Flug points to risks as banking competition work proceeds

The Israeli government approved a bill designed to increase banking competition in Israel on July 31, though Bank of Israel governor Karnit Flug said the legislation needed some further adjustment and threw up new risks.

The bill must still be passed by the Israeli parliament, but in its current form it enshrines the main recommendations of the "Strum committee", namely to separate Israel's two largest banks – Bank Leumi and Bank Hapoalim – from their card businesses.

The bill drops an idea raised in an interim report by the committee to separate mid-sized banks from their card businesses as well, which the Bank of Israel criticised at the time for fear it would damage the smaller players in the market, thereby reducing competition.

Flug welcomed the bill, but said policy-makers would need to deal with new risks that greater competition might throw up. She pointed to the "higher risk of collapse" smaller banks and more non-bank financial firms posed, and the possibility the reforms would encourage the trend of "rapid expansion" of credit to households.

"Therefore, it is important that increasing competition in the credit market, which is important on its own, be done carefully, with attention paid to developing risks and with appropriate supervision of the new credit providers," she said.

Staff at the International Monetary Fund expressed similar concerns in its assessment of the Strum committee's work, published on July 6. It said the reforms "explicitly encourage" the growth of shadow banking and warned there was "little international precedent" to inform the plans.

To help address the risks, Flug urged legislators to introduce deposit insurance, which was another recommendation of the Strum committee. She said such a "safety net" would help shield the rest of the financial system and economy in the event of an institution's collapse.

Flug said the bill would require "additional fine-tuning", particularly to determine the ownership structure of Shva, the company that provides the interface between card issuers and acquirers.

The Bank of Israel has already begun work in reforming the firm. "These changes include opening the Shva protocol and establishing the terms of access to the payment systems, which will allow the entrance of new players into the system," Flug said.

The Bank of Israel took forward its work on payments competition today (August 1), publishing the terms of access smaller players will have to meet to connect to payment systems operated by Shva and Masav, an automated clearing house.

"Publishing the terms of access to the controlled systems is an additional significant pillar in the measures that will enable additional entities to operate in the system," said Irit Mendelson, the central bank's director of accounting, payment and settlement systems.

The terms govern when an entity may connect directly or indirectly to the system, and clarify that those with direct access must provide "non-discriminatory" access to firms that wish to connect indirectly.

The announcement follows on from a July 18 report that made public the protocol governing the technical details of access to the Shva system.