Opinion

When Your Bank Wants to Lend You Money Oh So Bad

Bankers aren't always the hard-headed businessmen they're made out to be, as America's mortgage crisis demonstrated. When the competition gets tough, even the smartest banker can lose it

New cars lined up at the Eilat port.
Mori Chen

Israeli home prices are soaring, the roads are clogged with new cars, Israelis are travelling abroad in record numbers and consumer spending has been driving economic growth over the last two years.

The good news is that debt-driven household consumption is starting to calm down. The bad news is that households are already deep in debt and it could get deeper.

Everyone knows the economy has been doing well.We’re now marking 14 years of non-stop growth. Wages are rising and unemployment is at a record low. You would expect a consumer boom.

But, as the Bank of Israel, showed this week, a lot of that boom is being paid for with borrowed money. Since 2011, household borrowing has increased by 40%, lifting the ratio of household debt (not counting mortgages) to gross domestic product in Israel is now 14%.

That’s nothing compared to the 25% in America, where economists are starting to get jitters about an emerging lending crisis. But Israel’s ratio of household debt to GDP is among the highest of the countries the central bank surveyed.

Borrowers are stretching out loan terms, with a quarter of them committed to repayment over six to nine years. That means they will be stuck with monthly payments long after the shine of the new car has faded and the vacation pictures have been erased from their smartphone. Consumer borrowers are increasingly having trouble making the payments, and write-offs of consumer debt have been creeping upwards. The quality of the banking industry’s consumer-lending portfolios has deteriorated.

The consumer credit party got started after an assortment of rules and regulations made it harder for banks to lend to big companies, which had been their customer of choice.

Bankers have to lend to someone – after all, that’s why they come to work every day. So so consumers and small businesses became their new growth market. Record low interest rates made it easier.

Second wave

The good news is a lot of the frothiness is starting to dissipate. Home prices seem to be stabilizing, the car-buying mania has ended and consumer spending is starting to level off. But we’re still stuck paying off the accumulated debt. And just because people have gorged out on buying on a borrowed dime doesn’t mean the lending will stop. Intensifying competition over lending to consumers is almost certain to fuel a second wave of borrowing.

Unfettered competition is usually a good thing, but it isn’t always. In banking, it isn't.

Bankers and other financial professionals are supposed to be the hardest-headed businesspeople of them all, but the fact is they are not. As America’s mortgage crisis amply demonstrated, they can be just as smitten as anyone else by short-term considerations that blind them to unpleasant realities.

The loan officer is anxious to win another customer, her boss is looking forward to a bonus for exceeding his monthly quota for new lending, the CEO smiles at reports that business is growing and she’s taking market share from competitors, and the board celebrates with an increase the quarterly dividend. 

Yes, the party can’t go on forever, but when it’s over it will be over for everyone, even the party poopers, so you might as well enjoy it while you can.

Living on borrowed time

In Israel’s case, this sort of consumer lending blindness is just getting started because legislation based on the Strom committee recommendations aims to make it easier and cheaper for households to borrow by increasing competition. It will now be a less financially and regulatory onerous process to start a new bank because of lower capital and regulatory requirements. The two biggest credit card companies (Isracard and Leumicard) are being spun off from their bank owners in the hope they will become serious rivals to the banks for consumer loans.

All this is being done with the best intentions of helping hard-pressed households get money when they need it. But, of course, the new bank will need to build a loan portfolio from scratch, and the credit card companies will feel the pressure as standalone businesses to do the same. Consumers will be tempted with loans and lenders won’t be too cautious about who they lend to. As it is, the credit card companies, which do some lending already, have much higher rates of bad-debt write-offs than the banks.

To its credit, the Bank of Israel is aware of the trap the Strom legislation has inadvertently set and it hopes that measures, like a credit database that will enable banks to share information about risk, will help mitigate the dangers. But against that, interest rates are likely to remain low for some time and the culture of consumer borrowing has taken hold. Israelis don’t give it a second thought about taking out a car loan anymore.

By itself, ballooning consumer credit doesn’t pose anything like the danger America faced from mortgage lending. But financial crises have the habit of spreading in unpredictable ways. On top of their household loans, Israelis have big mortgage debts and the banks have lent heavily to the construction industry.  It’s not hard to imagine how a crisis on one segment could easily spread to the others, with consequences we can only guess at.