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InterviewsJuly 1 2013

Bank of Israel turns theory into practice

Stanley Fischer's time as Bank of Israel governor has coincided with dramatic changes in global thinking about the role of central banks. He looks back on how his work has evolved, and what still needs to be done to secure the future.
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Bank of Israel turns theory into practice

When Stanley Fischer was appointed governor of the Bank of Israel (BoI) in January 2005, he came with a formidable reputation forged from his time at the International Monetary Fund (IMF) during the Asian financial crisis of the 1990s. He was also the doctoral thesis supervisor of a certain Ben Bernanke. The news that Mr Fischer would leave the BoI at the end of June 2013 prompted one banker to fret about “key man risk” for the Israeli economy. BoI officials are privately doubtful that the Israeli government has a definite replacement in mind yet.

But when he assumed the role in 2005, it was Mr Fischer’s first stint as a central bank governor, and his first experience of sometimes turbulent Israeli politics – previous BoI governors such as David Klein and Michael Bruno clashed publicly with the government. Mr Fischer believes Israelis should not be unduly concerned about the functioning of the BoI after his own departure.

“There were questions over whether I could operate in the Israeli environment, so I am not sure that I came into office with as much credibility as is claimed ex-post. Everyone has to establish themselves in a role such as this, nobody knows how they will behave in the face of various challenges, and there are candidates who have considerable capabilities, who know monetary policy and the bank very well,” Mr Fischer tells The Banker.

Recession busting

The international context for Mr Fischer’s time in office could hardly have been more challenging. Yet Israel, and especially its banks, emerged surprisingly unscathed from the global financial crisis. Narrowly avoiding recession in 2009, the Israeli economy has grown by an annual average of more than 4% in the three years that followed. Only one of Israel’s top five systemic banks recorded an annual loss in 2008 – all have remained profitable ever since.

The BoI’s conservative approach must take part of the credit for this. While macroprudential regulation has become a fashionable term worldwide in recent years, the BoI has long been ready to make tough regulatory interventions to maintain financial stability. Low interest rates and a shortage of new supply have sent Israeli house prices soaring more than 60% since 2008, prompting the BoI to cap loan-to-value ratios and hike the risk weighting of mortgage assets well above international norms.

“We took some serious measures to deal with any potential housing bubble. We did not want at any stage to overdo it, and the net result is probably that we underdid it a little on average. But we have modified the effects of low interest rates on housing prices, although it is not possible to eliminate them altogether,” says Mr Fischer.

Watching the shekel

Another important change in the conduct of central banking is the attitude toward managing the exchange rate, especially in export-oriented economies such as Israel. The IMF published a paper in 2012 that reversed its long-standing objection to capital and exchange rate controls. The BoI had itself intervened to stem a sharp appreciation of the Israeli shekel in March 2008.

“I welcome what the IMF is doing, because the use of currency controls is already out in the open. What was happening to the shekel in 2008 was simply not appropriate given the state of the economy. We were asking ourselves if we should follow the rules that the IMF was then implying, that is, to accept this appreciation. But we could not see what the benefit was for the global economy of letting Israel fall into recession,” says Mr Fischer.

The BoI has twice cut interest rates by 25 basis points in recent months, again explicitly to help the exchange rate find an appropriate level. Mr Fischer says central banks in small, open economies have lost “a significant amount of control” due to global capital flows, especially in today’s ultra-low interest rate environment. But he still views more draconian capital controls as undesirable and difficult to administer.

The way ahead

Mr Fischer’s closing act at the BoI is an effort to boost competition in the Israeli banking sector, where the top five banks control 85% of the market. The BoI is proposing that banks must switch over utility and other fixed payment instructions automatically when customers move their current accounts. At present, the administrative burden falls on the customers, which is a major deterrent against moving banks.

He says he is highly satisfied with the BoI’s infrastructure for managing interest rates and economic forecasting. But he identifies as a vital task for his successor the construction of an equally efficient infrastructure to manage the new emphasis on financial stability.

“I am not sure that any central bank has yet found a complete answer to this. Possibly the Bank of England’s separate financial policy committee is the right way forward. In Israel, what is essential is better coordination among the different regulatory bodies,” says Mr Fischer.

He flags up the need to resolve potential differences of approach between the BoI and the Israel Securities Authority (ISA) that regulates financial markets. The ISA is always keen for information to be made public immediately, whereas the central bank sometimes prefers banks to keep information confidential during crisis conditions, until a suitable response is formulated.

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