Israel's first credit union begins life this week as Ofek Group launches a drive to draw depositors who double as shareholders.
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The inspiration was rooted in the 2011 cost-of-living protest that spawned a committee to increase competition in the banking sector. The idea was to set up cooperative banks that operate for the benefit of depositors.
Co-op banking is unknown to Israelis, there are around 50,000 credit unions around the world with some 200 million account holders, or 7.7% of the world's banking customers. They are particularly prevalent in developed markets like the United States, where they hold a particularly high 45% share of the credit market.
"Studies show that credit unions generally pulled through the last financial crisis and didn't need government assistance because of their conservative practices," says Prof. Ruth Plato Shinar, head of the center for banking law at Netanya Academic College.
Banking cooperatives could be a good way to fight concentration in Israel's banking system, says Plato Shinar, who adds that the two largest banks, Hapoalim and Leumi, are basically a duopoly that dictates prices.
Co-op banks are expected to charge cheaper prices than the top banks, since they will be competing to maximize the benefits to account holders. If profits are achieved in any given year they’re more likely to be used, for example, the following year in expanding operations or pricing fees competitively.
To provide cheaper banking services, co-ops rely on computer systems and the Internet, maintaining fewer branches or none at all. Ofek’s cooperative bank is expected to have only around 100 employees, compared with the 48,000 employed by the five largest banks combined. In this way, Ofek can pass profits on to clients.
The need for deposit insurance
Plato-Shinar, Ofek Group's adviser on regulatory matters, says Israeli co-op banks would need new legislation on several issues, like deposit insurance. "If new banks arise like a cooperative bank and the people are still unfamiliar with it and perhaps afraid to deposit their money, then clearly one incentive to transfer to such a bank is that deposits there are insured," she says.
Israel doesn't have deposit insurance, but in 2002, when Trade Bank collapsed in an enormous embezzlement case, the state compensated deposit holders. "Deposit insurance is only talked about when banks fail," says Plato Shinar. "Ultimately ... the subject is dropped since it would increase their costs, of course."
To what degree are Israelis actually worried about the absence of deposit insurance?
"Bankers at small banks still tell me the public has an aversion to depositing money with them, even if the interest and terms are good. So if you want to let new banks enter the banking system, deposit insurance is essential,” says Plato Shinar. “On the other hand, if only small banks are required to buy deposit insurance, the cost burden will make it hard for them to compete and offer attractive conditions. I think deposit insurance needs to apply to all banks."
Plato Shinar adds that a credit information law will also be necessary to help small banks and boost competition in the banking system.
Due to heavy pressure from the two largest banks, an amendment establishing a credit ranking system for private customers and allow information exchanges between banks has stalled. It would let banks offer good customers better terms. Israel is considered backward in this respect; even the Palestinian Authority has a sophisticated system for ranking customers.
The amendment has bogged down at the Justice Ministry, which opposes it based on potential violation of banking secrecy. As an interim measure, the banks supervisor plans to require banks over the coming year to issue “bank ID cards” stating each customer's credit ranking. Customers would be able to take their document to competing banks and shop for better loan terms.
"The bank ID card isn't a bad solution, but I don't think it's enough," says Plato-Shinar. "We need to adopt models found abroad and allow a flow of information between banks about borrowers."
The beauty of Internet banking
A third matter is letting customers open a bank account through the Internet, which the law that prohibits money laundering is blocking. "This law makes it hard to operate a lean bank. The idea behind a cooperative bank is to save on costs, meaning not to maintain a large network of branches and workforce,” says Plato Shinar.
“The solution is to put some of the operations on the Internet. We know this is a sensitive issue due to the fear of having the Internet exploited for money laundering, but it's important that the process of opening an account and switching banks can be done directly. Changing banks needs to be done in the easiest way possible, and that means through the Internet."
The Bank of Israel says that it will probably draw up a reform for opening bank accounts online by year-end. Amendments could be submitted to the Knesset within a year.
But current legislation might pose an additional problem. The Cooperative Societies Ordinance creates dual regulation for a bank co-op, says Plato Shinar. The banks supervisor is responsible for regulation, but the Cooperative Societies Ordinance grants enormous powers to the Registrar of Cooperative Societies, including supervision. The registrar has the authority to examine a cooperative's financial statements and disband it, and also has broad discretion in the registration stage.
"This is a situation where a company could be subject to different competing regulators," says Plato Shinar. "It’s inconceivable for the banking operations of a bank cooperative to be supervised by anyone other than the banks supervisor. An amendment should be enacted to clarify the division of power between the two regulators and ensure that the banks supervisor is the main regulator."