Israel’s banks are under scrutiny, with the government moving to break up the current credit card oligopoly. But opinion is divided on whether these reforms will boost competition more generally or are just an experiment. Pinchas Landau reports.

Bank Hapoalim

Israel’s credit card companies should have every reason to feel pleased, if not downright smug. Their results for the second quarter of 2017, published in August, displayed growth in most key measures as well as rising profits, maintaining the positive trend of recent years.  

Yet self-congratulation is noticeably absent from the credit card sector. Instead, the dominant emotions are disorientation with regard to the present and trepidation concerning the future. Even the positive performance data cannot dispel these negative sentiments, because the sector is facing upheaval.

The three credit card companies are all subsidiaries of Israel’s three largest banking groups: Isracard is 98.2% owned by Bank Hapoalim, while Bank Leumi owns 80% of Leumicard. Control in Cal is held by Israel Discount Bank (71.84%), with the remainder held by First International Bank (respectively, the third and fifth biggest Israeli banking groups).

Little competition

Unsurprisingly, this structure has allowed the banks and their card companies to enjoy a position of dominance, with, say critics, little competition between them and none from outside. The banks, by contrast, say the market was operating in a free and open way.

For decades, these bank-issued cards were primarily deferred-debit cards, with little actual credit activity. This has now changed and the card companies are more aggressively marketing credit, but cardholders’ credit activity is still linked to their bank accounts and overseen by the branch that issued the card.

However, this idyllic situation (for the banks, at least) ended in January 2017, when Israel’s parliament, the Knesset, approved the Law for Increasing Competition in Financial Services. This marked the biggest structural change in the country's banking sector since 2005, when the banks were ordered to divest their asset management operations.

The legislation was based on recommendations tabled by an inter-governmental committee chaired by Dror Strum, a former head of the Israel Anti-Trust Authority (IAA). But the driving force behind the reform of the credit card sector was finance minister Moshe Kahlon, who appointed Mr Strum and determined his committee’s mandate.

Mr Kahlon made his name as communications minister in Benjamin Netanyahu’s Likud-led government of 2009-13, by pushing through a sweeping deregulation of the cellular phone sector. New entrants to the cellular market triggered fierce competition and a dramatic fall in prices to consumers.

This success and Mr Kahlon’s ensuing popularity stoked his ambitions. However, after a clash with Mr Netanyahu he quit Likud in 2012 to form a new party, Kulanu, which garnered a 10-seat haul (out of 120) on its debut in the 2015 Knesset elections. Thanks to Israel’s proportional representation system, this was enough to give Kulanu a pivotal role in a Likud-led coalition, enabling Mr Kahlon to demand the powerful finance ministry.

From phones to banks

Now in a position to implement the programme that won him so many votes, Mr Kahlon has sought to replicate his cellular phone sector success, this time in financial services. The Strum Committee was his tool for achieving this, tasked with opening up the credit card sector and, by extension, the entire retail banking sector.

Both the committee discussions and the subsequent legislative process saw struggles on several fronts. One was a rearguard action by banks, which deployed their considerable lobbying clout to dilute (if not derail) the proposed reform. Another was an intra-governmental turf war over the extent of the reform, in which the Treasury and the IAA adopted a hardline stance, while the Supervisor of Banks (an autonomous department within the Bank of Israel) sought to moderate the proposals.

The outcome of this was a compromise, reflected in the new law’s central feature. The two biggest banks, Hapoalim and Leumi, must divest their credit card subsidiaries but Israel Discount Bank is not required to sell its subsidiary, at least pending a review of the sector in four years’ time.

Rationale for decisions

Hedva Ber, Israel's supervisor of banks since August 2015, says of her department's decision to dig in its heels on this issue: “The decision reflects our view that the level of competition in the banking system has to be seen in the wider context – in which Hapoalim and Leumi hold a combined market share of some 60% – rather than considering the credit card market on its own. The stronger the medium-sized banks such as Israel Discount Bank become, the greater the competition will be.”

The wider reform the Bank of Israel is pursuing requires the banks to relinquish their ownership of Automated Banking Services, a company jointly owned by the banks that currently has state-sanctioned monopoly status as the lynchpin of the country’s payments system.

For its part, the Treasury won a major victory by carving out a new regulatory body charged with overseeing the divested credit card companies (and any new ones), one that will come under its purview rather than that of the central bank.

But while the Bank of Israel and the Treasury advanced their parallel agendas, the banks emerged as losers on all fronts, leaving them frustrated. “There is no precedent anywhere for such a crude governmental intervention in a market which has undergone neither crisis nor market failure,” says one senior banker who did not wish to be named.

Offsetting the losses

But the banks will not necessarily end up losers, at least financially. Dorin Palas, head of research at Tel Aviv-based IBI Brokerage, ticks off the various revenue streams that banks will still enjoy after they divest their credit card subsidiaries.

“What will happen on ‘the day after’? The banks will be allowed to issue and distribute cards, and they will collect fees,” she says. “Furthermore, they will remain a major source of funding for the companies, to finance their credit operations. All this is in addition to the proceeds from the sale of the companies – so overall, much of the lost revenue will be offset.”

In any event, the divestment process is under way and the clock is ticking on the deadlines for Hapoalim and Leumi to sell Isracard and Leumicard. “The banks are gearing up for the sales, and potential buyers are expressing interest,” says Irit Avissar, banking correspondent at Globes, Israel’s leading business daily. “But currently, everything is in limbo until the Bank of Israel decides by how much to reduce the interchange fee that the card issuer deducts on each transaction.”

This decision, critical to determining the value of the credit card companies, has been repeatedly delayed and is now expected by the end of 2017. “That will enable the banks to move ahead,” says Ms Avissar, “currently it seems that Hapoalim is leaning towards floating some 20% of Isracard’s equity on the Tel Aviv Stock Exchange, thereby establishing a price, and then distributing the rest of the shares as a dividend in kind to its own shareholders. Leumi, on the other hand, prefers to sell Leumicard outright. I understand that some foreign private equity funds have expressed interest, as has IDI, a local direct insurance company.”

The law requires a divestment by direct sale to be made within three years, while allowing four years if the stock exchange route is used. Either way, IBI’s Ms Palas notes, the transition phase of the sector can be expected to extend over several years.

A win for customers?

But will the reform ultimately achieve its goals of greater competition and lower prices for consumers? Ms Ber is optimistic on this score, partly because the law allows the divested companies to become full banks. “The fact that they have this option has already generated competition and triggered improved offers to customers in many areas,” she says.

“One advantage of the companies becoming full banks is that this will allow them to fund themselves by attracting deposits, rather than borrowing from banks or issuing their own bonds. The deposit route is much cheaper. Moreover, it would enable them to provide competition to banks in other fields than just credit."

Ms Avissar is more sceptical. “The entire reform is a huge experiment, in the hope that it will bring prices down. In my assessment, in the best case prices will stay as they are. There is little likelihood they will fall.”

Citibank Israel equity analyst Michael Klahr is also dubious. “The goal is to create competition to the banks in the household sector, where barriers to entry are highest. I don’t know if this will work, but even if it does, opening up the credit card sector is not enough to have a systemic impact. The credit card sector has developed considerably in recent years as a lender, but is still only a marginal player,” he says.

 “What’s more, credit cards may be rendered obsolete by the very rapid impact of technology, which is driving disintermediation via fintech. Technology is a much more effective force for change than government,” he adds.


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