The Bank of Israel came out strongly against the idea of non-bank companies offering consumer loans in competition with banks, warning it could spin into a financial crisis as happened in the United States and Europe in 2008.
“No one should forget that the current global financial crisis – one of the longest in history – was born out of aggressive marketing of household credit in a low interest rate environment,” the central bank said in a sharply worded statement on Tuesday.
The bank was responding to a plan by the Finance Ministry, appearing in the Budget Arrangements Law, that would allow non-bank lenders to issue up to 2.5 billion shekels ($660 million) in bonds to finance consumer loans. The legislation would entitle the finance minister to double the figure.
Right now, under Israel’s Bank Law, only licensed banks can issue bonds for making loans. Allowing non-banks to do the same would enable them to raise sufficient funds to become a presence in the market.
The measure is one of several the government is pursuing, such as splitting credit card companies from the banks, to spur more competition in lending. But the moves have run into opposition from the Bank of Israel, which is concerned about undermining the financial soundness of the banks.
And, with the base lending rate in Israel at a record low 0.1%, consumers would be tempted to borrow because of the low cost of loans.
“Amending the [Bank] Law is likely to create risks to consumers, to small businesses and the economy as a whole,” the bank said. “Amending the law opens the door for an unlimited number of companies exploiting low interest rates to raise debt and market loans aggressively to households, mainly to households with low levels of financial literacy and none of the consumer protections such a market requires.”
Although the Finance Ministry plan would limit the amount of borrowing non-banks could undertake to finance loans, the central bank warned that it would easily spin out of control. It noted that in the United States in 2004, just four years before the financial crisis exploded, sub-prime loans amounted to just 2% of gross domestic product, a figure that would be 25 billion shekels annually in Israeli terms.
The bank said the reform should be delayed until a regulatory mechanism can be set up.
Even before the Bank of Israel issued its warning, sources in the banking industry had expressed concern about unfair competition. The banking industry is highly regulated and must abide by high levels of disclosure to borrowers that the non-bank sector does not have to observe.
Likewise, banking executives are worried about households accumulating high levels of debt, which in turn would hurt the banks’ consumer loan and mortgage portfolios.
The central bank isn’t opposed to all new competition and said on Tuesday it supported plans to create a nationwide credit database, which would help other lenders to make loans with more confidence. Right now, such information is controlled exclusively by the banks.
The government has set a November deadline for passing the credit database law; it’s expected to take another two to three years after that to establish a nationwide credit database.