Analysis |

The Four Big Challenges Awaiting the Next Bank of Israel Governor

The last of them is being able to call out the government when it is erring, but that kind of watchdog role seems to be out of favor in the Netanyahu era

Sami Peretz
Sami Peretz
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Moshe Kahlon and Benjamin Netanyahu speak, 2012
Moshe Kahlon and Benjamin Netanyahu speak, October 2012Credit: REUTERS
Sami Peretz
Sami Peretz

When Bank of Israel Governor Karnit Flug said a month ago that she wouldn’t seek a second term when her current one expires in November, the announcement was almost unnecessary.

Although no one disputes that she has done a good job, it was a given that neither Finance Minister Moshe Kahlon nor Prime Minister Binyamin Netanyahu – the two men who will name the next governor – weren’t interested in her staying on. Unfortunately, as the process gets underway to choose a successor, that’s about the only thing they agree on.

Flug’s tenure lacked almost any drama. She inherited from her predecessor Stanley Fisher – who had to cope with the biggest global recession since the 1930s – a strong, stable banking system and a new Bank of Israel Law that clearly defined the central bank’s powers.

Under Flug’s watch, Fisher’s policy of low interest rates remained in place and were even cut further to a rock bottom 0.1%, where they have stood for the past three years. Indeed, the Israeli economy has performed so well in the Flug years and beforehand, that many might be under the impression that it will an easy and unchallenging job for her successor.

The only challenges she faced was from Kahlon. Even before Flug took office, Kahlon signaled his determination to break the big bank duopoly of Hapoalim and Leumi by forcing them to spin off their credit card operations. Flug was reluctant but eventually consented, and the first fruits were seen this month when Leumi reached a deal to sell its Leumi Card unit to Warburg Pincus.

Flug ran up against Kahlon repeatedly on the issues of housing and tax policy. The Bank of Israel expressed skepticism about the efficacy and cost of Kahlon’s flagship program to bring down housing prices (Machir L’Mishtaken, or Buyers Price) and of his policy of lowering taxes whenever the opportunity arose.

Fortunately for Kahlon, a windfall of tax revenues in the last few years have removed any dilemma about whether to cut taxes or increase spending – Kahlon was able to do both.

But not before clashing with Flug, who expressed worries that too much of the windfall was based on one-time revenues (for instance, from crossborder mergers and acquisition deals) and because Israeli tax rates are already low, compared to other developed countries. She contended that any excess revenues should go to improving government services.

The subtext to all this is that as an elected official Kahlon wanted to show the voters he had accomplished something and Machir L’Mishtaken was slow in producing results. As an appointed official, Flug was more concerned with long-term considerations.

That fundamental difference has critical bearing on who will replace her at the Bank of Israel’s helm. Kahlon gets to choose the next governor, but Netanyahu has to approve it. It’s not at all clear the two share the same interests.


Kahlon and his Kulanu Party are competing for many of the same voters as Netanyahu’s Likud. As finance ministers go, Kahlon has positioned himself as the people’s friend with consumer-friendly policies and tax cuts.

The 2015 coalition agreement forming the current government ensured Kahlon had a lot of freedom to act as he chose, but he and Netanyahu are ideologically very much apart on economic issues. Even when they agree (such as on the issue of lowering taxes), Netanyahu wants to be the one to get the credit. With his hands tied by the agreement, Netanyahu wants the job of criticizing Kahlon to go to the next Bank of Israel governor.

Another critical difference is that Netanyahu has a strong preference for tapping overseas talent. Before Fisher, it was Jacob Frenkel, an Israeli who had spent most of his career abroad. This time around he has asked (but been turned down by) Martin Eichenbaum, a Northwestern University professor.

Netanyahu prefers someone from overseas, in particular American, not only because he likes the American approach to economic policy but because he wants someone who can market Israel abroad, calm global markets in the case of a crisis and last but not least br less likely to become too chummy with the finance minister.

Kahlon’s rumored to choice is Rony Hizkiyahu, who is now the treasury accountant general. Hizkiyahu was previously the Bank of Israel’s banks supervisor and did a creditable job in the post, but the most important factor for Kahlon is that the two men have known each other since childhood. It’s another reason for the PM to look abroad for a candidate.

While the next governor doesn’t have any immediate crises awaiting, he or she will face at least four major challenges.

The first is one shared by many of the world’s central bankers, which is how to elegantly exit from a decade of unusually low interest rates. The catch is how to raise them without undermining financial markets that have grown so used to near-zero rates. There’s a risk to pensions and other savings, and to the housing market.

The second challenge is the policy, adopted by Fisher, of regular intervention by the Bank of Israel in the foreign currency market. The central bank has bought tens of billions of dollars over the years to keep the shekel from appreciating too much and hurting the price competitiveness of Israeli exports. The bank now has reserves of $118 billion. Both a pullback from intervention and an increase in interest rates could be made easier by the U.S. Federal Reserve, which has been raising interest rates. The result has been a stronger dollar without the need for the Bank of Israel to intervene.

The banking system’s need to strike a delicate balance between ensuring competition and ensure the banks remain financially stable is the third great challenge. The system is about as financially strong as can be, enough so that the central bank recently permitted banks to buy back their own shares. But the banks face growing competition from spun off credit card companies, policies aimed at encouraging digital banks and credit unions, and technology that obviates the need for banks at all, like online peer-to-peer lending.

Finally, there is the challenge of fulfilling the governor’s role as “economic adviser” to the government. That role is tricky and it was the one that brought Flug into conflict with Kahlon.

The governor’s job is to act as the adult voice when elected officials are inclined toward populist and short-term programs. The Netanyahu government is not enamored of watchdogs in general, but it needs them more than ever – one who is courageous and outspoken. Can Netanyahu and Kahlon overcome their worst instincts?

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