A Dangerously Crippled Bank

Israel Discount Bank has undergone a series of traumas over the last few months that highlight the failure of government ownership and the urgent need for the bank's privatization.

Israel Discount Bank has undergone a series of traumas over the last few months that highlight the failure of government ownership and the urgent need for the bank's privatization.

The bank has suffered in recent years from ongoing losses that have eroded its equity and reduced its ability both to streamline and to provide new loans. To free itself of its commercial paralysis and return to profitability, Discount needs an infusion of capital. But this is where bureaucracy began to complicate its situation even further.

The bank asked the state to permit it to raise money on the stock exchange, but the state, which owns 57 percent of Discount, objected, on the grounds that should its holdings be diluted to below 50 percent, its ability to sell a controlling stake in the bank in the future would be harmed.

Discount then tried a different tack: putting its American subsidiary, Discount New York, up for sale. Discount New York is the most successful Israeli banking operation overseas and its contribution to its Israeli parent's profits is enormous. Without this source of income, Discount's situation would be even worse. The Finance Ministry thus fears that selling Discount New York would deprive the bank of its most important asset and hurt the state's chances of privatizing it in the future.

The problem is that the treasury has not offered Discount any alternative. Over the last few months, the bank's managers have found themselves conducting a dialogue of the deaf with treasury officials. Discount made it clear that the sale of its New York subsidiary was urgent in order to deal with its equity problem; the treasury responded by demanding clarifications and trying to buy time.

Meanwhile, the situation has continued to deteriorate. This time, the trouble stemmed from the new Accounting Standard 15, which requires companies to adjust the book value of their assets every year. Discount owns 26.4 percent of the First International Bank, and its balance sheet values this investment at NIS 870 million. On the stock exchange, however, these shares were until recently trading at a value of only NIS 330 million.

To justify its decision not to make a provision for the decline in the value of this investment, Discount commissioned a valuation of First International from Professor Yoram Eden, who said that the value listed on Discount's books accurately reflects the shares' true value.

Last week, however, businessman Zadik Bino signed a deal to buy First International, at a valuation 50 percent lower than that listed on Discount's balance sheet. Discount cannot ignore the price tag Bino has put on First International; it will therefore probably be forced to make a provision worth several hundred million shekels. Part of this sum will come out of the bank's equity, reducing it to just above the minimum capital adequacy ratio demanded by the Bank of Israel - 9 percent.

It is true that all this is merely an accounting procedure, but it is likely to have serious ramifications: Customers are liable to fear that a capital adequacy ratio that has fallen so near the minimum is a bad omen for the bank's stability and to react accordingly.

Discount believes that it can improve its situation if it exercises its right of first refusal on the sale of First International and buys the smaller bank itself. This will not spare it the need to make a provision, but at least it will have made a good deal at a good price, something that should improve its situation.

Once again, however, Discount's ownership structure has proven to be one of its major problems - because the state has decided that Discount's purchase of First International would contradict its privatization policy. Discount thus finds itself in an impossible situation: The state will not allow it to raise capital, denies it permission to sell its assets and also refuses to let it buy an asset at an attractive price.

In practice, the state has crippled the bank's management, thereby impairing its competitive capabilities. It is true that previous generations of the bank's management are responsible for its current troubles, and that the current managers must implement draconian cost-cutting measures, but the state must also make a decision.

To extricate the bank from the whirlpool in which it is sinking, two immediate decisions are needed: to allow it to raise capital, and to try to sell it. The consequences of leaving the bank in the government's hands while hamstringing its ability to make essential business decisions are liable to be far worse than those of a hasty sale, even if this results in a low price. And the First International deal gives treasury officials the green light for such a move.