In Israel, Virtual Banking Faces a Persistently Upward Battle

The former head of the Israel Antitrust Authority believes an Internet bank is the only way to stop us being fleeced by exorbitant charges and fees.

Imagine a world in which your bank takes a commission for only three services, instead of collecting dozens of fees for things you've never even heard of. A world in which the interest a bank charges you for loans is only half as much as current rates. Or a situation where, despite having been a loyal customer at your bank for many years, you are not offered good terms on a loan - and so, after one mouse click and filling out some details, you are able to move your account to another bank. All this would be possible, if only an Internet bank could be established in Israel.

Dror Strum, former director general of the Antitrust Authority and a member of the Trajtenberg Committee on socioeconomic reform, has for years complained that the lack of competition between banks costs Israeli consumers dearly. Today he heads the Israeli Institute for Economic Planning, which seeks to augment competition and efficiency in the country's economy. Strum does not believe miracles can come from within the existing banking system, one which the Bank of Israel itself defines as having "monopolistic characteristics where the Bank Hapoalim-Bank Leumi oligarchy controls about 60 percent of deposits and credit capital in the country." "For many years, when a new bank was not established in Israel, foreign banks did not enter the local market on a big scale. Even a deaf, dumb and blind person can grasp that this market is not competitive," Strum said in an interview with Haaretz. As he sees it, "establishing an Internet bank would provide the only chance for real competition in Israel's banking system. Technology is the only thing that can be used to infiltrate this monopolistic sphere in which the players fortify themselves against competition and regulation. It doesn't have to be a new bank; it could be a small bank that exists today but would start to operate as an Internet bank."

Illustration by Yael Bogen

Shlomo Piotrkowsky was one of the leaders of Israel's banking system in the 1990s. For more than five years, along with businessman and economist Isaac Devash, he has been knocking on doors here and overseas, in an attempt to raise funds for the establishment of an Internet bank. They are still a few dozens of millions shy of their goal of raising $100 million - the sum needed to create such a bank. This dream, to which Devash and Piotrkowsky are fully committed, seems logical and desirable. However, even though the country preens about its high-tech accomplishments, such a bank does not appear to be on Israel's horizons.

While traditional banks suffer from inefficiency - stemming partly from heavy personnel costs and also the costs of operating branches - an Internet bank would not face these costs. It would not need to employ clerks or maintain branches; its main personnel costs would relate to technology maintenance, and perhaps the operation of a small customer service center.

The savings in costs and the advantages attained by technology could enable an Internet bank to offer low interest loans to the public, and higher interest for deposits. The savings in expenditures - which would benefit the public - would be higher in Israel than in other countries, because Israel's banking system ranks as one of the world's most inefficient. In terms of bank efficiency, Israel ranks 14th out of 20 countries surveyed. With its commissions and interest rates, Israel's banking system takes 68 agorot out of every shekel that enters it. Most of the takers' fees are used to cover personnel expenses, and to operate branches around the country.

This figure in Israel is higher than ones in the U.S., Britain, Spain and South Korea. During the past seven years - more or less the period of Stanley Fischer's term as Bank of Israel governor - the banking system's efficiency has declined, and expenditures have grown at a rate higher than revenue.

Since the end of 2004, some 10,000 new workers have joined the rosters of the large banks. This is a 26 percent increase in personnel. Expenditures on wages have risen 45 percent - more than NIS 5 billion. This has happened in a period when Israel's population increased just 14 percent.

Speaking to the Knesset's Economic Affairs Committee two weeks ago, Fischer stated: "We cannot think in a populist fashion, and imply that bank costs can be reduced without limit, without such cutbacks having consequences regarding the system's stability." This statement incurred the wrath of Israeli activists, who organized a Day of Rage against the banks last week. They derided Fischer as "the banks' lobbyist."

No room to maneuver

Had they looked into the matter, the protesters would have learned that while revenues amount to NIS 26 billion for the banks each year, the wage expenditures they pay gobble up NIS 16.5 billion of that amount. This situation might suit the banks' workers, whose average salary level is twice the national average, and it certainly pleases the banks' top executives (between them, 42 execs have annual salaries totaling NIS 153 million ), but it leaves little room to maneuver. That revenue cushion is so small that a dramatic reduction in interest revenue or commission fees could cause the banks to lose money. That small cushion is also what recently caused Fischer to express concern about the banks' stability.

TheMarker previously published part of another plan to establish an Internet bank in Israel. The founding group is comprised of programmers and figures from the financial world. The group estimates that it will recruit between 15,000 and 20,000 new customers each year, and will thereby reduce prices for banking services, particularly commission and interest fees charged to households, by 50-70 percent.

Strum will not commit himself to figures, but he stresses that "interest is huge. An increasing number of people make sales and purchases on the Internet. If people get married online, why shouldn't they do their banking on the Internet? Wage expenditures incurred by an Internet bank are marginal, and technological development costs have decreased considerably. Technology has progressed rapidly, and a computer system that cost $100 million in the past can be purchased today for $20-$30 million. I once made a conservative estimate and concluded that NIS 3 billion can be saved each year - and that's just a conservative estimate."

Internet banks have been established in Canada, Germany, Spain, Australia, France, the U.S., Italy and Britain. Customers can start an account easily and then, with the click of a mouse, make deposits, receive credit and carry out countless numbers of transactions. Internet banks have millions of customers; they comprise 5-10 percent of the markets in which they operate.

ING Direct operates in many countries. Its base is in Holland, and it is owned by the ING insurance company. In 2011, the bank charged its 16.7 million customers 3.9 billion euros in interest fees. The bank's revenue from commissions reached 0.16 billion euros. In contrast, Israel's five large banks - serving a third of the number of customers who use the Internet bank - charged 5.3 billion euros in interest fees, and 2.8 billion euros in commission payments.

Operating costs of Israel's five big banks, which employ 50,000 workers, totaled NIS 28 billion (5.7 billion euros ). Operating costs for ING Direct, which employed 13,000 employees, totaled less than 2 billion euros. This margin of difference is what allowed ING Direct to charge marginal commission fees, lower interest rates and offer larger interest returns on deposits.

The household interest margin in Israel (the difference between interest charged by a bank for providing capital to customers and the interest it offers on deposits ) was 2.4 percent in 2011. ING Direct's margin was half this figure: 1.24 percent. For the Internet bank, this was a win-win situation - its efficiency benefited both customers and the bank itself.

A few years ago, the Bank of Israel changed its policy and decided to allow the establishment of an Internet bank. Launching such a bank would not be particularly expensive, but despite such considerations, there is still no viable plan to create an Internet bank here.

Among other concerns, the Bank of Israel is worried about the security of such a bank's information, and the abuse of the bank's service in fraudulent activity. In recent years, the country's banking system has suffered from money laundering and fraud on a huge scale. Worried about fraud, the Bank of Israel demands that a customer be identified in a face-to-face meeting when he or she opens an account.

Some officials at the governing body realize that the time has come to overcome such obstacles and worries, particularly in light of the fact that Internet banking has become so widespread around the world. In Israel, more than 70 percent of banking activity is done by phone or the Internet. The officials believe it should be easier for customers to switch banks; also, they believe, methods should be found to allow banks to identify customers without their having to come to branches in person - video technology or biometric identification might be utilized in this respect.

Strum says the Bank of Israel "is a conservative regulator, which asks itself why it ought to change the rules of the game. It sits on the fence. The Bank is stuck with what it views as a dilemma, a choice between the banks' stability or competition between them. But the relevant research emphasizes that competition enhances stability.

"In recent years," Strum continues, "the Bank of Israel has said that it supports an Internet bank, but it needs to take steps to make this possible. One such step would be to legislate a law for the provision of credit, which would allow for the accumulation of positive information about a customer so that other banks might compete to recruit him. Another move would be to allow customers to freely open a regular account and do most of their banking on the Internet. The Bank of Israel isn't taking these steps, and it is projecting an attitude of 'We're not very eager' for change."

A senior banker is not surprised that Shlomo Piotrkowsky "has not been able to raise the sum needed to establish an Internet bank, despite years of striving. The problem is that as long as one can't open a regular bank account on the Internet, there's no justification for an Internet bank." The banker added: "The Bank of Israel's conservatism overrides any desire to foster competition in the banking system."

This source believes that, were the Bank of Israel to remove obstacles and encourage the Internet bank initiative, new levels of interest would be sparked and some small banks would investigate joining the project. He explains: "Today, about four percent of clients, some 200,000 people, move from bank to bank each year, mostly because of marriage and relocation to new areas. But were it possible to open an account with a click of the mouse, this figure would rise to 8 to 10 percent a year. It would represent a breakthrough in fostering competition in the banking system.

"The Bank of Israel is worried about money laundering," the banker says, "but this fear has made it more conservative than the U.S. or Britain, which also confront financial fraud issues and yet allow Internet banks to operate freely. We've changed: our status as the world's leader in money laundering has turned the state into a conservative entity that encumbers ordinary customers due to fears of financial fraud, and prevents these customers from enjoying lower interest and commission fees."

Strum thinks the Bank of Israel should not have the authority to dictate affairs in this regard. "An Internet bank should be a national project, perhaps directed by the Prime Minister's Office," he says.

A well-situated source from the business sector adds: "The state decided to fund what it considered to be important: it gives grants and tax reductions to factories, and provides funds to support small businesses. It should also make sure that investments in an Internet bank have strong appeal to entrepreneurs."

Shortly before the Day of Rage staged by activists last week, the movement's leaders were summoned to a meeting with top officials from the Bank of Israel. Sonia Bogolovski, head of the bank's customer relations department, told the protest leaders that an intra-ministerial committee - established to examine the lack of competition in the banking system - will submit its report in another three months. Bogolovski said that the report will issue a number of recommendations to augment competitiveness. However, she stressed, these recommendations will not ruffle feathers in the banking system. They will apparently not include plans to impose an interest rate ceiling, or an endorsement for an Internet bank. Until such reforms are carried out, bank customers will continue to pay for the system's inefficiency.