Banking Risk Management in Turkey

1. Introduction 

In recent years, the Turkish banking sector has undergone significant transformation. Globalization, technological progress, and increasing regulatory requirements have compelled banks to develop more sophisticated risk management frameworks. Especially after the 2001 crisis and the subsequent restructuring of the financial system, risk management has become one of the fundamental elements of corporate governance.

The Banking Regulation and Supervision Agency (BRSA) plays a central role in shaping this transformation through regulations in line with Basel standards. The main goal is to ensure that banks maintain financial stability by identifying, measuring, monitoring, and managing their risks effectively.

Today, risk management in Turkish banking is not limited to minimizing potential losses; it is also a strategic management tool that helps banks enhance profitability and create long-term sustainable value. This holistic approach, supported by technological infrastructure and data analytics, enables proactive management of risks such as credit, market, operational, and liquidity risks.

Furthermore, risk management functions are now positioned as independent structures within banks, reporting directly to senior management and boards of directors. This structure ensures the integration of risk culture throughout the organization.

2. Regulatory Framework and BRSA Guidelines

2.1 The Role of the BRSA (Banking Regulation and Supervision Agency)

The Banking Regulation and Supervision Agency (BRSA) is the principal authority responsible for regulating, supervising, and monitoring the Turkish banking sector. Established after the 2001 financial crisis, the BRSA’s mission is to ensure the stability, reliability, and sound functioning of the financial system.

Through a series of regulations aligned with Basel II and Basel III frameworks, the BRSA requires banks to implement robust risk management, internal control, and internal audit systems. These regulations form the foundation of modern risk management practices in Turkish banking.

2.2 Alignment with Basel Principles

The Basel standards, developed by the Basel Committee on Banking Supervision (BCBS), serve as international benchmarks for bank regulation and supervision. Turkish banks are required to comply with these standards under the supervision of the BRSA.

Key Basel principles integrated into the Turkish framework include:

• Minimum Capital Requirements (Pillar I)
  Banks must hold sufficient regulatory capital to cover credit, market, and operational risks.

• Supervisory Review Process (Pillar II)
  The BRSA evaluates banks’ internal risk assessment processes and capital adequacy under various stress scenarios.

• Market Discipline (Pillar III)
  Banks must ensure transparency by publicly disclosing risk exposures, capital adequacy ratios, and risk management policies.

2.3 The Internal Systems Regulation

The Regulation on Internal Systems of Banks and Internal Capital Adequacy Assessment Process, published by the BRSA, sets out the framework for three key internal functions:

1. Risk Management

2. Internal Control

3. Internal Audit

According to this regulation, every bank must establish independent units responsible for each of these functions and ensure that they report directly to the Board of Directors or the Audit Committee.

The risk management function, in particular, is responsible for identifying, measuring, monitoring, and controlling all material risks that could affect the bank’s financial stability.

2.4 Corporate Governance and Risk Culture

The BRSA also emphasizes corporate governance and risk culture as critical components of sound risk management. Banks must establish a governance structure that ensures:

• A clear definition of roles and responsibilities,

• Independence of the risk management function,

• Direct oversight by senior management and the board, and

• The embedding of risk awareness across all levels of the organization.

The integration of governance and risk culture strengthens the alignment between business objectives and risk appetite, ensuring that risk-taking remains within the limits approved by the board.

3. Types of Risks in Banking and Their Management

Banks face a wide variety of risks arising from both internal operations and external market conditions. Effective risk management requires a clear understanding of these risk types, their interdependencies, and the mechanisms to mitigate them.
In the Turkish banking sector, the main risk categories are as follows:

3.1 Credit Risk

Credit risk refers to the potential financial loss arising from a borrower’s or counterparty’s failure to meet its contractual obligations.
It represents the most significant type of risk faced by Turkish banks.

Key practices for managing credit risk include:

• Creditworthiness assessment: Using financial statements, sectoral analysis, and scoring models to evaluate the borrower’s capacity to repay.

• Limit structures: Setting exposure limits by counterparty, sector, and region to prevent concentration.

• Collateralization: Securing loans with guarantees, mortgages, or financial instruments to reduce potential losses.

• Credit risk monitoring: Continuously monitoring loan portfolios and detecting early warning signals of potential defaults.

• Expected Credit Loss (ECL) modeling: Under IFRS 9, banks are required to estimate credit losses using forward-looking data and macroeconomic scenarios.

The BRSA monitors these practices closely to ensure consistent application of prudential standards across the banking sector.

3.2 Market Risk

Market risk arises from adverse movements in market prices such as interest rates, foreign exchange rates, or equity prices.
Turkish banks typically manage market risk through:

• Value at Risk (VaR) models: Quantifying potential losses under normal market conditions.

• Stress testing: Evaluating extreme scenarios and their impact on the bank’s financial position.

• Hedging strategies: Using derivatives such as swaps, options, and forwards to mitigate exposures.

• Daily limit controls: Defining position and stop-loss limits at trading desks.

The trading book of each bank is subject to strict BRSA oversight to ensure compliance with Basel’s market risk capital requirements.

3.3 Operational Risk

Operational risk refers to losses resulting from inadequate or failed internal processes, human error, system failures, or external events (e.g., cyberattacks, natural disasters).

To manage this risk, banks in Turkey implement:

• Process mapping and risk identification,

• Key Risk Indicators (KRIs) for early detection,

• Incident reporting systems for loss data collection,

• Business continuity and disaster recovery plans,

• Internal control mechanisms that ensure segregation of duties.

Given the growing importance of digital banking, the BRSA places special focus on information security and cybersecurity frameworks within operational risk management.

3.4 Liquidity Risk

Liquidity risk arises when a bank cannot meet its short-term financial obligations without incurring unacceptable losses.

Effective liquidity management includes:

• Maintaining sufficient liquid assets,

• Establishing maturity mismatch analyses,

• Implementing Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) as per Basel III,

• Conducting stress tests under different funding scenarios.

Banks are required to report their liquidity positions to the BRSA regularly, ensuring transparency and system-wide stability.

3.5 Interest Rate Risk in the Banking Book (IRRBB)

This refers to the sensitivity of a bank’s earnings and economic value to changes in market interest rates.
To manage IRRBB, Turkish banks use:

• Gap analysis to measure repricing mismatches,

• Duration and sensitivity analysis,

• Interest rate swaps for hedging exposure.

The BRSA requires periodic reporting of interest rate risk positions and the use of scenario analysis for forward-looking management.

3.6 Strategic and Reputation Risks

Strategic risk arises from poor business decisions or the failure to adapt to changes in the market or regulatory environment.
Reputation risk, on the other hand, relates to potential damage to a bank’s credibility or public image due to unethical behavior, compliance failures, or customer dissatisfaction.

To address these risks, banks adopt:

• Transparent communication policies,

• Strong compliance and ethics programs,

• Crisis communication protocols, and

• Regular board-level strategy reviews.

Together, these mechanisms ensure that the bank’s long-term vision aligns with its risk appetite and stakeholder expectations.

4. Risk Measurement and Assessment Methods

The effectiveness of risk management largely depends on the accuracy, consistency, and timeliness of risk measurement and assessment.
Turkish banks use both quantitative models and qualitative evaluations to identify, measure, and control various risk exposures.

4.1 Quantitative Risk Measurement

Quantitative methods rely on statistical models, mathematical calculations, and historical data analysis.
The main quantitative tools used in Turkish banking include:

• Value at Risk (VaR): Measures the potential loss in value of a portfolio over a specific time horizon at a given confidence level.

• Expected Shortfall (ES): Estimates the average of losses that exceed the VaR threshold, offering a more conservative perspective.

• Credit Risk Models: Probability of Default (PD), Loss Given Default (LGD), and Exposure at Default (EAD) models are widely used under the Internal Ratings-Based (IRB) approach.

• Stress Testing Models: Evaluate the impact of macroeconomic shocks, interest rate changes, or market crises on capital adequacy and profitability.

• Liquidity Ratios: Such as the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio (NSFR) as defined by Basel III.

These tools enable banks to measure risk exposures quantitatively and allocate capital buffers accordingly.

4.2 Qualitative Risk Assessment

Quantitative models alone cannot capture all aspects of risk. Therefore, qualitative evaluations complement numerical results by considering factors such as management quality, governance structure, and organizational culture.

Qualitative methods include:

• Expert Judgment and Risk Committees: Assessing complex or non-measurable risks through expert evaluations.

• Self-Assessment Surveys: Collecting input from business units to identify operational vulnerabilities.

• Risk Control Matrices (RCM): Mapping processes, risks, and existing controls for periodic review.

• Internal Audit Findings: Providing insight into recurring control deficiencies or process weaknesses.

These assessments help banks form a more holistic picture of their overall risk profile.

4.3 Stress Testing and Scenario Analysis

Stress testing has become an indispensable component of modern risk management, mandated by the BRSA and aligned with Basel III standards.
It involves simulating extreme but plausible events to evaluate the resilience of banks under adverse conditions.

Types of stress tests include:

• Sensitivity Analysis: Examines the effect of changes in a single variable, such as an interest rate or exchange rate.

• Scenario Analysis: Assesses combined effects of multiple risk factors under defined macroeconomic scenarios.

• Reverse Stress Testing: Identifies scenarios that could threaten the bank’s solvency and then assesses the likelihood of such events.

The outcomes of these tests guide capital planning, contingency measures, and recovery strategies.

4.4 Key Risk Indicators (KRIs) and Early Warning Systems

Banks also use Key Risk Indicators (KRIs) to monitor potential increases in risk levels and detect emerging issues early.
Examples of KRIs include:

• Non-performing loan (NPL) ratios,

• Customer complaint frequency,

• System downtime metrics,

• Employee turnover in critical departments, and

• Fraud incident counts.

Early warning systems integrate these indicators into dashboards and trigger alerts when thresholds are breached.
This enables proactive intervention before risks escalate into significant financial losses.

4.5 Integration of Risk Measurement into Strategic Decision-Making

Modern risk management goes beyond regulatory compliance—it is now an integral part of strategic planning and performance management.
Banks increasingly embed risk-adjusted metrics such as:

• Risk-Adjusted Return on Capital (RAROC)

• Economic Value Added (EVA)

• Risk Appetite Framework (RAF)

These measures help decision-makers balance profitability with risk exposure, ensuring that growth remains sustainable and within defined tolerance levels.

5. Capital Adequacy and Risk-Weighted Assets

5.1 The Importance of Capital Adequacy

Capital adequacy represents the financial resilience of a bank — its ability to absorb unexpected losses and continue operations without endangering depositors or the financial system.
A bank’s capital acts as a protective buffer between its risk exposures and potential insolvency.

In Turkey, the Banking Regulation and Supervision Agency (BRSA) enforces capital adequacy requirements aligned with Basel III standards to ensure stability and confidence in the banking sector.

Maintaining adequate capital levels helps banks:

• Strengthen their solvency and creditworthiness,

• Protect depositors and investors,

• Sustain market confidence, and

• Support long-term growth and lending capacity.

5.2 Components of Regulatory Capital (Basel III)

Under Basel III and BRSA regulations, regulatory capital is divided into three main tiers:

1. Common Equity Tier 1 (CET1):

• Ordinary shares, share premiums, retained earnings, and other comprehensive income (OCI).

• Deducted items: goodwill, deferred tax assets, and intangible assets.

2. Additional Tier 1 (AT1):

• Perpetual instruments and subordinated debts that are non-cumulative and have no maturity date.

3. Tier 2 Capital (T2):

• Subordinated loans with maturity over five years,

• Revaluation reserves, and

• General provisions for expected credit losses.

The Total Capital Ratio (TCR) is calculated by dividing total regulatory capital by Risk-Weighted Assets (RWA).
The BRSA mandates that Turkish banks maintain at least:

• 8% minimum capital adequacy ratio (Basel requirement),

• 12% total capital adequacy ratio (BRSA standard, higher than Basel for prudence).

5.3 Risk-Weighted Assets (RWA)

Risk-Weighted Assets (RWA) represent the total of all assets held by a bank, weighted according to their associated risk level.
This metric determines how much capital a bank must hold to safeguard against potential losses.

The BRSA classifies assets into categories based on credit, market, and operational risks:

Each category is multiplied by a risk weight (ranging from 0% to 150%), depending on the counterparty’s credit quality and collateral structure.

Example:

• Government securities: 0% risk weight

• Corporate loans: 100%

• High-risk exposures (e.g., equity investments): 150%

5.4 The Internal Capital Adequacy Assessment Process (ICAAP)

The Internal Capital Adequacy Assessment Process (ICAAP) requires banks to assess their overall capital adequacy relative to their risk profiles and business strategies.
Under BRSA guidelines, ICAAP must include:

• Identification of all material risks,

• Quantitative and qualitative risk assessments,

• Stress test results and capital planning,

• Strategic plans for capital allocation and growth.

Each bank must prepare an ICAAP Report annually and submit it to the BRSA.
This report demonstrates the bank’s ability to maintain adequate capital levels under both normal and stressed conditions.

5.5 The Supervisory Review and Evaluation Process (SREP)

The Supervisory Review and Evaluation Process (SREP) complements ICAAP by allowing the BRSA to evaluate a bank’s risk profile, governance, and capital adequacy.

The process ensures that:

• Banks maintain sufficient capital above the regulatory minimums,

• Risk management systems operate effectively, and

• Strategic decisions are aligned with the bank’s risk appetite and capital structure.

The BRSA may require additional capital buffers or corrective measures if deficiencies are identified during the SREP.

5.6 Capital Buffers under Basel III

To strengthen resilience, Basel III introduced capital conservation and countercyclical buffers:

• Capital Conservation Buffer: A mandatory 2.5% CET1 capital to absorb losses during financial stress.

• Countercyclical Buffer: Up to 2.5% of CET1 capital, activated during periods of excessive credit growth.

The BRSA has fully adopted these buffers, ensuring Turkish banks maintain robust capitalization even in volatile conditions.

6. Governance, Risk Committees, and Internal Systems

6.1 Governance Framework in Risk Management

A sound governance structure is the backbone of an effective risk management system.
In the Turkish banking sector, the Banking Regulation and Supervision Agency (BRSA) requires banks to establish clear governance frameworks ensuring accountability, transparency, and independence of risk oversight.

The governance model typically consists of:

• Board of Directors,

• Audit Committee,

• Risk Committee,

• Senior Management, and

• Independent Control Functions (Risk Management, Internal Audit, Internal Control, and Compliance).

This framework ensures that risk management is integrated into every level of decision-making within the organization.

6.2 The Role of the Board of Directors

The Board of Directors holds ultimate responsibility for the overall risk strategy and appetite of the bank.
Key responsibilities include:

• Approving the Risk Appetite Framework (RAF) and ensuring alignment with the bank’s strategic objectives,

• Overseeing the design and implementation of risk management systems,

• Monitoring adherence to approved risk limits and tolerance levels,

• Reviewing reports from risk and audit functions, and

• Ensuring adequate resources and independence for risk management units.

The Board’s proactive engagement in risk oversight fosters a culture of accountability and prudence across all business lines.

6.3 The Role of the Risk Committee

The Risk Committee acts as a specialized sub-committee of the Board, focusing on detailed evaluation and monitoring of risk exposures.

Core duties of the Risk Committee include:

• Reviewing the effectiveness of risk management policies,

• Ensuring that risks are within the limits defined by the Risk Appetite Framework,

• Assessing the results of stress tests and scenario analyses,

• Coordinating between risk management and other control functions, and

• Reporting critical risk issues directly to the Board.

By maintaining an independent oversight role, the Risk Committee ensures that risk decisions remain objective and well-informed.

6.4 Senior Management Responsibilities

Senior management plays a crucial operational role in executing the Board’s risk strategies.
Their responsibilities include:

• Implementing approved risk policies and procedures,

• Developing risk measurement systems and internal models,

• Ensuring compliance with BRSA and Basel regulations,

• Monitoring daily risk exposures and reporting breaches promptly, and

• Promoting risk awareness across business units.

They act as the link between the strategic direction set by the Board and the day-to-day management of risk.

6.5 Independent Control Functions

To safeguard objectivity and prevent conflicts of interest, the BRSA mandates that banks maintain independent internal systems, comprising:

1. Risk Management Function – Responsible for identifying, measuring, monitoring, and controlling all material risks.

2. Internal Control Function – Ensures that daily operations comply with laws, regulations, and internal procedures.

3. Internal Audit Function – Evaluates the effectiveness and efficiency of risk and control systems through periodic audits.

4. Compliance Function – Monitors adherence to legal requirements, ethical standards, and anti-money laundering regulations.

These functions operate independently from business lines and report directly to the Board or its committees.

6.6 Building a Strong Risk Culture

Risk culture refers to the shared values, beliefs, and behaviors that shape how individuals within the bank perceive and manage risk.
A strong risk culture is the foundation of sustainable risk governance.

Key elements include:

• Tone at the top: Leadership’s commitment to ethical and prudent risk-taking,

• Accountability: Clear ownership of risks at all organizational levels,

• Transparency: Open communication about risk exposures and incidents,

• Incentive alignment: Linking performance rewards to risk-adjusted outcomes.

The BRSA encourages banks to conduct periodic risk culture assessments, ensuring that the organization’s mindset evolves alongside regulatory and market changes.

6.7 Coordination Between Risk, Audit, and Compliance Functions

While these three functions have distinct mandates, effective coordination among them is essential for a robust internal system.

• The Risk Management function focuses on identifying and monitoring risks.

• The Internal Audit function evaluates whether risk management systems are effective.

• The Compliance function ensures that all activities comply with regulatory requirements.

Regular information sharing, joint reviews, and cross-functional committees strengthen the overall internal control environment and minimize duplication or blind spots.

7. The Future of Risk Management in Turkish Banking

7.1 Digital Transformation and the Rise of Technology-Driven Risks

The Turkish banking sector has been a regional leader in digitalization, with rapid growth in mobile and online banking services.
While technology has brought operational efficiency and customer convenience, it has also introduced new categories of risk — particularly in cybersecurity, data privacy, and third-party dependencies as IT Risk Management Standard concepts. 

Key challenges and focus areas include:

• Cybersecurity: Protecting systems from ransomware, phishing, and data breaches.

• Cloud risk management: Ensuring compliance and data integrity when outsourcing IT infrastructure.

• Third-party/vendor risk: Monitoring fintech partnerships and technology providers.

• Digital fraud detection: Using AI-powered systems to detect anomalies in real-time.

The BRSA has issued several regulatory updates focusing on information systems management, digital banking, and operational resilience, ensuring that banks can withstand cyber threats and system disruptions.

7.2 Data Analytics and Artificial Intelligence in Risk Management

Modern risk management increasingly relies on advanced analytics and artificial intelligence (AI) to enhance prediction accuracy and decision-making speed.
Turkish banks are gradually adopting data-driven models for:

• Credit scoring and risk-based pricing,

• Early warning systems for default detection,

• Fraud analytics using pattern recognition,

• Customer behavior analysis for portfolio management, and

• Predictive stress testing with real-time macroeconomic inputs.

AI-based systems enable continuous monitoring and dynamic risk assessment — shifting risk management from reactive to proactive.

However, the BRSA emphasizes the need for ethical AI use, model validation, and explainability to prevent systemic biases and ensure regulatory compliance.

7.3 ESG and Sustainability Risks

Global financial systems are increasingly integrating ESG (Environmental, Social, and Governance) considerations into their risk frameworks.
Turkish banks are aligning with these global trends, recognizing that environmental and social factors can directly affect credit, market, and operational risks.

Examples include:

• Climate risk analysis: Measuring exposure to carbon-intensive sectors.

• Green finance: Promoting sustainable lending and investment products.

• Social and governance factors: Evaluating human rights, diversity, and ethical practices in lending decisions.

The BRSA and other regulatory bodies, such as the Central Bank of the Republic of Türkiye (CBRT), have started encouraging ESG disclosures and risk integration within Internal Capital Adequacy Assessment Processes (ICAAP).

7.4 Strengthening Operational Resilience

Operational resilience is evolving from a compliance topic into a strategic necessity.
Banks must ensure that critical business services remain operational under extreme circumstances such as pandemics, geopolitical conflicts, or natural disasters.

To strengthen resilience, Turkish banks are:

• Establishing resilience frameworks aligned with BRSA guidelines,

• Conducting business impact analyses,

• Investing in redundant data centers and cyber continuity plans,

• Incorporating resilience metrics into Board-level dashboards.

The post-pandemic period has accelerated the sector’s commitment to building end-to-end resilience, ensuring that disruptions do not compromise customer trust or financial stability.

7.5 The Evolving Role of Risk Management Functions

The role of risk management is expanding beyond traditional oversight to become a strategic partner in value creation.
Future risk functions are expected to:

• Integrate risk appetite directly into business strategy,

• Utilize real-time data analytics for faster decision-making,

• Collaborate closely with product and innovation teams, and

• Support the bank’s transition toward sustainable and technology-driven models.

Risk professionals will need broader skill sets — combining financial acumen, technological literacy, and strategic thinking.
The BRSA’s evolving regulatory approach supports this transformation by encouraging innovation within a controlled and transparent framework.

7.6 Conclusion

The future of risk management in Turkish banking lies in achieving balance — between innovation and control, profitability and prudence, automation and human judgment.
As financial technologies, ESG principles, and data-driven approaches reshape the sector, banks that cultivate strong governance, agile systems, and a resilient risk culture will stand out as leaders.

Ultimately, effective risk management is not merely a regulatory requirement — it is the foundation of trust that sustains the stability, reputation, and long-term success of the Turkish banking industry.

References

• Banking Regulation and Supervision Agency (BRSA). (2023). Key Indicators of the Banking Sector

• Banking Regulation and Supervision Agency (BRSA). (2022). Cybersecurity Circular

• The Banks Association of Türkiye (TBA). (2023). Key Indicators Report of the Turkish Banking Sector

• Central Bank of the Republic of Türkiye (CBRT). (2023). Financial Stability Report (November 2023)

• Financial Crimes Investigation Board (MASAK). (2022). Annual Report 2022

• Turkish Informatics Industry Association (TÜBİSAD). (2023). Türkiye Cybersecurity Ecosystem Report 2023

• Borsa Istanbul (BIST). (2023). Workshop Report on SMEs’ Access to Finance and Risk Management

• Turkish Statistical Institute (TURKSTAT). (2023). Unemployment and Employment Indicators

• World Bank. (2022). Global Financial Development Report 2022: Risk and Regulation in the Digital Era

• Basel Committee on Banking Supervision. (2020). Basel III: Finalising Post-Crisis Reforms