karnit flug : the credit market and its supervision in the israeli economy remarks by dr karnit flug, governor of the bank of israel, to the knesset economics committee on the gray market, tel aviv, 15 july 2015. * * * main points : • the forces of supply and demand create the gray market ( a financing system that is an alternative to the institutional system ) in israel, some parts of which are a legitimate market that provides services that are complementary to the institutional system. this market can also contribute in certain aspects of competition. • the main problem in the gray market starts with the lack of regulation and supervision over activity in this market. the entities that are active in this market provide credit without any regulatory supervision in relation to this activity or at all. the lack of supervision has a negative impact on borrowers in the gray market, first of all from a basic consumer standpoint. in contrast to the banking market, there is no consumer protection system for borrowers in this market. • the risks in the gray market may spill over to the financial market, both due to regulatory arbitrage ( gaps in regulatory requirements ) that will lead to a decline in standards in the financial system, and from a prudential standpoint, particularly if the entities in the gray market grow and become a significant part of the credit market. • one of the reasons for the recent global financial crisis was the development of a nonbank financial system, mainly in the us, which was not sufficiently supervised. these systems grew rapidly while taking significant risks that in the end were realized in the form of a financial crisis. • it is preferable to act in this area in two directions : first, to reduce the gray market by developing alternative institutional sources of financing, and second, to regulate the legitimate activity in the gray market through legislation and regulation and to supervise activity in this market. • the bank of israel and the banking supervision department are acting to ensure accessibility and competition that will improve the situation for households and small businesses. as part of this, we are acting to increase competition both within the banking system and through entities outside the system, including other legitimate noninstitutional entities. • supervisory regulation of the gray market will make it possible to expand the sources of financing of the entities active in it. the proposal to enable certain entities to issue bonds and to provide credit without arranging the appropriate controls may led to serious harm to the economy. • i am aware of the desire for

mechanisms for insolvent banks, mechanisms for the approval of senior executives ’ remuneration, etc. i would like to congratulate the outgoing supervisor of banks, mr. rony hizkiyahu, for his excellent work in coping with crises. he is leaving the banking supervision department in much better condition than he had found it. we thank rony for his important contribution to israel ’ s financial system and economy. much work awaits his successor, david zaken. david, you will have to continue the processes that rony began and then continue to plot the course in your own way. you have the personal credentials to succeed in the very difficult and important task that you have taken upon yourself. i wish you success.