Taking Stock / Strum's Mistake

Shlomo Nehama, Zvi Ziv, Eitan Raff and Galia Maor couldn't have wished for a better Passover present: the antitrust commissioner, Dror Strum, took the entire financial establishment by shock, telling Haaretz in an interview Friday that he opposes forcing the banks to relinquish their provident funds and mutuals. Happy holidays!

His declaration came at a critical moment. A Finance Ministry team headed by director-general Yossi Bachar is designing a sweeping reform of the capital market based on exactly that - wresting the funds away from the banks. Above the team hovers a bill, supported by 51 Knesset members, to separate the funds from the banks.

Just two weeks before Strum's bombshell, Bank of Israel Governor David Klein declared in another interview with Haaretz that not only should the banks sell their provident funds and mutuals, but also he could name the buyer - the insurance companies.

Strum postulates that the banks have a monopoly over the distribution and marketing of investment funds due to their nationwide deployment of branches, know-how, customer relations, and experience in selling financial instruments. Therefore, no other entity could serve as a viable alternative, including the insurance companies, he says.

Therefore, he urges the regulators to accept the banks' de facto monopoly but to impose stringent pricing regulations. Rather than a monopoly that cannot be dismantled, there would be a tightly regulated system.

His very solution indicates his mistake - identifying the key problem in the capital market's structure. Strum views the issue of the banks' ownership of provident and mutual funds via a prism of the fees they charge customers. If competition cannot be introduced, then prices should be regulated, he suggests.

But the real problem that the Bachar committee needs to solve isn't the fees the banks charge; it is the tremendous dominance of the banks in the financial establishment and the countless conflicts of interest that creates. Strum has missed the point entirely.

The banks don't charge that much for their provident and mutual funds compared to local and international standards. The real cost of the banks' stranglehold is that a financial establishment that bypasses the banks cannot evolve.

The reason for divorcing the banks from the funds isn't to reduce fees. If anything, they might rise if insurance companies or foreign investment banks take control of the funds.

Management fees are a poor gauge of market competitiveness. Private fund managers usually charge more than the banks, if anything. But it doesn't matter. What does matter is yield, and it transpires that the private fund managers have achieved substantially higher yields even after deducting their higher fees.

Pursuing his narrow train of thought, Strum warns that even if the funds are taken away from the banks, they will continue to feed off them in any case, because they'll grab a lion's share of profits as marketers and distributors.

There is truth in that, but again that misses the point. The objective in separating the banks and funds isn't to reduce bank profits or management fees, but to create a new structure, a freer capital market not dominated by a single sector. Development of financing sources outside the banks will lead to better allocation of resources.

Mother of all conflicts of interest

The banks' dominance engenders the mother of all conflicts of interest, because of the many hats the bankers wind up wearing - lenders, underwriters and managers of other people's money.

Even if the banks continue to skim the cream of the market after being separated, due to their distribution services, forcing them to relinquish ownership of the funds would ultimately make yields more significant than who in fact owns the funds when they seek to raise money from the public.

Looking outside Israel, we find major asset management players with no relative edge in distribution and marketing. They compete against institutions that have more branches and agents, yet manage to flourish by outperforming the better-deployed rivals.

Trivial examples include mutual management firms such as Fidelity and Vanguard in the U.S. Their power doesn't lie in having more branches than Citibank or the Bank of America, but in their record of performance over time and their strong brand built over the years.

Strum's mistake in naming the problem matters not only because of the antitrust commissioner's special status, but also because Bachar's team might also succumb to the temptation of suggesting solutions for nonexistent or marginal problems, while neglecting to attack the heart of the matter, the real danger - the relentless dominance of the banks over the financial establishment.