Israeli Banks to Battle With Market Rather Than Fixed Rates in Personnel Costs

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Banks commissioner David Zaken is expected to require Israel's banks to use market interest rates for calculating the present value of liabilities toward personnel, as prescribed by International Accounting Standard 19 (IAS 19), rather than the fixed 4% rate used until now.

The change will have a particularly strong impact on Bank Leumi's books: The present value of the lifetime pension benefits to which about half the bank's workforce is entitled can be extremely sensitive to discount rate changes.

Adopting IAS 19 of the International Financial Reporting Standards (IFRS) could swell Leumi's liabilities by NIS 2 billion. This would offset its balance sheet by an equivalent reduction of NIS 2 billion in equity, which totaled NIS 25 million as of September 30, 2012.

Leumi's core capital ratio was 8:6 at the end of the third quarter. Diminishing equity by NIS 2 billion will force the bank to find other means to meet the capital adequacy requirements laid down by the regulator. The possibilities include unloading its stake in Israel Corporation – Israel’s largest holding company – with a profit potential of NIS 1.9 billion, selling off real estate holdings or cutting back on credit issued to the business sector.

Shedding risky assets would also improve the bank's capital adequacy position. The banking community believes Leumi will do everything needed to meet its capital adequacy requirements.

Leumi, managed by Rakefet Russak-Aminoach, currently has 5,039 employees, about half of whom – those hired before 1999 – have rights to a pension funded by the bank guaranteeing 70% of their final salaries for life from the age of retirement. Leumi reports the present value of this liability at NIS 7.16 billion when discounted at 4%. The bank also has 1,776 pensioners currently enjoying the same rights, a liability recorded in its books at NIS 2.96 billion.

Since 1995, Leumi has calculated its pension liabilities using a 4% discount rate in accordance with Bank of Israel instructions. At the beginning of 2013, however, IAS 19 became mandatory in Israel. The rule requires that liabilities be discounted according the yield to maturity at which AA-rated corporate bonds are trading.

This is only possible where an efficient market exists. The IFRS states that, in the absence of a deep enough market, liabilities to employees should be calculated according to the interest rate on government bonds. Leumi's problem is that Israel's corporate bond market isn't deemed as being sufficiently deep and it therefore will need to discount its liabilities according to government bond yields which are significantly lower than the rate it currently uses.

In contrast with other public corporations, the banking industry hasn't yet been subjected to IAS 19 by the regulator. Industry sources believe the banks commissioner will issue instructions imposing the standard beginning January 2014. Leumi was the only bank offering its employees this particular type of pension until 1999, when it grasped the long-term implications and dropped the plan for new employees joining its ranks. IAS 19 will affect the other banks as well, but to a much lesser degree.

The banks commissioner introduced new capital adequacy targets about a year ago under the international Basel III reform guidelines. In this framework Leumi and Bank Hapoalim are required to attain a capital adequacy ratio of 9% in January 2015 and 10% in January 2017.

Banks commissioner David Zaken.Credit: Tomer Appelbaum
A Tel Aviv Bank Leumi branch.Credit: Limor Edrey

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