Regulation of the Capital Market* Avi Ben-Bassat, Sharon Blei, and Asher Blass * The full report in Hebrew, including a detailed abstract in English, is available at http://www.idi.org.il/hebrew/catalog.asp?pdid=574&did=85

The Criterions The goals. The authorities and independence needed. For and against locating supervision of banks in the central bank. Conflicts of interest in the activity of regulators under the MOF. The global trend. Israel’s financial market structure.

The 5 Supervisors and the supervised bodies Banking Department Securities Authority Capital Market, Insurance & Savings Division Anti-Trust Authority Insurance Savings Insurance Companies Pension Funds Insurance agents Money Changers Banking Institutions Listed Companies Stock Exchange Underwriters Mutual Funds Investment Advisors & Portfolio Managers Competition in the various markets Providence Funds

The Goals of Regulation & Supervision Protection of consumers’ interests Intermediate Goals: Financial stability Market efficiency Competition Reducing conflicts of interest

Regulators’ Independence Index, 2005 Capital Market & Savings Division % Banks Securities Capital Market & Savings Division Anti-Trust Capital Insurance 1. Source of Authority 15 5 4 2. Managerial Independence 20 4.6 3.2 1 1.8 3. Licensing and Regulation 4. Enforcement: a. Information 17.5 1.9 4.3 1.3 b. Feedback 4.2 3 5. Punishment Power 3.1 2.8 3.7 Average Grade 4.0 3.6

Capital Market & Savings Division Inputs and output, 2003 Banking Department Securities Authority Capital Market & Savings Division Anti-Trust Authority Supervisors 152 121 73 60 Budget (in Million NIS) 81.4 70.5 22.2 17.8 Employees supervised (in thousands) 40 14 23 - Assets supervised (in Billion NIS) 443 404 424

Capital Market & Savings Division Input-Output Ratios, 2003 Capital Market & Savings Division Banking Department Securities Authority Supervisors/Assets supervised 1.00 1.99 1.74 Supervisors/Employees supervised 1.19 2.73 Labor Input/Assets supervised 3.39 3.18 Labor Input/Employees supervised 2.02 4.98 Budget/Assets supervised 3.51 3.33 Budget/Employees supervised 2.08 5.23

The Benefits of Locating the Bank Supervision in the Central Bank May benefit from the prestige and reputation of the CB. May solve financial crises faster, since the CB is the lender of last resort. Both monetary policy and banks’ supervision may benefit from exchange of information .

Separating the Bank Supervision Department from the BOI Conflicts of interest between the banks’ stability and competition. It also impairs the transmission mechanism of the monetary policy, and therefore its effectiveness. The Bank Supervision Department hasn’t benefited from being located in the BOI in managing financial crises. Israel belongs to the developed countries. Most of them have separated the banks’ supervision from the central bank.

The location of Banks’ supervision (70 countries, 2004) Per Capita Income ($, PPP) Only in the CB Outside the CB Only in the Monetary Institution Outside the Monetary Institution +30,000 1 12 13 29,900 – 20,500 10 2 5 7 20,400 – 10,300 8 6 4 10,200 – 6,000 2,700 – 5,900 Total 34 33 24 43

Conflicts of interest between economic policy and financial supervision in the MOF The stability of pension funds versus labor market policy. The stability of insurance companies versus cross subsidization policy. The stability of financial institutions versus the price of financing government debt.

The share of independent authorities 2004 vs. 1984 (percent)

Alternative Regulatory Structures Multiple authorities by industry: Banks ; Securities ; Insurance Multiple authorities by function: Prudential supervision Conduct of business A single regulatory authority

The Advantages of a Multiple Authority Greater specialization Competition among supervisors Prevention of excess power Avoidance of risk inherent in the reform process

The Advantages of the Unified Authority A comprehensive view of the regulated institution. Equality in the regulation & supervision of similar activities. Flexibility in regulation and ease of coordination. Economics of scale and efficiency. Focusing of responsibility and accountability.

30 Countries has reduced the number of authorities From 3 to 2 From 2 to 1 Australia Bulgaria Canada Luxemburg Mauritius Mexico Netherlands Austria Belgium Bermuda Denmark Gibraltar Ireland Iceland Sweden Malta Norway Poland Singapore Slovakia South Korea Taiwan Czech Rep. England Estonia Germany Hungary Kazakhstan Latvia Liechtenstein 7 8 15

Regulatory Structure in 79 Countries Pre and Post Reform Several Regulatory authorities Two regulatory authorities Single regulatory authority Securities & Insurance Banks & Banks & Securities 28 6 10* 5 30 Current Situation 49 7 8 Before the reform *The Netherland is classified by prudential and conduct of business supervision. Source: Courtis (2004) and the Israel Democracy Institute.

The Main problems in Israel’s Structure Considerable variance in regulatory and supervisory authorities. Significant differences in managerial independence. Marked differences between regulators’ resources. Potential conflicts of interest between monetary policy as well as competition and bank supervision. Potential conflicts of interest between MOF policy and the activity of the regulator located in the MOF. Similarity of financial institutions and scale of activities increased after Bachar’s reform.

Financial Services Authority Chairman Banking Unit Securities Unit Insurance Unit The BOI shall be responsible for the stability of the financial markets.

Unification Alternatives A federative authority composed of 3 industries departments. A single authority like the FSA in GB. Twin Peaks Model: Prudential supervision department Conduct of business department

Thank you! * The full report in Hebrew, including a detailed abstract in English, is available at http://www.idi.org.il/hebrew/catalog.asp?pdid=574&did=85