Israel’s Capital Market Reform Bank of Israel and the IMF Prof. Dan Galai Sigma PCM and the Hebrew University Feb. 27 2008

What Were the Objectives of the Reform? *Lessening the dominance of the major banks. *Enhancing competition. *Reducing potential conflicts of interests *Reducing operational costs to customers. *Enhancing information flow

Efficiency-What does it mean? Three meanings of efficiency: *Allocation (Pareto) *Information *Operations The trade-offs between classes of “efficiency”

How much Regulation is Optimal? -Read Stigler’s Organization of Industry His conclusion: at the end of the day regulators help the industry rather than the consumers. (e.g. the case of restrictions on investments in the QQQ). -The “shadow price” of regulation. -Not differentiating between more and less important issues.

“Hermon” as a Case Study -The reform’s intention was to enhance competition. -The incentives scheme to attract “stars”. -Competition is on yields; risks are usually ignored. -Managers assume more risks to achieve higher returns and maximize their incentives! -How to align risks, returns and incentives? -Where are the control systems?

On the Education of the Israeli Investor *lacks the proper education *is emotional about money *believes in real estate The Ostrich Effect Can the Regulator be the Educator?

What should be done? -Find the right balance between investors protection and competitiveness in the financial markets. Avoid “corner solutions”. -More transparency -More responsibilities on board of directors (e.g. the case of “Sharei Ribit”, or, “regulatory arbitrage”). -Align the regulators and make regulation more uniform.