crisis, 1 the credit card market has remained strong and solid. In the near-term, however, growing consumer lending and new regulatory restrictions, combined with other factors, are threatening the founda- tions of value creation in the business.<br><br> To counter these challenges, Turkish banks need to broaden their sources of revenue and define a strategy for growth in a mature market, all while continuing to manage risk effectively. In this article we examine the factors that fueled the fast yet sustainable growth of Turkey 9s credit card business, highlight recommendations for Turkish banks going forward and outline lessons for other emerging markets. A thriving market Credit cards have become a vital compo- nent of the Turkish economy.<br><br> In 2008, they accounted for 25 percent of consumer spending, up from 22 percent in 2007 (Ex- hibit 1 on page 4). Credit cards are now Turkey 9s most popular non-cash consumer payment instrument. It is only within the past eight years that credit cards have gained prominence in re- tail payments in Turkey.<br><br> The country 9s first charge card was introduced in 1968, and banks began offering standard credit cards to a small segment of wealthy consumers in the 1980s. Robust growth did not begin until after the introduction of multi-branded merchant network cards in 1998 and the fi- 1 Turkey 9s GDP contracted by 13.8 percent in 2009 Q1. 4 McKinsey on Payments September 2009 nancial crisis of 2001, when both inflation and interest rates began to decline sharply.<br><br> From 2002 to 2008, the number of cards is- sued grew from 16 million to 43 million, and total credit card purchases grew at a compound annual growth rate of almost 50 percent, from $15 billion to $130 billion. Today, on average, there is nearly one credit card in circulation for every adult in Turkey, up from 0.7 in 2007. Average annual spend- ing by card in 2008 was $3,000, up from $2,650 in 2007.<br><br> Compelling value for consumers and merchants A strong combination of product features has made credit cards extremely popular with Turkish consumers and merchants (Ex- hibit 2). Almost all credit cards in Turkey are cmulti-branded d merchant network cards, carrying a semi-independent card brand in addition to the bank 9s corporate brand and either the Visa or MasterCard brand. These standard, no-frills cards work everywhere in the world, with the Visa/MasterCard net- works serving in the case of international transactions and Turkey 9s Interbank Card Center handling all domestic transactions.<br><br> The fundamental appeal of credit cards to Turkish consumers, just as in every market, is convenience. In addition to providing a secure and easy way to make purchases, credit cards allow people to borrow for the short-term without a loan application for each purchase. However, there are additional benefits that set Turkish credit cards apart.<br><br> When con- sumers shop at merchants within their card 9s preferred merchant network, they re- ceive generous cash-back rewards and a va- riety of services. But the truly distinctive feature is the option to pay for most pur- chases through interest-free installments (i.e., extended zero-interest payment pro- grams). Merchants fund much of this serv- ice, often incorporating the cost of financing into the list price of goods.<br><br> In 2008, 20 percent of all credit card pur- chases were paid through cfree d install- ments, over an average period of six months. These benefits are usually offered for a card fee of less than $30 a year on av- 15.8 6.1 21.9 4.0 2.6 6.5 5.6 11.6 17.1 22.6 27.4 66.5 66.5 0.2 19.9 20.2 3.5 9.6 13.1 0.4 21.8 22.2 25.4 16.4 41.9 20.1 4.8 3.8 23.9 7.1 13.1 20.2 0.7 2.2 1.1 2.0 1.3 0.3 0.7 0.5 2.6 0.6 0.3 11.9 6.7 9.5 11.0 11.1 28.6 20.2 3.4 14.9 11.1 7.2 3.6 15.6 1.0 7.7 0.5 10.0 0.6 11.6 1.2 12.3 0.7 11.8 2.1 23.7 2.2 17.1 5.5 5.3 34.0 3.6 3.1 Credit card 2 Debit card Credit card Consumer loans 1,2 Portugal Poland Brazil U.K. 2.3 11.4 6.1 17.5 U.S.<br><br> Mexico S. Korea Malaysia Thailand Turkey France Spain 4.1 0 27.5 7.8 19.7 1 Excluding mortgages, including car loans, general purpose consumer loans and consumer finance 2 Year-end outstanding balances/ GDP of the year Source: State Statistical Institutes, Central banks, Euromonitor, RBR Report, Interbank Card Center Turkey (BKM), The Nilson Report May 2008, McKinsey analysis Exhibit 1 Credit card use in Turkey is among the highest in the world Share of cards in total consumer spending, 2007 Percent Credit cards per adult, 2007 GDP penetration of consumer lending, 2007 1,2 Percent 5 Credit cards in Turkey erage 3 an almost negligible amount com- pared to international benchmarks. Consumers also have the option to extend repayment further by revolving their bal- ances, which incurs an interest charge.<br><br> On average, 30 percent of credit card balances are revolved at any given time. For merchants, the primary benefit of ac- cepting credit cards is an increase in sales without assuming non-payment risk. In ad- dition, Turkish banks offer merchants the opportunity to run tailored promotional campaigns (higher cash reward points; free installments) and to advertise through the card brand.<br><br> Banks spend $200 million to $250 million annually to promote their semi-independent credit card brands, which can help attract attention to jointly mar- keted retail products bearing less well- known brands. Thus, Turkish merchants have leveraged credit cards not only as a payment instrument but also as a marketing platform to extend their customer base and increase customer loyalty. Banks and mer- chants share the costs of advertising and cash rewards to card users.<br><br> Merchants compensate banks with a com- bination of fees and float. In the case of standard purchases made without an in- stallment scheme, merchants either: a) pay a commission and receive payment one day after purchase, or b) pay no commis- sion and receive payment at a later date (close to the date of consumer 9s payment to bank). For purchases made with inter- est-free installments, merchants: a) pay a standard commission and receive payment from bank in line with consumer 9s pay- ment schedule, or b) pay a higher commis- sion and receive funds faster.<br><br> Whether the source is commission or float, revenues fall short of the funding and operating costs of the acquiring business. A profitable business for banks Credit cards generate more than 10 percent of banking sector profits (Exhibit 3 on page 6). Historically this income has come almost entirely from the revolving business.<br><br> The largest credit card banks 3 Yapi Kredi Bank, Garanti Bank, Akbank, Isbank, Fi- nansbank and HSBC, which together ac- count for nearly 85 percent of the issuing 1 Reward amount depends on the merchant and campaign, but typically equals 0.5%-1.0% of the purchase value and can reach 20% 2 Subject to negotiation between merchant and bank, but typically 0.5%-1.0% of total volume Source: Turkish Interbank Card Center (BKM), McKinsey Exhibit 2 The value system in Turkish credit cards Bank Issuing and Acquiring Merchant Loyalty pool Customer $ Customer pays Bank in interest-free installments as offered by Merchant Must pay minimum 20% of monthly statement balance, including installment May revolve remaining balance, which incurs interest charges Bank owns issuing and acquiring in closed-loop network Acquires the multi-branded merchant network (~100,000 merchants) Manages the loyalty scheme Develops and promotes campaigns together with merchants Co-funds cash-back reward scheme for purchases together with merchants Merchant shares cost of maintaining network with Bank Pays annual fee 2 to Bank for being in the network Co-funds cash-back reward scheme with Bank Pays a standard commission for each transaction to Bank and receives installment payments from Bank according to customer 9s payment schedule Pays higher commission to Bank for faster funds availability than customer 9s payment schedule Customer earns premium rewards 1 6 McKinsey on Payments September 2009 market 3 achieved their leading positions through rapid, simultaneous development of large merchant networks and a broad card- holder base. Growth in the number of card- holders sped growth in merchant acceptance, and promotional campaigns of- fered by these merchants attracted even more cardholders to the system and cus- tomers to banks. To build an appealing merchant network and a sizeable cardholder base at the same time, banks have kept the cost of card ac- ceptance and use low, limiting the value that issuing and acquiring can create on their own.<br><br> Yet sharply rising credit card spending increased cardholders 9 propensity to revolve and thus made the credit card business attractive for banks. Over the course of a year, approximately 80 to 85 percent of all credit card customers roll over their balances at least once. Even as many markets are in turmoil, the credit card business in Turkey has continued to generate increasing value in 2009.<br><br> How- ever, the composition of this income is chang- ing. On the one hand, profitability for the revolving business has declined due to falling interest rates and rising risk costs. Mean- while, the acquiring business has become moderately profitable, as banks, with height- ened profitability pressure, have resisted low- ering pricing for merchants.<br><br> At the same time, funding costs have declined, increasing banks 9 margins on acquiring balances. Unfor- tunately, this improvement in the profitability of the acquiring business may prove tempo- rary, because banks are gradually resuming competition on merchant commissions at the first signs of economic recovery. Historical and cultural context In the late 1990s, consumer lending was vir- tually non-existent due to a prolonged pe- riod of high inflation and high interest rates (Exhibit 4).<br><br> This gave credit cards a jump on other forms of consumer lending, which normally precede and hold back credit card lending in more developed markets. Organ- ized trade also started to build a meaningful footprint around the country at this time. The lack of consumer finance companies with captive relationships with Turkish re- tailers made it easier for banks to build mer- chant relationships to support multi-branded card programs.<br><br> In the declin- 6.3 8.6 0.6 1.7 Net revenues Operating costs Risk costs Pre-tax profit Issuing 2.0 -0.1 Acquiring 3.4 -0.1 Revolving 3.2 1.9 1.7 (11%) 13.3 (89%) Credit cards 100% = TL 15 billion Other businesses Source: McKinsey Exhibit 3 Credit cards generate more than 10% of total banking profits in Turkey, thanks to revolving credit This share is higher for top credit card player banks Estimated Turkish credit card P/ L by business, 2008 TL billions Turkish banking pre-tax profit pool, 2008 TL billions Represents an after-tax ROE of ~25% 7 Credit cards in Turkey ing interest rate environment of the early 2000s, the convenience of credit cards, cou- pled with aggressive marketing and advertis- ing by banks, fostered faster growth compared to consumer loans (despite cards being more expensive, when revolved). The fact that cards have adopted a tradi- tional and widely-used payment form has made them especially appealing. Histori- cally, merchant installment offers 3 both managed and financed by retailers as a way to boost sales 3 were practically the only form of consumer lending available in the market.<br><br> Merchants allowed their cus- tomers to pay in installments over a spe- cific period of time with promissory notes signed at the time of purchase, and incor- porated the cost of financing into the pur- chase price of merchandise. With multi-branded installment credit cards, Turkish banks have assumed control of this practice, and merchants have been happy to transfer payment collection oper- ations and payment risk to banks. Another crucial advantage for credit cards is the ability to reach riskier segments of the mass market, which consumer lending can- not do, because it does not price loans ac- cording to risk.<br><br> Earning high margins on re- volved balances, credit card lenders were able to absorb the higher risk costs of the mass market. Expansion into higher risk segments boosted card ownership and usage substantially, and credit cards are still today the only means of bank financing available to broad segments of the Turkish market. Success factors While favorable contextual factors fueled rapid growth, the success of Turkey 9s credit card business rests squarely on banks 9 exe- cution capabilities.<br><br> " Rapid growth: Turkey 9s six big credit card banks won the game because they built card acceptance and usage swiftly, focus- ing simultaneously on the needs of mer- chants and consumers. They promoted the credit card as a stand-alone product, sup- ported by a separate business unit and a distinct, independent brand. In addition to smart branding and aggressive advertising, banks deployed dedicated branch-based and mobile sales teams to reach merchants of all sizes and consumers from all seg- 1.0 1.4 1.1 1.1 2.3 0.8 0.5 1.2 1.8 2.7 3.4 4.1 4.6 1.5 Credit cards 2008 8.1 Consumer loans 1 3.5 2.4 1998 2.2 1999 1.3 3.7 1.0 2.7 2003 2.5 4.3 2004 2.6 5.3 2005 2.9 6.3 2006 3.1 7.2 2007 1.8 2001 1.2 1.7 2002 2000 39.1 69.3 29.7 18.5 9.4 7.7 9.7 69.9 68.8 8.4 10.4 65.3 110.9 55.8 42.3 26.5 18.8 19.6 79.2 74.5 22.2 19.6 Economic crisis 1 Includes car loans, general purpose loans, overdraft and consumer finance 2 Loan outstanding balances/ GDP Source: Central Bank, Undersecreteriat of Treasury Exhibit 4 Multi-branded credit cards grew in an underdeveloped consumer lending market Central Bank O/ N lending rate Percent CPI growth rate Percent 1st multi-branded credit card network with installments and loyalty scheme Consumer lending 1 GDP penetration 2 in Turkey Percent 8 McKinsey on Payments September 2009 ments.<br><br> Banks also developed specialized technology to manage promotional cam- paigns sponsored jointly with merchants. " Effective risk management: While growing rapidly, Turkish banks did not let growth outstrip their risk management infrastruc- ture and capabilities. Early implementa- tion of robust, automated underwriting systems and ongoing risk management en- abled banks to minimize losses while rap- idly extending credit to a broad cross-section of consumers with no his- tory of borrowing.<br><br> Banks worked together to establish an interbank credit bureau and individually to develop scoring sys- tems to track cardholders 9 purchasing and payment behavior and flag changes in a consumer 9s rating. Behavioral scoring also allowed banks to manage cardholder lim- its dynamically. " Revolving balances: Banks facilitated con- sumers 9 use of revolving credit by setting high spending limits.<br><br> They also offered in- stallment plans with delayed start dates for repayment, which increase consumers 9 ability and propensity to spend. Since banks established the right price for inter- est on revolved balances from the start and refrained from engaging in disruptive competition around interest rates, revolv- ing balances ensured that the credit card business created value. Outlook and recommendations Within the past few years, a number of high-profile personal bankruptcy cases have prompted regulators to set limits on the in- terest rates banks can charge.<br><br> These limits, combined with alternative forms of con- sumer lending and a rising default rate, pose significant threats to the future of Turkey 9s Five lessons fo r eme rg in g ma r kets Economic conditions, p ayment pr efe r ences and cultu r al facto r s diffe r ma r kedly ac r oss ma r kets. Howeve r , the success of Tu r kish banks in r a p idly buildin g a new p ayments inf r ast r uctu r e offe r s five key lessons, p a r ticula r ly fo r eme rg in g ma r kets whe r e con- sume r lendin g is less matu r e and inte r est r ates a r e hi g he r . 1.<br><br> Find the r i g ht method and level of p r icin g fo r r apid gr owth. In Tu r key, low fees and commissions made ca r ds an easy choice fo r me r chants and consume r s, and the tendency of Tu r kish consume r s to r evolve balances at least occasionally pr ovided com p ensation to banks. In some ma r kets, by cont r ast, con- sume r s may avoid p ayin g inte r est on r evolvin g balances, pr efe rr in g instead to p ay fees in exchan g e fo r the inc r eased secu r ity, convenience and othe r benefits.<br><br> 2. Link ca r ds with a cultu r ally familia r p r actice. Tu r kish banks tu r ned the lon g -established pr actice of installment p ayments offe r ed by me r chants into a p latfo r m fo r pr omotin g the ca r d b r and and inc r easin g total c r edit ca r d s p endin g .<br><br> 3. O rg anize and mana g e the ca r d offe r in g as a semi-autonomous business. As a r elatively new p ayment inst r ument, c r edit ca r ds can gr ow only if consume r s chan g e thei r behavio r and me r chants ado p t new pr ocesses.<br><br> This often r e q ui r es a dedicated team (o r even a se p a r ate business unit), an enticin g b r and and an a ggr essive sales effo r t focused both on delive r in g ca r d r eade r s to me r chants and p uttin g ca r ds into the hands of consume r s. 4. Keep consume r s info r med.<br><br> Consume r s natu r ally r eact to chan g e, and, in r es p onse, r e g ulato r s seek to cont r ol the im p act of new innovations. Banks should ensu r e that consume r s a r e fully info r med about the benefits that ca r ds pr ovide to society and advocate r e g ulations that allow fo r continued gr owth and o p timization of the p ayments system. 5.<br><br> Invest in r isk mana g ement ea r ly. Solid r isk mana g ement ca p abilities need to be in p lace f r om the ve r y be g innin g to ensu r e pr ofitable gr owth, p a r ticula r ly when c r edit ca r ds a r e extended to hi g he r - r isk se g ments. 9 Credit cards in Turkey credit card business.<br><br> Given the challenges of a mature, more tightly regulated market, banks should focus on five core aspects of the business: balanced value generation, growth, cross-selling, government and pub- lic relations, and risk management. 1. More balanced value generation from all aspects of the credit card business: With margins on the revolving business already declining due to regulatory caps on inter- est, banks need to boost revenue from the acquiring and issuing businesses, turning them into self-sustaining profit centers.<br><br> For example, they should consider in- creasing merchant commissions and fees or requiring consumers to pay interest on purchases made with currently cfree d in- stallments. Further reductions in the regu- latory interest cap are probable and would restrict the ability of the revolving business to create value, particularly when interest rates begin to rise again. It is cru- cial, therefore, that banks act now to im- plement new pricing models and give merchants and consumers time to adjust.<br><br> 2. New card usage through expanded func- tionality and growth in untapped mar- kets: Credit cards have nearly saturated the core areas of consumer credit card spending (e.g., at major grocery chains and clothing retailers), but there is ample room for growth in more specialized spending areas such as rent, tax and other government payments, business-to-busi- ness payments and public transportation. In addition, contactless technology, in- cluding mobile payments, can help cards capture a higher share of low-value pay- ments, not only at large retailers but in small shops as well.<br><br> 3. Cross-selling: All major credit card banks have a large number of credit card-only customers. Building deeper relationships with these customers by cross-selling card-related products (e.g., unemploy- ment and theft insurance) or other bank- ing products (e.g., bundled consumer loans) would boost results.<br><br> 4. Public education: To maximize the benefit of credit cards in payments and consumer finance, banks should effectively commu- nicate the advantages of cards to all stakeholders (emphasizing, for example, protection from fraud and theft, conven- ience, reduction in payment risk to mer- chants, ease of accounting and reduction of informal economy). 5.<br><br> Risk management: Given increased de- fault rates during crisis periods, banks need to refine their monitoring and fol- low-up processes to limit risk costs. For example, they could develop more sophis- ticated early warning systems or apply segmentation in collections. * * * Turkey 9s experience in rapidly building a sustainable, value-generating credit card business offers important lessons in how to take advantage of favorable market condi- tions, embrace traditional practices and excel in execution.<br><br> Through the combina- tion of right-pricing and solid risk manage- ment capabilities, the Turkish credit card business has continued to generate increas- ing value despite economic turmoil. Now, Turkish banks are entering a new phase of innovation, seeking to sustain profitability in a mature, more tightly regulated market. Mehmet Guvendi is a principal and Elsa Pekmez is an associate principal, both in the Istanbul office.<br><br> Erkin Aydin is an alumnus of the Istanbul office. Turkey 9s six big credit card banks won the game because they built card acceptance and usage swiftly, focusing simultaneously on the needs of merchants and consumers. <br><br>

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