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A long resilience building process

Interview - September 22, 2015

In an exclusive interview with Globus Vision, Dr. Nadine Baudot Trajtenberg, Deputy Governor of the Bank of Israel, talks about the country’s economic enviable performance and the role solid monetary policies play in the future of Israel’s financial system


Israel is making solid progress in building a modern, competitive and open financial system. Since the mid-1980s, the country has undertaken significant deregulation and liberalisation while the role of market forces has expanded. Please expand on the current situation of the Israeli banking sector and the main attributes behind its solidness.

The Bank of Israel’s first and formal job by law is the conduct of monetary policy. Depending on the country, the supervisor of the banks can be located in different places, in Israel the supervisor of the banks is within the Central Bank and we have a new supervisor of the banks that came in only a few weeks ago. The concern of the banking sector is first and formal the concern of the supervisor of banks which is also within the Bank of Israel, I mean Central Banks are always also worried about the banking sector. However our main concern is, of course, monetary policy which is inflation in the first place, economic development in second place and financial stability of the entire financial system not just the banking sector in the third place.

Having said that, one of the things that is most important for most countries and we tend to forget because we’ve had financial crisis in countries that were stable and that had good macroeconomic performances, being the US an obvious example, is that in order to have a stable financial system and a stable banking system you need to have strong macroeconomic fundamentals. Strong macroeconomic fundamentals mean that you have to have economic development that matches your potential in terms of real growth. Indeed, when having a quick look at the Israeli economy it shows relatively healthy growth with a low rate of unemployment. Furthermore it’s very important to have stable and low inflation; countries that don’t have low and stable inflation will typically often have problems in the financial sector. Israel has moved away from its past of high inflation and certainly for the past 15 years the country has had a low and relatively stable inflation. Recently we almost suffered the uncomfortable situation of having very low inflation; in fact we had negative inflation during the past year even though we continued to have economic growth. So this is a combination which a few countries now share. Similarly to Israel, various countries such as Sweden, Switzerland and Denmark did very well in the financial crisis and did not have banking crisis themselves. Despite not having a banking crisis, in Israel inflation is below target and it’s been below target for a little while now. Some people would say that these are rich people’s problems but they’re nevertheless very much the focus of the Central Bank.

Regarding the banking sector in Israel, it has enjoyed the stable macroeconomic environment. It’s true that it is a relatively concentrated banking sector which is something that does characterize a lot small economies. Banking sector has economies of scale and therefore it’s not surprising that you have a concentrated sector. But of course the banking business doesn’t operate alone, there’re lots of other financial institutions such as shadow banks and quasi banks that do similar things. One of the things that has occurred in Israel as a consequence of the reforms that were undertaken ten years ago is that the banking sector as a proportion of the financial sector is in fact contracting. This phenomenon also takes place in many other markets around the world. If you look just at the banking sector it’s true that it’s relatively concentrated; on the other hand, looking at the financial market you see that the banks’ importance in fact has receded, and sometimes even dramatically. For instance, 10 years ago, the largest corporations in Israel used to fund themselves through the Israeli banking system while today these corporations finance themselves in part through the banking system but in a very large part through either other financial institutions like pension funds and provident funds or they raise funds directly on the capital market. Consequently, in some areas you can see the banking sector receded and not growing very fast; while in other areas the banking sector still very much dominates the credit market, that’s true when you think of the retail and the small and medium size enterprises.

To what extent do you think regulatory intervention will safeguard the deposits for the general population?

Israel does not have banking deposit insurance which is something that exists in some other countries. And as you may know there’s a big issue as to should you have a banking deposit insurance service as you did in the United States and to some extent it did protect the depositors. On the other hand we know that if you have banking insurance there’s a moral hazard problem whereby the banks can afford to take larger risks because somebody else is guaranteeing their deposits and therefore they need to be heavily regulated. This is an issue that we’ve been looking at and it’s certainly at the table of the bank supervisor. Moreover there are some other issues resulting of this issue. Firstly if you give bank deposit insurance you need to consider to what extent and who finances this deposit insurance; secondly should there be a resolution funds as in some countries; and thirdly should all banking institutions benefit from this bank deposit insurance. All these issues are essential and have to be addressed before saying that we should or we shouldn’t have bank deposit insurance. 

Overview of the long term monetary policies which are needed in order to attain long-term price stability and keeping inflation fluctuations at their minimums.

Price stability is defined by law in Israel as the CPI and it’s defined to be between 1% and 3%. As I mentioned, during the past year we had negative inflation but the CPI has been wavering within that band for quite a number of years. There’re two things to be considered. One, being what are the tools that you have in order to try to ensure that you meet the target. And two, what are the macro conditions not only in Israel but also around the world that helps you reaching your target.

Perhaps the most important tool, and it’s a tool we often don’t talk about, is research. We have to have a good sense of where the economy, and not only the domestic economy, is going and why it’s going where it’s going. Although no one has a crystal ball, one has to attempt to get a sight as clear as possible. So not surprisingly the Central Bank of Israel has a very large research department which is extremely important for monetary policy. We really need this input. We need to look at what the markets are saying, particularly with respect to inflation expectations. In Israel there’s still a sizable market of indexed to CPI bonds, this is so because we did have inflation in the past and these uses remained even though we don’t have much inflation now. Due to having both inflation-indexed bonds and non-indexed bonds this allows the market to signal to us what are the expectations of not only the inflation in the near term but even in a longer term. Inflation expectations although they’re still within the band, they have lowed recently from where they were for quite a while. I think this is partly a reflection of the low inflation that we’re seeing around the world, and even though Israel has enjoyed growth we in part imported the deflation. In addition there’s a correlation between oil prices and CPI, and that correlation has strengthened following the global financial crisis.

Do you see this as a competitive advantage for Israel or one of the main reasons behind its resilience?

Israel has repetitive shocks coming, both internal shocks and shocks that come from the various conflicts that flare up every now and then. Resilience is built; you don’t suddenly discover resilience one morning. So part of the resilience that Israel is enjoying during these years is the result of a very long process of building that resilience. A very important element of Israeli resilience is that when you look at the overall leverage in the economy it’s not very high. If you take on a lot of credit it doesn’t really matters whether is the government taking a lot of debt or is the corporate sector, the banking sector or private individuals. If you live with a very high level of leverage you’re going to be less resilient whether there’s an internal or an external shock. So part of the resilience that Israel has built over the years comes from the fact that it has reduced remarkably its overall government debt burden which used to be very heavy. 30 years ago the government’s debt as a percentage of GDP was about 280% while Greece defaulted on its debt when it reached 140% of GDP. Israel, instead, never defaulted on its debt. Today the government’s debt as a percentage of the GDP is 67% which is a relatively comfortable number. Maastricht requirements for the European Union established that countries were allowed to get into the monetary union if they had at most 60% of government’s debt as a percentage of the GDP and Israel has had that target in mind for many years and we’re slowly approaching to it. In the meantime the European countries have gone the other way around and not only the weaker countries like Greece, Spain or Portugal but also counties like  France and Germany that currently have debt burdens of about 80%. So Israel looks relatively well when we compare ourselves to the OECD countries. Nevertheless, I still think that Israel given the neighborhood in which it lives and the potential shocks that it’s subjected to, needs to continue to reduce its government debt burden. We’ve done it through 30 years and we’ve done it in part because we’ve grown our GDP and also because the various governments of various parties and various coalitions maintained the fiscal discipline. 

As noted by Fitch, among the main sources of stability for Israel’s public finances are the US government guarantees in the event of a market disruption in Israel. In 2013, the total (stock) FDI from the US reached USD 19.7bn, making the US a key investor in the country. Also, Israeli investor has accumulated a total USD 10.3 bn in the US.  How could one weight the importance of the US for the Israeli economy?

Firstly, when you think of the United States you’re thinking about a very large economy. So thinking in economic terms, as a small open economy any large economy is going to be important for us. Regarding trade, Israel trades a lot with the United States although it trades more with Europe as a whole as Europe is a closer neighbor. The US accounts for 22% of Israel’s trade while Europe accounts for about 32% of it. But the US economy is going to be very important not only for Israel’s trade but also for further reasons, some of which you have mentioned.

There’s lots of foreign investment to Israel as well as there’s a lot of Israelis investing abroad. I think that reflects a very healthy economy without capital constraints where if you have a good idea to invest abroad you should invest abroad. This also allows savers in Israel to have their pension funds by having also foreign assets and not only domestic assets. During the past 5 years we’ve seen a lot of the institutional investors in Israel increasingly investing abroad. Similarly we see both portfolio and direct investment coming to Israel. Investments come from all sorts of places including the United States but I’d say that American firms were pioneers in making the first large investments in Israel.

Furthermore, there’s also compatibility in certain sectors of investment that need to be highlighted. When you look at technological innovation around the world, in Israel the high tech sector is very much at the forefront of technological development and it has an ecosystem which is not unlike what you find in the US. Silicon Valley type of ecosystem also exists in Israel. So there’s a compatibility of entrepreneurship culture that is needed for technological advances, which are not easy things to replicate in many other places. The bilateral relationship comes in all sorts of different ways. You can see it when looking at venture capital funds and money coming in, it also involves patents as many Israeli patents are going to be registered in the US, and there’re Israeli workers that go to work in the US. Plus there’re several American firms in the sector establishing R&D centers.

In addition, if you’re going to have a sector which is at the forefront of technological development you need an academic system at the forefront of excellence. The university system in Israel is very good and it’s very much measured and it operates by the standards of the United States higher education system. Any promotion system in the universities is based on recommendations from American universities. Plus most academics in Israel had studied either their PhDs or their post docs in American universities and they will continue to cooperate at that research level. That standard of excellence which has been established in Israel is also very much interlinked with the American system. Once more, this is not something that could be easily replicated but it’s something that we have to grow and focus on. Therefore it’s not only about money, but it’s about thinking in terms of excellence in general and what is needed in order to achieve it.

The Tel Aviv Stock Exchange in Tel Aviv is Israel's only public stock exchange. TASE plays a major role in the Israeli economy. TASE lists some 473 companies, about 47 of which are also listed on stock exchanges like NASDAQ. Your evaluation on the fact that Israel has more companies listed in 2012 on the NASDAQ stock exchange than any country outside the United States, save China?

Firstly I must point out the fact that there are no barriers now between the outside and the inside. When we look at the capital market we have to think in terms of the entire access to capital for Israeli firms. I think that a completely open market certainly allows firms not only to finance themselves domestically but also to finance themselves abroad. However this’s only true for two types of firms. It’s viable for large firms and more particularly for those large firms with an export market that are known abroad, so they’ll have access to foreign banks and foreign capital markets. And it’s also possible for firms that may be very small but have something very special being this the case of the high tech sector that has access to foreign venture capital funds. In fact most of the funding to the startups comes from abroad.

The question that we ask ourselves is: is the capital market sufficiently flexible for the firms that are neither big enough nor export oriented enough nor special enough in terms of technological development in order to get good and cheap financing? The banking sector is fairly concentrated and you have other players in the financial system but these players are not really in yet. This means that probably the capital market is not sufficiently developed for the domestic smaller firms in Israel. There are many important things that are needed to be reformed, one of them is the possibility of building asset-backed security as there’s no securitization yet in Israel. The securitization is now a fairly used tool, and one of the advantages of having waited for so long to introduce securitization is that we know how it can be misused and the dangers of introducing it. So there’s been an inter-ministerial commission that included the Bank of Israel that has finalized a report on that and hopefully we’ll see the securitization occurring. There are other things that are being discussed such as our willing to see more players in the capital market and therefore to have a more sophisticated capital market, particularly for small domestic oriented enterprises. This is important as we know that very often that’s the source of growth in the economies, but we know that we’re tackling our problem.

The G20 summit is taking place in Turkey in November this year, under the umbrella of implementation, inclusion and investment. What are your personal expectations for this summit in terms of economic stability on a global scale?

I think inclusion is the key issue. Part of the investment problems that we have and many countries are complaining about it, is the lack of investment whether it’s infrastructure investment or private investment to try to kick start growth again. I think that often the source of this lack of investment is, as the IMF has recently stated, the lack of hope for future growth. I believe that this lack of hope partly lies in the fact that not all populations have been included in the past growth and at the moment are still being excluded from the potential future growth. It’s only by bringing them into that we can all generate future growth. So inclusion is the main issue I’d like to see discussed. I don’t expect there’s a magic solution to it. As we don’t suddenly discovered resilience, we won’t suddenly discover inclusion but we have to get into a path so that we can regain hope that growth is possible for all and not just for the elite.