When it comes to competition, can there really be too much of a good thing? Enhancing competition has brought down Israeli cellphone rates to among the developed world’s lowest, and the conventional answer to why the cost of so much else in Israel is so high is the overwhelming presence of monopolies and cartels.
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It was with this in mind that Bank of Israel Governor Karnit Flug and Finance Minister Moshe Kahlon agreed last year to form a committee, headed by former antitrust commissioner Dror Strum, to see how more competition could be injected into consumer banking.
The committee met, researched the issue and came back with its key conclusion in an interim report: Bank Leumi and Bank Hapoalim – Israel’s two biggest lenders – should be forced to spin off their credit card businesses. As separate entities, Leumicard and Isracard would compete with the banks to make household loans.
But from here the two biggest powers in Israel's economy part ways. Flug can live with the big banks offloading their credit card issuers, but she has problems with Part B of the Strum plan, which would bar the banks from issuing cards at all after they had sold the credit card business.
In pointed comments at the College of Management Studies on Thursday, Flug warned that the proposal would have the exact opposite effect it intended. It would create a new monopoly of sorts by reducing the number of companies issuing credit cards, but the bigger issue was that competition in banking wasn’t a one-way street.
“The Strum-committee recommendation to ban banks from issuing credit cards will create a monopoly of three companies, compared with the more than 10 that now issue them,” Flug said.
“It’s easy to see how this would lead to an increase in the cost of credit. We should recall that when the cellphone market was opened to competition, they didn’t bar the existing companies from selling mobile devices to retain customers and attract new ones.”
Her comments mark the latest battle in the clash between Flug and Kahlon, and it’s not just credit cards. The two have been at odds over the treasury’s plan to replace its Capital Markets, Insurance and Savings Division with an independent agency whose wider powers would include supervising the credit card companies spun off by the banks.
Flug has also rejected Kahlon’s call to raise interest rates. The finance minister thinks higher rates would keep a lid on housing prices by raising the cost of mortgages, but Flug fears a hike could slow an already slack economy and make the shekel too strong, hurting exporters.
Some issues like credit cards are skirmishes in a wider war. The battle lines can be roughly drawn between Flug’s desire to keep the banks and economy stable versus Kahlon’s goal to increase competition in lending and bring down consumer costs.
Kahlon made his name in politics by unleashing competition in the cellphone industry four years ago, and as finance minister he aims to do the same elsewhere.
But as Flug cautioned on Thursday, in a remark apparently targeted at the finance minister: “Change in the financial system doesn’t happen through declarations and headlines, but through intelligent, elementary and long-term steps, and also a bit of patience.”
While competition is considered a magic word among policymakers, Flug warned that excessive competition in financial services like banking carried risks that no economy could take lightly.
Alluding to the global financial crisis of 2008, she said: “We’ve seen what happens when they allow and even encourage financial entities to earn profits while taking major risks and imposing risks on the broader public, when regulatory agencies stand aside and don’t track risks, or even worse, ignore them.”
Oversight must be proportionate to the risk, she added. If the central bank loses authority to regulate the credit card market to another agency with a different focus, the damage could outweigh the benefits of banks offloading their credit card operations. “The credit card companies are of systemic importance to the economy,” she said.
In a veiled barb at Kahlon, she said financial stability must be entrusted to a player who is “divorced from politics, who is not required to be measured by his daily popularity.”
“We won’t agree to steps that, in the name of competition, let financial institutions act without an oversight agency with an overall view to stability and the consumer,” she said. “Many countries and millions of unemployed around the world are still paying the price for irresponsible financial activity.”
Flug insisted she was committed to increasing competition: Stiff competition already exists in mortgage and business lending, and if competition for small-business and consumer loans is less intense, that’s gradually changing.
“We’re beginning to see growing competition in the non-mortgage consumer credit market as a result of the Bank of Israel’s step in recent years, even before the planned reforms in the sector,” she said. “Which of you hasn’t recently received a text message or email offering you credit?”
Israeli households are already relatively big borrowers, with levels similar to the United States, Britain, France, the Netherlands and Sweden measured as a percentage of gross domestic product. Interest rates on credit cards are low compared to the norm elsewhere.
It’s strictly business
On Sunday, a senior treasury official who requested anonymity said Flug’s remarks positioned her as a professional economist standing up to politicians. But he insisted that the issue was strictly professional.
“The economists in the treasury’s budget division have addressed the issue of increasing competition in the banking and credit market for more than a year and a half, before Kahlon was named finance minister, and they disagree with the governor’s stance,” he said.
“It’s beneficial and important for the economy that the banking sector, which today is in the hands of two big banks – Hapoalim and Leumi – will be open to competition. Separating the credit card companies from the big banks is an essential part of the process.”
On the issue of letting consumers borrow against their pension savings, another Strum recommendation, Flug said the proposal reflected short-term thinking. If borrowers can’t repay loans, this will come at the cost of their retirement savings and ultimately their living standards, with wider repercussions for the economy.
On Sunday, the Bank of Israel moved a step ahead on the consumer-credit issue with a program to issue every depositor a so-called bank ID. Sent once a year or on request, the ID would show a client’s bank balances and fees, as well as details such as standing orders and power-of-attorney accounts.
This would be complemented by a credit-history database maintained by the central bank. It would make it easier for consumers to shop for loans among lenders.
“The new report, written in simple language and in an identical format by all the banks, will help every client ... understand his or her overall financial situation,” Supervisor of Banks Hedva Ber said.
The Bank of Israel has already implemented what Flug called “the decisive majority” of changes recommended by a competition panel that was headed by former banks supervisor David Zaken. Clients can open and close accounts online, it’s easier for households to switch banks, and bank fees have been cut.
Still, she admitted, some of the Zaken-committee recommendations would take years to be put into effect.
Not only is the central bank working to increase competition among existing players, it’s striving to bring new players into the credit and clearinghouse sectors, Flug said. She noted that credit card companies spun off from the banks would enjoy softer oversight if they raised capital through bond issues. Since they wouldn’t be soliciting deposits, this supervision is consistent with the lower risk.
“The Bank of Israel is acting in the public interest, including vis-a-vis completion,” she said. “Competition is critical to the existence of an advanced financial sector,” she said.
“Without competition, our banking system won’t develop, service will suffer, consumer confidence in the system will be impaired, and ultimately there could be consequences for stability. We’re in favor of promoting competition. Competition doesn’t contradict to stability.”
Regarding another sector the Strum committee is trying to help, Flug agreed that small businesses pay exorbitant interest rates and fees, and have trouble securing funds. But she said the problem wasn’t as serious as it’s portrayed; the problem is comparable to levels abroad.
“I expect that the transition to digital services will reduce costs in this sector,” she added.