Why the Bank of Israel Won’t Let Banks Face Competition

Israel’s banks survived the 2008 financial crisis but that doesn’t mean the structure of Israeli banking makes sense.

Emil Salman

After a speech in which she highlighted the importance of the country’s banking system, noting that it did not crumble in the 2008 global financial crisis, and claimed to favor measures to increase competition in the sector and to oppose measures that would hurt consumers, Bank of Israel Governor Karnit Flug spelled out her red lines when it came to intervention in the name of encouraging competition.

She was responding to the recommendations of the committee formed in 2015 to examine ways to increase competition in Israeli retail banking, known as the Strum Committee after its chairman, former antitrust commissioner Dror Strum. Flug said she would not force the banks to stop issuing credit cards and that Israel Discount Bank and the First International Bank of Israel must be allowed to keep their joint credit-card unit, Visa Cal-Israel Credit Cards. She also said the Bank of Israel must retain supervision of the credit-card companies. The Finance Ministry wants to create a new agency under its own aegis that would assume responsibility for the issuers.

What is the governor so afraid of? Her arguments sound oddly like those made by the big banks themselves to the Strum Committee, and nobody would accuse the banks of slavering to face competition. Or aspiring to improve their service.

She argues that the banks should be allowed to continue to issue credit cards after being forced to sell their credit-card units, though the idea behind the breakup was to allow the credit-card companies to establish themselves as alternatives to the banks.

“This will create essentially a monopoly of three companies that will be issuing credit cards as opposed to 10 today. It is easy to see that this will lead to an increase in the price of credit,” Flug said.

Regarding the committee’s plan to force the banks to exit the credit card market, including Discount and First International, Flug said: “Leaving Visa Cal in the hands of Discount Bank and FIBI will strengthen their ability to compete with the larger banks,” the latter a reference to Hapoalim and Leumi.

Why not move supervision of the credit-card companies from the central bank to the Finance Ministry? Here Flug did not cavil at expressing contempt and lack of faith in any regulators not sitting at the Bank of Israel, under her wing: The Bank of Israel has the knowledge and expertise and is the most suitable body to supervise entities of systemic financial importance, she explained: “The fact that Israel weathered the crisis in 2008 relatively well emphasizes the need for professional and efficient supervision and illustrates the possible implications of not having such supervision... it is also important that an apolitical entity, which is not measured according to its day-to-day popularity, will have responsibility for maintaining stability.”

The truth comes out

One can and should carefully weigh all arguments for and against the reform of the banking system proposed by Finance Minister Moshe Kahlon. But her remarks on February 18 disclosed the real position of Flug and the Bank of Israel chiefs. They do not believe in this reform. They do not want this reform. They do not feel it is necessary.

In fact, the Bank of Israel does not want any reform. If it did, it could do it on its own. The Bank of Israel wants to leave the Israeli banking system exactly as it is now. The Bank of Israel likes it the way it is.

That insight shouldn’t be a big surprise. In 2008, proposals were raised to sever the credit card companies from the banks, to the horror of the Bank of Israel. It was led at the time by Governor Stanley Fischer, who rejected the idea out of hand. Back then, no one would pick a fight with Fischer.

Later, after the social protests of 2011, came the Trajtenberg Committee, headed by national economic adviser Manuel Trajtenberg. It too recommended reducing concentration in Israeli banking and enhancing competition. Again the Bank of Israel decline to pick up the gauntlet.

Finally, over the past year, top people at the central bank clarified in internal conversations that they have zero research in hand proving that the Strum Committee recommendations would really enhance competition; therefore, all that remains of the recommendations is fear that they will do harm. The only reason the Bank of Israel agreed to participate in the Strum Committee and in the finance minister’s efforts to reform the banking system is that it realized the public badly wants reform. It had to throw the howling masses, and yowling politicians, a bone.

So the Bank of Israel got dragged into the Strum Committee against its will. A bone – okay; material change in the banking market and in its balance of power with the rest of the economy – absolutely not.

Going further in America

In her attempt to disarm the Strum Committee, Flug seems to be saying that the banks versus the public is a zero-sum game: What one side loses, the other gains. Her slam-dunk argument is: We take care of the public (not the banks, heaven forfend), and if the stability of the banking system is undermined it is the public that will suffer.

But who said that bringing competition to Israel’s banks, and reducing the market share of the duopoly of Hapoalim and Leumi, which together control two-thirds of the market, would necessarily hurt the banks’ stability? In the United States the discussion over the political and economic clout of the big banks, and its implications for the economy, has resurfaced.

Last week Neel Kashkari, formerly of Goldman Sachs and now president of the Federal Reserve Bank of Minneapolis, who spearheaded the banks’ bailout in 2008, said the government and Congress should consider breaking up the big banks to protect the system from another crisis.

“I believe the biggest banks are still too big to fail and continue to pose a significant, ongoing risk to our economy,” Kashkari said in Washington. “Now is the right time for Congress to consider going further than Dodd-Frank with bold, transformational solutions to solve this problem once and for all.”

Regulators need to weigh options to split up these huge banks. Kashkari said, including the option of making them public utilities – “forcing them to hold so much capital that they virtually can’t fail.” And taxing leverage to make the system safer.

Reporting on Kashkari’s speech, Bloomberg clarified that his position is the same as Democratic presidential hopeful Bernie Sanders. Federal Reserve Chair Janet Yellen and the Republican establishment feel otherwise. Sanders himself responded by email to Kashkari’s address, saying, “I am delighted that the new president of the Minneapolis Federal Reserve believes that we need to break up too big to fail banks... Wall Street cannot continue to be an island unto itself, gambling trillions in risky financial instruments, making huge profits, assured that, if their schemes fail, the taxpayers will be there to bail them out.”

Meanwhile, in our neck of the woods, the banks and the Bank of Israel are still hawking the claim that Israel didn’t succumb to the 2008 crisis, which proves that our banking system is stable, safe and right for the Israeli economy and public.

Horsefeathers. There are many reasons why Israel was spared the 2008 crisis, but the size and clout of Hapoalim and Leumi are not among them. Everywhere in the world, it is now agreed that when banks get too big, it’s bad for the financial system and a risk to its stability. Just this month we saw how worries about the stability of one bank, Deutsche Bank, caused rumbles worldwide, spurring a global retreat in bank shares.

The Strum Committee is dedicated to increasing competition and the supply of credit in the banking system. But its real goal could be rephrased thus: weakening the Hapoalim-Leumi duopoly and letting in new players to compete with it.

The persistence of a duopoly of this kind, whose shares are held by the public and which is based mainly on the public’s deposits, and which the public will have to rescue if trouble comes, but which is run like its managers’ private fief, is unthinkable.

In the wake of Flug’s speech and the pressures by the Bank of Israel and the big banks, it’s anybody’s guess what the Strum Committee’s final recommendations will be. It’s even harder to guess which will survive the exhausting legislative process.

The next reform and next committee (which are inevitable) should probably start with adopting Kashkari’s recommendation – to break up the big banks and constrain their market share. At least that would be an especially fat and furry goat – known as a high-ball offer to anyone not familiar with the old Jewish tale – that the committee could eject, that is climb down from, at the least minute in order to get everything else it wants.