Don't Bank on It

The banks rake in higher fees from household customers than from big business * Banks must lower their charges and operate more transparently * The economy is overcentralized * On the plus side, the economy is blossoming and the private sector is a great growth engine * The media-averse but exceedingly polite Bank of Israel Governor Stanley Fischer talks about his first 20 months in Israel.

The phone call from Benjamin Netanyahu caught the Fischer family on the seashore, on an anniversary vacation in the Caribbean. On December 26, 2004, almost exactly two years ago, the Israeli finance minister asked the man who was then vice chairman of Citigroup, the world's largest bank, to leave his comfortable life in the stratosphere of the international financial world and immigrate to Israel in order to serve as governor of the Bank of Israel. Since that day, Prof. Stanley Fischer has preserved his privacy and his cautiousness zealously. Here and there he issued a public statement, but he has never described his worldview or his outlook on the reality of the economy, the banking system and the governmental system in Israel.

Fischer had a hard landing in Israel. It wasn't just the need to learn Hebrew. Not just the culture shock. Not just the unsettling discovery of how Israel manages itself and its state systems. It was a series of unexpected jolts: the resignation of Netanyahu, Sharon's collapse, the rise of Hamas, the war in Lebanon. But above all, what threw Fischer for a loop was the rot he uncovered in the ostensibly respectable central bank he heads: bloated salaries, hidden unemployment, organizational anachronisms and a culture of management that included fabricated reporting.

In his first 20 months in Israel, the banker from New York who came to deal with the major questions of the Israeli economy found himself having to conduct exhausting negotiations with the workers committee and with treasury bureaucrats without the political backing of Ariel Sharon and Benjamin Netanyahu, who had enticed him to immigrate.

The Bank of Israel building in Jerusalem is horrific. Drafts blow through the corridors, the cold is enough to freeze your bones. But the warm office of the governor is heated almost as oppressively as an American corporate building. Ben-Gurion and Herzl hang on the wall. Outside, a powerful storm is descending on the government compound. And Stanley Fischer, a blue suit snugly enclosing his lean frame, is very cautious in his replies. His Hebrew is surprising. So is his sense of humor: dry and English. He is enormously suspicious of the press. Born in Rhodesia and raised in the British tradition, and having been a senior official of the International Monetary Fund, Fischer projects a feeling of a man of quality who does not entirely trust the natives. Despite this, in his conservative way, he slaughters quite a few sacred cows and questions no few conventions. Stanley Fischer did not come to Israel to kill time. He came to leave the imprint of a reformer.

Structural changes

Twenty months ago you left one of the most coveted jobs in the world - vice chairman of Citigroup - to become the governor of the Bank of Israel. Was it worth it?

"Yes, of course. I had much satisfaction in my previous post. But it was a business position. Here, someone gave me the chance to contribute something to the State of Israel. I'm no longer a boy. This is an opportunity I would not have been given more than once."

When prime minister Sharon and finance minister Netanyahu persuaded you to take the job, did you and they formulate a vision about what you were going to do?

"We talked about a new Bank of Israel Law. I understood that there were problems and there was a labor dispute and that it would be necessary to make order. It was clear that there was a need to make structural changes. The goal was to carry out a reform in the Bank of Israel, to transform it into a modern central bank."

Were you surprised by the morass you found?

"There's a rule that says that every institution looks better from a distance. Whenever you enter an institution, you discover the problems. That rule was operative in this case, too."

So you came to deal with the macro and found yourself cleaning the stables?

"I expected that I would have to deal with managing the bank, but managing the bank requires more time than I expected."

Governor Fischer, you are very polite, but the truth is that you found a tainted central bank.

"It's far more complex. There are excellent people who do excellent work, but there are administrative problems and there are complicated wage agreements and reward systems whose origins are impossible to understand."

Do you think it is moral for an institution which for decades preached rigid wage discipline in the public sector and called for slashes and streamlining to pay a large number of its employees inflated salaries about which it does not file true reports?

"Regarding the possibility that the reports were incorrect - that has to be dealt with according to the law. No one in the present management accepts the notion of incorrect reporting. We discovered this, we reported it and we are trying to resolve it."

And the salary scale, the hidden unemployment, the people who receive incredible wages for work that is not always necessary?

"It is accepted throughout the world that salaries in the central bank are higher than in the public sector. But in the wage agreement we're trying to work out with the Finance Ministry, we'll save in two directions: about 10 percent of the employees will leave, and thus we will save NIS 20 million. And the salaries of future employees will be lower, which will also represent a large saving. There will be no more phenomena such as the supervisor of foreign currency remaining in his post even after foreign currency supervision was abolished."

Let us put the bank itself aside for a moment. As someone who comes from the management culture of America, what surprised you about the management culture of the public sector in Israel? Where did you experience culture shock?

"What surprised me was the interaction between the decision-making alignment, the public and the media. The country is so small that everything here happens very fast and very intensively. I haven't got used to that. You hear about every little thing that happens, but every phenomenon passes very quickly. The intensiveness and the speed of the changes here surprised me."

Could it be that all the noise means that there is not enough attentiveness to manage things in a businesslike, thoroughgoing way?

"Yes. Maybe because the governments have such a short lifespan."

In other words, there is a gap between the management ability in the public sector, where our level is of international standards, and the manner of management in the public sector, which in international terms sometimes looks bizarre?

"Such a gap exists. It stems from the instability of the governments and perhaps also from the political system, which is based on proportional representation."

Are there days on which you get home and say, 'Wow, what a crazy place'?

"Of course. I don't have to go home for that. I sometimes say it even in the middle of the day."

But at the same time, in an almost strange way, the economy is in good shape?

"The results of the economic policy of the State of Israel in the past two years are very good. I'm favorably surprised by the resilience of the economy and its ability to withstand all the pressures and jolts that have occurred since I took office."

The impressive private sector

Israel's economic growth rate is now running at 5 percent annually. Can we expect the same rate in the future?

"That depends on the geopolitical situation. If we make progress in the direction of quiet with our neighbors and if we continue to pursue the right economic policy, we can reach an annual growth rate of more than 5 percent within a decade. Today our per capita GNP is $21,000. That's 55 percent of the level in the United States. Because we are relatively far from the front of economic progress, we can grow at a faster rate than other countries in the West. I see no reason why we cannot grow at a rate of 6 percent during 10 years, if the conditions are right. If that happens, we will become one of the developed countries. Now we are above Greece and Portugal, close to Spain. There's no reason why we can't pass Italy and then France, and be close to Britain."

If so, we are talking about an Israeli economic miracle.

"In the 1950s and 1960s, and until 1973, Israel was considered a miracle economy. We grew at a very rapid rate. It is still too soon to say whether we have returned to that format or if the present high growth rate is a cyclical phenomenon. But already today we have a surplus in the balance of payments. For the first time in the country's history, exports are higher than imports. That's not something I expected to see in my lifetime."

What is causing this miracle? What are the sources of strength of the Israeli economy?

"The private sector. The innovativeness we have in the private sector. In high-tech especially, but not only there. When you visit industrial plants around the country, as I do, you see the high-tech revolution trickling down into other industries as well. The result can be seen in the data on work productivity. It is rising very rapidly. That's also one of the reasons why inflation is so low. Because the rate of work productivity is rising faster than the rate of wage increases, there is no internal inflationary pressure and the cost of goods does not increase. This phenomenon is similar to what has occurred in the American economy since 1995 and has generated prosperity there.

"Another factor is the human capital, including the immigrants from the former Soviet Union. And the fact that we have a budget framework that is succeeding in controlling the deficit. We must not forget that between 1985 and 2005, a revolution took place here in terms of the openness of the economy, foreign currency supervision and budgetary policy. In 2003, we were not in a good situation. There was a large budget deficit and insecurity concerning the government's ability to control the deficit. But within two or three years we were able to get control of the deficit and the budget, conduct an excellent monetary policy and persuade not only ourselves but the whole world that we will not allow that situation to recur. Concurrently, changes occurred in the tax rates and a reform was introduced in the welfare system. I'm not saying that everything that was done was perfect, but the direction was right.

"The security situation also improved greatly. The result is a fundamental change. People always asked how it was that the Jews succeeded economically everywhere except in Israel - but today that question is no longer being asked. We are succeeding here, too. The private sector is simply impressive. So, if we can make progress in the peace process and if we continue along the present route of economic policy, we will be one of the most developed economies in the world."

Is there a close connection between making progress toward peace and economic growth?

"In the long term, yes. We can grow without progressing toward peace, too. But we are talking about the difference between 4 percent growth a year and growth of 5-6 percent a year. And the difference between 4 percent growth and 6 percent growth is not 2 percent - it's 50 percent."

Is this the price of the conflict?

"It is the dividend of peace."

You are describing a strong and impressive Israeli athlete. Does this athlete also have an Achilles heel?

"The situation of the education system and the higher education system bothers me. I think this is one of our big problems. We're proud that we have a few Nobel Prize laureates, and justly so. But the conditions in the higher education system are not as good as they were. There is a larger brain drain than there was in the past. And to achieve quality in education, you have to invest in elementary schools no less than in universities. In both of these areas, we are liable to have problems in the future."

Israel has become a country of flagrant inequality. Apart from the social injustice this entails, is the equality issue also an economic problem?

"In China there are tremendous disparities. And the Chinese decided not to pay attention to the disparities. The result is growth at a rate that has not seen in the history of the world. So the question is what the society is ready to accept. In Israel the problem is even more complex, because it has a cultural dimension. More than half the poor in Israel are Haredim [ultra-Orthodox Jews] or Arabs. To solve the poverty problem, the special problems of those two communities must be addressed."

You are talking about poverty that stems from the fact that many Haredim and Arabs don't work. But in Israel there is a severe problem of working poor people. And we are seeing the erosion of the middle class. There is a warped social structure that concentrates the wealth in the hands of a very small stratum.

"I don't know whether there is erosion of the middle class. As for the working poor, the negative income tax will deal with that problem. It is important not to focus only on the inequality but on the standard of living. If we want to deal with the disparities, it is simply possible to take taxes from everyone above the average level and transfer the money to the poor. But then, over time, everyone's level will decline - the weak strata, too. Therefore, it is necessary to preserve a balance between the need to deal with social problems and the need to encourage growth."

Which economic model do you find more congenial - the American or the European?

"A combination of the two. There are special conditions in Israel. There are security problems and there are immigrants from many countries. We are still in the process of building a society. And among Jews, there is a feeling that we are close to one another. Mutual surety is part of our ethos more than it is part of the American ethos. The tradition is that the Jewish community looks after the weak members of the community. And we also have to help the non-Jewish minority, in which the weak constitute a high percentage. So, in terms of the importance of the market and the importance of the legal framework, the source of inspiration should be the United States. But in the social realm, the American model will aggravate disparities. I don't want Sweden here. That's excessive. The model of a big government does not succeed, and our government is too big. But it's possible that between Europe and America, we have to find the right place in the middle of the Atlantic."

The concentration of wealth

What about the centralism? How serious is the centralism in the Israeli economy?

"Centralism is a problem of other small economies, too, but it's still a problem. There is high centralism in the Israeli economy. It has social implications and political implications, because centralism is not only economic power, it is also political power. It is said that in Colombia 20 families control the economy. Here it was said to be 18 families, but I think it's a little more. But it's not a high number. That affects the structure of the economy. Economically, it's very difficult for someone to be important in the Israeli economy if he is not connected to one of these groups.

"You see in Israel something you don't see in the United States: companies with interests in a number of industries. The centralism exists not only within a certain branch of industry but is reflected in the ability to influence the economy in a number of branches. The centralism can be seen also in terms of the distribution of the wealth, which is very concentrated. In this sphere, the situation in the United States is similar, but because the economy there is so large, no one family there has such great proportional influence as is the case here. Even Bill Gates does not control a large part of the economy. And he has competition. He's 10 times richer than anyone in Israel, but in relation to his economy he is far less important than certain people here."

Are the rich in Israel richer than their counterparts in the United States?

"In proportion to the size of the economy, yes."

And the centralism of capital accords unreasonable power to certain groups and creates market distortion?

"The potential for market distortion exists here. It is a constant threat. This is something to which thought must be given, and we have to think how to prevent it, too. I would be happy if the rate of investments in Israel were higher, but with closer supervision that would try to cope with the problem of the impact of centralism."

Is it possible that the way in which the privatization process has been managed here since the start of the 1990s contributed to the centralism?

"We could have perhaps privatized more through the market. I constantly ask myself if the system of controlling interests that we have in the Israeli economy contributes to centralism. That may be so. I still have not reached a final conclusion, but it's possible that if we were to move - in the banks, for example - to a system that distributes the shares to the public through the market, the level of centralism would decline. That's actually what [former finance minister Benjamin] Netanyahu and [Accountant General Yaron] Zelekha tried to do until Sharon and Olmert torpedoed it in the Bank Leumi tender.

"It is impossible to change the fact that we have a small economy. But it is possible to influence the scale of the problem. We have to be aware of the centralism problem, we have to be aware that it leads to monopolistic behavior, and we have to try to change that. We must never say that we have a basic problem here and not do anything about it. It's possible that we will start with the centralism of the banking system and then move to the economy-wide centralism."

Is there a singular problem of centralism in the Israeli banking system?

"Yes. The bank I worked for, Citigroup, is the world's largest bank. But Citigroup's proportion of the entire American banking system is less than 4 percent, I think even less than 3 percent. In Israel, each of the two big banks [Hapoalim and Leumi] controls more or less 30 percent of the banking system, one of them even more."

The figures you have just cited show that the situation is intolerable.

"That's the present situation. People are talking to us about the problem of the bank fees and about improving the service to the clients. We are examining seriously the possibility of supervising the fees. We are trying to contribute to an improvement of the service. But all that makes only a marginal contribution and doesn't solve the problem. Until we deal with the problem of competition, we will not succeed in bringing about a basic change. We need to do all we can to strengthen the competition in the banking system."

Do the banks in Israel behave as though they are a cartel?

"Your question has legal implications and therefore I am unable to reply to it. We need to take into account that when there are very few players in the market, it's difficult for them to behave in a manner that looks competitive."

What are you, as governor, doing about this?

"I'm trying to bring in a foreign bank. Every time I am abroad, I go to the chairmen of the big banks and try to persuade them to open a branch here. If we succeed in getting foreign banks to work here on the retail side, it will be a major accomplishment for the country. That will solve the problem."

We talked about the problem and about the solutions but not about the symptoms. What, in your view, are the most severe symptoms of the Israeli banking problem?

"When I arrived here, I listened to people's complaints against the banks. I saw that when I look at my bank statement, I have to devote too much time if I want to understand what it says. There are a great many fees that are impossible to understand."

Is there both a problem of excessive fees and an absence of transparency?

"If you say so."

Will the Bank of Israel take action regarding the bank fees?

"I would not be surprised if we make a proposal. If, in the meantime, the banks were to succeed in solving the fee problem, that would help."

Are the salaries in the banking system too high?

"It's very hard to say how much salary someone deserves who contributes a huge sum to the society. But the question which the Securities Authority is examining is whether the procedure in the banks regarding the question of wages was right. There were problems in a few cases in the decision-making process. That has to be dealt with."

Profits from households

Are the banks' profits too high?

"No. There's a tendency to think that every amount in billions is high. But the rates of return on capital of the banks in Israel are not especially high. Last year they were not low because it was a good year at the macro level, but this year they will also reach 14 or 15 percent, when many banks in Europe and the United States reached 20 percent."

So if the salaries are not necessarily too high and if the profits are not too high, what did you learn about the banks in Israel that outraged you?

"I didn't understand why the clients of the banks in Israel feel so exploited and so angry if the banks are not making excessive profits. I looked for a solution to this and I think I found it. The problem is not in the banks' profits but in their origins. The banks' profits from companies are very low compared with the international scene, but their profits from households are high."

What you are saying is that the banks in Israel are very good, maybe too good, in their attitude toward big business, but are not good at all in their attitude toward small consumers.

"A Lebanese goes into a police station in Beirut during the period of Syrian control and says that a Swiss man stole his Syrian watch. The policeman says: You mean that a Syrian stole your Swiss watch. The Lebanese replies, If you say so."

That's all very funny, but you are saying something dramatic here. You are saying that the Israeli banks benefit the big clients and are not attentive enough to the small ones.

"According to the facts and the data that were provided to me, that is so. In comparison to the international sphere, the big companies get credit at very good terms. Someone else pays for that. It's a case of cross-subsidization. The margin in one sector would appear to fund the margin in the second sector and subsidize it. It's possible that in an international comparison, Israeli consumers are paying more and the big companies are paying less.

"The banks have to understand that the atmosphere regarding them is very sensitive. Therefore I would advise them to be more cautious in the use they make of the great power they wield. In Australia and Canada, for example, there are not many different banks - three, four or five. But the question is how they behave. And what we can learn from Australia or Canada is that when the number of banks is small, supervision over the competition contributes to the service the clients get."

We'll move to a different subject. There has been much talk of late about corruption. Is it your impression that there is significant corruption in the state's highest echelons?

"I don't want to say that there is no corruption. I read in the papers about things that are unquestionably corruption. But I think that there is tendency to call too many things corruption. In the British tradition, the officials recommend and the minister decides. Here I read that if the minister makes a decision contrary to the recommendation of an official, that is corruption. Sometimes I say to myself that maybe we are exaggerating."

There is a case of suspected corruption about which you might testify: the Bank Leumi episode. Was the sale of Bank Leumi carried out normatively?

"I was in favor of making the sale in a different way. I thought that it was possible to sell the bank's shares to the market. But it was explained to me that this would be an experiment and that no one wanted to carry out an experiment with the No. 2 bank in the country. I thought that was a legitimate argument. I didn't say that if someone didn't agree with me, he was corrupt. I said that he didn't agree with me because he had a different opinion."

Is the Bank Leumi affair much ado about nothing?

"Whenever someone holding a responsible position raises such a subject, it has to be taken seriously. But all the facts I know say that there were only professional differences there."

I hear a note of anger in your voice.

"I think that the tendency of everyone here to make accusations is a problem. There is someone I have known for a few years who is considered an excellent businessman and his reputation is untarnished in 40 years of doing business abroad. Then suddenly he appears in the press as a suspect in corruption. Maybe in Israel people are already used to this. They know it's not important, that it's not serious. But in other countries, it is very serious. Maybe names should be published. I don't know. But it is unacceptable that they were published as names of people suspected of trying to get what they wanted by means of corruption."

It's impossible to conclude an interview with the governor of the central bank without asking him a few short questions about monetary matters. Is the shekel not too strong? "The shekel is not too strong. We are getting stronger against the dollar, which has weakened internationally, but on average we have not become stronger against the euro. In our actual exchange rate, we have devaluation over the past five years. When you have a 5 percent surplus in the current account, it is impossible to argue that your currency is overvalued. In the future, too, in the long term, the dollar will continue to weaken and it's reasonable to assume that the shekel will strengthen."

Before this interview you lowered the interest rate by half a percent, but some still think that the interest in Israel is too high.

"Historically, the interest rate is a very low level. It is also 1 percent below the Fed's interest rate. We're in a place where we've never been before. If in the future we think that in order to reach the inflation target we have to lower the interest rate, we will do so. If we reach the conclusion that there is a danger of exceeding the target, we'll raise the interest rate. Our approach is to adjust the interest rate to the inflation target."

However, in the past year the inflation rate was lower than the target. Isn't inflation of zero percent a failure of the Bank of Israel?

"Inflation of zero percent in conditions of recession is a problem. Today, too, I would prefer to be within the target. But when the economy grows at an annual rate of almost 6 percent and when unemployment falls and when there is a balance of payments surplus and when the budget is in a good situation, I am not concerned about the state of the economy. The state of the economy is excellent, touch wood."

The Bank of Israel continues to call for minimal budget deficits - isn't that excessive rigidity?

"We will continue to support a conservative budget policy. As I told you, we have a huge debt. If a rapidly growing economy does not maintain a small deficit, it will never maintain one. If that happens, we will one day find ourselves with a large deficit and a large debt, and that will cause very serious problems that will affect the economy for years. Therefore, we think the deficit should be 1 percent (according to the international definition), and within a few years it should be zero percent. In years of growth, the deficit should range between 1 percent and zero percent."

Twenty months after moving to Israel, what is the state of your Israel-shock? What impresses you here and what disturbs you?

"I'm impressed by the Israeli economy. I have met a great many people with extraordinary human and professional qualities. What disturbs me is the complexity of the public and governmental systems, including the Bank of Israel. There is a true difficulty here to make decisions and execute them. But in the final analysis, I'm optimistic. I believe in the economy and I also believe that despite all the difficulties I will succeed in fomenting changes and leaving behind a strong, efficient and modern Bank of Israel." W