In recent days, there
has been significant progress in the efforts to promote competition in the
financial system, with the presentation of the Strum Committee’s main
recommendations to the government, and the publication of the outline for
establishing new banks by the Banking Supervision Department.  I would like to take this opportunity to
thank the committee members, Committee Chairman Dror Strum, and obviously the
Minister of Finance, who put these issues on the agenda and acted to establish
the joint committee.  The agreements the
committee reached, and the agreements concerning the establishment of the
National Credit Register in conjunction with the Ministry of Finance and the
Ministry of Justice will generate a change that will serve the public.

 

In my remarks today, I
would like to present the Bank of Israel’s philosophy regarding the desired
model of competition in the Israeli financial sector, particularly as it
relates to the banking system.  While
doing so, I will clarify how our position relating to the correct
implementation of the reforms in this area was formulated.

 

The desired
competitive model must be built looking at a number of dimensions, which I will
detail, and the various reforms intended to increase competition in Israel must
be developed on this basis.  Before I get
into the details, I would like to say now that there is room for change in the
competitive model in the Israeli banking and financial system, as agreed upon,
such that will increase competition in the household and small business
sectors.

 

The first dimension
relates to the unique characteristics of the banking sector as opposed to other
sectors in the economy.  I note at the
outset that the banking sector is unique, the risks inherent in its operations
are large, and the realization of those risks would have serious social and
economic ramifications.

 

In short, the banking
system around the world is characterized by very high leverage and a short
duration of liabilities.  Creditors
(mainly depositors) are very dispersed and have no real ability to track or
monitor the bank’s activity.  The
duration of the banks’ assets is long, and their financial value is uncertain,
which creates and strengthens the traditional risk problem.  As a result, banks are more exposed than
other entities to default risk and to the contagion effect., and due to their
importance to the modern economic system, the social cost of their failure is
high.  We saw this in recent years with
the failure of many banks in the US and in European countries.

 

With these
characteristics, it is clear that competition in the banking sector cannot be
similar to competition in other sectors. 
History proves that if we permit and even encourage the banking and
financial system to engage in unlimited competition in favor of the profit
line, the price paid by creditors, and the economy as a whole, meaning the
entire public, is too heavy to bear.  It
is therefore important to support the competitive model that will be chosen
with proper regulation.

 

The second dimension
relates to the question of what objectives we want to achieve by increasing
competition.  In general, competition
should lead to three main results: (1) the development of the financial sector,
including greater efficiency of financial services; (2) increased accessibility
and lower prices for financial services to companies and households; and (3)
innovation and improvement of the banking service and product, and adapting it
to the customer.  In other words, without
competition, our banking system will not develop, service to the consumer will
be negatively impacted, consumer confidence in the system may be harmed, and in
the end, it could also have implications for stability.

 

I mentioned the
stability of the system, and I now come to the third dimension, which relates
to the questions of whether there is a contradiction between stability and
competition, what the proper balance is between the level of competition and
protection of the stability of the system, and how to maintain it.  I have in the past spoken about the
importance of the stability of the financial system and the central role the
Bank of Israel plays in ensuring it.  I
would mention that maintaining stability of the system is a public interest,
which first and foremost serves bank customers—meaning the broad public.  Stability relies to a large extent on public
confidence in the banking system, which increases the more the system is fair
and competitive.  When this is
understood, we can even see competition and stability as complementary factors
that strengthen each other.  The aim is
to achieve the proper balance between the two, and this is a constant
challenge.  Even in the UK, the only
country that has entrenched the regulator’s role of promoting competition in
legislation, the promotion of competition is an objective that is subordinate
to the main function of the regulator, which is maintaining stability.

 

Given these three
dimensions, the last dimension, which completes the picture, relates to an
analysis of the existing structure of the banking system, while identifying the
competitive failures inherent in it, and accordingly, selecting the places for
regulatory or legislative intervention.

 

Such an analysis has been
conducted in-depth by the Bank of Israel, as part of our role in the Strum
Committee.  I will now briefly present
the main points of that analysis.

 

The financial system
in Israel has been changing in the past few years, and currently has a broader
variety of players, with the banks remaining the most prominent among
them.  But alongside the banks,
institutional investors are becoming more important, and nonbank financial
entities, as well as the fintech industry, are developing.

 

·       
The banking system’s share
of the credit to large corporations market has been gradually declining, and
institutional investors have become a significant player, creating an
alternative to the banking system.  As a
result, there is no dispute that the credit to large corporations market
features a high level of competition.

·       
The area of mortgages also
features very high competition, as well as informed consumerism by customers
themselves, who make comparisons before signing a transaction, even within the
current structure of the banking system. 
This is also a result of the fact that housing credit is backed by
collateral, which significantly reduces the risk and the problem of asymmetry
of information.

·       
The segments where there is
room to continue acting to increase competition are the small business sector,
and to a certain extent, the household sector (other than housing credit).  In these sectors, the banks are the dominant
credit supplier and the spreads are still relatively high, despite the rapid
growth in the supply of bank credit and the decline of spreads to these sectors
in recent years.

 

How, then, do we
promote competition in the financial system in general and in the banking
system in particular?  How do we expand
the competition that has developed in the business sector and in the mortgage
market to households and small businesses as well?

 

Expanding the supply
and increasing competition can be accomplished by bringing new agents into the
bank and nonbank credit markets, and by improving the competitive abilities of
both existing and new agents.  Those abilities
will be supported by, among other things, reducing the information gaps between
the customer and the (new) bank and between the bank and nonbank
agents—measures that were recommended by the Zaken Committee and implemented by
the Bank of Israel, and which will now be expanded with the establishment of
the National Credit Register.

 

The Strum Committee’s
recommendation to separate the two credit card companies from the large banks
is consistent with this strategy, and the Bank of Israel therefore supports
it.  These companies are financial
entities, the operations of which are currently the closest to a bank’s
operations, and the Banking Supervision Department has even developed an
outline for turning them into banks in a shortened process if they choose to do
so.

 

In parallel, the
Banking Supervision Department is promoting a lenient outline to establish new
banks from scratch, with the intention of handling barriers that existed in the
establishment of a new bank, and even to provide incentives for going in this
direction.  Thus:

 

·       
In relation to the capital
barrier—The capital requirements of new banks will be significantly lower than
what has been customary until now, once the required infrastructure is
established to manage the risks inherent in this;

·       
In relation to the IT
systems—The Banking Supervision Department will make it possible for new and
existing banks to operate without an independent computer system, but via an
outsourced joint computer and operational infrastructure.

·       
In relation to the barrier
resulting from the need for a broad network of branches—A number of months ago,
the Banking Supervision Department published a directive reflecting a change in
supervisory policy regarding banking through means of communications, which
makes it significantly easier to offer a full variety of banking services
directly, without branches, through service centers, via the Internet, and
through digital applications.

·       
There is also a barrier
resulting from uncertainty of the process. 
The process of obtaining a bank license will be simpler and subject to a
predetermined timetable, thereby creating greater certainty for investors.

·       
And in relation to the
information barrier—In addition to the Banking ID that every customer received
beginning this year, we are promoting the establishment of the National Credit
Register at the Bank of Israel.  This
register is expected to reduce the information gaps between the bank and the
customer and between the bank and competing entities, and will serve as an
essential tool for new banks to properly price the credit they provide.

 

In addition, we are
supporting and incentivizing the banks to become more efficient and to use new
technologies, which can lower the costs of credit and of managing deposits in
the banking system, and enable them to offer more convenient services adapted
to the customer and in real time.

 

These are very
significant steps, which constitute a change in our supervisory policy.  So what has caused the change in philosophy
at the Bank of Israel?

 

I would like to
mention that a little more than a decade ago, a number of small banks in Israel
failed, and the various studies in this field showed that small banks do not
contribute to competition (mainly because of the large fixed costs that created
large disadvantages to being small), but they definitely had a negative effect
on stability.  Accordingly, supervisor
policy actively made it very difficult to establish small banks.  In view of this, the Bank of Israel’s focus
in the following years was to improve competition within the banking
system, and broad reforms were made by the Banking Supervision Department to
encourage competition by improving the position of consumers.

 

The developments in
the financial system in Israel and around the world, technological changes that
can significantly reduce the costs of automation and the need for a network of
branches, and that in any case decreased the advantage of size, alongside
attention to public discourse on the matter, led the Bank of Israel—as happened
with regulators in other places in the world—to reassess the existing
competitive potential in the activity of small banks.  These banks will be able to operate and
specialize in niches that will give them a competitive advantage, while relying
for instance on technologies that reduce fixed costs.  We believe that in addition, the removal of
the barriers I outlined, which will make it significantly easier to establish
new banks, can lead to improved competition in the banking field, whether
directly or by creating a competitive threat.

 

Similar to the
significant measures taken in the Zaken Report to improve competition in the
financial sector, which are only now beginning to have initial positive
effects, we will need to be patient in order to examine the effects of the
measures currently being implemented by the Banking Supervision Department and
those recommended by the Committee to Promote Competition.  We must remember that a change in the
financial system requires steps that are informed, thorough, and long-term, as
well as a little patience.  I can promise
that all of the many steps we are taking in the area of competition are being
taken responsibly, after a serious and professional examination of the benefits
and possible risks that may result from each and every step.  This is critical to the success of the
measures while minimizing the risks existing in the process.

 

A complementary and
necessary step for implementing the recommendations to promote competition,
which is also a condition for granting some of the leniencies in the outline
for establishing new banks, is the promotion and improvement of tools to handle
a bank in stress and a failing bank, including deposit insurance.  These tools, which have become very
commonplace around the world, inter alia due to the lessons from the Global
Financial Crisis, will provide a safety net in a case where a bank encounters
difficulties, so that the damage to depositors, the financial system, and the
economy as a whole, will be moderate.

 

One more word of
caution, to conclude:  The trend of
growth in credit to households is continuing rapidly, and we therefore must
cautiously examine the many initiatives to further increase the supply of
credit to this sector.  From the
standpoint of the borrowers, the increase in the volume of credit may lead to
overleverage and an increased burden of repayment in the future.

 

The economy is
currently in a period of growth, although slower than in the past, in a
near-zero interest rate environment and full employment.  Possible changes in any one of these parameters,
such as an increase in the interest rate or unemployment, may endanger the
financial state of households and small businesses, and make it difficult for
them to meet their obligations.  The
strength of the damage that a financial crisis may cause requires us to be
extra careful when implementing reforms in the financial services industry, and
to learn the lessons from international experience.

We must remember that a collapse of a financial agent may cause contagion and a
negative impact to confidence in other financial agents and the reputation of
the financial system as a whole.  For
these reasons, it is important that increased competition in the credit market,
which is important on its own, be accomplished with caution, while paying
attention to the developing risks and with proper supervision of the new credit
suppliers.  The Committee for Financial
Reform, which is expected to be established soon, and which will be comprised
of the various regulators in the financial system, will have an important role
in ensuring the monitoring, early identification, and timely handling of risks
to the financial system.

 

In summation, the
continued implementation of the significant processes I have outlined, which
reflect a long-term view of the good of the consumers and the economy, will
lead to a significant change in the competitiveness of the financial system
without endangering stability or negatively impacting consumers.  Therefore, it is important now to focus on
the implementation of the reforms.  These
are large changes and we must enable the system to become accustomed to them
and to reach the new equilibrium that will be created as a result of the
changes and reforms.

 

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