The Bottom Line / Banking on the Market Failure

The Bank of Israel's Supervisor of Banks, in an unusual move, notified Bank Leumi that he opposed Leumi's plan to hike its commissions by 2 to 4 percent. Leumi fumed, but had to toe the line, and yesterday it announced that it was freezing the move. "We believe that increasing commissions at the present time is unreasonable and insensitive from the public point of view. Therefore, we oppose the rate increase you have requested," Deputy Supervisor of Banks Mordechai Fein wrote to Leumi.

The supervisor's intervention in the matter of commissions is exceptional. In recent years, he has made do with publicizing comparisons between the rates charged by different banks. The objective was to spur the banks to compete to get brownie points for being named the cheapest. But this incentive stopped working with Leumi. Although the supervisor's recent comparison indicated that Leumi (and Israel Discount Bank) charge the highest commissions, CEO Galia Maor favored the easy route of hiking the charges over the supervisor's pat on the back.

On the face of it, intervention by the Bank of Israel in matters such as rates and prices in a competitive market seems like over-regulation. But under the circumstances, such intervention is inevitable. Regrettably, Leumi's chiefs have put themselves in a situation in which the supervisor had no choice but to second guess their professional judgment.

The banks' costs did not go up over the last few months. Inflation since the beginning of the year has been negative, and in any case it is the household sector that generates most of the banks' profit - so it makes no sense to impose losses generated by other sectors on this cash cow. Competition between the banks in this sector is minimal, because the cost of moving between banks is too high. With such a market failure, the supervisor's intervention is quite justified.

But Leumi's plan to push up its commissions was also ethically wrong. Just like the rest of the banking industry, Leumi too has suffered a severe drop in its profit margin, caused by irresponsible loans that it extended to the business sector and by the recession. Normally, a bank would try to expand its sources of income and cut expenses. But Leumi picked the easy way out - imposing the entire burden on its clients, with executives and employees getting off scot free.

In 2002, CEO Galia Maor and Chairman Eitan Raff gave up 5 percent of their wages because of the slump, but in the beginning of 2003, their wages were raised again. Other executives refused to take salary cuts, and employees even received a fat bonus a few months ago, which totaled a few tens of millions of shekels.

When executives and employees are not made to feel the recession themselves, they cannot expect their clients to go on paying exorbitant commissions to cover the cost of the salary orgy at the bank. Only when the banking sector truly streamlines and stops paying oversized salaries and unparalleled 250 to 300 percent severance pay out of their clients' pockets will it be ethically acceptable for them to reach any deeper into those pockets.