Bank of Israel Cracks Down Again on Foreign Forex Speculators

Stanley Fischer, the governor of the Bank of Israel, dropped his second bombshell announcement in two days in his war against currency speculation on the shekel, and sent forex markets into a spin. Fischer surprised investors - and in particular foreign speculators - by requiring all Israeli banks and financial institutions to keep a 10% liquidity reserve requirement for all foreign exchange derivative contracts of non-resident investors, including swaps and forward transactions, for all foreign currencies against the shekel.

The new directive will take effect January 27.

Stanley Fischer
Ofer Vaknin

The forex markets responded by sending the dollar and euro soaring against the shekel. (See box. )

Yesterday's surprise announcement came only a day after Fischer shocked investors by publishing a draft directive under which currency transactions amounting to more than $10 million a day, and makam and government-bond transactions greater than NIS 10 million a day, must be disclosed in full to the central bank. Makams are zero-coupon, short-term government bonds issued by the Bank of Israel.

The central bank has been working on these steps - and possibly others - for months. The central bank's main objective is to halt the more than three-year trend strengthening the shekel against leading currencies, in particular the dollar and euro. This has done serious harm to Israeli exporters and industry.

Until now, Fischer has mostly made do with a single weapon against currency speculation: Purchasing dollars in the open market. After buying more than $40 billion, Fischer has still not been able to control the shekel's appreciation. That led the governor to finally take his two recent steps.

The disclosure requirement is a new one for Israel's central bank, but other countries have similar requirements - Brazil and Chile, for example.

The Bank of Israel explained its decision yesterday in a press release: "In the last few months, the volume of foreign exchange derivative transactions by non-residents has increased markedly. A significant part of the increase in non-residents' transactions is in short-term instruments. This measure will strengthen the Bank of Israel's ability to achieve the objectives of its monetary, foreign exchange and financial stability policies," wrote the central bank in its official announcement.

The supervisor of banks, David Zaken, and his staff, as well as the central bank's legal department, have been working on the new rules for some time - and most likely other steps, too.

As to whether there are any more steps in the pipeline, the press release said: "This step is being implemented by the Bank of Israel in the framework of measures being considered by the Bank of Israel and by the treasury in the field of foreign exchange."

The new directive requires banks to put aside a 10% reserve of the nominal value of any foreign currency swap or forward contract with a non-resident. The reserves must be deposited with the Bank of Israel - and will not earn interest.

This is "dead money" as far as the commercial banks are concerned. It means that these funds are lying unused in the cellars of the Bank of Israel and earn no interest, cannot be lent out or used in any other business transaction. The Bank of Isrel calls it a safety cushion.

The new requirement will make such swap and forward transactions 10 to 20 basis points (0.1% to 0.2% ) more expensive, and such contracts already have very small profit margins for the banks.

The central bank wants to reduce the number of such transactions with foreigners, as well as reducing the amounts involved.

For example, foreigners share of the makam market has climbed from just 2% at the beginning of 2009 to some 20% at the end of 2010.

The Bank of Israel is worried that foreign investors might withdraw huge sums quickly in the event of a crisis, or even just with a change in investors' sentiments, which could influence Israel's economic stability.

(More coverage on Page A8. )