Regulation as a business enabler: the Israeli case

Author: | Published: 5 Sep 2017
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The Israeli Supervisor of Banks has introduced several regulatory initiatives aiming to encourage banks to improve business efficiency and management. These initiatives reflect the understanding of the regulator that a sustainable business model is crucial for the stability of the banking system; and enabling that is a key role of the regulator.

The great recession shaped the regulatory environment

Since the 2008 financial crisis and the following great recession, regulators around the globe have been focusing on strengthening the stability of the financial system. The scale of the crisis and its deep impact led to the conclusion that stability is the key for sustainable growth, and any decline in profits due to tightening regulation is less damaging than the potential impact of a financial crisis. The change of the regulatory framework collided with other challenges that the banking system has faced, such as dealing with the low interest rate environment, the rapid technological changes and the need to be attractive and relevant to millennials. As major components of the post-crisis regulation have been implemented, regulators and political figures indicate that it is time now to absorb the changes that were introduced and to stabilise the regulatory framework itself.

The Israeli experience: similar but different

Israel and its financial system did not experience the financial crisis and the great recession. The contrary is true. The Israeli economy continued to grow in the last decade and its banking system was sound and stable and did not need financial support. However, the Israeli Supervisor of Banks (the Supervisor) has adopted the major components of the Basel III regime, mainly the capital and liquidity requirements, with local adjustments. Thus, Israeli banks are required to hold 9% of Core Equity Tier 1 (CET1) capital, as of January 2015, while the two largest banks are required to hold 10% of CET1, as of January 2017. It is important to mention that the Israeli banks implement the standardised approach of Basel credit rick requirements. The liquidity coverage ratio (LCR) has been implemented in Israel since 2015, with full implementation from April 2017. The CET1 capital requirements for Israeli banks are higher than the minimum capital requirements set by the Basel Committee. In addition, the timetables for full implementation of the capital and liquidity requirements are shorter than the global standard.

A unique banking reform

The Israeli banking sector is highly concentrated and dominated by the two largest banks (see Box). Banks are the owners of the three credit card companies that provide issuing and acquiring services. Negative public sentiment about the banking system, together with its concentrated structure, was reflected in the political arena in recent years. Eventually a comprehensive set of legislation was introduced that aimed to enhance competitiveness in the banking system by forcing structural and other changes.

Israel banking sector structure

The banking sector is comprised of five major banking groups alongside several small banks and a subsidiary and branches of global banking groups. The market share of the five largest baking groups is over 95% in terms of asset size and net profit.

The main law of the reform was enacted at the beginning of 2017, while complementary legislation was introduced in the last two years, both by the Israeli parliament (the Knesset) and by the Bank of Israel (BoI). The various changes are expected to take place in coming years, and their main components are as follows:

  • Forced sale of credit card companies. As noted above there are three credit card companies in Israel, all of them are owned by banks. The two largest banks are required to sell their credit card companies within three to four years. Since the credit card companies have a large client base, IT and operational capabilities and risk management infrastructure, they may be able to compete with their former owners and the rest of the banking system in a relatively short time.
  • Closing the information gap between banks and potential competitors. Banks hold credit history records of a large portion of the population, which provides them with an advantage with regard to risk assessment and pricing. Two initiatives were introduced in order to close this gap: (1) a central credit repository (CCR) is being established in the BoI, as an infrastructure of the credit data sharing system; and (2) banks will be required to provide a view access to clients' accounts information for any entity that will receive client permission. These initiatives will enable non-banking credit providers to offer competitive pricing.
  • Allowing institutional investors and other non-bank financial entities to grant credit to retail and small business customers. In general, Israel law prohibits banks from providing insurance products and prohibits insurance companies from providing banking services. This separation is also applied to holding and ownership, as banks and insurance companies are not allowed to be part of the same group or be controlled by the same shareholders. As part of the reform, insurance conglomerates and other non-bank financial entities are allowed to provide credit to the retail and small business sector and to compete with the banks on this population.
  • Sharing of IT resources by small banks. Until recently, all banks were required to own and maintain their main IT systems. For a small bank, this requirement puts a heavy burden on its budget. The reform changed this by allowing small banks to share IT infrastructure and hence to cut IT expenses substantively.
  • Easing licensing requirements of new banks and credit card acquires. The BoI eased the licensing requirements of new banks and credit card acquirers, mainly small ones. Inter alia, the BoI will be committed to take decisions in a pre-defined timeframe and it will lower the initial capital requirements of a new bank. Some of these changes will be applied after completion of the establishment of the CCR, introduction of a deposit insurance system and setting a recovery and resolution regime for banks.
  • Enabling more competition in the credit card processing market. As noted above, there are three credit card companies in Israel and all are owned by banks. The IT and communication infrastructure that is used in the credit card transaction processing is managed by a company (Shva) owned by several banks. The reform introduced several measures to enable potential competitors to enter the market: (1) licensing rules for acquirers had been adjusted and the BoI granted a new acquirer licence during 2017, subject to completion of certain requirements; (2) the IT infrastructure provider (Shva) is required to provide access to new acquirers so they can execute transaction processing; and (3) the ownership of Shva should be changed so other entities can purchase its shares.
Market share of the five largest Israeli banks

Asset Net Profit

NIS millions
Poalim group 448,105 2,628
Leumi group 436,603 2,791
Discount group 219,577 905
Mizrahi-Tefahot group 230,455 1,266
FIBI group 127,907 521
Data is based on Bank of Israel publications regarding the financial statements of banks as at December 31 2016

New ecosystem means new challenges

The reform of the financial sector and its expected impact on revenues and profit came on top of other pressures on the core business model of the banking system. Banks are dealing with major challenges such as the rise of alternative banking services providers, the tightening regulation and enhanced enforcement,high operating costs and the low interest rate environment

Some of these challenges have unique characteristics in Israel. For example, the employment agreements in the banking sector include unique components due to historic reasons and powerful labour unions. Inter alia, the agreements include annual salary increases in certain percentage, the need to get the approval of labour unions before laying off employees and implementing organisational and structural changes and other terms. Another example is the rise of rent and lease costs in recent years, which put a heavy burden on banks that have a branch network, IT premises and large back office and headquarter units.

These characteristics are reflected in the banking sector's financial results. The efficiency ratio measures cost to income, and it is a common indicator of the operational efficiency of a bank. According to a comparison performed by the Supervisor of Banks, the average efficiency ratio of the Israeli banking system is higher than the average efficiency ratio of banking systems in the OECD countries.

Efficiency ratio of the banking system (2014-2016 average)
Israel OECD average
69.4 64.2
Source: 2016 review of the Israeli banking system, the Supervisor of Bank, May 2017

Supervision and regulation as support to the business model

The Supervisor has introduced several initiatives to address these challenges in recent years. These initiatives reflect the understanding that a sustainable business model is crucial for the stability of the banking system, and enabling it is a key role of the regulator. The main initiatives are as follows:

  • Encouraging reduction of labour costs. The Supervisor publicly raised the need to reduce the number of employees and to adjust the employment agreements to reflect the current reality. In addition, adjustments to regulation were introduced to support banks in executing these measures. As a result, banks did take care of the labour cost challenge. Over 1,900 employees (about 4% of the banking labour force) left the banking system during 2016, and more layoffs are expected on 2017 (according to the 2016 review of the banking system, the Supervisor of Banks, May 2017). For example, one of the largest banks in Israel has announced that at the beginning of July 2017 it approved an early retirement program for 500 to 600 employees (about 4% of its labour force). In 2016, the same bank reduced its labour force by more than 1,000 employees (about 8%) according to its financial statements.
  • Encouraging reduction of other costs. The Supervisor encourages banks to reduce other costs as well. The same regulatory adjustments that applied to reducing labour costs will be applied to reducing headquarter costs by moving them out of the high cost central business districts to zones with lower property taxes and other costs.
  • Encouraging technological changes. The Supervisor established a dedicated innovation and technology division. This division promotes the adoption of new technologies in the banking sector, including payment systems. The Supervisor eased certain requirements that limited the use of direct channels, while strengthening information security requirements and promoting coordination among banks with regard to cyber threats and attacks.

A strong regulatory framework is the foundation of a stable financial system, while regulation that supports a sustainable business model is no less important. A profitable financial sector is able to provide credit, which is essential to the benefit of all stakeholders as well as to the growth of the economy. The Israeli Supervisor of Banks has always adopted and promoted a strong regulatory framework, which has supported the strength of the banking system in Israel that guided Israel through the 2008 crisis undamaged. However, the recent BoI initiatives aiming to support the business model show a refreshing and innovative approach to regulation. This trend is welcome and recommended to be adopted by other jurisdictions as well.

The views appearing in this article are own private views of the undersigned writers, and they do not necessarily reflect the official views of KPMG in this particular area. The information herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

About the author

Eileen Toledano

Partner and Head of Financial Services, KPMG Somekh-Chaikin
Tel-Aviv, Israel
T: + 972 (3) 6848120
F: + 972 (3) 6848444

Eileen Toledano heads the KPMG Israel financial services (FS) practice with over 30 years of experience in the financial sector. The Israel Financial Services (FS) practice includes Audit well as Advisory Services.

Toledano is involved in both national as well as global KPMG projects, and is a member of the Global KPMG Fintech Community of Interest. Toledano is the chairperson of the liaison committee between the Bank of Israel and the Institute of CPAs in Israel (ICPA), as well as a member of various subcommittees of the Israel Securities Authority.

About the author

Dan Gan-Zvi

Manager, Thought Leadership, Banking, KPMG Somekh-Chaikin
Tel-Aviv, Israel
T: + 972 (3) 6848532
F: + 972 (3) 6848444

Dan Gan-Zvi is a manager at KPMG Israel financial services (FS) practice, leading knowledge management and industry expertise of the banking sector. In addition, Gan-Zvi is involved in various audit and advisory projects of banks and credit card companies.

Prior to KPMG, Gan-Zvi worked for the regulation unit of the Supervision of Banks department at the Bank of Israel.




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