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

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

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

4. 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.

5. “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?

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

7. 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.