People who have attended parlor meetings with Moshe Kahlon, the former Likud cabinet minister who is expected to return to politics, have emerged charmed from their meetings. Kahlon, who served as communications and social affairs minister prior to last year’s election but decided not to run for reelection to the Knesset, projects a folksy style, but he also demonstrates an understanding of Israel’s economy and society.
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He also has credentials to show for himself when it comes to lowering the cost of living.
As communications minister, he was successful in boosting competition in the cellular service sector, which in turn drove down prices. Customers who at one point were paying between 600 shekels and 700 shekels ($160 to $185) per month are now paying no more than 100 shekels ($26). At this time, as plans are afoot for a new party headed by Kahlon that would have a platform highlighting his experience opening up the cellular market, he has set his sights on the banking sector.
Two years ago, Kahlon was already saying more competition is needed in the banking sector. People who have attended his parlor meetings believe him when he says that what he did for mobile service rates he will also do for banking fees. They overlook the fact that Kahlon was also social affairs minister, and did not leave much of a mark in that position.
Without intending to discourage Kahlon in his task, it’s worth taking a closer look at why Kahlon was so successful at cellular reform and why reform of the financial system in general and the banks in particular could be much more difficult. Such an analysis is warranted because Kahlon is creating high expectations that what he did in one sector would necessarily work in another. These expectations have to be put into proper perspective.
Let’s take a look at the conditions in the cellular market before the reform. There were three major players: Cellcom, which at the time was controlled by Nochi Danker; Partner Communications, which does business as Orange and was controlled by Hutchison Whampoa and then by Ilan Ben-Dov; and Pelephone, which was controlled by Haim Saban and Apax Partners and then sold to Shaul Elovitch.
The barriers to competition awarded all of them with huge profits, while exploiting consumers. The Communications Ministry removed one barrier after another (by allowing customers to switch carriers without losing their phone numbers, for example) and ultimately opened the door to new service providers (Golan Telecom, Hot Mobile, YouPhone and others) that offered unlimited calling and data usage plans at well under 100 shekels a month.
The removal of these barriers enabled customers to immediately switch to a more attractive company, which in turn pushed the veteran players to sharply reduce their prices too. The long-time players had to tighten their belts and adapt to the new market conditions. The bottom line was that Israeli consumers have collectively saved close to 10 billion shekels on their cellular bills, a sum that was lopped off the cellular companies’ revenues.
Unsurprisingly, none of the cellular firms collapsed. In fact, they all continue to report respectable levels of profitability.
How did Kahlon pull this off?
First, the providers were reaping huge windfall profits (mostly from individual consumers, since businesses were paying lower rates). Second, the cellular sector was relatively new, meaning that the barriers to competition were not as entrenched as they are, for example, among some workplaces with strong workers committees and rigid labor agreements. Third, as the person in charge of regulating the cellular industry, Kahlon believed that his job was to protect the consumer rather than the stability of the industry.
He did face opposition, however, from the businesspeople who controlled the cellular firms and from some media companies, which wanted the mobile service providers to have enough revenue to continue spending a good chunk of it on advertising.
A lot of fat
Now let’s examine the financial sector, particularly the banks, to see whether a similar revolution would be possible. There are several similarities to the cellular industry.
In the financial sector, too, high profit margins are derived from individual consumers, who pay the highest interest rates on loans and get the lowest interest on their savings. Competition is low. And when it comes to pensions and private medical coverage, the situation is even worse. Pension management fees eat up between a quarter and a third of pension savings. And private health insurers enjoy windfall profits in a sector in which payouts are small compared to the premiums that the public pays.
In both cases, there is a lot of fat, and profits can be cut for the benefit of the consumer. But there are also major differences.
In the financial field, there are a number of players capable of scuttling any effort at boosting competition. The primary one is actually the agency that regulates the sector.
In banking and insurance, the job of the regulator is first and foremost to maintain stability for the benefit of account holders and the insured. The law gives those overseeing the banking and insurance sectors major powers to maintain this stability, and any effort to inject more competition causes those who oversee the industry sleepless nights. That’s because their job is to prevent banks, insurance companies and pension funds from collapsing on their watch.
The regulators use their veto powers to bar the entry of new competitors through requirements such as high capital adequacy. In the past, such requirements have blocked the entry of new players in the banking sector.
Claiming the need for stability, regulators could block a large number of initiatives meant to increase competition, whether or not the argument is justified. It is unclear whether Kahlon would be able to overcome regulatory opposition that is enshrined into law.
Another source of resistance, particularly at the banks, comes from workers committees and inflexible labor agreements.
New competition in the banking sector would require the banks to streamline. Even without such competition, they have been forced to carry out efficiency measures due to regulatory changes that have reduced the number of bank branches customers need.
The banks are nonetheless hobbled by thousands of unnecessary staff members on their payrolls, even as the workers retain the capacity to disrupt the economy if the banks announce needed layoffs.
The result is that from time to time, the banks offer their employees extremely generous terms if they take early retirement, sometimes paying staff members 1 million shekels to stop working. Of course, that’s a great arrangement for those who get it.
These kind of retirement packages can be found at government workplaces, or those that are quasi-governmental or used to be state-run. It’s made possible mainly by the massive stashes of money, either from the state treasury or huge banking profits, that are capable of funding it. And the workers committees have considerable political influence through political parties and access to politicians.
In the cellular sector, there was no opposition from organized labor. But things are different in the financial sector.
We must also take into account the influence of financial institutions, and those who lead them, on politicians and other decision makers. Banks have outsized political clout all over the world. They finance political parties, have access to sensitive, valuable information on every one of us, and control the flow of resources in the economy.
They decide who gets loans and who doesn’t, and they themselves are major employers with a range of cushy jobs available, in the industry and beyond. The banking sector has an army of lawyers, accountants, advisers, lobbyists, public relations people, academics and media outlets that benefit from the current order of things and that are available to do their best to scuttle increased competition.
Kahlon would have to face all these forces when the time comes to make good on his promise to inject competition into the banking, insurance and pension industries.
Though the challenges are far more substantial than Kahlon has previously faced, the rewards of victory — which could affect economic growth, allocation of resources and, of course, our pension accounts — could far outshine his cellular success.