First assessment of the new draft Law of the Bank of Israel

10.07.02

Assessment by the European Central Bank of the Bank of Israel Law
and to the new Draft Law Proposed by the Ministry of Finance

Ø	The assessment by the European Central Bank (ECB) of the amendment to the Bank of Israel Law proposed by the Ministry of Finance states that the proposal does not afford higher priority to the maintenance of price stability than it does to the Bank of Israel’s other targets, and it is therefore incompatible with the European Union (EU) requirement of central bank institutional independence.
Ø	The view of the ECB is that central bank operational independence requires that the central bank be granted the means and instruments needed to preserve price stability. The proposed amendment does not contain a provision granting the Bank of Israel independence with regard to the instruments and means.
Ø	The view of the ECB is that the proposed amendment to the Bank of Israel Law does not specifically prevent conflicts of interest and allows members of the Monetary Council to hold office in a business organization or public body which could conflict with their role in the central bank.

The European Central Bank (ECB) has expertise in reviewing the compatibility of central bank laws with the requirements of the European Union (EU). When the ECB was established, each member country had to undertake that the legal status of the independence of its central bank would be consistent with the requirements defined in the Statute of the European System of Central Banks (ESCB) and the ECB (henceforth ‘the Statute’). Their detailed examinations of central bank laws resulted in many amendments to those laws.

The legal department of the ECB also examines the central bank laws of countries wishing to join the Union (Accession Countries), to ascertain that they do not contradict the EU requirement of central bank independence which is a condition for entry to the Union. The Statute specifies that central banks shall have institutional as well as financial and operational independence, and decision makers must have personal independence.

The Bank of Israel notes that Israel has signed an Agreement of Association with the EU. The agreement also determines that there shall be economic cooperation encompassing all aspects of economic policy, including monetary policy, and that there should be regular exchange of information and mutual consultation. The agreement also specifies that the parties shall make every effort to harmonize their laws in order to facilitate the implementation of the agreement. Against this background and as part of the existing cooperation between the ECB and the Bank of Israel, the latter forwarded to the ECB’s legal department the amendment to the Bank of Israel Law proposed by the Ministry of Finance (Draft Bank of Israel Law, Amendment No. 20, 5762-2002), and the existing law which has been in force since 1954, asking for the ECB’s expert opinion on the extent to which they are compatible with the rules adopted by the EU. The purpose of the request was to provide the government, the Knesset and the public further information before the completion of the legislative process relating to one of the most crucial laws in a modern economy.

The ECB assessment is that the Bank of Israel Law and the amendment proposed by the Ministry of Finance are basically inconsistent with the EU Treaty and the ESCB Statute.

THE MAIN POINTS OF THE ECB ASSESSMENT

a.	Institutional independence, the Bank’s aims and their implementation
1.	In the amendment to the Bank of Israel Law proposed by the Ministry of Finance, the preservation of price stability is not given higher priority than the Bank’s other targets such as the support of the government’s economic policy, and the proposal therefore runs counter to the institutional independence of the central bank. Furthermore, according to the proposal, the discussions and the decisions of the Monetary Council to be established will be subordinated to the policies determined by the government. If the government changes its targets and its aims, the Minister of Finance shall give the Governor of the Bank written notice accordingly. In this matter, too, the proposal is incompatible with the EU requirement of central bank independence.
2.	The Ministry’s amendment contains a proposal that the Minister of Finance shall determine the financial remuneration of the members of the Monetary Council. Their remuneration should be established according to fixed and objective rules, and the proposal is therefore opposed to the institutional independence of the central bank.
3.	The view put forward by the ECB is that to avoid situations which could adversely affect independent decision-making, the Statute requires that the central bank’s external auditor shall be an independent body. The purpose of this requirement is to prevent the central bank from being subordinate to any governmental body.
4.	The Statute determines that control of the amount of money in circulation (‘legal tender’) is a basic task of the central bank and must not be subject to authorization by any third party such as the government, as is specified in the existing Law, nor to any other body outside the central bank.
b.	Independence in operating policy instruments
	Operational independence of the central bank requires that it has the means and the instruments to enable it to fulfill its role as the defender of price stability. The view expressed by the ECB is that the proposed amendment to the Law lacks a clear statement that formulation and implementation of monetary policy is the exclusive responsibility of the Bank of Israel. The ECB therefore recommends the abolition of the clause in the existing Law that requires government approval of any decision to issue securities for purposes of executing monetary policy and of decisions related to regularization of the liquidity of the banking corporations. The ECB also recommends that a clause explicitly stipulating the Bank of Israel’s independence be added to the proposed amendment.
c.	Accountability of the central bank
1.	Comprehensive reporting of specific future monetary policy steps of the Monetary Council (as specified in section 24 of the proposed amendment to the Bank of Israel Law) could be seen as ex-ante consultation with the government, which could be used by the government to influence the Council’s final decisions. This would be inconsistent with the Treaty and the Statute.
2.	The proposed obligation to send the minutes of the Monetary Council’s discussions to the government immediately and as a matter of course (in accordance with section 25 of the proposed amendment) could be misused as a means of influencing decisions of the Monetary Council, and would be inconsistent with the Treaty and the Statute.
d.	Personal independence
1.	Personal independence is necessary to ensure that no conflict of interest arises among decision makers in the central bank; the European law therefore prohibits members of a monetary council from holding any office in a business organization, public body or any other body which could give rise to a conflict of interest. The ECB is of the opinion that the proposed amendment does not specifically prevent conflicts of interest and permits members of the Monetary Council to hold office or be an interested party as a representative of a business organization.
2.	The ECB’s view is that the reasons given in the proposed amendment for dismissing the Governor of the Bank, ‘if there are differences of opinion between the government and the Governor on fundamental policy issues’ or removing the Governor or a Deputy Governor from office ‘if they perform acts which in the opinion of the government are unbecoming to their (his) status’ leaves too much discretion to the government. The same applies to an act by a member of the Monetary Council that is ‘unbecoming to his status.’
3.	Appointing members of the Monetary Council for four-year terms of office is inconsistent with the minimum five-year term of office stated in the Statute.
e.	Financial independence
	An important component of the independence of a central bank isits ability to avail itself of sufficient economic means to enable it to carry out its role. In this respect the proposed amendment does not contradict the European requirements. With regard to this point, the Bank of Israel notes that there are other proposals for amending the Bank of Israel Law which specify that the budget of the Bank should be approved by an external body, such as the Knesset; this would be contrary to the Treaty and the Statute. The opinion put forward by the ECB is that the government must not be allowed to use the central bank to finance its (the government’s) activities, as this could jeopardize the primary objective of price stability. The European Treaty and regulations detail prohibitions on monetary financing. The ECB comments that it did not relate to this aspect of the proposed amendment to Israel’s central bank law.

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