Turkey’s Islamic banks have struggled to tap the vast potential of the country’s agriculture, manufacturing and SME sectors. Could the emergence of sharia-compliant factoring in the region be a breakthrough for banks and exporters? John Basquill reports.


Over 95% of Turkey’s 84 million inhabitants are Muslim, yet according to research by ratings agency Moody’s, the market share held by the country’s Islamic banks sits at under 6% – well below the average rate of 43% across the Middle East and Malaysia.

The Turkish government is keen for that to change. It has founded three state-owned Islamic banks since 2015, and more broadly, is putting US$2.6bn towards the establishment of an international financial centre in Istanbul – the country’s largest city and a bridge between European and Asian financial markets – scheduled to open in 2023.

Harun Çelik, the Islamic Trade Finance Corporation’s (ITFC) regional head for Turkey, says the sector is already undergoing rapid expansion – albeit from a low bar.

“If we look at growth rates, in the last 15 years [Turkish] Islamic banks’ growth is almost 27% annually. The rest of the banking industry is growing at around 17%, so the Islamic banks are clearly outperforming the wider sector,” he tells GTR.

Moody’s predicts in a January report that assets held by Turkey’s Islamic banks will double within 10 years, as its “slow start” compared to other markets in the region “means it has ample room to expand”.

There are now six Islamic banks operating in Turkey, with Kuveyt Turk, Turkiye Finans and Albaraka Turk holding around three quarters of their market share.

All six are legally obliged to become members of the Participation Banks Association of Turkey (PBAT), an industry group and quasi-authority that oversees the standardisation of Islamic banking products. PBAT has made no secret of its high hopes for the sector, setting an ambitious target of 15% total market share within just five years.

However, despite the government’s support and the industry’s promising growth patterns, Çelik says that target “would be difficult to hit without reaching out to some segments where the Islamic banks have not been very active so far”.


Agriculture, manufacturing and SMEs: untapped potential

“Agriculture is one of the sectors where Islamic banks have big growth potential,” says ITFC’s Çelik. “Out of almost Tl120bn (US$18.5bn) of agricultural finance in Turkey, the six Islamic banks are only getting 1% of that. That’s where the growth potential is.”

Vegetable and food exports accounted for around 10% of the country’s exports in 2018, according to World Bank data, with a total value of more than US$15bn. Turkey is the world’s leading producer of several fruits, including apricots, cherries and pomegranates, and the wider agricultural sector is estimated to account for around a quarter of employment.

Aleksandar Medjedovic, an executive board member at the Turkish-German Chamber of Commerce and vice-chairman of the Foreign Economic Relations Board of Turkey (DEİK), says the nation has also earned a reputation as a “large and powerful manufacturing hub”.

“Between Europe and Asia, it offers all the advantages of the so-called western engineering and manufacturing style, while also offering competitive prices, very high flexibility in terms of what you can agree with the producer in Turkey, and, extremely importantly, highly reliable supply chains and engineering quality,” he said at March’s GTR Turkey event in Istanbul.

Turkey’s trade-based economy is highly diverse. Though perhaps best known in Europe for its production of clothing and textiles – 70% of the US$27.9bn-worth it exported in 2018 was to European countries – its largest export is transportation-related goods, which totalled US$28.7bn in value in the same year. Close behind are machinery and electronics worth US$24.6bn and metals worth US$24.2bn.

The country also benefits from a broad range of global trading partners. Though Germany has long been the top destination for Turkish goods, with exports totalling over US$16bn in 2018, it is followed relatively closely by the UK, Italy, Iraq, the United States, Spain and France.

Perhaps the greatest nascent opportunity lies with small-to-medium enterprises (SMEs). A 2017 European Union study found SMEs account for 99.8% of all Turkish companies, as well as 73.5% of employment and 53.5% of value added to the economy – all above the EU average.

“Turkey’s performance is above the EU average on entrepreneurship and comparable to the EU average for skills and innovation, environment, ‘responsive administration’ and internationalisation,” it said. “However, on access to finance… Turkey lags behind the EU.”

For Çelik, that situation represents significant untapped potential for the Islamic financial sector. However, reaching new businesses may require some creativity.

One useful emerging tool could be a product that is widely used in international finance, but relatively new in the Islamic world: factoring. A form of supply chain finance, factoring typically involves a supplier selling its invoices to a third party at a discount. For the supplier it means quicker access to working capital, while the third party makes its profit once the invoices are paid.

“Islamic banks seem to be underperforming in the SME market, and in our view this is one of the areas where – if supply chain finance can be done in a sharia-compliant way – it can open up new potential in Turkey and globally,” Çelik says.


Islamic factoring: the key to a new market?

One of the main principles of sharia-compliant finance is that charging or paying interest – or riba – is prohibited on all transactions.

Finance cannot be provided to support the trade of goods, services or activities that are not permitted within the religion, such as alcohol, gambling or non-halal food, and insurance or reinsurance that is not in keeping with Islamic principles is also forbidden.

At face value, a ban on charging interest could appear to undermine any possibility of factoring, as the process involves the transfer of a debt from the supplier to a third-party financial intermediary for their financial gain.

However, FCI, a global association for the receivables finance industry, has been a staunch supporter of factoring within the confines of Islamic law. In its view, Islamic factoring functions in an almost identical way to internationally accepted receivables finance programmes.

In June 2018, FCI published a three-page supplemental agreement to its existing General Rules of International Factoring. Produced by a working group comprising members of the association’s legal committee, Noor Bank and ITFC, the vision is that parties to an Islamic factoring transaction can demonstrate their compliance with sharia law by signing up.

“The only difference is we don’t say ‘interest’; instead, we say ‘late payment amount’, and some products cannot be factored,” explains Istanbul-based Betül Kurtuluş, FCI’s regional director for Central, Eastern and South-Eastern Europe and the Middle East.

“When we look at these general rules, we see minimal differences between the two products,” she tells GTR. “The difference arises from the way of funding.”

ITFC’s Çelik gives a practical example. If an Islamic bank knows that its customer, a supplier, is planning to export goods, it can step in to purchase that supplier’s goods and sell them onto the buyer. The supplier would be permitted to manage the operations on the bank’s behalf as an agent.

That can be done as long as the financier is “engaged in the transaction at the initial point, before any trade transaction happens”, he says. The bank can charge commission without falling foul of the ban on interest payments.

The product is not yet live in Turkey, but FCI’s Kurtuluş says its goal is for the first transactions to take place before the end of 2020. If that transpires, she says, it represents “a major opportunity for stakeholders to boost economic growth in and between both Islamic countries and others”.

“The solution is relatively new to the Islamic world, but it has the potential to transform cashflow, facilitate trading, and improve payment and financial terms between corporates and their supplier networks,” Kurtuluş adds. “In Turkey the product will be very useful for exporters, so we are all waiting for the launch here.”