Address by Governor of the Bank of Israel Prof. Amir Yaron at the joint conference of the Bank of Israel and the Coller School of Management of Tel Aviv University
Hello all. I am happy to open this important conference on the subject of securitization, jointly organized by the School of Management of Tel Aviv University and the Bank of Israel. Securitization is a platform for creating new opportunities and increasing the sophistication of the market in Israel, and it is of crucial importance to the Israeli economy. When I became Governor, I made it one of the Bank’s strategic goals.
After years of extensive discussion by all of the relevant regulators, it appears that we will soon see real progress on this front.
To start off, I would like to thank the organizers: Professor Dan Amiram, Vice Dean of the Coller School of Management of Tel Aviv University; Professor Michel Strawczynski—Director of the Research Department; Micki Kahn—Head of the Research Department’s Finance Division; and Dr. Oded Cohen of the Research Department’s Finance Division.
I would also like to thank my colleagues in academia and in the regulatory spheres who are contributing to the panels during the conference – the panel of CEOs from the finance sector in Israel and the panel of senior regulators.
What are we talking about today? First, I will present the financial ecosystem in Israel: the level of financial development in Israel and the factors explaining it. After that, I will talk about the points on which we are not doing well enough and which call for improvement.
I would also like to briefly talk about the recommendations that we made in a recently published policy document on the strategic issues facing the Israeli economy, and finally I will focus on securitization – its advantages and the issues that deserve attention.
When we examine the financial development of the economy, we see that as a country Israel is not among the global leaders in financial innovation; on the contrary, it lags behind the global average.
The aforementioned low level of financial development is primarily a manifestation of the relative lack of financial instruments in the Israeli capital market. This includes securitization, benchmark interest rates, a business credit database, an efficient and competitive lending pool and a developed factoring market.
It is important to mention that there are elements of financial innovation in which Israel is a global leader. One of the them is the world of fintech.
As in the case of high tech, which is the Israeli economy’s growth engine, the fintech industry in Israel is undoubtedly a global leader. Currently, there are about 530 fintech companies in Israel, which have been growing rapidly in recent years and are attracting the interest of foreign investors.
During the past year, investment in Israeli fintech companies reached about $1.8 billion, making up about 5 percent of all global investment in fintech.
Furthermore, investment in Israeli fintech companies is growing rapidly, as is the median value of investment in fintech companies. This is part of the overall growth in Israeli high tech. As I noted, this is a phenomenon with high strategic value for the Israeli economy and it constitutes an “engine” for the entire economy.
Unfortunately, the lion’s share of the activity in the fintech sector does not take place in Israel but rather is exported to other countries and even though there are other positive points in the financial system in Israel, such as the robusteness of the banking system, we are still lagging relative to the average global level, a situation that needs to be improved.
Thus, for example, one of the most important indicators of the weakness in the Israeli financial markets is the ratio of private sector debt (i.e., not including government debt) to GDP.
The ratio in Israel is low in international terms and the gap became even larger during the COVID-19 pandemic, reaching more than 50 percentage points.
Over time, the low level of credit leads to a lower level of investment, thus constraining economic growth.
The gaps exist with respect to both bank credit and non-bank credit. The financial sector constitutes the “motor oil” of the real economy. The link between financial development, reflected in the quality and size of the credit and capital markets, and economic growth and investment has been studied extensively, and it has been found that the connection is strong and positive.
Thus, for example, in an economy with a sufficiently developed capital market, the flow of credit for the financing of real activity and of companies in the real sector is more efficient and less exposed to the volatility in asset prices.
Therefore, the development of the financial sector in Israel, which will be manifested in new instruments and growth in the supply of credit, will increase productivity in the economy as a whole and will contribute to raising the standard of living in Israel.
About a month ago, the Bank of Israel published a comprehensive document that includes four axes for strategic action that were recommended to the government. One of them is the development of the financial system.
It is a long and exhaustive document and I recommend that you read it from cover to cover. I intend to present you with the highlights of the recommendations and to briefly focus on one of the main ones – securitization.
The process of exiting the crisis means that we are again facing important challenges to the economy.
In order to move ahead and to exploit the opportunities that the crisis brought with it as well, there are structural reforms that need to be implemented over the upcoming decades in a variety of contexts: education; infrastructure; finance; and reducing bureaucracy and increasing digitization. These are the four axes that are the focus of the document.
I will now focus on the axis of strategic financial issues.
Among the recommendations is the encouragement of securitization, the subject of this conference. I will survey the advantages of securitization and the points that deserve attention.
What is securitization? I assume that most of the participants are familiar with the concept and therefore I will go over it very briefly. The originator sells assets that produce a flow of cash (such as a mortgage) to a special-purpose entity (SPE) which finances the purchase by issuing bonds.
The use of an SPE is meant to facilitate investment whose risk is concentrated solely in the securitized assets, since the portfolio of securitization assets serves as the exclusive source for servicing the debt.
Thus, the structure of the transaction creates an economic and legal separation between the assets that are being transferred in the securitization transaction and the rest of the originator’s assets.
Securitization is uncommon in Israel even though it is widely used in major markets throughout the world.
The development of the securitization market in Israel will achieve the following outcomes:
- More efficient spreading of risk: Securitization makes it possible to pool a large number of loans into one instrument and to divide and sell that instrument to a large number of investors. Furthermore, a number of tranches are created with different levels of risk and that are suited to investors with different levels of risk appetite. In this way, greater spreading of risk is achieved in the financial market.
- Expansion of investment by institutional investors in the domestic market: This is a critical factor during periods in which a large proportion of the funds held by large financial entities is invested abroad.
- Development of the non-bank credit market and a lower cost of financing: This is particularly important because the credit market in Israel is not sufficiently developed.
- The possibility of freeing up capital in the banking system with the goal that it be allocated to, among other things, the financing of small and medium-sized businesses. Furthermore, it is important to emphasize that the securitization vehicle will be used by companies in the real economy, such as those involved in leasing or infrastructure in the local authorities, and not just financial companies.
- Now that we have described securitization’s advantages, I would like to mention a few points that are important for the development of the securitization market in a prudent and responsible manner, with the goal of avoiding the negative phenomena that were observed in the not-too-distant past in the US and Europe.
- The first point that deserves attention is the issue of whether a true sale is occurring: One of the main risks in a securitization transaction is that the sale of the assets to an SPE will not be fully recognized. This risk exists for both the originator and the investors:
o For the originator, to the extent that the securitization transaction is not a true sale, when the cash flow from the securitization assets is insufficient to cover the payments on the asset-backed bonds, the purchasers of the bonds will be able to make a claim against the originator and against his assets.
o For the investors, in the case of default by the originator and to the extent that the securitization transaction is not a true sale, it may be that the securitization assets will be considered to be part of the assets that service the debt of the originator’s creditors.
· We believe that the securitization of securitized assets should be prohibited by law: This is in view of the difficulty in pricing the risk of this vehicle and the systemic risk that is liable to arise as a result. Europe, for example, prohibits the securitization of securitized assets, except in special cases.
· Ongoing reporting of the originator’s level of risk: Thus, the concern that there will be mispricing of the securities will incentivize the originator to maintain the level of risk specified in law throughout the life of the transaction, and the information possessed by the investors will be kept current to whatever extent possible.
· A market failure may result from the information asymmetry between the originator and the investing public with regard to the risk implicit in the securitization assets. Therefore, in order to prevent the transfer of particularly risky assets in the securitization process, the originator should have to continue to hold part of the securitized portfolio.
In the time remaining, I would like to talk about securitization as a supplementary vehicle to the policy measures in recent years, which are intended to increase the supply of credit in the economy.
The subject of open banking or as I like to call it – “open finance”: As part of the open banking reform that we are promoting at the Bank of Israel, there will be an interface between a provider of financial services, such as a bank, and other service providers, such as fintech companies, with the consent of the customer.
By means of the interface, it will be possible to share information on the customer or to initiate payments in his account. Thus, other players, such as banks or fintech companies, will be able to compete over the provision of services that will become more advanced, less expensive, and better suited to the customer.
The existence of a securitization market will make it possible for small new companies to compete with the veteran players in the market. This will allow them to provide credit in greater volume and without having to own large amounts of capital.
As in the case of the open banking reform, the separation of the credit card companies introduced new players into the financial market who compete in the provision of credit.
It appears that they will also benefit from a securitization market and will be able to obtain financing at a lower cost in order to provide credit to the public and at more attractive prices.
The securitization vehicle is likely to be particularly important during a crisis, such as the COVID-19 pandemic, during which the regulator is interested in incentivizing the banks to provide credit to small and medium-sized businesses, with emphasis on those with a higher level of risk. The legal and operational platform of securitization is likely to increase the types of collateral for monetary loans and thus can be used by the central bank to make credit more accessible to small and medium-sized businesses during a crisis.
Another measure recommended in the strategic document is to increase the sophistication of the repo market to include government bonds as well. The repo market is the most developed market for managing the cash flow of financial entities and large corporations in other countries; however, there has been no further development of this market in Israel during the past decade, primarily due to the liquidity situation in the financial system.
At this time, it may be that the conditions are more conducive to the development of the repo market. Although the liquidity situation has not changed, the Bank of Israel carried out repo transactions with all of the main institutional investors during the COVID-19 crisis, and this activity contributed to the market’s understanding of the need for this vehicle even during routine periods.
Another domain that the Bank of Israel is working to develop and systemize is the Telbor interest rate market as a source of the shekel benchmark interest rates. These interest rates will facilitate the use not only of a fixed nominal interest rate or a daily variable rate but also an interest rate that changes over longer horizons and is defined ahead of time.
The benchmark interest rates constitute an important component of global capital markets, and they expand the possibilities for business financing. Benchmark interest rates also provide a foundation for an interest rate futures market, which allows businesses and the public to reduce their interest rate risk.
It is reasonable to assume that with an efficient Telbor market, financial companies will have the possibility of hedging and better managing their risk. They will be able to do so by adopting the longer-horizon IRS instrument, which facilitates exchanging fixed-interest and variable-interest cash flows. This will eventually lower the cost to the end user as well.
Apart from securitization, the aforementioned measures will contribute significantly to the advancement of financial efficiency and of the Israeli economy as a whole.
· The financial system in Israel is less developed that in other developed countries and in particular, the supply of credit in Israel is not very large.
· We are working to develop new markets and to remove barriers and distortions from the financial system, an effort that will increase the possibilities of financing, will improve the allocation of credit and its pricing and will facilitate a more efficient spreading of risk among the financial institutions.
· The securitization vehicle enables a more efficient and larger-scale flow of credit, by means of shortening the financial intermediation process and lowering its cost.
· In view of the above, there is a need to promote the Securitization Law—whether or not by means of the Economic Arrangements Law—in a responsible and prudent manner and in a way that will benefit the economy and minimize risk.
I would like to wish us all a productive and insightful conference. Thank you.