager or

assistant general manager, or in an equivalent position, at the bank or its partnerships

subject to consolidation.


The Regulation also stipulates qualification requirements to the members of the audit committee (similar to those in the Banking Act).53

According to Article 7, the audit committee has the duties and responsibilities, on behalf of the board of directors, to supervise the efficiency and adequacy of the bank’s internal systems, the functioning of these systems and of the accounting and reporting systems in accordance with the Law and applicable regulations, and the integrity of the information that is generated, to carry out the necessary preliminary assessment for the selection of independent audit institutions and rating, valuation and support service institutions by the board of directors, to monitor regularly the activities of the institutions selected by the board of directors and with which contracts have been signed, and to ensure that the internal audit activities of the partnerships subject to consolidation in accordance with regulations introduced under the Banking Act are maintained and coordinated in the consolidated fashion.

Further, the audit committee has duties and powers:

– to supervise compliance with the provisions hereof concerning internal control and with

the internal policies and implementation procedures approved by the board of directors

and to make proposals to the board of directors in relation to measures which it is

considered necessary to take;

– to supervise whether the internal audit unit is performing its obligations as determined in

the Regulation and in the internal policies;

– to establish the channels of communication that will enable the units included within the

scope of the internal systems to reach the audit committee directly;

– to supervise whether the internal audit system covers the existing and planned activities

of the bank and the risks arising from these activities and to examine internal regulations

concerning internal control that will enter into force upon their approval by the board of

directors;

– to make proposals to the board of directors concerning the selection of managers to

those units included within the scope of the internal systems which are attached to the

audit committee, and to submit an opinion during the removal of such managers by the

board of directors;

– to receive the opinions and proposals of the top-level management concerning the

internal systems and to evaluate such opinions and proposals;

53

At least one member of the audit committee must have received education in law, economics, finance, banking, business management, public administration or an equivalent subject at the undergraduate level as a minimum or, if they have received education in an engineering branch at the undergraduate level, they must also have received education in one of the above-mentioned subjects at the graduate level.


– to ensure the establishment of the channels of communication for the reporting of

irregularities within the bank directly to the audit committee or to the internal audit unit

or inspectors;

– to monitor whether the inspectors are performing their duties independently and

impartially;

– to examine internal audit plans;

– to make proposals to the board of directors concerning the qualifications required for

personnel to be employed in the units included within the scope of the internal systems;

– to monitor the measures taken by the top-level management and subordinated units in

relation to matters identified in internal audit reports;

– to evaluate the levels of professional training and the competence of the managers and

personnel employed in the units included within the scope of the internal systems;

– to evaluate the availability of the necessary methods, tools and implementation

procedures for identifying, measuring, monitoring and controlling the risks carried by the

bank;

– to have discussions with the inspectors and with the independent auditors of the

independent audit institution conducting the independent audit of the bank, at regular

intervals and at least four times a year, under programmes and agendas to be

determined;

– to report its activities carried out in a given period, on condition that such period does not

exceed six months, and the results of these activities to the board of directors, including in

such report its opinions regarding measures that need to be taken in the bank, practices

which are considered necessary, and any other matters which it considers important for

the activities of the bank to be carried on safely; and

– to monitor whether or not those who are authorized to extend loan themselves or their

spouses or minor children, or other natural or legal persons that constitute a risk group

together with them, are involved in the stages of evaluation and decision-making related

to any credit transactions to which they are party, and to establish the channels of

communication that will ensure they are informed of these points.

3. Top-level management

According to Article 8, the responsibility of the top-level management includes, inter alia:


– to coordinate the bank personnel employed in the units for which they are responsible, to

make a division of tasks among such personnel in view of their competencies, and to

monitor whether they effectively perform their duties and responsibilities;

– to analyse deficiencies or errors arising in the units for which they are responsible and to

report these or the measures considered necessary to the relevant internal systems

officer; and

– to make timely and reliable reporting to the board of directors about important risks to

which the bank is exposed.

4. Internal control

According to Article 9, the purpose of the internal control system is to ensure that the assets of the bank are protected, that its activities are conducted efficiently and effectively and in accordance with the Banking Act and other applicable legislation, with the internal policies and rules of the bank, and with the established practices of banking, that the reliability and integrity of the accounting and financial reporting system is maintained, and that information is available in a timely manner.

In order to achieve the intended purpose of the internal control system:

– a functional division of tasks must be established and responsibilities are apportioned

within the bank;

– the accounting and financial reporting system, the information system and the internal

communication channels must be established such that they operate effectively;

– a business continuity plan and other related plans must be prepared;

– internal control activities must be formed; and

– workflow charts must be formed showing the work steps and the controls over the work

processes of the bank.

The internal control system shall be structured so as to cover the domestic and overseas branches of the bank, its head office units, its partnerships subject to consolidation, and all its activities.

Terms of reference

According to Article 10, the powers and responsibilities of all units, personnel and committees within the bank must be determined in writing, with a division of tasks in relation to the activities on the same subject, in order to prevent mistakes, fraud, conflicts of interest, manipulation of information and misuse of resources at the bank.


Conflicts

Activities from which conflicts of interest may arise must be identified and minimized and the functions of deciding to carry out a transaction that creates a risk, accounting the transaction and managing the risk that arises from the transaction shall be entrusted to the responsibility of different members of personnel.

Contingency plan

According to Article 13, banks must have an emergency and contingency plan, approved by their boards of directors. This plan must be put into the form of a guide book and distributed to all relevant units of the bank in order to ensure that members of personnel are informed of the plan and their responsibilities under the plan. An authorized unit must be designated to coordinate the matters outlined in the plan.

5. Internal audit

According to Article 21, the purpose of the internal audit system is to give the senior management assurance that the activities of the bank are conducted in accordance with the Banking Act and other applicable legislation and with the internal strategies, policies, principles and targets of the bank and that the internal control and risk management systems are effective and adequate.

All activities of the bank without any limitation and all its units, including the units of the domestic and overseas branches and the head office, must be examined and audited periodically and on a risk basis, any deficiencies, errors and abuses shall be identified, opinions and proposals shall be submitted to prevent them from occurring again and to secure the effective and efficient use of bank resources, and the accuracy and reliability of information and reports communicated to the Agency and to the senior management must be assessed, through internal audit activities.

Audits

In periodic and risk-based audits:

– the adequacy and effectiveness of the internal control and risk management systems

must be assessed;

– the conformity of operational activities with the procedures specified, and the functioning

of the related internal control implementation procedures, must be tested;

– the conformity of operations with the Banking Act and other applicable legislation and

with the internal strategies, policies, implementation procedures and other internal

regulations of the bank shall be audited; and

– the accuracy and reliability of reports made to the board of directors and the audit

committee under the internal regulations of the bank, and of statutory reports, and the

conformity of these reports with the applicable time-limits, shall be audited.


Risk models

Where risk measurement models are used in the bank, the following points shall be audited in relation to such models:

– whether the results obtained through the risk measurement models and methods are

incorporated in daily risk management;

– the pricing models and valuation systems used by the bank;

– the risks covered by the risk measurement models used by the bank;

– the accuracy and suitability of the data and assumptions used in the risk measurement

models;

– the reliability, integrity and timely availability of the source of the data used in the risk

measurement models; and

– the accuracy of the retrospective tests used for the risk measurement models.

Separate unit and manager

According to Article 22, the function of internal audit in banks must be performed by the internal audit unit. The manager of the internal audit unit must have a minimum of seven years’ experience in banking. The manager of the internal audit unit must conduct the internal audit activities in accordance with the policies and implementation procedures concerning audit activities and with the internal audit plans.

Audit plan

According to Article 25, periodic and risk-based internal audit activities of banks must consist of preparing the internal audit plan, putting it into effect, executing it through work programmes, reporting the results to the management of the internal audit unit, to the management of the unit concerned, to the relevant internal system officer, to the audit committee and, through the audit committee, to the board of directors, and monitoring the measures taken by the management bodies of the units concerned in the framework of the audit reports.

6. Risk management

According to Article 35, the purpose of the risk management system is to ensure that the risk exposure of the bank is defined, measured, monitored and controlled through policies, implementation procedures, and limits, which are intended to monitor, to keep under control and, where necessary, to change the risk-yield structure of the future cash flows of the bank and, in connection with this, the nature and level of its activities.

In order to establish a suitable and adequate risk management system within the bank:


– adequate policies, implementation procedures, and limits, to enable the management of

the different aspects of risks arising from activities; and

– risk management activities shall be clearly defined in accordance with the procedures and

principles specified in the Regulation.

Policies

According to Article 36, banks must determine written policies and implementation procedures on a consolidated and non-consolidated basis to manage each of the risks arising from their activities.

In determining the risk management policies and implementation procedures, the following points as a minimum shall be considered:

– the strategies, policies and implementation policies related to the activities of the bank;

– conformity with the volume, nature and complexity of the activities of the bank;

– the level of risk that the bank can take;

– the risk monitoring and management capacity of the bank;

– the past experience and performance of the bank;

– the levels of specialization of the managers of the units that conduct the activities in their

respective areas; and

– obligations stipulated in the Banking Act and other applicable legislation.

The board of directors or the relevant internal systems officer must regularly evaluate adequacy of the risk management policies and make the necessary changes.

Risk management policies and implementation procedures must also include risk mitigation techniques such as hedging, insurance or credit derivatives.

Limits

According to Article 37, written limits must be determined for quantifiable risks such as credit risk, market risk, interest rate risk and liquidity risk arising from the activities of banks, and these limits must be approved by the board of directors.

The risk limits must be determined jointly with the high-level managers concerned, including the relevant internal systems officer, the manager of the risk management unit and the general manager of the bank.

Risk limits must be determined:


– in accordance with the level of risk that the bank can take, with its activities and with the

size and complexity of its products and services; and

– as a minimum on the basis of personnel, units, the bank as a whole or the group in which

the bank is included.

The risk limits shall be regularly reviewed and adapted in accordance with changes in market conditions and in the bank strategy.

Risk management unit

According to Article 39, risk management activities must be conducted by the risk management unit and personnel. The risk management activities must consist of: (i) measurement of risks; (ii) monitoring of risks; and (iii) controlling and reporting of risks.

According to Article 40, the risk management unit must have the following responsibilities as a minimum:

– to design and implement the risk management system;

– to determine the risk management policies and implementation procedures on the basis

of the risk management strategies;

– to ensure that the risk management policies and implementation procedures are

implemented and complied with;

– to ensure that, before entering into a transaction, the risks are understood and

sufficiently evaluated;

– to participate in the process of designing, selecting and putting into practice the risk

measurement models and giving preliminary approval, to review the models regularly and

to make the necessary changes;

7. Notifications to Agency

According to Article 43, banks must notify the Agency in writing of the appointment or removal of the internal systems officer, the members of the audit committee, and the high-level managers of the units included within the scope of these systems, within seven working days from the date of the relevant decision.

I.C. Regulation on Banks’ Corporate Management Principles

The Regulation on the Banks’ Corporate Management Principles (published in November 2006) (in this section – the “Regulation”)54 has as its objective the regulation of the structures and

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processes relating to the corporate management of banks (Article 1). The Regulation includes an Annex, which sets out the principles for banks’ corporate management.

The Annex includes the following general principles:

– Principle 1- Corporate values and strategic targets shall be established within the Bank;

– Principle 2- The authorities and responsibilities inside the bank shall be determined and

applied clearly;

– Principle 3- The members of the board of management shall have the qualifications to

fulfil efficiently their duty and be conscious of their role they undertook within the

corporate management and they shall carry out independent evaluations about the

bank’s activities;

– Principle 4- The senior management shall have the qualifications to fulfil its duties

efficiently and in conscious of its role within the corporate management;

– Principle 5- The studies conducted by both bank supervisors and independent auditors

shall be exploited effectively;

– Principle 6- The compliance of the wages policy with the ethical values, strategic targets

and internal balances of the bank shall be provided; and

– Principle 7- Transparency shall be ensured in corporate management.

According to principle 1, the bank’s board of managers must determine and declare the mission and the vision of the bank. The board of managers must ensure the application of policies determining, preventing or administrating the possible conflicts of interest, which may occur because of the role of top-level management inside the activities of the banks or inside the group.

According to principle 2, the board of managers must determine the authorities and responsibilities of the members of the board of managers and top-level management55 and must monitor the activities of top-level management and whether or not the top-level managers comply with the policies determined by the board.

According to principle 3, the members of the board of management must have the qualifications to fulfil efficiently their duties. The board of management members must:

– conduct their duties towards the bank and shareholders in fidelity;

– understand their task in protecting the bank;

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Defined as including the general manager and assistant general managers of the bank, managers of the units within the scope of internal systems and the managers in a position equivalent to assistant general manager or higher of units excluding consultancy unit, even if they have been employed under a different title.


– spare sufficient time for bank businesses and participate to the board of management

meetings;

– fulfil forethoughtfully their duty as member of board of managers and in good intentions;

– know the legislation to which the bank is subject to and ensure that the relations between

the bank and regulatory and supervisory authorities are efficient;

– not give in to the pressures creating results which may be disadvantageous to the bank

and not accept financial interest for that purpose; and

– not give incomplete and incorrect information to mislead the other members.

According to principle 4, the senior management56 must have the qualifications to fulfil their duties efficiently; they must not be appointed to branches in which they do not possess the required knowledge and skills.

The senior management members must carry out their duties in a fair, transparent and accountable way.

According to principle 6, the board of managers must ensure that salaries of the members of the board of managers, top-level management and other authorized personnel are compatible with the bank’s ethical values, internal balances and strategic targets. The salaries of the “committee formed by the members of board of managers” must be determined with consideration of their responsibilities; however they must not be related to the short-term performance of the bank.

It is possible to effect payments to the members of the board of managers with executive duty and the top-level management in accordance with the bank’s performance, but these incentive payments shall be attached to objective conditions in a way to affect positively the bank’s corporate values.

The task definitions and distributions of the personnel as well as the performance and rewarding criteria shall be determined and announced by the top-level management. These criteria shall be reviewed regularly according to the standards determined and special task responsibilities.

I.D. Capital Market Act

According to Article 1, the objective of the Capital Market Act is to regulate and control secure, transparent and stable functioning of the capital market and to protect the rights and benefits of investors with the purpose of ensuring an efficient and widespread participation by the public57 in the development of the economy through investing savings in the securities market.

The Capital Market Act itself has few provisions related to corporate governance of issuers. In fact, for the purposes of this review, such provisions are mostly related to financial reports.

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Defined as including the board of managers and top-level managers of the bank. 57

It is interesting to note that under Article 11 of the Capital Market Act, shares of joint stock corporations having more than 250 stockholders are considered to have been offered to the public and such companies shall be subject to the provisions applicable to publicly held joint stock corporations.


According to Article 16, issuers and capital market institutions58 must prepare financial statements, financial reports and other information required by the Capital Market Board, including consolidated financial statements, in compliance with the form and principles to be determined and generally accepted accounting principles, definitions and standards.

Issuers and capital market institutions must have their financial statements (as specified by the CMB) audited by independent auditing firms. Independent auditing firms are legally responsible for losses arising from false or misleading information and statements in the auditing reports they have prepared for the financial statements and reports that they have audited.

I.E. Communiqué Amending the Communiqué Regarding Independent Auditing in Capital

Markets

1. Prohibition on non-related audit services

According to Article 1 of the Communiqué,

“Independent auditing firms, their auditors and other staff shall not provide any issuer or intermediary, contemporaneously with the audit, any non-audit service, with or without fee, including;

a) Book-keeping and other related services,

b) Financial information systems design and implementation services on management,

accounting and finance

c) Appraisal or valuation services and actuarial services,

d) Internal audit outsourcing services,

e) Legal services and expert services,

f) Any other consultation services,

However, within the framework of the Law No. 3568 on Independent Accountancy, Independent Accountancy Financial Advisory and Sworn-in Financial Advisory, it is not prohibited to examine financial statements and tax returns and verify their conformity and to give opinion and prepare reports in accordance with tax legislation.

Any consulting firm that is related with any independent auditing firm by way of capital or management shall not provide any consulting service to any issuer to which the related independent auditing firm provides audit service for the same period. This prohibition includes consulting services rendered by shareholders or directors of the independent auditing firm.”

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According to Article 32 of the Capital Market Act, such institutions include: (i) intermediary institutions; (ii) investment companies; (iii) mutual funds; and other institutions given permission to operate in capital markets.


2. Audit committee

Further, the Communiqué provides that listed companies must have an audit committee with at least two members. If the committee has two members, both of them, if committee has more than two members, the majority of them cannot be from an executive post (e.g., general manager or executive committee member in the board of directors).

Non-listed companies can voluntarily establish an audit committee according to principles regulated in this article and disclose to the public.

3. Responsibility for financial statements

The Communiqué provides that the board of directors of an issuer or intermediary is responsible for the preparation, presentation and true and fair view of financial statements and reports in accordance with the Board’s accounting standards and generally accepted accounting principles.

The board of directors of issuers and intermediaries must adopt a separate decision related to the approval of financial statements and annual reports. Published annual and interim financial statements and annual reports must be signed by the general manager, accounting officer and, if there is, staff assigned by the board of directors, with the following explanations:

a) financial statements and annual reports were examined by [the respective persons];

b) according to information that they have, the reports do not include any unrealistic

explanation or by the date of announcement, there is any deficiency that result in

misleading explanations; and

c) according to information that they have, financial statements and other financial

information in the reports reflect true nature of the financial situation and operation

results of the issuer.

I.F. Communiqué on Principles Regarding Cumulative Voting at Shareholders Meetings of

Joint Stock Corporations Subject to Capital Market Law

The Communiqué provides for cumulative voting regime.

According to Article 5, cumulative voting regime relates to the election of boards of directors and auditors. The number of cumulative votes is calculated separately for the election of the board of directors and auditors.

To adopt cumulative voting regime, an explicit provision in the articles of association of a corporation is required. Cumulative voting is mandatory for corporations whose shares are “not traded” (?) in the exchanges and whose total number of shareholders is determined to exceed 500 continuously for the last two years. Such corporations must amend their articles of association to include provisions of cumulative voting in the next ordinary general meeting.

Cumulative voting can also be introduced by other corporations.


I.G. Corporate Governance Principles

The Governance Principles59 were adopted by the CMB in June 2003 and amended in February 2005 (the “Principles”).

According to their text:

…the Principles mainly address publicly held joint stock companies.60 However, it is

considered that other joint stock companies and institutions, active in private and public

sector, may also implement these Principles. The implementation of the Principles is

optional. However, the explanation concerning the implementation status of the

Principles, if not detailed reasoning thereof, conflicts arising from inadequate

implementation of these Principles, and explanation on whether there is a plan for change

in the company’s governance practices in the future should all be included in the annual

report and disclosed to public. Within the framework of the regulations to be enforced by

the CMB, the rating institutions conducting rating of corporate governance will determine

the implementation status of the Principles. Within the Principles, “comply or explain”

approach is valid. However, the (R) letters on the sides of some of the Principles indicating

that those are recommendations only. With respect to non-conformity with these

Principles, which are only recommendations, no disclosure is required. Additionally, the

Principles, marked as recommendations, may be subject to of “comply or explain”

approach in medium and long term.

The Principles consist of four main sections: (i) shareholders; (ii) disclosure and transparency; (iii) stakeholders; and (iv) board of directors.

The first section discusses the Principles on shareholders’ rights and their equal treatment. Issues such as shareholders right to obtain and evaluate information, right to participate in the general shareholders’ meeting and right to vote, right to obtain dividend and minority rights are included in detail in this section. Matters such as keeping records of shareholders and the free transfer and sales of shares are also discussed hereunder.

The second section discusses the Principles regarding disclosure and transparency issues. Within this scope, Principles for establishment of information policies in companies with respect to shareholders and the adherence of companies to these policies are discussed.

The conditions of today’s global financial economy and conditions faced in our country have been taken into consideration while setting single standards for the procedures for providing information via periodic financial statements and reports and detailing such standards through consideration of functionality.

The third section is concerned mainly with stakeholders. A stakeholder is defined as an individual, institution or an interest group that is related with the objectives and operations of a company in

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any way. Stakeholders of a company include the company’s shareholders and its workers; creditors, customers, suppliers, unions various non-governmental organizations, the government and potential investors who may consider to invest in the company. This section includes the Principles to regulate the relationship between the company and stakeholders.

The fourth section includes Principles concerning functions, duties, obligations, operations and structure of the board of directors; remuneration thereof, as well as the committees to be established to support the board operations and the executives. Under the section concerning the board of directors, it is proposed that the board of directors be composed of two different types of members. These are executive and nonexecutive members. In case a member bears its administrative duty as a managing member, then the mentioned board member is defined as the board member having an execution duty. A non-executive member is defined as an individual not having any administrative duties within the company. The chief executive officer (CEO) is the individual who is responsible for the implementation mentioned under the articles of association at the highest level. In case there is no CEO in corporate structure, same function will be fulfilled by the general director.

The company’s chief executive officer/general director and the general coordinator, their assistants, staff directing the main units in the company organization chart and their assistants, and the personnel that are directly working with the board of directors, chairman or chief executive officer/general director and other personnel such as consultants have been collectively named as executives within the Principles.

Selected specific principles are covered in more detail below.

1. Shareholders

According to Principle 3.4.12, all candidates should be present during the election of the members of the board of directors. Shareholders must be provided with information concerning the candidates and also with the opportunity to pose questions to such candidates. In particular:

– shareholders should be informed about the other companies on which each candidate

fulfils a duty as a board member and exclusively on whether or not in-house regulations in

that respect are observed.

– minimum requirements for disclosure of information about the candidates should be

stated in the articles of association. Shareholders are informed about any information that

the candidates refrain to disclose.

– the information that candidates are required to disclose may be outlined as follows:

identification information of the candidate; level of education; current and previously

held positions within the past five years and reasons for departure from each position; the

characteristics and level of relations with the company; board membership experience;

official tasks; the characteristics and level of relations with the individuals related to the

company; the characteristics and level of relations with main institutions with whom the

company deals with; financial status and/or declaration of property; whether or not


independence criteria is meet and will be maintained at the time of general shareholders’

meeting and other similar matters that may affect the company’s operations in case of

board membership.

According to Principle 3.4.14, shareholders should be given the opportunity to express their views and suggestions in relation to the remuneration policy that is applicable to board members and key executives.

According to Principle 6.1, the board of directors and executives of the company are prohibited from diminishing the profit through, collusive transactions, as defined in the related legislation.

2. Section II – Public Disclosure and Transparency

Declaration “comply or explain”

According to Principle 1.6, a unilateral declaration of the board of directors, which covers information about whether or not the Principles are being properly applied, if the Principles are not being applied, the reasons for such non-application and all possible conflicts of interest due to the improper adoption of the Principles, should be included in the annual report and disclosed to public, together with pertinent harmonization report, if any.

Website in English

According to Principle 1.11.2, the company’s website should also be made available in English for foreign investors.

Beneficial ownership

According to Principle 2.2, the company’s ultimate controlling individual shareholder or shareholders should be disclosed to the public, as identified after being released from indirect or cross ownership relationships between co-owners. The company’s capital structure should be presented in a table format that would include the names of the ultimate controlling individual shareholder/s (names of the real personalities), amount and proportion of their shares and their share class and such table should also be incorporated into the annual report and financial statement footnotes.

Related party transactions

According to Principle 2.5, commercial and non-commercial transactions between the company and companies, where board members, executives and shareholders, who either directly or indirectly own at least 5% of the company’s capital, possess at least 5% and more of shareholding or having the control of the latter are disclosed to public.

Voting arrangements

According to Principle 2.6, shareholders can engage in voting agreements in order to be effective within the company’s management. The company should disclose information about the voting agreement to the public once being informed of such agreement.


IAS

According to Principle 3.1.1, periodical financial statements and footnotes should be prepared in accordance with the current legislation and international accounting standards and applied accounting policies should also be included in the footnotes of the financial statements.

Annual report

According to Principle 3.2.2, the below listed issues should be incorporated in the company’s annual report:

– analysis of significant transactions carried out during the preceding year with the

group companies and other related persons and institutions;

– commercial and non-commercial transactions between the company and companies,

where board members, executives and shareholders, who either directly or indirectly

own at least 5% of the company’s capital, possess at least 5% and more of

shareholding or having the control of the latter;

– the curriculum vitae of the company’s board members and executives; their duties

and responsibilities within the company; positions held outside the company and

compliance with the internally established company rules in that respect;

independence statements by the independent board members; remuneration,

bonuses and other benefits3 offered and performance evaluation of the corporate

governance committee; proportion of shares and amounts invested in the company’s

capital; transactions made between the mentioned persons and the company,

possessions in the company’s capital market instruments; lawsuit filed against them

on company operations; and

– ownership structure table showing the controlling shareholder(s), as released from

any indirect and cross ownership relations.

Audit

According to Principle 4.1, the audit firm and auditors employed by such audit firm must be independent. Independence principle indicates that the independent audit activities should be conducted without being influenced by any relationship, benefit or other factors that may impede the auditor’s professional discretion and impartiality.

According to Principle 4.2, audit firms should be subject to regular rotation. The board of directors should appoint an audit firm for continuous and/or exclusive audits for a maximum period of five years.

According to Principle 4.3, audit and consultancy services should be clearly separated. Audit firms, auditors and other related staff working for such institutions are not permitted to provide


consultancy services to the companies to which they provide external auditing services within the same period, either in return for a fee or free of charge.

The consultancy firm and its members of staff, where there is a parent audit firm which has a direct and indirect controlling relationship with respect to the management and capital to the consultancy firm, shall not provide consultancy services to the company that the parent audit firm provides external audit services to, within the same period. Consultancy services provided by the real personality shareholders and executives of the audit firm are also within this scope.

3. “Section III – Stakeholders”

Recognition of stakeholders

According to Principle 1.1, the corporate governance framework should recognise the rights of stakeholders established by law or through any other mutual agreement.

Protection of the Company Assets

According to Principle 3, neither the board of directors nor any of the executives may take actions that would cause the company assets loose value and that would lead to the deliberate loss for stakeholders.

Ethical Rules

The ethical rules of the company should be prepared by the board of directors, submitted to the general shareholders’ meeting for information and disclosed to the public. The operations of the company should be carried out in accordance with the company’s ethical rules.

4. Part IV – Board of Directors

According to Principle 1.1, the board of directors is the strategic decision-making, executive (management) and representation body of the company. The board of directors should define the mission/vision of the company and should disclose this to the public.

According to Principle 1.3, the board of directors should constantly and effectively revise the company’s level of success in achieving its goals, operations and past performance. In doing so, the board of directors endeavours to abide by international standards in all respect. In case any difficulties or problems are encountered, the board of directors should take all the necessary means and measures without any delay or prior to occurrence thereof.

Internal control and risk management

According to Principle 1.3.2, the board of directors should establish an internal control and risk management mechanisms that are appropriate for the company to minimize adverse effects of the company’s risks, which would also negatively affect the shareholders and stakeholders. The board of directors also takes all necessary measures for sound functioning of such mechanisms implemented.


Committees

According to Principle 1.3.3, the board of directors should form committees to perform tasks in a sound manner.

Duties and liability

According to Principle 2.3, each board member should perform his/her duty prudent and in good faith. Performance of duties in a prudent manner and in good faith requires demonstrating minimal care and diligence as will be required for similar events under similar conditions.

According to Principle 2.5, members of the board members will be jointly liable should they intentionally or unintentionally fail to properly perform their duties assigned to them by legislation, the articles of association and the general shareholders’ meeting.

Declaration in writing

According to Principle 2.12, which has the status of a recommendation only, before commencing work, members of the board should declare in writing that they will comply with the legislation, articles of association, in-house regulations and policies, and in case of incompliance, that they would be jointly liable to compensate the loss accrued to the shareholders and stakeholders.

Additional responsibilities

According to Principle 2.14, beyond basic functions of the board of directors and in accordance with opinions and suggestions of the committees, the board of directors should undertake the following responsibilities:

– to control the company’s material expenditures exceeding 10% of the total assets value in

the most recent balance sheet of the company;

– to determine the ethical rules; and

– to determine the working principles of the committees; to ensure them to work

effectively and efficiently.

Monthly meetings

According to Principle 2.17.5, the board of directors should convene on regular basis at least once a month, as planned in advance, and if necessary more often without any delay.

Secretariat

According to Principle 2.19, a secretariat should be established under the responsibility of the board chairman in order to serve the board of directors and to keep documents related to the board meetings in order.

The secretariat should basically engage in communication between members of the board; make preparations for the board meetings and committee meetings; keeps the minutes of the


meetings; records and archives all communications made by the board of directors, including announcements

Conflict of interest – no attendance

According to Principle 2.20, a member of the board is not permitted to attend the board meeting that may concern his/her own interests or the interests of his/her spouse and his/her blood or affinity relatives up to the third degree.

Requirements to candidates

According to Principle 3.1.5, minimum requirements required for candidates for board membership positions are:

– to be capable of analyzing and interpreting financial statements and reports;

– to have basic knowledge about the legal regulations applicable to the company for daily

or long term business as well as dispositions; and

– to be able to participate in all board of directors’ meetings in the relevant budget year.

Training

According to Principle 3.1.6, candidates who do not have the above-mentioned qualifications but elected to the board of the directors should be provided with the necessary training within the shortest period of time. Once the members of the board of directors are appointed, the corporate governance committee should commence its adaptation program. The adaptation program should be completed in a rapid and efficient manner and address the below mentioned issues:

– meeting the executives and visits to the production units of the company;

– evaluations of the executives’ CVs and performances;

– strategic goals of the company, current situation and problems; and

– indicators of market share of the company and its financial performance.

Composition, independence, and voting

According to Principle 3.2, the board of directors comprises of both executive and non-executive members.

The board chairman and chief executive officer should not be the same person and the majority of the board of directors should consist of non-executive members.

Non-executive members of the board of directors should regularly conduct internal meetings.


According to Principle 3.3, the board should be composed to comprise independent members who have the ability to execute their duties without being influenced under any circumstances.

Independent board members should comprise at least one third of the board of directors and in any case two members of the board should be independent. While calculating the number of independent members, fractions should be considered as the next whole number.

A person who has been a member of the company’s board of directors for seven years cannot be appointed as an independent member to the board of directors.

A member of the board who fulfils the below mentioned requirements may be qualified as an “independent member”:

– not to have any direct or indirect relationship of interest in terms of employment, capital

or trade and commerce between the company, its subsidiaries, affiliates or any other

group company and himself/herself, his/her spouse and his/her blood or affinity relatives

by up to the third degree within the last two years;

– not to be previously elected to the board of directors as a representative of a certain

group of shareholders;

– not to be employed in a company, primarily for the audit and consultant firm, which

undertakes full or partial activity or organization of the company under a contract and not

to be have a managing position therein within the last two years;

– not to be previously employed by the external auditor of the company or not to have

been included in the external audit process within the last two years;

– not to be previously employed by a firm providing significant amounts of services and

products to the company and not to have a managing position therein within the last two

years; and

– for his/her spouse or any of his/her relatives by blood and affinity up to the third degree,

not to have a managing position or be a shareholder holding more than 5% of the total

capital or the controlling shareholder by all means, or not to hold a managerial position or

not to be effective in the control of the company, not to receive any compensation other

than the board membership compensation and attendance fee; to hold shares of less than

1% if he/she is a shareholder due to his/her duty, provided that such shares are not

preferred shares.

Independent member of the board of directors should provide a written declaration to the board of directors, stating that he/she is independent within the framework of the legislation, articles of association and the criteria stated above.

According to Principle 3.4, priority should be given to the use of cumulative voting in the election of the board of directors.


Compensation

According to Principle 4.2, in principle, compensation for the members of the board of directors should be determined by the general shareholders’ meeting so as to counterweigh the time invested and performance of membership duties as a minimum.

The compensation of the members of the board of directors should be close to the fixed wage per hour provided to the chief executive officer/general director, as a general principle. The level of the compensation should be calculated by taking into consideration the amount of time which a member has to spend for the company in the meeting, and pre and post-meeting preparations and special projects.

According to Principle 4.3, incentive remunerations of the board of directors should be based upon the performance of the members of the board in connection with the performance of the company. The corporate governance committee may propose any suggestions on this issue together with the reasoning thereof.

The board of directors will be held liable for the company’s level of achieving its predetermined operational and financial goals. Should those goals not be accomplished, the reasons thereof are clearly explained in the annual report. Thus, the board should conduct a self-assessment and performance evaluations of both the board and the members thereof, in line with the Principles established by the authorized committee.

According to Principle 4.4, the company is not entitled in any way to lend money, to extend any credits, to prolong the terms of existing loans and credits, to improve the conditions thereof, and to extend credit under the name of any personal credit means through a third person or to provide warranties to a member of the board or the executives . Only those institutions which offer personal credits to individuals may be entitled to offer loans to above-mentioned persons via credits credit cards and other means.

Committees

Pursuant to Principle 5.1, in accordance with the conditions and necessities of the company, an adequate number of committees should be formed so as to enable the board to execute its tasks in an efficient manner.

According to Principle 5.2, the chairman for each committee should be elected from among independent members of the board.

According to Principle 5.3, each committee should comprise of at least two members. If there are two members, both of them should be non-executive members. If there are more than two members in a committee, the majority of its members should be non-executive members.

According to Principle 5.4, in principle, members of the board of directors cannot be assigned to more than two committees. If necessary, experts in specific areas may be eligible to be commissioned at a committee, even if they are not board members.

According to Principle 5.6, an audit committee should be established (in charge of supervision of the financial and operational activities).


The audit committee should supervise whether or not periodic financial statements including footnotes are prepared in accordance with the current legislation and international accounting standards and should declare its opinion to the board of directors in writing upon receiving the opinion of the independent audit firm.

According to Principle 5.7, a corporate governance committee should be established in order to monitor the company’s compliance with the corporate governance Principles and perform improvement studies and offer any possible suggestions to the board. The majority of the corporate governance committee should comprise of independent members. The chief executive officer/general director should not hold a position at this committee.

The corporate governance committee should:

– determine whether or not corporate governance Principles are being fully implemented

by the company, if not, the reason thereof, and state any conflict of interests arising as a

result of imperfect implementation of these Principles, and present remedial Principles to

the board of directors;

– constitute a transparent system for determination, evaluation, training and rewarding of

candidates eligible for the board of directors and determine policies and strategies in this

respect;

– offer suggestions regarding the number of board members and executives; and

– determine the Principles and practices regarding the evaluation of performances of the of

the board members and executives, career planning and rewarding of the same.

Outside appointments

According to Principle 6.5.2, the chief executive officer/general director should not accept any duties outside the company. However, the chief executive officer/general director may be commissioned as a board member or manager in institutions, as associated with the company in management and capital aspects, in order to protect the interests of the company.

Principles’ compliance reports

According to Principle 6.6, the executives should obey the legislation, articles of association, in-house regulations and policies while performing their duties; and submit a report regarding the conformity of the performed works with the Principles to the board of directors each month.

Compensation of losses caused

According to Principle 6.9, which has the nature of a recommendation only, the executives should compensate the losses incurred by the company and third persons as a result of not performing their duties duly.

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