IMF Slams Key Plank of Israeli Banking Reform

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A Tel Aviv branch of Bank Hapoalim, June 13, 2016.
A Tel Aviv branch of Bank Hapoalim, June 13, 2016.Credit: David Bachar

The International Monetary Fund has sharply criticized the centerpiece of the Israeli government’s banking reform, saying it could lead to higher interest rates for consumers and undermine the banking system.

Some of the recommendations of the Strum committee “could affect the financial system in ways that would be potentially destabilizing,” the IMF said in the report crafted at the behest of the Bank of Israel and released Wednesday.

The committee calls for Israel’s two biggest banks Hapoalim and Leumi to spin off their credit card units in the hope that the separate companies will compete in the household finance segment. The Strum panel said the government should also consider forcing Israel Discount Bank and First International Bank of Israel to divest their credit card joint venture.

The recommendations aim to increase competition in consumer lending and reduce the cost of borrowing, but the IMF said they might have the exact opposite effect and jeopardize the banking system by encouraging risky lending.

“Separation of all three card companies could, in the short term, make a significant dent in the profitability (and competitive muscle) of the mid-sized Israeli banks, and lead to higher retail interest rates and fees,” the IMF said. “Over time, the reforms could generate a ‘race to the bottom’ form of competition through lower lending standards.”

The criticism is a blow to Finance Minister Moshe Kahlon, who has put banking reform and lower home prices at the heart of his economic policy. Kahlon pushed to form the Strum committee, emphasizing the benefits to consumers against the concerns of Bank of Israel Governor Karnit Flug about weakening Israel’s banks.

Bank shares led the Tel Aviv Stock Exchange lower Wednesday, though much of the pressure was due to falling bank shares globally amid renewed concerns about global economic growth. The TASE’s banking index ended down 1.3%, with Leumi dropping more than 2% for a second day.

Still, the IMF said Israeli banks remained financially strong, adding that they were “conservatively managed and ... well capitalized, with good asset quality and consistent profitability.” Returns on equity are around average for countries in the Organization for Economic Cooperation and Development.

But the IMF said the banks’ operating costs were too high, pressuring lenders in an era of record low interest rates, and the sector was too concentrated and impervious to new competition and people.

Also, the IMF faulted the Strum committee for using what it said was outdated information on the banking sector to form its conclusions. It said the most recent data showed that there had been substantial growth in lending to small and midsize businesses as well as to households (excluding mortgages) over the past three years. In Israel, interest rates on overdrafts and credit card interest rates are low relative to other OECD countries, and the ratio of consumer credit to GDP is high.

“These data suggest that access to retail credit in Israel may not be as constrained as had been thought previously, although margins on SME lending may be judged as having further to fall,” the IMF said, referring to small and midsize enterprises. “Accordingly, the competition problems to which the Strum committee’s comprehensive reforms are addressed are less apparent based on more timely data.”

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