1. Israel’s Capital Market Reforms – Achievements and Challenges Ahead Professor Zvi Eckstein Deputy Governor of the Bank of Israel Feb. 27, 2008

2. 2 The Structural Reforms in the Financial System A gradual process aimed at decreasing the government’s intervention in the economy, integrating the economy into global markets and increasing competitiveness in the domestic economy Results: –Development of financial markets and sophisticated financial tools –Diversification of the public’s asset portfolio –Increased competition, liquidity and tradability in the markets

3. 3 The Bachar Reform (2005) The primary goal of the reform: –Reducing the concentration in the financial system and the share of the banks in the management of savings and provision of credit The primary measures of the reform and its results: –Transfer of the management of mutual funds and provident funds to non-bank financial institutions –Increased competition in the management of public savings and the provision of credit.

4. 4 The Banking System and Financial Companies after the Reforms YearTotal Assets (NIS billions) Five Largest Banking Groups Five Largest Insurance Companies Other Companies Long-Term Savings 200326052%21%27% 200743511%55%34% Mutual Funds 200310184%2%13% 20071191%39%59%

5. 5 Bank and Non-Bank Credit to the Business Sector (rate of change 12/00-12/07) Rate of change in non-bank credit Rate of change in credit to business sector Rate of change in bank credit * Billions of shekels, September 2007 Source: Bank of Israel 350* 728* *378

6. 6 The Banking System and Financial Companies after the Reforms Supervision: –Increased risks outside of the banking system and increased need for cooperation between supervisory authorities Competition and efficiency in the financial sector: –Low competition, especially with respect to retail banking –Most of the activity in demand deposits, credit cards, mutual funds, custody of securities and loans is concentrated in the largest two banks –There is a need to develop advanced financial instruments and safe mechanisms for the transfer of funds

7. 7 Herfindahl Index for Selected Banking Systems International Comparison, 2005 Source: Ruthenberg, 2006.

8. 8 Increased Competition in the Retail Banking System Main components: –Commissions Law (2007): reducing the number of commissions by about two-thirds, reducing transfer costs between banks, etc. –Increased competition in banking services: Marketing of mutual funds on the Internet Money market funds and money market funds for payments –Establishment of a virtual bank

9. 9 Marketing of Mutual Funds through the Internet The project will enable the public to purchase mutual funds directly on the Internet: –Reduced dependence on the distribution system of banks –Significant reduction in costs The project is being implemented by the Israel Securities Authority, the Bank of Israel and the Association of Mutual Funds

10. 10 Money Market Funds MMF: A type of mutual fund characterized by a portfolio of liquid assets with low risk, but with a higher return than alternatives with similar characteristics of risk and liquidity, such as bank deposits Status in Israel: –Operating since 1/08 –So far about NIS 7 billion has been deposited, and there is a much greater potential –Supporting the development of commercial papers market Additional measures to expand this market: –Addition of payments capability to money market funds

11. 11 Increased Efficiency and Competition in the Money Markets Development of a settlement system (ZAHAV- RTGS) and participation in CLS REPO Securitization Market for interest rate futures (Telbor)

12. 12 ZAHAV-RTGS Real-Time Crediting and Transfers Final real time settlement of the largest shekel payments The Zahav system is the crown jewel of the reform in the payments and settlement system which resulted in a reduction in risk and the modification of the Israeli payment system accepted international rules The system has been operating since 9/07 This is a necessary condition to join the CLS

13. 13 Participation of the Shekel in CLS (Continuous Linked Settlement) The CLS system performs the final settlement of transactions in the 15 most common currencies; the daily volume of settlement in the system: about $3.2 trillion The method of settlement of transactions through CLS reduces the risks of settlement, improves cash flow management, reduces the cost of transactions and increases their efficiency. The participation of the shekel in the CLS system is expected in 5/08; This step will place the shekel among the primary world currencies and will improve the economy’s global financial status

14. 14 REPO General Background REPO transaction: A security owner sells the security to another investor in exchange for cash with an obligation to repurchase it on a set date and at a set price REPO is a major financial tool with a large turnover in the USA and Europe, which lowers management costs of banks and other financial institutions Developing this market in Israel has been delayed, primarily due to the lack of regulatory, taxation and legal frameworks

15. 15 REPO Status of the Measures to Develop the Market 3/06: Laying the legal groundwork for REPO transactions 2007 onward: The Bank of Israel, the Ministry of Finance, the Israel Securities Authority, TASE and the tax authorities are working on this project: –The Bank of Israel initiated tenders for reverse REPO –Formulation of a bilateral agreement for repurchase transactions and raising the requirements for liens on a bank’s assets –Establishing taxation principles –Groundwork for the creation of a central REPO settlement system (2008) –Preparing the accounting framework for REPO transactions

16. 16 Securitization General Background Securitization transaction: Sale of ownership of a loan’s cash flow through bonds, guaranteed by an asset Contribution to the development of the capital market: –Reduction in the risk borne by lending institutions. –Increase in the quantity of bonds – deepening and increased variety in the market. –Increased sources of capital which will lead to a decrease in the rate of interest.

17. 17 Securitization Status of Measures to Develop the Market Securitization transactions are very common in other countries and account for about 50% of the corporate bonds traded in global markets In Israel: –2005: Recommendations of an inter-ministerial committee for development of this market –Transactions similar to securitization are carried out in the leasing sector –Securitization of loans is in the development stage: work is being done on legislation, bank regulation and modification of tax rules

18. 18 Telbor Rate of Interest Telbor: The interest rates determined on the basis of interest rate quotes from the banks on inter-bank shekel loans for various terms which serve as a base asset for derivative financial assets The Telbor Interest Rate Committee determined definitions and procedures for quotes that will increase the commitment and transparency of interest rate quotes given by the banks Starting from March 2007, the commercial banks began operating according to the new rules

19. 19 Thank you!