The Importance of Stability

Continuing economic stagnation, and the government's unsuccessful attempts to find creative means of jump-starting the economy, have encouraged senior officials in the Finance Ministry and the Prime Minister's Office to try to divert the blame.

Continuing economic stagnation, and the government's unsuccessful attempts to find creative means of jump-starting the economy, have encouraged senior officials in the Finance Ministry and the Prime Minister's Office to try to divert the blame. As usual, the target they've found is the Bank of Israel, which is responsible for attaining price stability in the economy, and also for maintaining stability in the banking system.

A year ago, in an earlier round of blame-throwing, Bank Governor Dr. David Klein was targeted. Threats about his removal circulated in order to force him to significantly lower interest rates. This time around, the threats are aimed at the Bank of Israel's Supervisor of Banks, Yoav Lehman, who has clamped limits on activities of big borrowers in the economy. In a private meeting, the Prime Minister's Office Director-General Avigdor Yitzhaki recently criticized Lehman harshly, and threatened to oust him (even though he lacks authority to do so). The background to these threats was an order issued by the Lehman to toughen limits on the conferral of credit to the economy's largest borrowers.

Lehman is concerned about the concentration of credit in the economy. He fears that such concentration could undermine the stability of the nation's banking system. According to a Bank of Israel study, in 2002 1 percent of debtors in the economy received 71 percent of bank credit - a figure that indeed reflects a very high level of concentration.

The bank supervisor set a new criterion for the definition of a borrower group. Under this definition, should borrowers be linked in such a way that harm to the financial stability of one of them is liable to undermine the stability of another, or if the same factors are liable to damage the stability of both entities, then both will be regarded as belonging to one borrower group. The Bank of Israel prohibits the banks from providing to one such borrower group credit on a level that exceeds 30 percent of the bank's capital; and so the practical meaning of the new policy is to reduce significantly the supply of credit to major borrowers, particularly those who are connected to one another in partnership arrangements.

This new policy has already scuttled the planned merger of cable television companies, because both Eliezer Fishman and the Dankner family were unwilling to assume full responsibility themselves for the debt incurred by the new, amalgamated, cable company.

Pointing to the economy's high level of concentration, accountants warn about the implications of the bank supervisor's new order, saying that it will further aggravate ongoing credit problems faced by tycoons like Fishman, the Dankner family, the Ofer brothers, and others.

Such warnings issued by accountants, bankers and businessmen should not be ignored, since they express genuine concerns about business collapse. Yet these warnings should be counter-balanced by a consideration of the larger picture: we must ask tough questions about the costs entailed by the continuation of huge lines of credit to a small group of borrowers, whose members are connected to one another.

Lehman argues that the cost of such increased concentration is instability in the banking system. He has therefore taken steps to limit such concentration. In practical terms, Lehman is encouraging the economy's largest credit takers to search for financial sources outside of Israel's banking system; possible alternatives are foreign banks, insurance companies and outlets on the capital market. Israel's banking system cannot be expected to bear all the risks of credit provision in the economy.

In fact, even in the absence of the deep, continuing stagnation which has gripped the economy in recent years, it is wrong to place the entire burden for the provision of finances to the private sector in Israel in the hands of the banks. The banks, which have for years had unchallenged control of the credit market, have in the past blocked the aspirations of potential competitors due to partisan, internal calculations; and they have not encouraged the development of alternatives in the capital market. Today, the banks themselves realize that if they are to continue to finance business firms, they must share risks with other institutions and forces. Some bankers are pleased by the new restrictions enforced by Lehman, since the new policies help banks reject credit requests submitted by major clients, requests whose risk levels have increased substantially. The new restrictions stop such customers from complaining about cut-off credit lines.

Yitzhaki's threat to dismiss Lehman on account of the bank supervisor's energetic activity to stabilize the banking systems seems influenced by connections with a small group of business interests (borrowers); and the threat does not seem to be predicated upon a view to the larger public interest. A stable banking system is a supreme public interest. Even the tycoons in whose name Yitzhaki threatens to dismiss Lehman have an interest in such stability. Some of these tycoons, as in the case of the Dankner, Ofer and Arison families, even have ownership interests in the banks.