Israel’s Finance Sector Is Screaming for Reform

The country’s banks and insurers behave like feudal lords, and we’re the hapless serfs.

Leo Atelman

As a compass reading – it was a good start.

A combined attack by the three most powerful women in the Finance Ministry on executive pay at banks and insurance companies is definitely a refreshing change after a decade of robbery in the Israeli capital market.

But after having praised the three regulators — Finance Ministry Accountant General Michal Abadi-Boiangiu, Finance Ministry Director General Yael Andorn and Commissioner for Capital Markets, Insurance and Savings Dorit Salingar — let us not mistake the roots of the revolution. If not for the social-justice protests of 2011, the public’s paradigm shift and the exposure of the brutal, corrupt “economic concentration club” that ruled regulation in Israel with an iron fist until two years ago, there’s zero chance the Finance Ministry would have attacked executive pay in the finance sector.

We can assume that the three regulators would have behaved very differently in the face of the robbery before 2011. Treasury officials tended to aspire to a cushy post-government job; their anticipated entry into the banking and insurance establishment made them dependent on and sympathetic to the perspective of that establishment.

In private conversation, Salingar, Abadi-Boiangiou and Andorn say executive pay levels at Israeli banks and insurance companies reflect neither skill nor market forces, but rather the rotten cartelist and monopolist structure of the finance establishment. The sector manages trillions of shekels of the public’s money, and its leading actors have no interest in checking salaries. The higher they are, the more they benefit — at the public’s expense.

“In high school we learned about the feudal system. The analogy is pretty close,” a former treasury official who a decade ago began making millions of dollars a year after signing on with one of Israel’s big monopolies explained a few days ago, in private conversation. The older workers in Israel’s private and public monopolies are like the privileged elite, he said: “They don’t always work, but they earn tons and live well. The younger generation works hard and barely scrapes by, and all are ruled by the regional dukes – the millionaire managers.”

Andorn, Salingar and Abadi-Boiangiou could have wound up becoming regional dukes at one of the banks or insurers. But as fate would have it, the public came to its senses. New voices arose and their minister, watching himself in horror collapse in the polls, realized that he too had to take a swipe at the bankers and insurers.

But to go back to the beginning, the Finance Ministry’s moves against executive pay levels in the finance system are just a compass reading. They mark the professional and moral platform of a series of reforms needed in the Israeli financial market. Without these reforms, the ministry’s moves will be useless and will do nothing to improve the situation of savers, investors and finance customers, or the efficiency of resource allocation in the economy.

Money for nothing

The Finance Ministry’s purpose in intervening in pay at the banks and insurance companies is to officially determine that the Israeli capital market is concentrated, that competition is feeble, and that much of the companies’ income is rent, based not on creating value but on transferring from the many to the few; and that the system’s pay and reward mechanisms do not serve the public. With that said, action needs to be taken.

It’s hard to think of any industry that cries out more for new players with new technologies and lower costs than the finance system. But it’s not going to happen because the financial monopolies are surrounded by a deep, hidden moat infested with crocodiles and regulators. The Israeli finance system — the banking giants Hapoalim and Leumi with the smaller banking metastases Discount-Mizrahi-First International, the Psagot investment house and the five insurance giants (Migdal, Clal insurance, Harel, Phoenix and Menora) — manage about 2 trillion shekels in pension, mutual and provident funds, and in executive insurance policies, and charge the public almost 100 billion shekels a year — about $28 billion.

The banks grow automatically year by year together with the economy, with no significant change in their market shares and no competition from foreign banks. The insurance companies have been growing at a tremendous rate, with no administrative intervention, because the public must by law save for retirement through one of the insurance companies in order to get tax benefits. This tens of billions of the public’s money goes to one of the retirement programs run by the insurers, which don’t have to lift a finger to get that money.

Israel’s banking system is built around the great duopoly of Hapoalim and Leumi, which controls 60% of bank credit and most of the households in Israel. Bank Mizrahi-Tefahot has the lead in mortgage lending and Discount Bank and First International in the margins fall in line with Hapoalim and Leumi regarding prices for their services, interest rates, fees and pay levels.

The insurers, meanwhile, operate as a cartel with regard to executive insurance (bituah minhalim), which has been protected by the regulator for years. The insurers manage about 200 billion shekels in veteran plans of this sort, early exit from which is almost impossible.

The greatest wage gaps and robbery of the helpless customer are at the banks. Their wage costs tells the story. A group of around 7,000 so-called first generation employees with tenure for life and direct and indirect wage costs of 50,000 shekels to 100,000 shekels a month costs the banks’ shareholders between 5 billion shekels and 7 billion shekels a year beyond its economic value.

In the past decade, Hapoalim and Leumi have managed to achieve impressive, consistent profitability, even with interest rates approaching zero percent, and a return on equity of about 10% despite crushingly heavy surplus expenses. They could do this because their industry is a duopoly. The cost is borne by helpless households and by small- and medium-sized businesses.

In any other industry, especially in today’s digital age, the situation would have been a classic opportunity for new players to jump in and upset the applecart. But this is the finance system, which is based on the heaviest of regulation and tremendous barriers to entry. Most businesses and households are shackled to their bank; they have nowhere to switch for less-than-insane interest rates and less preposterous fees.

Wanted: Massive regulatory intervention

The only way to offer Israeli bank customers relief from the duopoly and cartels in the finance sector is through massive regulatory intervention. Only a decision handed down by the prime minister, finance minister and Bank of Israel governor, defining competition in the banking industry as a national strategic goal, can lead to real change.

They should announce a goal of reducing Hapoalim and Leumi’s market share within 15 years by any means possible, from allowing Internet banks to operate, to passing legislation on disclosing credit ratings, to severing the credit-card companies from the banks to encouraging the establishment of new financial bodies.

The fact that Hapoalim and Leumi hold 800 billion shekels in financial assets suffocates business and gives them political and economic clout that stifles competition in numerous sectors. The two banks have no reason to lend to new competition in various industries, given that the two of them finance all the players.

The supervisor of banks should create nurturing conditions for Internet banks and to a banking cooperative. The Finance Ministry should help entrepreneurs who want to compete with the banks, by financing them. A quarter of a century ago, the state created the Israeli venture capital industry through its fund Yozma, which provided subsidized capital to new venture capital funds. Now the state should subsidize entrepreneurs who want to create new financial institutions in Israel, that will compete with the banks. Banks are a critical infrastructure for economic development and the economic concentration in the banking sector threatens not only competition but democracy itself.

The rhetoric by Finance Minister Yair Lapid against Phoenix CEO Eyal Lapidot was a decent enough public-relations gambit, but it won’t change the situation of Phoenix policyholders, or those at the other insurance companies Migdal, Clal Insurance, Harel or Menora. What’s needed is an industry-wide change of the rules.

Salingar should set new standards and procedures that constrain management fees on executive insurance policies or enable the full mobility of the money locked into these plans.

The treasury has been leery of touching the vast sums locked therein, which has served the interests of the insurance companies and their owners. It’s time to do the job. While customers can haggle over fees on provident funds, lowering them to 0.5%-0.7%, some 200 billion shekels are locked into veteran executive insurance policies on which the companies charge double the management fees.

The social-justice protests, the collapse of the tycoons, the economic concentration committee and reform of the capital market, and the cellular revolution have done the groundwork for reform of the finance system, including the creation of a new self-managed savings avenue with fees of no more than 0.25% a year.

If only it could, much of the public would prefer to pay lower fees and save more for retirement through a passive track, that invests in indices of government bonds, shares and corporate bonds. There is no reason for government regulation to force the Israeli saver to invest his money for retirement with managers who mostly create no value, do not beat the market, and are often preoccupied with alien interests, their own or their bosses’.