War on Money Laundering: Foreign Deposits in Israeli Banks Have Shrunk by Nearly $30 Billion

The decline reflects the fear of Israeli banks over tangling with the American authorities

A branch of Israel Discount Bank Of New York.
Americasroof

The heavy pressure brought to bear by the United States on financial institutions worldwide in its fight against money laundering has changed world banking over the last decade. Discrete tax shelters for wealthy clients who made their fortunes in an ambiguous manner have been required to police their clients and collaborate with the tax authorities, and in fact be agents of change when it comes to undeclared capital worldwide.

Israeli banks are not alone in this matter. The Swiss banking industry came first. It had been based on many years of complete discretion, which made Swiss banks the perfect tax shelters. The Israeli banks are under major pressure because of the entanglements of three of them with the U.S. authorities. Leumi has already settled its fines with the American regulators, paying 1.2 billion shekels ($331.9 million), and that’s not the end of it. Mizrahi Tefahot had to pay $342 million.

An aerial view of Herzliya, Israel
Ezra Levi

But that’s not the only change. A look at the deposit files of Israeli banks in Israel and their branches abroad shows that the extent of deposits by foreigners has shrunk by 100 billion shekels in a decade. In 2007, foreigners deposited 201 billion shekels in Israeli banks and their branches abroad, and at the end of 2017, that figure had shrunk to 102 billion shekels. In terms of percentages, deposits by foreigners had shrunk from 26 percent to a mere 7 percent. The sharp decline was by foreign deposits in banks in Israel, which plummeted from 89 billion shekels to 28 billion.

The decline reflects the fear of Israeli banks over tangling with the American authorities, because the law obligates them to file reports on their clients and the movements of their money. Identifying clients and the sources of their money has become common practice over the past decade. That is a dramatic change from the past, where banks were a conduit with no questions asked, and certainly no reports filed with the tax authorities. Because of the high fines and uncompromising policies of the U.S. authorities, Israeli banks have adopted a policy of taking no risks in accepting money from unknown sources. The heavy cost just isn’t worth it.

Conspiracy of silence

The Israeli banking industry was based for years on receiving deposits, especially from Jews abroad, which served the Israeli economy’s foreign currency needs. It was a kind of conspiracy of silence between the governments and the banks. The government didn’t ask the banks to be selective about where they got their foreign deposits, either in Israel or abroad, because it served a purpose when Israel was short on foreign currency. That’s not the situation today. Israel has foreign currency reserves of $116 billion as a result of its policy of purchasing dollars from the central bank, and it doesn’t need help from the banks, certainly not the kind that would mean huge fines for the banks.

This change has led to a number of significant results. For example, Israeli banks have for the most part ended their activities abroad. Leumi shut down its activities in Switzerland, Luxembourg, Latin America, London, Jersey, Kazakhstan and the Cayman Islands, and is in the process of shutting down its branches in Switzerland and Miami. Discount has shut down its branches in Switzerland, London, Latin America and the Cayman Islands. First International has shut down its branches in Switzerland and London, and Mizrahi Tefahot has ceased operations in the Cayman Islands.

The lure of real estate

The closures show the nature of the banks’ activities abroad. They were connected to a Jewish clientele, based on money whose origins were not necessarily known. All the talk over the years of “synergies” and “relative advantages” and “we’re serving our clients all over the world,” turned out to be one big bluff. The Israeli banks have no advantage at all abroad, and after the robust actions taken by the U.S. authorities, even the Jewish connection isn’t relevant any more.

The past decade has seen a brisk business in investments in housing in Israel. Some of the money withdrawn from the banks may have gone to buy apartments, which could be perceived as somewhat of a shelter for money that reached Israel and doesn’t want to return to the home country due to tax considerations. The challenge to the banks of giving up the foreign deposits is not only vis a vis depositors abroad, but also when it comes to new immigrants and Israelis coming back to live in Israel. That is because of a unique law in Israel dubbed the “Milchan law,” which exempts new immigrants and returning Israelis from taxes on all of their income and on the sale of real estate abroad. But this exemption does not absolve the banks from identifying the client and the source of the money.

That is apparently what is channeling some of the money from the banks to the real estate market. A senior banking official said that the banks know the risks and the fines and won’t get into trouble again, but there is a concern that undeclared money coming into Israel will pass through the Fintech bodies, the postal bank or institutions.

The U.S. fight against tax evasion puts special obligations on banks worldwide to handle accounts held by U.S. citizens, even when they don’t reside there. The U.S. Congress passed the Foreign Account Tax Compliance Act, known as FATCA, in 2010, which obliges non-American financial institutions to do due diligence with their accounts, to identify American account holders and to inform U.S. tax authorities about their accounts or else face a 30% penalty on all receipts of American origin.

Other countries have followed, with the OECD developing a system to exchange financial information and the Common Reporting Standard. Israel is the only OECD country that still hasn’t passed the needed legislation to adopt this standard. Until it does, Israel will not be able to receive reports by foreign countries about Israeli-held accounts abroad that could be used to evade taxes.

This development has made Israeli banks less global and more dependent than ever on Israeli clients. Still, the Americans have managed to change global banking, serving as the main agent of change in the fight against money laundering.