Viewpoint / One Problem Solved, Two Created

So many proposals to reform the banks are making the rounds that it's hard to winnow the wheat from the chaff, let alone the good ideas from the dreadful ones. While most of the bank managers are making rounds of their own wearing their sad-clown masks, one honest soul took a time-out last week to put things into perspective. "It is the government's prerogative to reform the capital market and demand that the banks sell their provident fund holdings. But this matter with the local authorities comprises a complete breakdown of faith between the government and the banks. I don't see how the rift can be mended."

Some of the proposals tabled in recent months are genuinely needed reforms. But this business with the local authorities isn't another reform or legislative proposal to promote competition. It is something else entirely.

This rift was caused when the Knesset passed a law allowing the local authorities to pay salaries using tax and other money that creditors can't touch. Meaning, the municipalities could, and do, owe billions to the banks, but once they deposit tax and other income in a special account designated for salaries, the banks can't have any of it.

The law was designed by the treasury's budget director, Kobi Haber, helped by the deputy legal counsel to the Finance Ministry, Drora Lipshitz, and people from the Justice and Interior Ministries.

The law was born due to the dreadful mismanagement at certain local authorities, which accrued enormous deficits and debts and stopped paying salaries. Workers languished for months without pay, reaching the point of starvation. The law applies only to local authorities activating recovery plans, and ultimately aims to reduce government financing and involvement in the municipalities and councils.

And it does solve the problem of unpaid workers, an end that could have been achieved without legislation. The banks had agreed to give salaries higher priority.

But the law created two new problems.

One is that the banks won't grant a sou more in credit to the local authorities, not even to the ones doing perfectly well. That is because the banks' faith in the government's commitment to the local authorities has been shattered.

So instead of sipping coffee at the banks, the local authority chiefs are lining up at the treasury, asking for handouts. From this perspective, the law boomeranged. Now the startled treasury is starting to suggest compromises to the banks.

It isn't just that the banks are flexing muscles to frighten the treasury. Their change in attitude reflects the change in the risk environment of the local authorities, which leads to the second problem. Because loans to the local authorities have become riskier (higher probability of default), the Bank of Israel's Supervisor of Banks may intervene and demand more stringent capital requirements by the lending banks. That would make less credit available for businesses and households. And that would be a certainty if the MKs pursue various plans to adapt their initiatives granting more and more sundry bodies higher priority than the banks.