Stanley Fischer: Israel's economy and the challenges facing its banking
system
Address by Professor Stanley Fischer, Governor of the Bank of Israel, at the AGM of the Association
of Banks in Israel, Tel Aviv, 23 November 2006.
* * *
Mr President of the Association of Banks in Israel and Chairman of Bank Leumi, Eitan Raff; Executive
Director, Association of Banks in Israel, Freddy Wieder; my banker colleagues and colleagues from
the Bank of Israel; ladies and gentlemen: may I start by thanking the Association of Banks in Israel for
inviting me and giving me the opportunity to speak before you today.
I would like to relate first to the current state of Israel's economy, in which the banking system plays an
important role, both as an active, influential participant and as an entity affected by economic
developments. I will then address the challenges facing the new Supervisor of Banks and Israel's
banking system.
The economic situation
Israel's economy today is doing very well, even after the war in the north. Although activity slowed
during the war - reflected by a negative rate of growth in the third quarter - the latest indicators point to
a relatively rapid recovery of economic activity after the war.
The economy has enjoyed three years of rapid growth. In the light of the National Accounts data of the
third quarter published recently by the Central Bureau of Statistics, the Bank of Israel assesses that
GDP will grow by 4.8 percent in 2006. This is a high rate of growth by international standards, and
reflects a rise in investment and in exports, a surplus in the balance of payments, a very high rate of
foreign investment, increased productivity and an improvement in employment - and all this despite
the war's adverse impact on growth.
Budget data show that tax revenues have revived. The government's budget deficit in 2006 is
expected to be about 1.8 percent of GDP.
Inflation in Israel is low, and in 2006 is expected to be below the target, mainly due to the fall in oil
prices and the appreciation of the shekel. In accordance with the Bank of Israel's flexible inflation
targeting approach, our intention is to bring inflation back gradually to within the target range of 1-3
percent a year.
Ten-year interest rates in Israel are below 6 percent a year, and this is important to everyone who has
to take a mortgage. The markets are robust and stable.
Three main factors account for the economy's success and its ability to withstand the negative impact
of the war:
1. The structural changes that the economy has undergone in the last fifteen years.
2. The macroeconomic policy pursued by the government and the Bank of Israel before, during,
and after the war.
3. The background conditions that affect all of us, i.e., developments in the global economy,
and the security situation
Having said that, the economy is currently facing two important challenges: reducing the
government debt, and tackling the problem of poverty. I have spoken in the past, and will speak
again in the future, about the solutions to these problems. Today, however, as it is my intention to deal
with the problems currently facing the banking system, I will end this part of my address by saying that
Israel's economic situation is very good, but we must try to ensure that this continues and not rest on
our laurels. To you, the bankers, I would like to quote the English saying, "bad loans are made in good
times;" from a macroeconomic standpoint, we are now in good times.
The targets facing the new Supervisor of Banks
In the second part of my address I would like to talk about the banking system. The banking system
plays a very important role in every economy, and of course, in Israel's economy too. What is
important, of course, is that the banking system be stable, competitive, and fair, and that it serve all
its customers - households and the business sector - well.
First, I would like to thank the outgoing Supervisor of Banks, Yoav Lehman, for his 28 years of service
to the Bank of Israel and to Israel's economy, and I would also like to congratulate the new Supervisor,
Rony Hizkiyahu, and wish him success in confronting the important challenges facing him within the
Bank of Israel and vis-a-vis the banking system.
Within the Bank of Israel the Supervisor faces the vital and difficult task of managing a large, complex
department. The task is far from a simple one, particularly as it involves a transition to a new system of
supervision, i.e., Basel II.
The implementation of Basel II constitutes a major objective for the new Supervisor and the banks.
Although we gave high priority to the implementation of the Basel II guidelines by the banking
supervision and the banks, insufficient progress has been made so far. I must stress that Basel II is
not just a new rule book, but it entails a whole new approach - with the supervision of management
systems, and in particular risk management, taking the place of setting detailed rules. It is easy to tell
the banking supervision to determine general principles instead of detailed rules, but it is difficult to
carry this out. This also presents a challenge to the banks, who sometimes find it comfortable to
operate according to specific rules and even ask for them.
I have discussed Basel II with bankers, and I note that in Israel they all want to adopt advanced
internal models. Operating according to such models requires sophisticated and costly data and
management systems and an extensive database, which are not within reach of small banks. For
comparison, in the US it is thought that only the largest twenty banks need to adopt the most
advanced models. We are aware of the efforts by the smaller banks to cooperate in the formulation of
statistical systems and appreciate their endeavors.
More intense efforts to align the system for the implementation of Basel II and for the adoption of the
"SOX 404" rules for internal controls will lead to the improvement of the whole system of management
and control in banks. This will instill high standards into Israel's banking system that are on a par with
the most advanced in the world.
The second external goal for the Bank of Israel and the new Supervisor of Banks is strengthening
competition in the banking system, particularly retail banking. Making the banking system more
competitive is one of the major objectives of the Bank of Israel, and, I would assume, of every
government in Israel.
The Bachar Committee dealt with the issue of competition in the areas of credit and the capital market,
and there is a need to increase competition in banking services provided to households and small
businesses.
In this context, I would like to refer to the latest occurrence in which one bank increased its fees, and
the other banks followed, creating a distinctly uncompetitive impression. It is not surprising, therefore,
that the public and its representatives in the Knesset reacted critically as they did. Here too,
competitive conduct would be beneficial to customers, to the bank, and to the banking system.
Another factor that does not add to the degree of competition is the long, and perhaps even ridiculous,
list of fees. I fail to understand why in Israel the banking system operates thus, while in other countries
banks make their money essentially from the spread between their lending and their borrowing interest
rates.
It would be a very good thing if a foreign bank were to enter the field of retail banking in Israel, and I
hope this will happen.
I would also like to speak about the need to improve the level of customer service. There are too many
justified complaints, and the banks must invest resources to avoid such situations. I would like to
clarify the position of the Bank of Israel on the matter of consumer protection. I am in favor of our
involvement in this area, but I would like to place the responsibility where it belongs, and that is with
the banks. To clarify my position: the situation should be that a dissatisfied customer first turns
to the bank with his complaint, and only then, if he feels the complaint has not been dealt with
properly, does he approach the Banking Supervision Department. In a competitive banking
system the banks must deal with most complaints against them, with the central bank acting only as
the customer's last resort and not his first port of call.
In this context I would like to share with you a conversation I had. I was asked how I am settling down
in Israel, and if I understand what goes on here. I answered that the hardest thing to understand was
my pay slip, but the truth of the matter is that there is something even harder to understand, and that is
my bank statement.
The last topic I would like to talk about is the cooperation between the various supervisors of the
financial system. The supervisors currently cooperate with each other, and it is our intention to
institutionalize this cooperation in an MOU (memorandum of understanding). I view this step as a first
stage in closer cooperation between the supervisors and the financial system.
Finally, the new Supervisor faces enough challenges to stop him from being bored. His approach will
be one of less detailed regulation, and more regulation according to principles. His success in this
depends not only on him, but on responsible and competitive conduct by the banks.
Thank you.