Retail banking came of age in Turkey during the 1990s, its growth fueled by consumer lending and the popularity of credit cards (Exhibit 1). With state-of-the-art distribution systems, including ATMs and Internet accounts, Turkish banks offered services few other European banks could match. But the financial crisis of 2000 and 2001, followed by the country’s worst recession in more than 20 years, has laid the sector low. Many banks closed, and even the big four—Akbank, Garanti Bank, Isbank, and Yapi Kredi Bank (YKB)—have suffered.

Tough times expose flaws in the banking systems of many emerging markets. In Turkey, the worst of these flaws were weak regulatory supervision and weak corporate governance. This bad state of affairs was made worse by political and macroeconomic instability, which brought rising budget deficits and government debt. Profitability thus came to depend on government lending and on trading income rather than on core banking activities. The cost of restructuring private and public banks now comes to more than $20 billion, much of it to be borne by the taxpayer.

Unless the regulatory and governance gaps are closed, any progress banks make in rebuilding confidence by modernizing their operations or offering more attractive services could...