Foolish, Israel Does Not Have Deposit Insurance

Banking crises are difficult. The 2007-9 banking crisis punctuated this point, wherein markets suffered, liquidity dried up, unemployment soared, and sovereigns lost ability to fund themselves through capital markets. Working-class and fixed-income retirees often went from comfortable existence to hand-to-mouth existence. Those on the edge fell into poverty.

In 1980, the Knesset passed the Bankruptcy Ordinance that protects indebted consumers through an insolvency regime. It has since been updated to become more debtor friendly. Similarly, Israeli law recognized the need for corporate rescue by passing the Companies Ordinance of 1983, which provides corporate rescue through receivership and the like. This is particularly important due to the increasing shift from an emphasis on agricultural economics to corporate economics.

This is notable because it shows that the Knesset is less reactionary and more proactive when preparing for a possible economic downturn. In the U.S., Congress passed the Dodd-Frank Act of 2011 that is an all-encompassing financial legislation focused on regulating the financial industry. Amongst the Dodd-Frank legislation is the creation of the Orderly Liquidation Authority, whose charge is to monitor and possibly takeover systemically important financial organizations, so there will be no more reactionary taxpayer bailouts. In 1933, Congress passed the Banking Act, creating the Federal Deposit Insurance Corporation that, among other things, insures certain accounts up to $250,000. Through deposit insurance, Americans have confidence in the banking system even during times of crisis. Israel lags woefully behind.

In its infancy, the socialist-Zionist Israeli regime supplied funding for Kibbutzem throughout Israel. This funding shaped Israel’s agricultural economy. The system rewarded those who worked the land, despite its arid climate and severe lack of water. Even today, those dwelling on a Kibbutz are entitled to special tax treatment.

Despite the will of the farmers and the socialist-Zionist ideology, the Israeli economy constantly felt financial shock. Having Arab neighbors as customers was mercurial; the severe lack of water and costs for desalination depleted resources; socialist economic principals. e.g. indexing inflation, curtailed growth. Things needed to change.

In recent years, Israel moved away from the agrarian economy and into the hi-tech and consumer economy. Under the stewardship of former Bank of Israel Governor Stanley Fischer, Israel devalued its currency in an attempt to make its homegrown technology more attractive for foreign buyers. The currency devaluation spawned an explosion of Israeli technological exports in the form communications, computer parts, and military drones, to name a few. The result was a stronger economy with a new corporate focus.

Nonetheless, Israel still has not addressed banking concerns. While the recent slowdown in the Israeli economy has not approached the economic discord of the past, the lack of strategic planning is vexing. Of the world’s developed economies, Israel is one of only three that lacks deposit insurance. Banks, specifically commercial banks, rely on the liquidity from depositors. By allowing banks to remain uninsured, there are less depositors and a higher possibility of bank runs. As a result, there is less money for banks to lend, which in turn leads to less commerce.

Moreover, having deposit insurance strengthens the banking system overall. It allows smaller banks to compete with larger foreign and domestic banks because people are less concerned with bank safety issues. This results in greater economic balance and helps those starting businesses, who often do not qualify for loans from larger banking institutions, with access to important startup capital. On the same note, depositors would have more trust for a smaller bank, instead of the current system where they trust large institutions but are skeptical of smaller ones.

Arguably, deposit insurance engenders excessive risk taking that threatens an economic system, thereby making it unattractive and unwarranted. This economic theory holds that banks whose depositors are protected through deposit insurance will inherently have bigger risk appetite because they realize that their depositors are protected. This is the theory of “moral hazard” because government intrusion shelters risk takers from negative consequences. To counteract this type of moral hazard, Israel needs a comprehensive regulatory system to control banking risk, similar to those of other developed countries. It can utilize twin methods for creating a safety net for depositors and controlling the banking economy: add deposit insurance and introduce a bank regulatory regime.

The Israeli economy is at a crossroads. While the country as a whole has moved from agrarian socialist-Zionism, tugs toward the kibbutz economy remain. Deposit insurance, tempered by proper bank regulation, would help prepare the economy for possible shock. When will the socialist-Zionist economic kingmakers finally release their grip?