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The Ministerial Committee on Legislation yesterday approved a bill to legalize free loan funds, despite the objections of the Finance Ministry and the Bank of Israel.

These funds serve mainly the ultra-orthodox community.

The bill, which was sponsored by Knesset Finance Committee chairman MK Moshe Gafni (United Torah Judaism), would allow free loan funds to operate without Bank of Israel supervision, even though they essentially function as banks.

The societies, called Gamahim in Hebrew - "good deed" societies - provide small interest-free loans to the needy, and are used mostly by the ultra-Orthodox.

The chairman of the ministerial committee, Justice Minister Yaakov Neeman, announced at the start of the session that he supported the bill, but noted that his ministry opposed it.

Finance Minister Yuval Steinitz is in Paris and did not have a representative at the meeting. Steinitz also did not provide the chairman with the treasury's opinion on the issue, as is normally done. Instead, the treasury sent a mid-level official, who said nothing.

A treasury source said the ministry's professional staff, as opposed to the politicians in charge, strongly objects to the bill. The only minister who voted against the bill was Public Security Minister Yitzhak Aharonovitch (Yisrael Beiteinu).

Yesterday, Gafni presented a letter to the committee from Bank of Israel governor Stanley Fischer, dated May 2009. In the letter, Fischer promised Gafni that despite the problematic nature of the proposal, the central bank would cooperate to allow the institutions to exist, while making sure the situation could not be abused.

But immediately after the vote, the Bank of Israel announced that while it "appreciated the importance of free loan societies among the Jewish community for hundreds of years, the Bank of Israel favors a solution within the framework of the law that is consistent with Israeli banking laws."

Gafni told the committee: "The Bank of Israel has promised me a thousand times that it would solve the problem of the free loan societies, since they are problematic in terms of banking and money laundering regulations. My aide has been calling once a week for 10 months to find out how to solve it. I am not willing to have the Bank of Israel continue to tell me, 'It'll work out.'"

But political sources say that what really happened last week is that Prime Minister Benjamin Netanyahu's bureau, Gafni, the Bank of Israel and the treasury struck a deal behind the scenes. Under the deal, Gafni would expedite the Finance Committee's work on the new Bank of Israel bill and finish debating it before the Knesset recesses for the Passover holiday, in return for the passage of the free loan societies bill.

The passage of the new Bank of Israel Law, as Netanyahu has promised Fischer, is what Fischer is said to be waiting for before agreeing to take a second term as central bank governor. His first term ends April 30.

Gafni attacked those accusing him of making a deal: "It is hard being Haredi. I know who leaked the connection between the Bank of Israel Law and the free loan societies law. Good deeds have been transformed into [something disgusting]. They would not dare write that about something that is not Haredi," said Gafni.

Gafni himself strenuously denied there was any deal, saying there was no connection between the two laws.

The banking laws essentially ban free loan societies. The law states: "Anyone who is not a banking corporation may not do business in accepting monetary deposits and providing credit." But the law has never been enforced.

Gafni increased his work on behalf of the societies as the Bank of Israel bill advanced in the Knesset. That bill does not make provisions for free loan societies.

Gafni's bill would legalize the societies, allowing them to accept and loan funds, but without providing for any regulatory mechanisms or supervision, including by the banks supervisor.

Historically the societies lent out small sums to those in need, or to those who needed money for specific occasions such as weddings, births and bar mitzvahs. Over the years the amounts involved have grown, and some societies now lend out quite significant sums.

They raise money from well-off Haredim as well as from the ultra-Orthodox public, sometimes as deposits and sometimes as charitable contributions. They are well-known institutions in the Haredi world and beyond, and sometimes lend to the needy regardless of their level of religious observance.

No one knows the true number of free loan societies, or the amounts involved, But estimates are in the hundreds of millions of shekels, if not more.

Fischer said the problem with the societies was not the charitable contributions, but the deposits, and he said he hoped to find a solution because of the importance of the organizations. Both treasury and central bank officials are worried what would happen if the funds run into liquidity problems, or even bankruptcy. Depositors would be left with no protection and no way to recover their money. In addition, the funds could be used for illegal operations including money laundering, as has happened in the past.