Israel has launched a major reform of its credit card industry in a shakeup that has wide-ranging implications for consumers — despite several false starts, opposition from vested interests and skepticism from independent observers.

The recent passage of the Law for Increasing Competition and Reducing Concentration in the Israeli Banking Market by the Knesset (parliament) marks the biggest structural change in the banking sector since the ‘Bachar reform’ of 2005 — named after Yossi Bachar, former finance ministry director general — which required commercial banks to divest their asset-management subsidiaries. These reforms resulted in a far-reaching shake-up of the pension, insurance and investment sectors.

The new law — based on recommendations from a committee chaired by Dror Strum, former head of the Antitrust Authority — aims to open up the financial sector to more competition to benefit consumers. It fulfills one of the campaign promises of a new centrist political party, Kulanu, led by Moshe Kahlon, which won 10 out of 120 seats in the 2015 Knesset elections. Due to Israel’s proportional representation system, the seats were enough to give Kulanu the balance of power in a Likud-led coalition and enabled Kahlon to lead the powerful finance ministry.

The central feature of the new law is the requirement that the two biggest Israeli banks — Hapoalim and Leumi — divest their credit card subsidiaries. Yet, this obligation is less sweeping than the Bachar reform, in which all banks were effectively expelled from the asset management sector. This time, the divestment is limited to Isracard and Leumi Card, the two main credit card companies and hence the dominant players in the sector, which are owned by Hapoalim and Leumi respectively.

However, the third major card company, Cal, is currently not included in the restructuring. It is owned by Israel Discount Bank and First International Bank, the third- and fifth-biggest banks, with 72% and 28% stakes, respectively.

Turf Wars Behind the Scenes

Cal’s fate generated one of the fiercest struggles in the new law’s deliberations and during the legislative process, because Kahlon and the ‘reformist’ camp wanted it included in a complete shake-out of the current players. However, the ‘conservative’ camp, led by the Bank of Israel (the central bank), demanded that credit card reform be viewed within the overall structure of the banking industry.

“Israel has launched a major reform of its credit card industry in a shakeup that has wide-ranging implications for consumers.”

“The whole move (of restructuring the credit card sector) must be done in a balanced way,” explains Ilanit Madmoni, head of innovation in the financial technology unit of the banking supervision department at the Bank of Israel. “We insisted that a distinction be made between the two big banking groups and the Israel Discount group. Detaching Cal from Discount would be a much greater blow to it than would the loss of Isracard and Leumi Card to their parent banks, and could even pose a threat to Discount’s stability. Conversely, allowing Discount to retain Cal would narrow the gap between it and ‘the big two’ — and thereby improve the overall competitiveness of the banking sector.”

The outcome, as reflected in the final version of the law, was a compromise — but one that leans heavily towards the Bank of Israel, which dug in its heels and “made Cal into a ‘red-line’ that could not be crossed,” Madmoni says. Instead of requiring the sale of Cal, the law stipulates only that its status be reviewed in four years — by which time Isracard and Leumi Card must be sold. The new structure of the sector should also be clearer by then.

The fight over Cal was one of numerous clashes between the different regulatory bodies represented on the Strum committee. Probably the most important turf war, at least from the viewpoint of the ministries and agencies involved, was over how and by whom the divested credit card companies — as well as any new ones — would be regulated. In this respect, the finance ministry emerged victorious, because the new regulatory entity charged with overseeing consumer finance is to be established within the comptroller of pensions, insurance and capital markets — a department within the finance ministry.

Meanwhile, Hapoalim and Leumi were given three years to divest Isracard and Leumi Card, either by being spun off, or sold to strategic or financial investors. If they choose the former route, the law allows them to sell 60% of their stake within three years and to complete the process in the fourth.

Following the sales, the two big banks will not be allowed to engage in clearing operations for credit cards, but they will still act as issuers — as banks do all over the world. Many of the new law’s provisions — such as the stipulation that every bank must contract to work with at least two clearing companies in a fair and transparent tender process — are connected to the detailed implementation of the goal of opening up the clearing process to competition.

As for the credit card companies themselves, the law puts in place a ceiling of 52% for any single company’s market share. Currently, Isracard is close to the market share cap, holding about 50% of the market compared to Leumi’s 26%. Overall, the divestiture of the big credit card companies “is a blow, but not a major blow,” to the banking sector, according to an adviser to the big banks.

Opening Up the Credit Card Market

The bigger impact of the law is the opening up of the consumer credit market to new entrants. At present, commercial banks dominate both the mortgage and non-mortgage lending to consumers with a combined market share of more than 90% as of September 2016, according to Bank of Israel data.

While the mortgage sector is fiercely competitive, pushing lending margins to very low levels, the non-mortgage lending market has much fewer competitors, according to central bank and independent analysts. And the size of the non-mortgage consumer credit market is a big prize: It comprises 11% of the typical Israeli household’s debt.

The combination of less competition and significant market size makes the credit card sector attractive to potential entrants. It is this concept that underpins the reform — yet realizing this potential is no guarantee. That’s why simply requiring divestitures of credit card subsidiaries was deemed insufficient without addressing other issues.

The first major hurdle facing any would-be entrant into the credit card sector is the need for credit data. In the existing system, where the commercial banks effectively “own” their household customers, the line of credit extended by the bank’s credit card company to a cardholder is part of its overall relationship with that customer. How much credit is made available is decided by the customer’s branch and is either a supplement or an alternative to an overdraft facility (a near-ubiquitous feature of Israeli household finance).

This is a very cozy relationship for the bank, because it knows its customers and has ample data on them. But it is a very constricting relationship for the customer, because the data is proprietary — so customers seeking to switch to rival banks must effectively start from scratch.

Thus, an essential prerequisite to opening up the credit card sector was to make data available — a lesson learned the hard way in 2001, when a previous attempt to achieve this goal foundered thanks to the banking lobby’s success in blocking efforts to force them to provide data that would enable a system of credit scoring.

This time the data issue was resolved in advance, via a law that authorizes the Bank of Israel to set up a national databank that’s accessible to all licensed lenders. Although it will not be up and running until late 2018, the Strum Reform obliges the banks to transfer all back-data on cardholders to the future buyers of the credit card companies.

Access to data, however, was only one of a series of issues that required ancillary reforms to achieve the goal of increased competition in the credit card sector. As part of large banking groups, Isracard and Leumi card were reliant on their parents’ computer systems for many functions. Future competitors will lack even the processing capabilities that the existing companies have, creating a serious and potentially insurmountable barrier to entry for new players.

“The bigger impact of the law is the opening up the consumer credit market to new entrants.”

The law addresses this problem by allowing any bank other than the ‘big two’ to offer computer facilities to credit card companies. The law also requires the finance ministry to issue a tender for the establishment of independent data processing infrastructure, or to finance it directly. In the event that neither of these options is realized, it allows the finance minister to impose on the banks the requirement to provide access to their systems.

Beyond that, in another component of the wider reform that the Bank of Israel is pursuing, the law obliges the banks to divest their ownership of Automated Banking Services Ltd., a company owned by the banks that currently has state-sanctioned monopoly status as the lynchpin of the country’s payments system.

A further important feature of the law, designed to enable new players to establish themselves in the consumer credit market, is the requirement that in the period between the fourth and the seventh year after the law’s passage — by which time Isracard and Leumi Card must be divested — banks Hapoalim and Leumi must reduce by 50% the total amount of credit lines allocated to their customers through their credit cards in 2015, prior to the law’s passage. This requirement does not extend to customers with credit lines of up to NIS5,000 (about $1,400) — who are mostly low-income. The cut will therefore fall disproportionately on upper-income customers, thereby creating an incentive for them to use the new companies’ cards.

But Will It Work?

Nevertheless, the success of the reform remains uncertain. One major concern is finding buyers for the credit card companies being divested. In a June 2016 conference devoted to the Strum committee’s recommendations, former Isracard CEO Dov Kotler was not optimistic about the attractiveness of Isracard and Leumi Card to buyers given the terms of the reforms. Starting a new credit card company from scratch is even less enticing, in his view.

Kotler focused on the insufficient potential profits that the credit card companies could generate for investors. Meanwhile, banking law expert Dalia Tal pointed to the lack of clarity in the regulatory structure as a problem even after the passage of the law, as new and old regulatory bodies vie to define their roles, functions and territory.

Tal heads the banking practice at Israel’s largest law firm, Meitar Liquornik Geva Leshem Tal. Her colleague, Assaf Oz,  shared Tal’s concerns about the new regulatory structure and stresses the need for a flexible approach in the face of a rapidly changing financial and technological environment.

Oz also highlighted two things the credit card companies will need — data and financing. While the data issue seems to have been resolved, the supply and cost of the financing that the credit card companies will need in order to offer credit to their cardholders, remain uncertain.

This raises a fundamental issue regarding the socio-economic goal of the reform, namely to provide more and cheaper credit to a wider group of people. Compared to the U.S., U.K. and other nations, the cost of credit taken through credit cards is very low in Israel. It is therefore difficult to see how it will become cheaper when independent credit card companies raise funds through bond issues or from banks with whom they will be competing in the consumer credit market.

These problems, potential and actual, are well-understood by the finance ministry and the Bank of Israel. Despite their differences, both committed to making the reforms work. One aspect of this commitment is the new law’s creation of an oversight committee to ensure that the measures laid out in the legislation are actually implemented. If not, it has the power to take action. In the end, only time will tell if the government’s well-meaning efforts will bear fruit.