Turkey: Memorandum Regarding Banking Act (Law No. 5411) Part 1

The Banking Act abolishing and replacing Banks Act (Law No. 4389) (as amended by Laws No. 4491, 4672, 4743, 4842 and 5020) came into force upon publication thereof in the Official Gazette dated November 01, 2005.

The new Banking Act is consisted of 171 articles and 23 temporary articles; and Articles 90 and 91 shall become effective within 2 months following the promulgation of the Banking Act while Paragraphs (B – C – D and E) of its Article 168 shall become effective on 01.01.2006.

This study aims to summarize some of the important provisions of the Banking Act.

Banking Act’s purpose is establishment of confidence and stability in financial markets, and ensuring efficient operation of the credit system, and protection of the rights and interests of the savers.

The Banking Act covers the following institutions and activities thereof:

• deposit banks,

• participation banks to be established also by transformation of the previous Special Financial Institutions,

• development and investment banks,

• Turkish branches of the organizations founded abroad and characterized as one of the banks listed above (hereinafter shall shortly be referred to as "foreign banks"),

• financial holding companies,

• Turkish Banks Association ("TBB"),

• Turkish Participation Banks Association ("TKBB"),

• Banking Regulation and Supervision Agency (the "Agency"),

• Savings Deposits Insurance Fund (the "Fund"), and

• banks established by private laws, without prejudice to the special provisions...

None of the previous laws regulating the banks provides a list of banking and bank transactions, nor do they define the concept of banking. It is seen in the Banking Act No. 5411 for the first time that a list of the activities that can be carried out by banks has been provided. Therefore, these listed activities shall be included to their legal capacities in terms of their activities as joint stock companies.

As we know, Article 137 of Turkish Commercial Code stipulates the following provision regarding the "legal person capacity" in context of trade companies:

"Trade companies possess a legal personality and they can acquire all rights and can assume all obligations on condition that they do not infringe the subjects of activity written in their articles of association."

Being a joint stock company at the same time, banks are also obligated to comply with the provision of "(making) a clear-cut definition of the boundaries of the subject of the company in Articles of Association" as stipulated by Article 271 of Turkish Commercial Code.

Accordingly, in the event that banks intend not to carry out some of the activities referred in Article 4 of the Banking Act, they have to state this fact clearly in their articles of association, which can be deemed as the constitution of the company – based on their obligation to state the subject of the company clearly.

The Banking Act stipulates banking activities as:

• Accepting deposits (for deposit banks),

• Accepting participating funds (for participation banks),

• Extending cash, non-cash, and other kinds and forms of credits,

• All payment and collection transactions including cash and bank payment and fund transfer transactions, acting as a correspondent bank or use of check accounts,

• Purchase transactions of checks and other foreign currency notes

• Custody services,

• Issuing payment instruments such as credit cards, bank cards and travel checks, and performance of activities regarding thereof,

• Foreign exchange transactions including effective transactions; purchase and sale of money market instruments; purchase, sale and custody of precious metals and stones,

• Purchase and sale of and acting as intermediary in transactions of the future contracts, options contracts, and multiple-derivative financial instruments with simple or complex content; based on economical and financial indicators, capital market instruments, commodities, precious metals and foreign exchange,

• Purchase and sale, and repurchase or resale commitments, of the capital market instruments,

• Intermediary transactions for the sale of the capital market instruments via issues or public offerings,

• Purchase and sale of the issued capital market instruments for intermediary purposes,

• Guarantees such as the assumption of collaterals, guarantees and other such liabilities in the name of others,

• Investment consultancy services,

• Portfolio operations,

• Portfolio management,

• Acting with the capacity of market maker in purchase and sale transactions within the framework of obligations to be assumed under a contract established by the Treasury Undersecretariat and/or Central Bank and the professional associations,

• Factoring and forfaiting transactions,

• Intermediation to the transactions of buying and selling money in interbank market,

• Financial lease transactions,

• Insurance agency and private pension intermediary services, and

• Other activities to be determined by the Banking Regulation and Supervision Agency

The Banking Act explicitly prohibits the deposit banks to:

• accept participating funds, and

• carry out financial lease transactions....

Participation banks are not allowed to collect deposits.

Development and Investment banks, just like the deposit banks, are not allowed to:

• accept participating funds, and

• carry out financial lease transactions.

(i) Incorporation of banks in Turkey, (ii) opening the first branch in Turkey by a bank incorporated abroad ("foreign bank"), (iii) incorporation of a bank in Turkey exclusively for carrying out off-shore banking activities, (iv) opening off-shore banking branch in Turkey by foreign banks, and (v) opening by foreign banks of a "representative branch" in Turkey on condition of not accepting deposits and participating funds; are subject to the duly receipt of authorization from the Banking Regulation and Supervision Board ("Board").

• It should be a joint stock company,

• Its shares should be issued in cash and all of its shares should be registered (written to name),
• Founders of the bank should possess the required legal qualifications,
• Members of its Board of Directors should have the required professional experience,
• Its activity subjects should be in harmony with its planned financial, administrational and organizational structure,
• Its cash paid capital should be at least YTL 30 million (two third of this figure applies to development and investment banks),
• Its articles of association should be in compliance with the Banking Act,

• Its shareholders structure and organizational chart should be transparent and open in order to facilitate its audit,
• There should be no impediment for a consolidated audit,
• At least the following documents should be submitted to the public authorities:

The Banking Act has identified the qualifications of banks’ founders in its Article 8. Accordingly, qualifications of real persons include the concepts of (having the required financial strength and reputation) and (having the honesty and compatibility required by the job); whereas qualifications sought from legal person founders of banks include among others the condition to (have a transparent and open shareholders structure together with the risk group).

Following conditions should be fulfilled in order for a foreign bank to open a branch in Turkey:

• It should not be banned from its "principal activities" in the country of origin,
• Authorized supervision authority in the country of origin should not have given "negative" opinion for the bank in question to have activities in Turkey,
• Its paid-up capital should be similar with the Turkish banks,
• Members of the Committee of Managers of the foreign bank branches should have the professional experience required by the Banking Act (professional experience means the conditions stated in the institutional management principles and the experience required by the intended activities),
• Business plans for the activity subjects covered by their authorization, and the budget plan and the activity program showing the structural organization of the foreign bank should be submitted to the authorities,
• The "Group" it is a member of should be transparent and open...

The Banking Act requires the banks which receive authorization for incorporation or opening branches in Turkey to obtain authorization from the Agency separately – just like it was in the previous period - in order to start their operations. These authorizations become effective upon their publishing in the Official Gazette. Following conditions should be fulfilled before granting such authorizations to banks:

• the capital should be paid in cash,
• at least one fourth (¼) of 10 percent of the minimum capital (system entry share) provided by the Banking Act should be deposited to the Fund,
• conformance to institutional management principles as well as to the adequate qualified personnel and technical hardware criteria should be attained,
• Banking Regulation and Supervision Board should decide that the bank is qualified to carry out its activity subjects...

Banks’ opening branches including off-shore banking branches, establishing representatives and founding and participating to partnerships are subject to the consent of the Banking Regulation and Supervision Board.

A bank’s certificate of activity is cancelled in the events of; (i) the certificate of activity is received based on unreal statements, or (ii) failure to start operations within 6 months after the receipt of the Certificate of Operation, or (iii) being inactive for a period of 6 months uninterruptedly in a year.

Opening domestic branches in Turkey has been set free on condition of notifying to the Banking Regulation and Supervision Agency.

Positive opinion of the Banking Supervision and Regulation Agency is taken for the amendments to be made to banks’ articles of association.

Banks’ articles of associations are published in their internet pages in an updated fashion.

Banks’ capital increases should be done in cash without resorting to their "internal sources".

A person’s acquisition of a bank’s shares representing 10 percent and more of that bank’s capital through "direct" or "indirect" ownership, or share acquisitions/transfers between a bank’s shareholders resulting in the rise/fall of "a shareholder’s" direct or indirect shares above/below 10%, 20%, 33% or 50% of the bank’s capital are subject to the consent of the Banking Regulation and Supervision Board.

Assigning, transferring or issuing new shares which grant their owners the privilege to appoint members of the Board of Directors or the Audit Committee* are subject to the consent of the Banking Regulation and Supervision Board without any consideration to the above mentioned ratios.

In granting of authorization for share acquisitions and transfers; a "transfer fee" at the rate of 1 percent of the nominal value of the bank shares taken over should be deposited to the Fund by the party taking over such shares.

Shareholders holding qualified shares should posses the qualifications sought in founders.

The Banking Regulation and Supervision Agency’s consent is required in order for any one bank active in Turkey to:

It is ruled by the Banking Act (Article 19) that, so long as the share of the total assets of the subject banks does not exceed the rate of 20 percent in the banking sector in general, the provisions of the Law Regarding Protection of Competition; regarding the mergers and takeovers in its Article 7, regarding the obligation to notify the agreements, mergers and takeovers to the Competition Board in its Article 10, and regarding the regulation of the procedure of the notification of mergers and takeovers to the Competition Board in its Article 11 shall not apply to banks’:

Banks may wish to end up their operations and liquidate themselves by their own will. This is called "potestative liquidation" by the Banking Act. Such liquidation is subject to the permission/consent of the Banking Regulation and Supervision Agency who should supervise such liquidation process. This supervision activity of the Banking Regulation and Supervision Agency shall be governed by a regulation to be issued by the Agency.

The Banking Act stipulates that the Banking Regulation and Supervision Agency should determine the complete set of rules introduced globally and especially in economically developed countries by the concept of "Corporate Governance" in order to prevent the loss of the rights of various stakeholders such as shareholders, managers and creditors of the organizations such as publicly held companies and banks which have a decisive role in the management of the funds of third parties. The Banking Act provides that this determination process should also take into consideration the opinions of the Banks Associations of Turkey, the Association of Turkish Participation Banks and the Capital Markets Board. The fact that principles thus determined should be complied by all banks can be deducted from references in many articles of the Banking Act.

In addition to this regulation of the Banking Act, new provisions introduced about the "Audit Committee" indicate that there is a continuous supervision and control on banks in terms of legal and banking activities.

The Banking Act provides the following provisions regarding the management:

Banks’ board of directors should consist of at least five persons including the general manager.

Qualifications required for general manager under the Banking Act are also required from Board members in the number of one plus half of its members. This means, for instance, in a board of directors with seven members, at least 5 members should possess the referred qualifications.

The Banking Act introduces the following qualifications for the General Manager:

Executive Directors should also possess the qualifications sought for general managers.

Positions of General Manager and Board Chairman can not be carried out by the same person.

Foreign banks should establish a Committee of Managers consisting of at least three members.

Committee of Managers established in foreign banks has the authority and responsibility of Board of Directors, and is subject to the provisions applied to the Board of Directors in regards with the qualifications of its members. Manager of Turkish central branch of the foreign banks is assumed the same as the General Manager of Turkish banks in terms of their (qualifications), (appointment) and (discharge from their positions) as referred in (Article 25/5).

Board of Directors is in charge of the following activities regarding the internal control, risk management and internal audit systems:

Banks’ boards of directors should establish an "Audit Committee" other than the "Board of Auditors", which is elected by the General Assembly as one of the administrational organs of the bank, in order to "assist" the Board of Directors in its "supervision and control" activities. This "Committee" consists of at least two members of the Executive Committee. It is a stipulation of the Banking Act that Audit Committee members should be elected from among the members of the Board of Directors who are not in any executive position.

In foreign banks, the duties of the audit committee are assumed by "one" member of the Committee of Managers who has no executive position assigned to him.

The Audit Committee or the "Audit Member" elected by Committee of Managers (in foreign banks) is in charge of and responsible from the following activities in the name of Board of Directors or Committee of Managers:

Further responsibilities and obligations of the Audit Committee are:

Audit Committee may request information and documents from;

and may further outsource consultancy services subject to the approval of the Board of Directors.

Members of the Audit Committee should possess the qualifications as determined by the Banking Regulation and Supervision Board; the documents certifying such qualifications together with the names of the assigned persons should be communicated to the Banking Regulation and Supervision Agency within 7 days after their assignment.

Assistant General Managers are required to possess at least 7 years of professional experience.

In case there are more than one Assistant General Managers assigned in the bank, at least two thirds (⅔) of them should have received the appropriate education for the post. Positions which are equivalents of the Assistant General Manager though under different titles are subject to the provisions that apply to Assistant General Managers.

The names of the persons to be appointed to the Assistant General Manager positions, just like to the General Manager positions, should also be notified to the Banking Regulation and Supervision Agency; the assignment may only be finalized if the Banking Regulation and Supervision Agency does not deliver NEGATIVE OPINION about the assignment within the following 7 days.

are subject to the provisions of the Law No. 3628 about Submission of Declaration of Wealth, and Fight Against Bribe and Corruption.

The Banking Act charges banks with establishing and operating an adequate and efficient system for

which is consistent with the content and the nature of the activities of monitoring risks and maintaining control over these risks, conforming to the changing conditions, and which "covers all branches and the companies subject to consolidation".

The principles and procedures regarding this subject shall be determined by the Banking Regulation and Supervision Agency.

Banks, in order to monitor the risks they encounter during their transactions and maintaining control over these risks, have been charged with establishing an efficient internal audit system and risk control and risk management system whose principles and procedures, in compliance with the scope and nature of the scope and nature of their activities, shall be governed by the regulations to be issued by the Banking Regulation and Supervision Agency.

In banking business, continuously keeping the possible risks under control is of crucial importance. That’s why banks have jointly established BASEL Committee in 1974 under the roof of BIS* , which acts as "the central bank of the central banks", in order to ensure the operation of all banks under common standards. This is the underlying approach at the base of the supervision systems which care for the capital adequacy and the risks. BASEL Committee in 1988 reviewed operational criteria, risk tolerances, and capital adequacies of banks and came to the conclusion that the ratio of the banks’ capital to the risks should be at least 8 percent or above. The standards introduced by these meetings are today known as (BASEL-I).

Upon increased complications and tumult in the markets, it was decided that new criteria should be introduced for the risks of banks; and subsequently determined standards were named as (BASEL-II) criteria. A couple of what we regard as the major approaches introduced BASEL Committee in (Basic Principles of Efficient Regulation and Supervision in Banking) are:

Assessment of the companies is expressed in the form of a (rating), and the bank may feel itself secure and comfortable to the degree of its rating. The lower rating requires the bank to set aside "more provisions and more capital". It is clear that this requirement means (more expensive credit).

Crisis-averting principles required to be introduced by institutions which regulate and supervise the banking industry – the Banking Regulation and Supervision Agency is one of them - in order to guarantee safe operation of banks have been considered as a "public service" under BASEL Basic Principles as well as under our laws. This public service should be viewed as a public service instrumental in reducing the costs to the country of internally and externally originated economic crisis, and the measures taken should be implemented seriously. While a general monitoring of the conformance to the laws and regulations by the regulatory authorities is an appropriate and required procedure in the institution and implementation of the public regulations, this is not sufficient alone; immediate interventions as required by the economical life should not be evaded, and done in a timely manner. The Banking Regulation and Supervision Agency has crucial responsibilities in creation of a healthy market in the country along the guidelines of BASEL Banking Committee, and its burden is rendered still heavier as banks’ smooth operation in a comfortable environment is getting harder due to the pressing conditions created by the economical forces acting freely under the cover of an internationally recognized globalization concept in general, the requirements posed by the harmonization process with European Union, and the debt stocks inherited from the previous governments which managed to present to the public in and out of the country Turkey’s borrowing in domestic and international markets as their success. It is well known that equities of Turkish banks are not adequate. Turkish banks intend to cover this shortage of theirs via foreign capital under the supervision of the Banking Supervision and Regulation Agency. On the other hand, markets have been flooded with hot money. Turkish banks are expected to reach to a more stable environment as the efficiency of the money policies carried out firmly by the Central Bank under its IMF-monitored Stability Program yields the results of decreased country risks and other risks.

The Banking Act under its Article 31 obliges banks to establish, implement and report their risk policies in compliance with the principles set out by the Banking Regulation and Supervision Agency under their risk management system. The execution of the risk management activities by (Risk Management Unit) to "report directly to the Board of Directors", and by the staff of this Unit, is also among the stipulations of the Banking Act.

It is seen that the Banking Act uses the terms (control) and (audit) in separate meanings to stand for two different situations – though they are synonyms in Turkish.

(Internal Audit) denotes solely an activity carried out on paper by the bank’s auditors for a past procedure after that process ends; in a way it means the audit of past activities; in short it has been introduced in place of the concepts of (inspection and inspection board) (TN: Turkish word used here is “Teftiş”. Teftiş is also a synonym of the above used control ("Kontrol") and audit ("Denetim")) in the former application.

Having thus outlined these concepts, we can now explain the contents of the concepts (internal control) and (internal audit) as follows:

According to the Banking Act;

By the concept of their internal control, banks are obliged to ensure:

... via continuous control activities to be complied and practiced by their staff in all levels.

Internal control activities just like the risk management activities are carried out by (internal control unit) reporting directly to the Board of Directors, and (the internal control personnel).

9.4.2. Internal Audit System

Internal audit which covers all units, branches and companies subject to consolidation is established as a system, and the audit of the conformance of the activities to:

Unlike in the previous applications, it is no longer possible for the procedures and principles to be prepared by the Banking Regulation and Supervision Board regarding the establishment of the system to occasionally exclude the bank’s central units in their headquarters from the scope of the audit; because the Banking Act has put it manifestly and unconditionally that internal audit covers "all units".

It is mandatory under the Banking Act that INTERNAL AUDIT REPORT to be prepared by the Internal Audit Unit or by authorized auditors be submitted to the Audit Committee and then to the Board of Directors at least on "quarterly basis / in three-month periods". It is understood from Article (148/6) that the sanction to be imposed on those who do not conform to this stipulation is an administrational fine of YTL 5,000 – 1,000.

The Banking Act lists the "authorized organizations" as has been presented in the diagram named "Subject Institutions of the Banking Act" given in the introduction of this study as follows:

These organizations have to have (compulsory insurance) in place in order to cover the any damage that may arise out of the services they provide (Article 36).

The principles for the performance of these organizations are regulated by the Banking Regulation and Supervision Board.

The Banking Act particularly underlines the following two points.

Independent audit firms shall be liable against the damages they cause on third parties regarding the activities they perform pursuant to Banking Act. These organizations, in addition to their authorization to audit bank activities, may also be assigned to carry out audits, for instance, on capital markets institutions in accordance with capital markets laws and regulations; their responsibilities in such a case are determined by the related laws and regulations.

Independent audit firms are obliged to notify to the Agency "immediately" all and any facts and proofs they detect during their audit which (jeopardize the existence of banks) or which show that (bank executives have violated the Banking Act and the bank’s articles of association). This obligation to notify to the Agency is not deemed as a violation of other possible obligations such as (confidentiality), (disclosure of a secret), etc.

Assessments provided under the Banking Act and the regulations thereunder are carried out by assessment companies whose principles and procedures are to be determined by the Board.

Rating agencies established for the rating of the debt payment capacity (solvency) across the world and particularly in financially developed countries shall also be included to Turkish financial system along with the principles and procedures to be determined by the Board, and consequently, banks shall also become an integral part of the independent audit activity. Rating activity of the institutions in Turkish capital markets and the rating agencies to carry out such activities has already been regulated; however, undergoing a rating procedure is currently "optional", and it can become "mandatory" only via a relevant decision of the Capital Markets Board.

The Banking Act defines these organizations as "organizations offering services that can be characterized as an extension of or complementary to the principal services of the organizations under the Banking Act within the framework of the principles to be determined by the Board (excepting those organizations established or owned by the Central Bank or the settlement, custody and central registration organizations which are under the supervision of the Capital Markets Board). Actually, the capacity of the (support service providers) to perform the services banks request from them, for instance discharging of the ATMs and delivery of their content to the related bank units, has always been questioned in the context of laws, frequently leading to the conclusion that they had no such capacity under the current laws and regulations. The new Law, through its provision (...as an extension of or complementary to the principal services...) makes it easier to conclude that banks indeed can outsource some support services.

However, under the new law, banks are supposed to prepare a "program" in order to assess and manage the "risks" that can arise out of the support services and also to assess the expected benefits and costs in relation therewith, and to submit this report to the Agency.

The Banking Act, however, also stipulates that the support service should not be of a nature that prevents the fulfillment of the banks’ legal obligations, banks’ compliance with the pertinent regulations, and an efficient audit of the banks.

The Banking Act regulates the following issues in brief:

Banks have to (i) apply uniform chart of accounts in their accounting systems, (ii) account all their operations in accordance with their real content, and (iii) prepare their financial reports "in a comprehensible, safe and comparable fashion and content that guarantees the satisfaction of information requirements, that can be audited, analyzed and interpreted, and in a timely accurate manner.

The concept of holding (parent) company is a concept attributed to a bank which consolidates the financial statements of the companies which are under its control and the companies which are determined in line with the procedures and principles determined by the Banking Regulation and Supervision Board under its own financial statements. Financial situation and operational results of these banks identified as holding company are required to be prepared as "consolidated financial results".

Banks have to prepare an annual activity report which also "includes" the following:

- The reports specified by the Board are signed by:

The signatures of the above listed persons should be accompanied by their names and titles over the annotation of "in compliance with the regulations and accounting records".

The content of this article is intended to provide a general guide to the subject matter. Specific advice should be sought about your specific circumstances.

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