Bank of Israel Is Two-faced on Splitting Credit Card Firms From Banks

The banks supervisor says one thing and the central bank chief says another. No wonder the banks' lawyers are in a tizzy.

Meirav Arlosoroff
Meirav Arlosoroff
Bank of Israel Governor Karnit Flug. Decided not to introduce quantitative easing or lower base interest rate.
Bank of Israel Governor Karnit Flug. Decided not to introduce quantitative easing or lower base interest rate.Credit: Michal Fattal
Meirav Arlosoroff
Meirav Arlosoroff

“In recent years the banks in Israel have significantly changed the nature of their business: They’ve shifted their focus from large business clients to households and small businesses.

“As a result, competition in these areas has increased. Service charges for individuals have declined, both in commissions clients pay banks and in the spread between the interest paid on credit and deposits. Comparisons with other countries indicate that commissions in Israel are among the lowest in the world.”

With these words, the Bank of Israel’s banks supervisor, Hedva Ber, presented her division’s report on the country’s banking system for 2015.

From Ber’s speech, we could surmise that everything was great with Israeli banking competition, not to mention the way her division was making its mark on small businesses and households. These two areas are topping the agenda of the Strum Committee, which was set up to seek ways to increase banking competition.

While Ber was discussing the annual report, her boss, Bank of Israel Governor Karnit Flug, was presenting the committee’s recommendations to the cabinet.

“The changes we’ve agreed on are very significant,” Flug told the ministers. “These changes, along with initiatives spearheaded by the Bank of Israel and its supervisory division, will soon create a progressive banking system that is more competitive in the retail and small-business sectors.”

So is there or isn’t there competition among banks regarding small businesses and households?

Hedva Ber, the Bank of Israel’s banks supervisor.Credit: Ofer Vaknin

Well, if you think the Bank of Israel is speaking with a forked tongue, you’re right. Justice Ministry officials emerged from a meeting confused by the apparently contradictory statements.

They implored the bank to decide whether there is or isn’t competition in attracting small businesses and individuals. After all, the Justice Ministry will be the one that has to respond to banks’ lawyers when petitions are filed at the High Court of Justice against the Strum Committee’s recommendation to split credit card companies from banks.

The committee recommends that Bank Hapoalim’s Isracard and Bank Leumi’s Leumi Card be separated from the two banks. A third credit card company, Cal-Israel, can remain associated with Israel Discount Bank and the First International Bank of Israel.

Lawyers in a quandary

This decision is cannon fodder for lawyers representing the two larger banks in court petitions. If there’s such a big problem with competition, requiring the two larger banks to give up a key asset, why doesn’t this apply to the third credit company?

It appears the bank will have to carry the ball for the state at the High Court of Justice unconvinced that it’s right.

Again, the banks supervisor cites increasing competition for small businesses and households. “Recent years have witnessed a significant increase in credit given by credit companies to individuals,” says the report, quoting a 19% uptick in one year.

The report says “the average interest rates charged by credit card companies in Israel are lower than in other developed markets.” It cites rates of 8.3% and 7.3% charged by credit card companies and banks, respectively, compared with 13% to 18% in developed countries.

“The returns on interest-bearing activities have declined for the fourth straight year, currently standing at 2%, still high by international standards,” the report says.

“The decline encompassed all spheres of activity but was prominent in sectors that are usually characterized by higher rates such as small businesses and individual households (excluding mortgages). This is an indication of improved competitiveness in these areas.”

Profitability on small businesses is still large, at 4.2%; profitability on households is also solid at 2.85% though not dramatically higher than the rates paid by large businesses.

And the Bank of Israel says these high rates are justified – these are costly clients for the banks both operationally and in terms of the credit risk.

According to the central bank, when this risk is accounted for, individuals have no reason to quibble about the high rates because the banks’ returns on them is minimal. Only regarding small businesses is there some indication of relatively high returns for banks.

Playing the efficiency card

Not that things are so bad regarding small businesses. Credit to this sector rose 8% in 2015, and banks are chasing this segment.

“The credit market for small businesses is characterized by low competitiveness in comparison to large businesses because small businesses’ options are more limited for obtaining credit elsewhere, relying exclusively on banks. Nevertheless, there are indications of growing competition in the small business sector,” says the report.

This is the only place in the report where the bank admits to a problem with competition in the small business and household sectors, but its says there’s nothing to worry about because competition in this segment is constantly rising.

“The extent of competition in the banking system is not uniform . When one looks at profits made by granting credit to various sectors one notices differences,” the report says. “In the past three years profits have slipped in retail, including small businesses.”

“Competition is not uniform” this is possibly a hint that competition for small businesses is smaller than for larger ones, though over the past three years competition in small businesses has been growing as well.

The banks supervisor has clear ideas on what needs to be done to speed up competition. “We estimate that if the banks improve their efficiency in the coming years, based on our guidelines, this will enable a further reduction in the costs of banking services,” Ber said.

She has already taking action by initiating steps to increase efficiency that would let banks reduce their fees.

Given that, the question arises: How is improved efficiency related to the banks’ divesting of their credit card companies? Ostensibly, the Bank of Israel’s supervisory division doesn’t believe there’s a lack of competition between banks in pursuing small businesses.

If it recommends steps for augmenting competition, these focus on making banks more efficient. The need to dissociate banks from credit card activities is unsupported by the Bank of Israel’s own numbers. Apparently the bank doesn’t really believe in this move despite having agreed to it.

The bank’s spokesman promised that it would soon present its final position to the Strum Committee and explain its recommendation to separate the two credit card companies from the banks.

The impression is that these are forced explanations and that the central bank isn’t really eager to increase competition, certainly not by splitting the credit card companies from the banks. In this respect, the Justice Ministry has good reason to feel confused and anxious when defending the state’s position at the High Court.

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