Innovation and Competition: The changing landscape of the Israeli banking sector

Author: | Published: 30 Sep 2016
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The Israeli banking sector may be on the verge of a fundamental change in its structure and business environment. Various legislative initiatives are aiming to reshape the banking sector, inter alia by make it easier to establish new banks that will compete with the existing banks in providing credit to retail and small business customers. These legislative initiatives were triggered by public and political changes and this is alongside the forces of the technological revolution and the unique characteristics of the generation that is new to the workforce and the client base.

The various initiatives provide opportunities as well as challenges to potential newcomers and to the current players. Only time will tell how these initiatives will actually change the markets, and now is the time for entrepreneurs and investors to be part of this change.

The current structure of Israel banking sector

The Israeli banking sector is highly concentrated, dominated by two banking groups, whose combined market share is about 60% in terms of asset size and profit. In addition to their market share, the two largest banking groups own two out of the three credit card companies that operate in Israel. Two other banking groups share another 30% of the market share, while the remaining 10% is shared by three other banks and four global bank representatives.

The structure of the banking system is a result of a consolidation process that had been taking place over the past few decades. This process took place partially due to the policy of the Bank of Israel, the central bank that is in charge of banking supervision, after the collapse of several small banks at the beginning of the 2000s'. The 2008 crisis and its outcome enhanced this trend because complying with post-crisis regulations, such as increased capital requirements and an enhanced control environment, is much more challenging to a small bank with limited resources and capabilities.

One of the main challenges of the banking sector is its relatively high costs, mainly the costs of its labour force. Measured by two common ratios, the efficiency ratio and the average cost ratio, the Israeli banking system seems to be less efficient than the most OECD banking systems (source: 2015 annual review of the Israeli system, the Bank of Israel, June 13, 2016). In times of decrease in interest rate spreads due to the lower interest rate environment and the increasing digitation, the need to lower labour cost is crucial. The Bank of Israel expressed its concern about this challenge, and in a letter issued at the beginning of 2016, it required banks to prepare long-term efficiency plans. In an unprecedented initiative, the Bank of Israel will provide capital reliefs by reducing capital targets for a transitional period for the cost deduction gained by these plans. This is in addition to other measures of the central bank to encourage deduction of costs of the banking sector.

Market share (in %) of the Israeli banks

Asset market share (%) Profit market share (%)
Poalim group 29.7% 36.3%
Leumi group 28.70% 33.40%
Discount group 14.10% 8.80%
Mizrahi-Tefahot group 14.40% 13.30%
FIBI group 8.60% 5.20%
Others 4.50% 3.00%
Total 100.00% 100.00%
Data is based on Bank of Israel publications regarding the financial statements of banks as at December 31, 2015

Public figures have been challenging the concentrated structure

The concentrated structure of the banking system has been criticized by political and public figures, claiming that it prevents competition and that it is actually a duopoly of the two largest groups. According to the critics, the lack of competitiveness is reflected in high fees and interest rates paid by the retail and small business customers, together with lack of credit supply to these populations.

One of the notable critics of this concentrated structure is the incumbent Minister of Finance ("the finance minister") who took office in May 2015. Enhancing the competitiveness in the banking sector was put on the top of the agenda of the Finance Ministry. The Bank of Israel also announced that it will support various measures that will enhance competitiveness in the banking sector.

As a result, several unprecedented legislative initiatives were introduced in recent months

After discussions between the central bank and the Ministry of Finance, several initiatives were introduced, and currently they are in different stages of enactment. The various initiatives combined are aiming to strengthen the smaller banks, to increase the number of players in the banking system and to enable non-banking entities to compete with the banks. The focus of these initiatives is the retail and small business sectors. The main legislative initiatives are as follows:

Forced sale of two out of the three credit card companies owned by the two largest banks. As noted above, there are three credit cards companies in Israel, all of them owned by the banks. One of the major initiatives for enhancing competitiveness in the banking sector is forcing the two largest banks to sell their credit card companies. 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. According to the understandings between the Ministry of Finance and the Bank of Israel, currently the two largest banks will be forced to sell their credit card companies, and a decision about the third credit card company will be taken in four years. This initiative is unique and it may raise concerns about the expected increase of the household debt and the optimal supervisory model. In addition, the banks oppose this initiative, claiming that it breaches basic civil rights.

Establishing a central credit repository. To date, unlike most developed countries, there is not yet a credit scoring system in Israel. Because the banks do have credit history of a large proportion of the population, the lack of a central credit repository (CCR) gives them advantage in term of pricing and other terms of credit granting over non-banking credit providers. Thus, another infrastructure for enhancing competitiveness in the banking sector is the establishment of a central credit repository. This information sharing will enable the non-banking credit providers to compete with banks and consequently to increase the credit supply and lower fees and interest rates paid by the customers. Legislation for the establishment of a CCR was enacted in 2016, according which a CCR will be established and maintained by the central bank. Banks and other credit suppliers will provide the CCR with credit history information, while credit bureaus will score individuals based on the data stored in the CCR. The law sets an aggressive timeframe of less than three years for the completion of the CCR establishment.

Allowing institutional investors to grant credit to retail and small business customers. Under the current legal framework, banks are not allowed to provide insurance products and insurance companies are not allowed to provide 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. One of the initiatives of the finance minister is to allow insurance conglomerates 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. Currently banks are required to own and maintain their main IT systems. For a small bank, this requirement puts a heavy burden on its budget. According to the understandings between the Ministry of Finance and the Bank of Israel, this requirement will change so that small banks will be allowed to share IT infrastructure and hence to cut their IT expenses substantively. A regulation draft with regard to this was issued by the Bank of Israel, while the Ministry of Finance is considering allocating budget to support the establishment of a new banking IT infrastructure and thus making this initiative possible.

Easing licensing requirements of new banks. The Bank of Israel issued several drafts for easing the licensing requirements of new banks, mainly small ones. Inter alia, the Bank of Israel will be committed to take decisions in a pre-defined timeframe and it will lower the initial capital requirements of a new bank. Issuing the new drafts reflects some change of the policy of the central bank, which historically preferred the stability that comes with larger banks than the competitiveness advantages of having smaller ones. However according to the drafts issued, these changes will be applied after completion of the establishment of a central credit repository, introduction of a deposit insurance system and the setting of a recovery and resolution regime for banks.

Adjusting the supervision framework to support the suggested changes

As a complement measure to the various initiatives, the Ministry of Finance and the Bank of Israel discussed the desired supervisory model of the expected new environment. The main issues of the discussions were which body will be in charge of the supervision of the credit card companies after sold, how to ease some supervisory requirements to small and new banks, which body will be in charge of the supervision of non-banking credit supplier and more.

In addition to the legislative initiatives, the technological revolution makes its own impact

Israeli banks, like their counterparties globally, need to deal with the technological revolution. Peer to peer lending, payments, robo-advisory are only some of activities that had been performed by banks and are threatened by new Fintech entrepreneurs. The vivid start up ecosystem of Israel attracts financial institutions from all over the world looking for cutting edge technology and innovation. The generation that is joining the labour market and the client base uses technology naturally and is not attracted by old style face-to-face banking. From a competitiveness point of view, the Fintech initiatives are targeting the banks and forcing them to lower fees and interest rates. The Israeli regulators are seeking ways to encourage innovation and technological progress of the banking system and are considering the regulatory model of the growing Fintech community.

The future is being shaped today, as the financial system, newcomers and the regulators are setting the foundations for a new era. Now is the time for everybody to prepare so they will be part of the future and will not be left behind.

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
KPMG Somekh-Chaikin

Tel-Aviv, Israel
T+972 3 6848120
F + 972 3 6848444

Eileen 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.

Eileen is involved in both national as well as global KPMG projects, and is a member of to the Global KPMG Fintech Community of Interest.

Eileen is the Chairman 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
KPMG Somekh-Chaikin

Tel-Aviv, Israel
T+972 3 6848532
F + 972 3 6848444

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

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


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