The Bank of Israel and the Israel Securities Authority (ISA) have started examining the legal status of the structured deposits sold by the banks and private brokers.
Until recently, Supervisor of Banks Yoav Lehman and his staff have only looked at the banks' exposure to the instruments, and if they were liable to affect the banks' stability. However, now the supervisor and the central bank have acknowledged that there is also a problem from the customers' point of view.
The structured instruments are not considered securities, but only deposits. Therefore, they can be sold quite easily without any of the restrictions of the securities or investment advisory laws.
In internal discussions, both the Bank of Israel and the ISA admit the way these instruments are being sold to the public is problematic, and it is necessary to deal with the problem before it turns into a crisis.
Senior banking industry officials said at the end of last week that granting credit for buying these structured instruments is similar to the bubble during the 1993 period, when the banks pushed customers to take loans for the purchase of mutual funds and stocks.
Changing the legal status of the structured instruments is a complex matter, and requires changing the law, so in any case it is impossible to speak of an immediate solution. Because the instruments are considered deposits and not securities, they can be sold without a prospectus and with only minimal information. In most cases, the customer does not know the limitations of the instrument he has bought, if he is able to exit the investment early, and what is the cost of such an exit.
The restrictions of the laws on investment advice require the banks to operate according to set criteria, to require customers' signatures on forms and warnings, and to carry out a prolonged process handled by licensed investment advisers using a sophisticated computer system. If the instruments are become securities, and not deposits, the banks will no longer be able to "push" them on their customers through the use of loans for their purchase.
There are varying estimates as to the extent of the problem. According to a survey by the Bank of Israel in November, the banks sold more than NIS 10 billion in structured instruments in 2003, in addition to those sold by private brokers. But other estimates are in the NIS 30 billion range.
The reason for the growth in these structured deposits is the low level of interest on regular bank deposits or on dollar investments compared to the much higher interest on these instruments. But the higher interest rates are also a result of the higher risk involved.
A number of the professionals in the Bank of Israel and the ISA claim the structured instruments are much closer to options than deposits, and that is why they need to be classified as securities. The same officials admit the advice the banks are providing, including the explanations about the disadvantages of these instruments, is inadequate - and raises serious doubts as to whether the public is aware of the risk/reward involved.
"In order to sell government bonds linked to the CPI, or short-term government notes, or a short-term shekel mutual fund with minimal risk, it is necessary to follow all the rules and regulations, and pass through the seven levels of hell on the way. But any junior bank clerk can sell structured instruments," said one senior market official last week.
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