Restart: Israel’s payments arena

Author: IFLR Correspondent | Published: 24 Sep 2019
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The Israeli payments arena has gone through a fundamental change in recent years. Among other things, new players have entered the market, ownership structures have changed, pricing rules have been recalibrated and volumes have increased. The coming years will determine the outcome of these changes and will set a new equilibrium between industry, users and regulators.

Rapid technological development, which is as dramatic as the industrial revolution, has created new methods of payments, such as dedicated payment applications with slick interfaces, near-field communication (NFC) technology, social media features for money transfers and electronic wallets. In addition, technology giants such as Google and Apple offer payment services and include them in their products. Another aspect of the technological revolution is the rise of the e-commerce giants, led by Alibaba, Amazon and eBay. These mega-retailers offer their clients an end-to-end service which includes payments and credit.

Aiming to enhance competitiveness in the retail and small business banking sector, a series of reforms were introduced in 2015

Millennials, born into the technological era, embrace new technologies and use the internet and their mobile phones for virtually everything, from buying clothes to registering onto academic courses. They expect financial services to be available, user-friendly and cheap, just like streaming music or buying shoes online.

These technological developments and social changes have coincided with post-financial crisis reforms and are in line with the dominant framework of competitiveness and fairness. Politicians and regulators around the globe have introduced various initiatives, such as the EU Payment Services Directive (PSD 2) and open API initiatives, that aim to enable new technologies and open payment systems to new players.

The Israeli case: global trends with local adjustments

Israel is also experiencing a technological and social revolution, which has been further accelerated by its young population and its 'start-up nation' characteristics. However, substantive efforts had to be invested in to enable the payments system to be prepared to absorb those trends.

The main payments systems in Israel are the following:

  • Zahav – a real time gross settlement (RTGS) system. Its name, Zahav, is the Hebrew acronym for real time credits and transfer, and it is operated by the central bank, the Bank of Israel (BOI). It is used for transferring relatively large amounts, including cash settlements of the stock exchange clearing house.
  • Banks' Clearing House. The commercial banks, the postal bank and BOI are members of Bank's Clearing House, which primarily provides two services. The first is inter-bank credit and debit movement clearing, operated by a designated corporation: Masav. This system is used for money transfers which are not executed through Zahav, with designated modules that enable the withdrawing of money from one bank account and its distribution to multiple payees such as employees, tax authorities, provident funds or suppliers. The second service is paper-based clearing, mostly cheques, which are still a popular means of payment.
  • Continuous linked settlements (CLS). This is the global foreign currency clearing system used for cross-currency transactions.
  • Credit card purchases. All credit card transactions are operated through Shva, a company that provides a communication service between merchants and acquirers and that operates the acquiring process.

The Israeli banking sector remains highly concentrated, dominated by two banking groups whose combined market share is about 60% in terms of asset size and profit. Two other banking groups share another 30% of the market, while the remaining 10% is shared by three other banks and four global bank representatives. Three credit card companies operate in Israel, and until recently they were owned by the three largest banks. Masav and Shva were established by the banks and were owned and controlled by them.

Aiming to enhance competitiveness in the retail and small business banking sector, a series of reforms were introduced in 2015 by the Ministry of Finance and the BOI. A major component of the reforms was directed to the payments system and in particular to the credit card market and the clearing systems operated by Shva and Masav.

The amendments included the forced sale of two of the three credit card companies owned by the two largest banks

The amendments included the forced sale of two of the three credit card companies owned by the two largest banks. In an unprecedented step, the two largest banks were required to sell their credit card companies. The stand-alone companies would compete with their previous owners, mainly in the retail sector. In addition to the forced sales, the banks were prohibited from issuing their own credit cards directly and obliged to use at least two credit card companies to issue cards.

As part of the reforms, the banks were not allowed to hold more than 10% of either Shva or Masav, and therefore had to sell their excessive holdings. The reforms also enabled the granting of licences to new players and the BOI has since granted licences to two new acquirers, though they were still not operational by mid-2019. The licensing was accompanied by regulations that eased the capital requirements on small acquirers and that will force the current credit card companies to provide processing services to the new players.

As a complementary measure, interchange fees were reduced such that the maximum interchange fees will be gradually reduced between 2019 to 2023. The maximum fee for deferred debit transactions, which are the most credit card transactions, was reduced from 0.7% to 0.5%, while the maximum fee for immediate debit transactions was cut from 0.3% to 0.25%.

As part of the struggle against money laundering, legislation for limiting cash transactions was also introduced. Starting in January 2019, limits were set on the amounts that could be paid in cash and with cheques. The new law is expected to increase the use of electronic means of payment, either through money transfers or credit card transactions. The key challenge for the new law will be enforcement, due to the nature of cash transactions. In a related effort, in January 2019, the Knesset enacted a new payments bill based on the EU PSD 2. The bill sets a legal framework for new means of payment and for future technological developments and it requires high standards with regards to customer protection.

The reforms and their repercussions

The 2015 reforms were followed up but their outcomes have not necessarily been as expected. As required by law, the two largest banks sold their credit card companies. One company, Leumi Card, was sold to US private equity firm Warburg Pincus. The other company, Isracard, was sold by issuing shares to the public via the stock exchange. The banks also sold their excessive holdings of Shva and Masav. But it seems that the overall results of the reform are more complex than anticipated, due to several reasons.

The reforms changed the position of the credit card companies. Under the banks, the credit card companies built strong issuing brands. Under the new regime, the credit card companies were sent backstage with regard to the issuance of bank cards, which increased the importance of the non-bank cards. As a result, competition from on large customer clubs such as retail chains increased, strengthening the relative position of the retailers.

As mentioned above, the interchange fees are on a gradual tapering path, making the acquiring business less profitable which may result in an increase in other sources of income.

Competition from large customer clubs such as retail chains increased, strengthening the relative position of the retailers

The banks also developed payment applications of their own, with the three largest banks introducing payment applications that were not only offered to their customers. These applications enable payments between individuals. However, their aim is to provide payment services to businesses, making credit cards redundant. The BOI set some limits on these activities, and it will consider them more in the future.

Global online retailers and technology giants may shuffle the cards as in Israel, like in many other countries, online shopping is increasing. In many cases, online transactions are cleared through the retailer's accounts or via a service such as PayPal, reducing the volume processed by credit card companies. Technology giants such as Apple or Google have not yet introduced their financial services in Israel, but when they do that it will impact the payments industry.

The new credit card acquirers have not started their operations. In addition, to finalise their operative readiness and licensing requirements, the new acquirers will need to be linked to Shva's credit card system. As it stands, Shva only serves the three exiting credit card companies, so it will need to make substantive investments to enable their systems serve other processors.

The EMV standard, a global standard for credit and debit payment cards based on chip card technology, has not yet been implemented. At the end of July 2019, only 26% of the point of sale systems (POS) in Israel are EMV POSs (according to Shva's CEO) that enable the use of new technology such as NFC and may make services such as Apple Pay available in Israel. The cost of replacing the existing POSs is the main obstacle for moving to the EMV standard.

Only time will tell whether the reforms have achieved their goal. The playground is now defined, and existing and new players will have the opportunity to shape it and to leverage their investments.

The views in this article are the private views of the undersigned writers, and 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 endeavour 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

Hila Keren-Erez
Senior banking partner, KPMG Somekh-Chaikin
Tel-Aviv, Israel
T: +972 3 6848244
M: +972 52 8540027

Hila Keren-Erez is a senior banking partner at KPMG Israel with over 20 years of experience in the financial sector.

Hila has led complex engagements with leading banks, credit card companies and investment houses, in addition to her leadership roles in KPMG Israel Financial Services practice (FS).

Hila is a member of the liaison committee between the Bank of Israel and the Institute of CPAs in Israel (ICPA), which deals with the complex accounting and regulatory challenges of the industry.

About the author

Dan Gan-Zvi
Banking thought leadership manager, KPMG Somekh-Chaikin
Tel-Aviv, Israel
T: +972 3 6848532
M: +972 52 6060659

Dan Gan-Zvi is a manager at the KPMG Israel financial services (FS) practice, and heads knowledge management and industry expertise for 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.