How Israel lowered concentration in banks’ credit portfolio and cleaned up its banking system (lessons for India?)

Interesting remarks by Dr. Hedva Ber, Supervisor of Banks at Bank of Israel:

The supervisor points how from 1990-2010, Israel’s credit market was highly concentrated in hands of few companies. Since then, they have cleaned up the system taking stringent steps involving firing several key people:

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.

Reads quite similar to the situation in India as well. Though, we do not know till what extent is the clean up happening both externally and internally…

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