Israeli Finance Chiefs Battle Over Badly Needed Bank Reform

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Pedestrians are reflected in the windows of a Bank Leumi branch in Tel Aviv in this May 30, 2013. Credit: Reuters

Just before the government formed in May, Finance Minister Moshe Kahlon collided with the prime minister. Everything had been arranged – who gets what ministry and what powers, except for one little thing. Kahlon demanded that the coalition agreement force the banks to sell their credit card companies.

Kahlon had spent two years in political limbo in his small office at Netanya Academic College, spearheading his Center to Advance Reforms financed by some of his friends. There he and his aides forged plans to force competition on the banks and lower housing prices.

He figured he was perfectly positioned to become Israel’s next finance minister, even before the party he founded, Kulanu, won a single Knesset seat – Benjamin Netanyahu even promised him as much. Sure enough, he became finance minister.

Kahlon hoped to start off with a slam-dunk reform of the bank and credit card industry, but Karnit Flug, the governor of the Bank of Israel, had other plans. She warned that forcing the banks to sell their credit card companies could undermine their stability, for which she’s the watchdog.

Netanyahu heard her out and tried to get Kahlon to climb down. In the event, the prime minister persuaded Kahlon to put off gratification and appoint a panel to study the issue.

The panel was headed by Dror Strum, a former antitrust commissioner, who promised – and this month delivered – an interim report with the recommendation Kahlon wanted: Make the banks cut ties with the credit cards. In a joint appearance, Strum tried to glam things up by talking about “breakthroughs,” but the animosity between Kahlon and Flug was palpable.

In fact, the interim report is riddled with clashes between the Bank of Israel and Finance Ministry – a problem because reforms depend on the minutiae being executed, not grand statements by senior officials. But it was inevitable that the ministry and central bank would collide.

Finance Minister Moshe Kahlon, May 18, 2015.Credit: Gil Cohen-Magen

Kahlon wanted ministry officials on the Strum committee to shake up the banks and force competition on the industry. Flug wanted the central bank people on the committee to make sure the banks wouldn’t be jolted, and if competition was to ensue on the credit card market, it would be subdued.

The final recommendations aren’t in yet – the banks may yet keep their credit card companies. In the meantime, the parties are digging in.

Give the smaller banks a break?

Kahlon already said he hadn’t promised to adopt all the committee’s positions, and a Finance Ministry department published an alternative paper that’s even more aggressive than the Strum recommendations. The Bank of Israel, meanwhile, suggests that for the sake of competition, it may let credit card companies severed from the banks turn into banks themselves.

One major dispute between Kahlon and Flug is whether only Leumi Card and Isracard should be severed from their parent banks (Leumi and Hapoalim respectively), or whether banks Discount and First International should also be forced to sell their credit card company, Cal. Another dispute is who will regulate the credit card companies after they’re split from the banks – the Bank of Israel or the Finance Ministry.

The Bank of Israel thinks Cal should stay where it is, arguing that Discount and First International would be strengthened versus the big duopoly of Leumi and Hapoalim. In other words, competition would be enhanced. Also, Israel would be spared the need to change supervision over the credit card companies – this would remain the fief of the central bank, which could assure that competition doesn’t go wild to the detriment of the banks.

Bank of Israel Governor Karnit Flug.Credit: Emil Salman

Despite the conventional wisdom, Israelis aren’t heavy credit consumers. The Central Bureau of Statistics found in 2013 that only 34% of households were in overdraft for at least 10 of the preceding 12 months; 54% were in overdraft for one of the previous 12 months. A third had a non-mortgage loan and 29% had mortgages.

Overdrafts, in short, aren’t a problem of the Israeli economy. In 2013, the ratio of household debt to gross domestic product was 39% versus 71% in the euro zone.

Thus a lot of credit would have to be handed out before Israel reaches international levels, exactly the thought making Flug sweat. The Bank of Israel doesn’t want Israelis to join the global credit spree. It doesn’t want Israeli bubbles and crises.

But wait, does the Finance Ministry want that? Of course not. It wants to lower the cost of living by, in this case, lowering the cost of consumer credit. Israelis could save thousands of shekels a year.

It’s a vast distance between vibrant competition and destabilizing the banks. The banks and credit card companies have tons of room for competition before they’re in any danger. They could be enormously more efficient.

Established brands and models

No supervisor, whether at the central bank or ministry, would let consumer borrowing run riot. Whoever buys the credit card companies won’t start lavishing cheap loans on every Tom, Dick and Yossi. This isn’t the mobile phone industry or a chicken for a shekel, the latter a supermarket chain’s campaign a few years back. There’s risk and it differs from borrower to borrower.

The credit card companies have information on their clients, not to mention relationships with them. The have established brands and models to rate their clients’ risk (credit scoring). But they don’t “give credit” like, say, American credit card companies – the banks (which own them) do.

There is zero point in leaving the credit card companies under the supervision of the Bank of Israel unless they’re allowed to turn into banks that accept deposits from the public. In that eventuality, supervision over them and the banks couldn’t be split.

In any case, it’s good for competition that there’s a single supervisor so we can see real changes, not cosmetic ones. If anything, the central bank could be motivated to turn the credit card companies into banks so they would definitely come under its wing.

But the utter lack of trust between the Bank of Israel and Finance Ministry is disturbing. The banks supervisor, Hedva Bar, brought in fresh blood and ideas by agreeing to sever the two big boys, Isracard and Leumi Card, from their parent banks. That’s a refreshing change in that ultra-hidebound institution. But the Finance Ministry views her acquiescence as a tax she’s willing to pay to relieve pressure on the central bank, not a demonstration of a desire to increase competition.

There have been plenty of ideas in the last 20 years about competition, like letting in foreign banks and Internet banks. Nothing came of it, not that the Bank of Israel sabotaged the ideas. But it didn’t lift a finger to help them happen.

The burden is now on the Bank of Israel: Sever the credit card companies from the banks and promote real competition. As for the banks, there’s much they need to do to improve efficiency and competitiveness. The banks supervisor could do much to push efficiency. Banks’ sagging inefficiency is as much a threat to them in a competitive environment as technological advances.

Technology changes industries, consumer habits and business models. Somehow the revolutions passed over the banking system, and that’s no surprise – it’s an industry the regulator coddled with very high barriers. Banks, in Israel and elsewhere, have become very adept at crushing nascent competition.

Even the big tech boys don’t drool over the thought of taking the banks on despite the huge profits banks have made. In no other industry on the planet is there so much to go around, and the supervisors know it. That’s why they’re so conservative.