The Bottom Line / Profiting From the Embezzlement

There was a highly unusual scene this week at the conference on bank profitability, held annually for the past 25 years by Tel Aviv University. This is usually a dull conference, not characterized by emotional gestures.

This time, the organizers saw fit to thank outgoing Supervisor of Banks Yitzhak Tal for his service, praising his work and achievements. Conference participants - mostly bankers with little love lost for regulators - didn't remain indifferent, honoring Tal with applause. This was not just a polite gesture, but real sharing of his joy, after Tal was informed this week that the state comptroller's report found a direct connection between his performance and the failure to uncover the embezzlement that led to the collapse of Trade Bank.

The state comptroller's report on Trade Bank published yesterday produced many sighs of relief at the Bank of Israel. In April 2002, shortly after the discovery of the fraud, Tal and Bank of Israel Governor David Klein were heavily criticized for their handling of the affair.

Tal explained that it is not his purview to identify fraud and that the banks' managements have a clear interest in doing it themselves. The state comptroller accepted that position.

The supervision of banks division sees its role as regulating the main risks to bank stability, namely credit risks, risks inherent in inflation linkage and interest rates, and market risks. The comptroller determined this approach is "reasonable."

The comptroller's report, which did find deficiencies in the banking supervision that were not directly related to fraud, reinforced the supervisor and recommended adding additional regulatory tools.

In contrast to its rigid reputation, the comptroller's findings regarding supervision of Trade Bank reveal a certain softness. Despite the fact the supervisor discovered many instances at Trade Bank of deviations from proper banking procedure, erroneous and even distorted reporting, as well as serious failures of management, the comptroller determines Tal did not utilize his powers and did not take legal action against the bank or its managers.

The impression arising from the report is that Trade Bank was a rotten institution with poor managerial standards that the supervisor of banks recognized in his audits. Nonetheless, no steps aggressive enough to deter were taken against the bank, its executives or its shareholders. "The supervisor's long-term abstention from imposing sanctions on the bank and its executives, after finding repeated violations, undercut deterrence from violations of proper banking procedure guidelines or of specific supervisory instructions to the bank," the comptroller writes. He recommends the supervision division give up understatement and subtle wording and adopt an aggressive approach when it identifies deviations at banks.

The comptroller recommends the Bank of Israel initiate legislation to authorize the supervisor to impose civil fines on banks and bank executives violating instructions or providing false statements regarding the correction of deficiencies, as occurred at Trade Bank.

If new Supervisor of Banks Yoav Lehman adopts the recommendations, it will be clear that the collapse of Trade Bank actually fortified him and conferred additional regulatory tools on him. Will this prevent future frauds at other banks? Not necessarily. The supervisor leaves that mission to bank managements, and now he has the comptroller's permission to do so.