Remarks by the Supervisor of Banks at the parliamentary inquiry on large borrowers
- The Banking Supervision Department has acted decisively and methodically to deal with the problem of concentration in the banks’ credit portfolio, which was a reflection of concentration in the economy, and prevented the realization of large risk.
- In the many audits carried out by the Banking Supervision Department on the matter, a small number of cases were found where there was suspicion of a conflict of interests or criminal activity, and these were handled with determination and then transferred to the State Prosecution and the police.
- In many of the cases of large borrowers that were discussed by the committee, the defects were in the practicalities of credit provision. The audits carried out by the Banking Supervision Department provided thousands of audit notes and comments, and led to a dramatic change in how credit is provided and managed.
- The Banking Supervision Department has many effective enforcement tools. The Department was involved in ending the terms of about 15 banking officials and invalidated the appointments of about 80 candidates for senior positions at the banks.
- The Banking Supervision Department’s actions are reviewed by the State Comptroller, as well as by international organizations including the International Monetary Fund, and the Financial Action Task Force on Money Laundering (FATF).
“Between the late 1990s and 2010, a problem developed of very high business concentration in the economy and high concentration in the banks’ credit portfolio— which was a reflection of concentration in the economy—against the background of the privatization of government companies and the requirement that the banks had to sell off nonfinancial holdings. The Banking Supervision Department at the Bank of Israel has worked decisively and methodically during the past 15 years to deal with the problem, and has prevented a large risk from being realized. The issue was a main focus of the Department’s work over the years, even long before I took the position of Supervisor, and included many audits, regulations and enforcement operations as part of the Department’s work to protect depositors’ money.
We can now say that the provision of a high volume of leveraged credit to large borrower groups is the “banking of the past”, and looking forward this is not one of the main risks facing the banking system. For instance, in 2005, there were 28 borrower groups with outstanding credit that was more than 10 percent of the lending bank’s equity. In 2017, there were only two such groups. Moreover, the potential for a conflict of interest on the part of an official at the banks has declined greatly in recent years due to the significant strengthening of audits, and of the structure of corporate governance as a result of Bank of Israel directives. Some of the changes made in the Supervisor’s directives were inserted due to a State Comptroller’s examination on large borrowers that was published in 2013, and interministerial committees such as the “Concentration Committee” and the “Debt Restructuring Committee”.
The many audits conducted by the Banking Supervision Department during the relevant period found that there was a low number of very serious cases where there was a suspicion of the conflict of interests. The published case of former Bank Hapoalim chairman Dani Dankner, which was a particularly serious case, properly demonstrates how the Banking Supervision Department works. The Bank of Israel acted to have him removed from his position due to very serious defects the Department found in aspects of corporate governance. In addition, the Department sent the case to the police and the State Prosecution for handling.
The decisive action by the Bank of Israel in removing Danker from his position was taken despite tremendous public pressure at the time on the Bank of Israel Governor and the Supervisor of Banks against such a step. During the relevant period, there were very few other cases where the audits raised the suspicion of a conflict of interests, or of criminal activity by banking officials. These cases were transferred to the State Prosecution and police investigation, and were then handled by the Department in accordance with the findings.
In the cases of other large and leveraged borrowers that were discussed by the committee, the defects were, in general, different, and particularly were not criminal. The Banking Supervision Department’s audits over the years showed that high-risk credit of very large amounts was provided, with practices that were not conservative, relying on the companies’ value on the stock market, and sometimes with an over-reliance by the banks on prior experience with the borrower and too little reliance on the companies’ financial state or cash flow. In these cases as well, the Banking Supervision Department acted decisively and required the banks to amend and change their policy and processes. In the 95 audits on large borrowers and credit carried out by the Banking Supervision Department during the period being examined by the committee, there were thousands of audit notes that led to a dramatic change in how credit is provided and managed.
The Banking Supervision Department has many effective supervision and enforcement tools, some of which are not known to the public, and it continues to make use of them on an on-going basis. For instance: The Banking Supervision Department was involved over the past decade in ending the terms of about 15 officials for various reasons related to corporate governance. In addition, the Department invalidated the appointments of about 80 candidates for positions as officers of the banks in the past decade due to concern of conflicts of interest, associations (with a large borrower from the bank or a significant nonfinancial corporation), defects in the candidate’s personal or professional integrity, or unsuitability.
The reason that some of these supervisory measures are not public is that the law sets out that, in general, individual information and documents provided to the Department are not to be publicly disclosed. It is important to emphasize that this fact enables the rapid and effective handling of problems. Beyond that, it is important that some of the supervisory measures in the banking system remain unpublished, since the publication of information on a problem at a particular bank or with a particular borrower may have a negative impact on the ability to handle the problem rapidly, and the public’s reaction to such news may actually reinforce the problem to the point of significantly impacting stability, which will have widespread macroeconomic ramifications. The Department is aware of the public’s desire to know more about its activity, and of public criticism in this regard, and is acting to increase transparency within the limitations of the law.
The International Monetary Fund, which carried out an audit of the Banking Supervision Department in 2016, noted that the Department in Israel has adopted a strict and comprehensive approach, operates along the international standard and sometimes beyond that standard, and that the Department’s approach has led to significant benefit to the Israeli economy and society in general. The Department is subject to the Bank of Israel Governor, is examined by the State Comptroller (who can receive all the reports and materials in the Department’s possession), and is examined on a voluntary basis by the IMF and the Financial Action Task Force on Money Laundering and Combatting Terrorism (FATF), who conduct examinations every few years. This structure of supervision and control over the activity of Banking Supervision Department and its head, maintains the Department as a professional and independent body that is not susceptible to external pressure, and that therefore serves the public and the economy.
The test of results shows that banking in Israel remained stable when the “hurricane” hit global banking and many banks went bankrupt; no depositor in Israel lost his money during the past decade; the quality of the banks’ credit portfolio in Israel is significantly higher than that of banks in other advanced economies, even when including credit losses in respect of the large borrower groups; credit to the large borrower groups was dealt with decisively and declined dramatically; the number of cases where there was evidence of a conflict of interests in the provision of credit was low and those cases were dealt with decisively and unhesitatingly; and the lessons were learned from the incident of banks helping American customers evade taxes, which led and will lead to fines against the banks, while the supervisory requirements were made much more strict. These results are proof of the professional and uncompromising work that has been done and is being done by the Banking Supervision Department to protect the public’s money at the banks. They are proof that when there are defects discovered at the banks the Department deals with them decisively, with tools that the broad public and its representatives are not always aware of, and that there is a continuing process of learning and improvement.
With an economy-wide view of the issue of large borrowers and a forward-looking view of the financial market and the risks that develop, the Bank of Israel acted to complete legislation to establish the Financial Stability Committee, which will enable the narrowing of the regulatory arbitrage that has developed. This committee will create structural coordination between the regulators of the capital and money market, and is essential not only because of credit to large borrowers, a large portion of which is raised from institutional investors and in the capital market, but also in view of the rapid increase in credit to households from nonbank entities.