Taking Stock / The Mammoths or the Foreign Banks?

Two weeks ago, David Klein detonated a bombshell. In an interview with Haaretz, the Bank of Israel governor declared that he saw the insurance companies as the source of competition to the banks.

As the man behind most of Israel's financial reforms in the last 15 years, Klein has been talking for years about the need to separate the banks from the provident and mutual funds they run. He has been propounding the need for the capital market to adopt a new structure from every soapbox. But this was the first time he was concrete, and named a candidate to take on the banks.

Like many others in Jerusalem and Tel Aviv circles (i.e. political and business), Klein feels the time is ripe. For years the banks had steamrolled over finance ministers and Knesset members alike. For years they crushed any attempt to legislate reform. Now growing public anger may give Finance Minister Benjamin Netanyahu, Knesset Finance Committee Chairman Avraham Hirchson and the other parliamentarians the courage to pursue genuine change.

Criminal records

Even before Klein had a chance to flesh out his vision, he drew fire from all directions. And indeed, earmarking the insurance companies as the chief competition for the banks is a highly problematic proposal.

We have devoted endless columns to the business models of the insurance companies, and how they and their agents made their living chiefly based on the ignorance of their customers.

Lately, the practices of the insurance companies have gained increasing exposure due to their remarkable profitability during the recession and their appetite for buying tangential businesses.

One morning the world woke up and discovered that the insurance companies had become mammoths nearing the size of the big banks. Rising against the monsters Bank Hapoalim, Bank Leumi, Israel Discount Bank and United Mizrahi Bank were companies that had generated billions for their shareholders in the last decade.

Is Klein unaware of the insurance companies' practices over the last decade? Does he not know that they charge some of their customers outrageous fees? Did he overlook the insurance cartel, which stained most of the records of the industry's executives with criminal convictions?

Klein's half-full cup

Klein must be fully aware of all that. But he desperately wants to find major business entities with distribution capacity and money management know-how that can compete with the banks and that have the wherewithal to buy the pension, provident and mutual funds from the banks.

The Finance Ministry hastened to rebut that it would be better for the banks to sell their fund holdings to foreign investment banks or asset management companies.

That is true: the main goal of separating the banks from their funds is to create a financing system outside the banks, while also improving the financial market. But another goal is to diversify the focus of power and policy-making. You can't achieve the first goal without the second.

The insurance sector is overly dominated by too few entities, and it is tightly tied to the banks and to banking shareholders. The insurance companies cannot serve to genuinely diversify power and policy design.

Bank Leumi is a partner in Migdal Insurance. Israel Discount Bank is a partner in Harel Insurance Investments. Bank Hapoalim has a stake in Clal Insurance, and The Israel Phoenix Assurance Company was acquired using massive loans from Bank Hapoalim.

Worse, even if the Bank of Israel forces the banks to relinquish their insurance holdings, it probably cannot sever the tight business relations in the clique of the banking and insurance owners.

A compromise

Just ask Shlomo Eliahu, who owns the Eliahu insurance company, which owns a third of Phoenix. He is also a partner in Union Bank of Israel and owns 10 percent of Bank Leumi. He'll tell you that all of 20 people control the banking and insurance world in Israel. They may compete with each other tooth and claw, but they also take care not to step on each other's toes, not to overdo it, and mainly not to trigger revolutions that would change the rules of the game.

And what if foreign investment management companies came to Israel and bought the banks' funds? Then we really might see a change in the game's rules.

The advantage of having foreigners run investment portfolios is that they wouldn't have the myriad interests that the banks and insurance companies have. They could recruit customers based solely on their performance.

The solution may be a compromise. The banks should sell their provident funds, pension funds and mutual funds to foreign investment management firms and to insurance companies, or to consortia containing both.

Which leaves one key question. Are these funds worth it? Will foreign investment management firms and insurance companies stand in line to buy them?

The banks' lobbyists at Knesset and the treasury pooh-pooh the whole concept. The funds can't be sold as stand-alone vehicles; there is the advantage of size to consider.

Maybe there's a grain of truth there. But clearly, the economic feasibility of buying the funds depends to a huge degree on regulatory decisions when they finally address capital market reform.

Come what may, the Finance Ministry and Knesset must not miss or castrate capital market reform, whining that there are no buyers or only the banks can do the job, and so on. No, it is their duty to find a comprehensive solution creating a new structure for the capital market - a structure in which NIS 1.4 trillion of the public's assets are not a toy for a club of 20 people, whose dearest wish is to keep things exactly as they are today.