Foreign Banks’ Activity in Israel
Until the last few years, foreign banks showed little interest in Israel’s economy for political as well as economic reasons. These included the Arab boycott of companies which had business relations with Israel, and interests in Arab countries which acted to prevent companies engaging in activities in Israel even after the lifting of the boycott; the existence of an advanced banking industry which does not offer exceptional opportunities as do emerging economies; the lack of economic stability (high inflation, large deficits in the balance of payments and in the budget); and foreign-exchange control.
In the last few years foreign banks exhibited growing interest in the possibility of opening representative offices or branches in Israel, in the light of processes which were reflected in Israel’s improved credit-risk rating: the Middle East peace process which reduced the political risk; improvement in Israel’s macroeconomic features (lower inflation and budgetary restraint); and liberalization and deregulation, for instance the process of removing foreign-exchange control, which enabled Israel to participate in the globalization trend.
In addition, the development of Israeli high-tech companies offers business opportunities to foreign banks in the form of offering their services to the companies themselves, as well as providing private banking facilities to the directors and managers of these companies who had amassed great wealth and broadened the basis of potential customers for such services in Israel.
At this point in time, foreign banks’ activity in Israel is still in its infancy. The entry of these banks into the market is usually by means of opening branches, and not the purchase of a domestic bank.
The entry of foreign banks is likely to benefit the Israel’s economy in the following ways:
- Increased competition in the banking industry: although the industry is currently more competitive than it was a decade ago, it is still characterized by a high degree of concentration;
- More competition in Israel’s banking system may enable the relaxation of certain requirements which were introduced to help achieve that objective, and which restrict the activities in which Israeli banks may engage and limit the possibilities of mergers between the banks;
- The import of banking technology developed and implemented in overseas banks’ activities, and the import of new management techniques;
- Increased efficiency of the banking system: research has shown that the entry of foreign banks contributes to improved banking-system efficiency regardless of the size of the foreign-bank market share. This occurs as a result of more intense competition and of the introduction of new financial instruments and better risk-control techniques.
- Improved access to the international capital markets for companies and individuals in Israel. This applies particularly to those entities which are not large enough to belong to the “top tier” companies which were active in those markets even prior to the start of foreign banks’ activity in Israel.
There are several arguments which apparently do not support the entry of foreign banks:
- Foreign banks tend to focus on selective market niches, and provide services to large or international companies in the host countries (known as “cherry picking”), which in turn make inroads into the market share of the domestic banks. The concern is that in countries where there is a significant presence of foreign banks, the credit market will be segmented, with the domestic banks being left to supply credit to less creditworthy customers (peripheral customers, or small- and medium-sized enterprises), which would raise the overall risk of their assets portfolio.
The claim of selectivity in foreign banks’ activity is generally correct in the initialstages of their activity in the host country, but is not necessarily valid after some time. In Central European countries, where banking is very competitive and there is significant penetration by foreign banks, the latter have expanded their activity and grant credit to small and medium firms and to households. Furthermore, there is no problem at that initial stage of the process provided that risks are priced rationally in the domestic banking system (i.e., there is no cross-subsidization) and that they are reflected by appropriate spreads.
- Foreign banks are generally motivated by opportunities which arise throughout the world, so that when the host country is experiencing a recession they will divert their activities from that economy to those offering better possibilities. The domestic banks, on the other hand, have a commitment to the domestic economy arising from their
long-term business relations with their customers and their patriotic affinity with the national interest. In addition, the conduct of the foreign banks is also influenced by events in their home country. This can be seen in the behavior of Japanese banks which stopped granting credit in Asia when they were facing difficulties in their home market.
The view that favors the entry of foreign banks is that they operate against the business cycle in the host country and they are in a better position to go through periods of recession there as they have greater accessibility to the international capital markets and they can avail themselves of credit lines from their parent bank. This view is supported by the fact that the foreign banks’ balance-sheet assets are spread more widely. The experience of Argentina and Mexico showed that foreign banks’ volatility of credit is lower than that of domestic banks.
- The entry of foreign banks when the domestic banks are unable to merge harms the interests of the latter. Many countries adopt a policy whose purpose is to limit concentration in the banking system, and so they do not allow mergers of the large domestic banks. One example is provided by Australia which adopted a “four pillars” policy according to which no mergers between the four large banks would be permitted until the authorities were convinced that competition had reached a satisfactory level. Supporters of this approach argue that economies of scale have not yet been shown in banking (except for the entry-threshold requirement of a certain minimum size).
Recent research has given rise to a counter-argument based on the high level of investment in technology required. If the entry of foreign banks makes a satisfactory contribution to competition, it will be possible to allow domestic banking mergers, even between medium and large banks.
- Israel’s limited experience in this field indicates another problem faced by the domestic banking system, namely the movement of skilled staff in key positionsfrom domestic banks to foreign banks which started operating in Israel. The problem derives from the collective wage agreements which bind the domestic system, while the foreign banks offer higher salaries. A foreign bank can operate in Israel in three ways: through a representative office, a branch, or a subsidiary.
A representative office of a foreign bank in Israel is permitted only to provide information and to refer customers to the foreign bank. It may not carry out banking transactions or other business activities in Israel, and it must not be authorized to commit the bank abroad through its activities.
Only a small investment is generally required to open a representative office in Israel, and it provides an opportunity for the foreign bank to familiarize itself with the business environment in Israel, to enable it to decide whether to open a branch or a subsidiary company here.
No permit under the Banking (Licensing) Law, 5741-1981 is required to open a representative office in Israel. However, if the intention is to use the word “bank” or a derivative of it in the name of the representative office, it must obtain the consent of the Governor of the Bank of Israel as per Section 4(1) of the Banking Ordinance, 1941.The Governor’s consent is granted on condition that the activity of the representative office is strictly confined to providing information and referring customers to the bank. In order to avoid misleading customers into thinking that the office is a branch of the bank (which would be under the supervision of the Supervisor of Banks in Israel) the representative office is required to include in its name (in its letterhead, sign on its office, etc.) that it is a representative office in Israel of the bank.
The activity of a representative office is not supervised by the Supervisor of Banks, unless a doubt arises regarding the nature of its activity related to what is permitted in the Governor’s consent to the use of the word “bank” in its name.
There are currently nine representative offices of foreign banks in Israel which received the Governor’s consent to include “bank” as part of their name. There were another four in the past which ceased their activities as representative offices in Israel (one expanded its activities and opened a branch in Israel). The nine offices are:
HSBC Republic Bank (Suisse) S.A.
HSBC Bank USA
Discount Bank and Trust Company
Union Bancaire Priv?e
Multi Commercial Bank
CA IB Investment Bank
Credit Industriel et Commecial CIC (CIC BANQUES)
Bank of America International Limited
Foreign banks’ growing interest in Israel resulting from the changes in Israel’s geopolitical and economic environment was referred to above. This is also reflected in the number of representative offices which were opened: from 1994 to 1997 there was a slow trickle (on average one office a year), while in 1998 and 1999 the rate increased, and the Governor gave his consent to three and four a year, respectively. In 2000 only one representative office opened; nonetheless, there is continued interest from foreign banks. In addition to the above, there has been a rise in activity in Israel by other foreign financial entities in the last few years, including banks in whose names the word “bank” does not appear. These engage in areas such as investment banking, including underwriting services and advising Israeli companies issuing shares or bonds abroad or prior to acquisitions or mergers, as well as brokerage services
Activities via a branch or subsidiary
There are various attitudes as to whether activity by foreign banks is preferable via branch or via a subsidiary. From the supervision perspective, there are certain advantages to the former since a branch is supervised by another authority in the home country, and at least hypothetically the entire capital of the banking group is available to the branch. Some claim that this serves to make a subsidiary preferable to a branch, as a subsidiary is a stand-alone entity with its own capital.
In practice, from a supervision point of view the distinction between the two types of entity is blurred, particularly in the case of large international banks or countries which have proper banking supervision on a consolidated basis, as experience has shown that a large bank, to maintain its reputation, will not abandon a subsidiary, and further, a “comfort letter” can be requested to establish the commitment on a formal basis.
Most Asian countries permit foreign banks to operate only via branches. South Africa, on the other hand, Central Europe, and Latin America are more flexible and leave the decision to the foreign bank itself, and supervise both types of entity on an equal, consolidated basis
.In Israel, a foreign bank can perform banking activities by establishing a branch or a subsidiary company. The Bank of Israel issues permits to open branches to large banks which have a high international rating and which meet the criteria described below. If a bank does not meet all the requirements for opening a branch, consideration is given to whether activity in Israel should be performed by a subsidiary
.A permit granted to a foreign bank to establish either a branch or a banking subsidiary enables it to undertake activities in Israel under conditions similar to those applying to domestic banks. The Banking Supervision principles in Israel do not differentiate between domestic and foreign-owned banks.
Branches of foreign banks
The Bank of Israel grants permits to open branches to large banks which have a high
international rating. The following additional aspects are examined before a permit is
- Is there banking supervision in the home country of the foreign bank on a consolidated basis which will include the branch to be opened in Israel, and which is conducted on the lines of the Core Principles for Effective Banking Supervision of the Basel Committee? The significance of the requirement for supervision on a consolidated basis is that the bank has complete responsibility for the activity of the branch in Israel.
- There should be no restrictions on the free flow of capital in the bank’s home country.
- The consent of the foreign bank to information being transferred by the authorities in its home country to the Supervisor of Banks in Israel is required, and also its consent to information being transferred in the opposite direction regarding the activities of the branch in Israel. This latter consent is required due to the secrecy obligation as in section 15A of the Banking Ordinance which applies to information received as per the Ordinance or as in the Banking (Licensing) Law.
- Information regarding the identity of the holders of the controlling interest in the
The permit granted to a foreign bank which met the criteria enabling it to open a branch in Israel does not restrict the types of activities allowed by comparison with those allowed to a domestic bank, but the permit does contain conditions relating to the following points: the determination of “endowment capital”1 imposed on the branch to enable stability restrictions to be applied; management and reporting of the branch; reporting of the parent bank; supervision and control; the appointment of key personnel in the branch; adaptation of the regulations applicable to domestic banks to the branch, and limitations on the transfer of deposits at the branch to the parent banking group; and sometimes, limitation of the extent of the branch’s activity which allows the Supervisor of Banks in Israel to require that the foreign bank operating in Israel should, at a certain stage, operate as a subsidiary to be incorporated in Israel, and not as a branch.
Although opening a branch entails a larger investment than does opening a representative office, the fact that the parent bank exists means that the infrastructure investment required is far less than that needed to establish a new bank (the branch relies on computer services supplied from abroad and on existing work procedures), and there is no need to appoint a board of directors.
Currently there are two branches of foreign banks operating in Israel, one of Standard Chartered Bank, and one of Citibank N.A. The first started its activities in Israel in 1997 as a branch of the ANZ Bank (part of the Australia and New Zealand Banking Group) whose head office is in Australia. In the second half of 2000 the bank sold its internationalbanking activities in the Middle East (including Israel) and South Asia tothe London based Standard Chartered Bank, whose main activities are in Asia and other emerging markets. The branch in Israel provides services for the residents of East Jerusalem, where it is located. The bank has a representative office in Tel Aviv.
The branch of Citibank N.A, which started operating in 2000, is initially focusing on providing banking services to large companies in Israel. These services include accounts management (the bank has the advantage of having a wide international spread), company financing, etc. According to the statement by the bank’s directors when the branch opened, the plan is to extend activities into the area of retail banking.
In early 2001 HSBC Bank plc, part of the UK banking group Hongkong and Shanghai Corporation Holding plc, is expected to open a branch in Israel. HSBC has annou ced that it intends to operate in Israel in three areas: private banking, provision of banking services to large companies, and investment banking services in the high-tech sector.
Banking activities can be performed in Israel by a foreign bank through a subsidiary either by establishing a new bank in Israel, or by acquiring control of a domestic bank. The policy towards establishing a bank in Israel does not distinguish between holders of controlling interests who are nonresidents, including a foreign bank, and Israeli residents. According to the policy, the holders of the ultimate controlling interest are
examined in the same way as is anyone wishing to acquire control of a bank in Israel (regarding financial soundness, integrity, and management ability); among other requirements for the bank is a minimum equity requirement.
In cases of the acquisition of a domestic bank, the same examination of the purchasers as described above takes place. If the buyer is a foreign bank, the ultimate holders of the controlling interest are also examined, if they can be identified.
There are two foreign-owned domestic banks currently operating: one is Bank Polska Kasa Opieki Tel-Aviv (Bank Pekao) Ltd., which started operating in Israel as long ago as the beginning of the 1930s as a branch of the Polish Bank Pekao. In 1993 it changed from a branch into a subsidiary company, and in 1999 the parent bank in Poland, including the bank in Israel, was sold to the Italian bank UniCredito Italiano. The bank has only one branch, in Tel Aviv, and it provides banking services to Israelis and credit overseas. The bank’s share of Israel’s banking system is marginal.
The second is the Investec Clali Bank Ltd, controlled by the South African Investec Bank. The bank in Israel (formerly Israel General Bank Ltd) was purchased by the South African bank at the end of 1996. The bank engages in all types of banking activity but focuses on the capital market and private banking. The bank has only three branches (one each in Tel Aviv, Jerusalem, and Haifa), as it does not aim at retail banking. Its balance sheet accounts for about one percent of the total of Israel’s banking system.
In the permit, this “endowment capital” of the branch is determined as a function of the capital of the bank in the same way as the capital base for an Israeli bank.