Digitalisation in the Banking Sector in Turkey
The Turkish banking sector has been attributing more importance to technological developments and innovations in the past two decades, which makes it immensely important for regulators to also keep up with such developments and trends in their regulations. In parallel to the global transformation of banking activities from analogue to digital, which has gained momentum in the banking sector with the use of online banking, Turkish banks have quickly adapted to such new technology and innovations in practice. They may be considered among the leaders in using and aiding the development of fintechs.
Following the significant increase in the use of digital platforms and online services due to COVID-19 all around the world, and with a view towards preparing the landscape for digital banking systems, in 2020 the Turkish regulators introduced the “open banking” concept into both the banking legislation and the legislation on payment systems, payment institutions and electronic money institutions. In so doing, the Turkish regulators adapted the innovations in payment services introduced under Directive 2015/2366/EU of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market (PSD2), amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC.
On 19 August 2021, the Banking Regulation and Supervision Authority (BRSA) published on its website the long-awaited Draft Regulation on Operation Principles of Digital Banks and Service Model Banking (the “Draft Regulation”), which aims to set forth the principles of digital banking (ie, branchless banking and the "banking as a service" (BaaS) business model). The Draft Regulation, if enacted, would enable the establishment of banks that provide services solely through digital channels, without any physical branches. Moreover, the Draft Regulation would also provide the lead on operational principles for branchless banks as well as the principles for BaaS.
It is as yet uncertain whether the Draft Regulation will be passed as is, or with certain alterations; the draft was made public by the BRSA to collect market players’ comments and to monitor their reactions. The timing of its enactment is yet to be determined; however, the market is eager to have it enacted, and soon.
How does the Draft Regulation define digital banks?
The Draft Regulation defines digital banks as credit institutions that provide banking services mainly through electronic banking services distribution channels rather than physical branches. The key elements of this definition, namely the utilisation of electronic distribution channels and the lack of physical branches, will be the main focal points behind the further digitalisation of the banking sector in Turkey in the forthcoming days.
What are the differences between the services performed by traditional banks and digital banks?
In principle, digital banks will be entitled to perform all services that can be offered by traditional banks. To do so, they will be required to comply with certain activity limitations imposed by the Draft Regulation, such as offering their services exclusively to individual financial consumers and small- and medium-sized enterprises, which are enterprises that employ fewer than 250 employees annually and whose annual net revenues or financial balances do not exceed TRY125 million. Accordingly, if the Draft Regulation enters into force as is, digital banks will not be allowed to provide banking services to entities that surpass the small- and medium-sized enterprise thresholds.
On the other hand, digital banks will be allowed to:
Digital banks will be permitted to extend unsecured cash credit lines to their financial customers in an amount not exceeding four times the average monthly net income of the customer. In cases where the monthly average income of the customer cannot be determined, the upper limit of the cash loans that can be provided will be TRY10,000.
That being said, digital banks to which a total paid-in capital amount of TRY2.5 billion is committed at establishment may apply to the BRSA to request an exemption from the activity limitations mentioned above.
What will be the minimum paid-in capital for a licence?
One of the requirements that will have significant repercussions in the market will be the amount of paid-in capital requirements. Many institutions that are currently licensed as payment institutions have been waiting for the Draft Regulation to pass before they file for a licence to act as a digital bank. The draft has set the threshold at a figure that exceeds the expectations of those players, requiring the subscription of at least TRY1 billion as paid-in capital for a licence.
Which principles will govern digital banks?
As per the Draft Regulation, digital banks will generally be subject to all rules and principles applicable to credit institutions unless otherwise explicitly stated in the legislation. Therefore, digital banks will be required to comply with the rules that govern credit institutions; ie, deposit banks and participation banks.
Digital banks will not be permitted to open physical branches other than for the fulfilment of certain purposes defined in the Draft Regulation. That being said, all digital banks will be expected to open at least one physical office to deal with customer complaints and problems, provided that these offices do not operate in the capacity of a bank branch and solely act as customer contact centres. Digital banks may establish their own ATM networks to offer certain services to their customers in addition to using existing ATM networks.
Does the Draft Regulation impose any requirement on digital banks to create sustainability?
The service continuity percentage commitment undertaken by digital banks for the internet banking and mobile banking distribution channels will not be lower than 99.8%. By setting such a high threshold, the BRSA has signalled an intent to create a sustainable and more or less uninterrupted environment for digital banking customers. Digital banks will also be obliged to announce this percentage on their websites.
Which procedures need to be followed by existing licensed payment service providers in order to serve as digital banks?
The Draft Regulation allows licensed payment and electronic money institutions to apply for digital bank licences, provided that such entities and their shareholders respectively meet the conditions required for the incorporation of banks and the qualifications sought of the founders of banks.
It is not known whether many in the sector would apply for digital bank licences (which are, in fact, obtained from a separate regulator), as the minimum paid-in capital requirement is considered to be excessive in the market. On a relevant note, together with the new regulation on payment services enacted in December 2021, the costs applicable to companies operating in payment industry have also been increased. The minimum capital amount for payment institutions is now TRY2 million, and TRY5 million for e-money institutions, and additional equity requirements depending on the type of services offered by the same have been introduced.
Service model banking
In addition to the provisions relating to digital banking structures, the Draft Regulation also focuses on regulating BaaS business models. Under the proposed model, service banks may only offer BaaS services to interface developers that are established in Turkey. In other words, companies or platforms established abroad cannot procure BaaS services from banks in Turkey. Traditional banks may also act as service banks.
In order for a service bank to offer its services to an interface developer, the service bank and the customer must execute an agreement that includes certain provisions obliging the interface developer to comply with transparency requirements and to refrain from storing information relating to the customers of the bank that is not necessary and essential within the scope of its services.
Financial technology companies developing interfaces are strictly prohibited under the Draft Regulation from using titles or words suggesting that they are a payment service provider, bank, payment institution or electronic money institution, or any other words that may give the impression that they are operating as a bank/payment service provider or that they collect deposits or funds.
Opinions from sectoral players
Even though there are many debates in the market on the Draft Regulation, the most heated among them is on the minimum paid-in capital requirement of TRY1 billion. It can easily be said that this question has divided the sector into two.
The proponents of the TRY1 billion minimum paid-in capital requirement claim that a high capital requirement is vital for the protection of banking customers and the banking sector itself. As the relationship between a bank and a customer involves a high degree of trust, the holders of a digital banking licence must have adequate financial power to meet the rigorous demands of the sector and their own customers. Therefore, it is argued that meeting this high capital threshold is an indication of the reliability of digital banks, and that the requirement must remain in the final version of the regulation.
Conversely, this requirement has been criticised by a number of other players in the sector, which mainly consist of fintech start-ups, payment institutions and electronic money institutions. The critics argue that the TRY1 billion minimum paid-in capital requirement effectively excludes most fintech start-ups from the digital banking sector, as only a very few among them in Turkey would be able to meet this requirement. Local fintech start-ups also claim that the lack of adequate support for the growth of the fintech and venture capital sector in Turkey may not only curb investors’ enthusiasm in these sectors, but also may result in the digital banking sector being dominated by foreign-funded global players that are more easily equipped to meet the financial demands set forth in the Draft Regulation. The latter will result in a decreased number of entities operating in the digital banking sector and hinder effective competition. Turkish media coverage indicates that a number of major global players are considering applying to, or have already been discussing their business models with, the BRSA, with the hope of securing a digital banking licence following the entry into force of the Draft Regulation.
Since the BRSA is currently collecting opinions from all stakeholders, the Draft Regulation remains subject to amendments. Therefore, whether the fintech sector will successfully be able to lower the minimum paid-in capital requirement set forth in the Draft Regulation will be revealed in the first days of 2022.
A critical ban from the Central Bank: prohibition of use of crypto-assets in payments
While the Turkish regulators prepared to introduce future-looking regulations on digital banking and open banking services, the Central Bank of the Republic of Turkey (CBRT) took a conservative tack, and on 16 April 2021 published the Regulation on the Disuse of Crypto Assets in Payments (the “Crypto Regulation”), which set down some rules and principles prohibiting the use of crypto-assets on various platforms. Prior to the issuance of the Crypto Regulation, there was no direct and clear piece of legislation regarding the use of crypto-assets under Turkish law, and any irregular activities were monitored under anti-money laundering rules.
The reasoning behind the CBRT’s decision to ban all uses of crypto-assets in any types of payments was, as per its announcement, largely due to the significant risks that crypto-assets entail, as they are subject neither to any precise regulation and supervision mechanisms nor any central regulatory authority. Among the reasons underlying its policy decision, the CBRT named the fact that crypto-assets’ market values can be excessively volatile; that they may be used in illegal actions due to their anonymous structures; that wallets can be stolen or used unlawfully without the authorisation of their holders; and that crypto-asset transactions are irrevocable.
The CBRT further emphasised that the use of crypto-assets in payments may cause non-recoverable losses due to the above-listed factors, and that they include elements that may undermine the confidence in methods and instruments used currently in payments.
In light of the above, the Crypto Regulation defines crypto-assets as intangible assets that are created virtually by using distributed ledger or similar technology, and distributed over digital networks, and that are not qualified as money, dematerialised money, electronic money, payment instruments, security or any other capital market instrument.
It is worth noting that the Regulation does not prohibit trading in and/or with crypto-assets, and only eliminates their use as a payment tool.
In addition to the ban on using crypto-assets (directly or indirectly) for payments, the CBRT also barred payment and electronic money institutions from acting as intermediaries to platforms that offer trading, custody, transfer or crypto-asset issuance services, and to fund transfers from such platforms. Payment service providers are also required to refrain from creating business models that involve the direct or indirect use of crypto-assets for the provision of payment services, and may not provide services related to such business models.
In addition to the recent developments in the digital banking and cryptocurrency realms mentioned in this article, proposed amendments and compliance works in relation to payment institutions and systems seek to enable rapid progress, especially in open banking transactions in Turkey. However, with the entry of digital banks into the market, especially traditional banks and payment institutions may lose the leverage may lose the leverage and advantages they have held under the current regulations in comparison to traditional banks.