The Bank of Israel's credit database will go online in six weeks. Although it has thus far attracted little attention, the database will lead to far more dramatic changes in the consumer credit market than the Strum committee reforms for increasing competition in common banking and financial services now being implemented.
The credit database initiative began five years ago at the National Economic Council in the Prime Minister's Office. Following several years of intensive work involving both legal and technological-operational aspects, the system will go online in six weeks. The Bank of Israel, which is in charge of the database, will begin a campaign this week to create more awareness of it.
The credit database will dramatically change the retail credit market, currently dominated by the banks, particularly the two large banks: Bank Hapoalim (TASE: POLI) and Bank Leumi (TASE: LUMI). Despite the rise of non-banking players in recent years, the banks still rule the consumer credit roost with a combined market share of over 80% (90%, if mortgages are included).
The main reason for the banks' domination is information. The banks have a large amount of information about us: our income, spending, financial assets, whether we have loans, etc. This knowledge gives them great power. It enables a bank to make the best offer tailored to the customer. A non-banking concern, on the other hand, has little information; in order to hedge its risk, it will usually require a higher price than a bank for the money it lends us.
In contrast to business credit, in which there is stiff competition from investment institutions and the capital market, the banks' dominance in consumer credit enables them to maintain large spreads. Consumer credit is one of the banking system's last cash cows. For example, Bank of Israel figures show that the average interest rate on consumer credit in 2017 was 5.87%, compared with 2.5% in the medium and large-sized business sector. It is true that consumer credit is riskier than business credit, which is usually backed by collateral. Nevertheless, one of the reasons for the wide spread is that the banks had no real competition for customers.
The rules of the game will change next month. Once the information about customers is available to all of the credit providers, the providers will be better able to price loans (and especially better able to make attractive offers to good customers) in competition with the banks.
The Bank of Israel has devoted large resources in recent years to setting up a credit database with information about all of the customers in the system. The Bank of Israel has spent over NIS 160 million on the database to date. The database will regularly receive data about customers from the banks and credit concerns and transfer it to the credit bureaus, which will use it to rate every customer. The Bank of Israel granted a license to the credit bureaus for this purpose; they will have exclusive access to the database. There are three such bureaus as of now: Dun & Bradstreet, BDI, and Trendline (TASE: TREN).
1. Will the big banks go to war?
At present, the investment institutions are almost completely inactive in the retail credit market. According to Bank of Israel figures, the volume of their consumer credit is a mere NIS 15 billion out of a NIS 190 billion market.
The investment institutions have money for granting loans: tens of millions of shekels of the public's money passes through their hands yearly, mainly in pension savings instruments. One of the main barriers that prevented them from entering the sector was the lack of financial information about customers and their inability to rate the risk. The credit database will both give them this information and a rating for the customer, thereby saving them the trouble of setting up their own rating system.
Some investments institutions previously considered this activity, but gave up the idea because of the operating costs involved. They can now save at least the expenses for rating customers. There are still regulatory barriers and sizeable operating expenses in managing consumer credit. It is certainly possible, however, that if more barriers are removed, and the investment institutions see that this sector has potential for a better return than other investment alternatives, they will enter this field.
The banking system believes that, in the coming years, we will see investment institutions becoming important players in this sector at the banks' expense, either directly or through cooperation with other concerns, such as credit card companies Isracard and Leumi Card (now named Max), which are in the process of being separated from the banks.
The consumer credit market currently amounts to NIS 190 billion, and is growing at NIS 5-10 billion a year. Investment institutions receive tens of billions of shekels a year, and are looking for places to invest them. If they invest just 10% of this new money in consumer credit, they will become important players in this market within a few years.
The interesting question is what the banks will do: whether they will go to war over their market shares, leading to a price war, or will agree to surrender market share in exchange for limiting the damage to their profit margins. It is likely that Bank Hapoalim and Bank Leumi will adopt defensive postures, because they are the largest in this field, and also because they have already begun reducing their exposure to consumer credit. For the medium-sized banks, on the other hand, the database provides an opportunity for exposure to new customers and to grow, each in accordance with its appetite. There is no doubt, however, that the most significant threat of a price war comes from non-banking concerns.
2. The strong will get stronger and the weak weaker
The credit database will provide financial concerns with far more information about the situation of the borrowers. This transparency will improve the situation of the good customers. The banks and financial institutions will compete for this group, because their risk is very small. Even if the interest rates on loans to them fall, they will still be attractive.
On the other hand, the full exposure of the state of the weak customers that the credit database will provide will have a negative effect on them. These customers currently receive loans from various concerns without those concerns knowing about the customers' other loans. They will now have difficulty obtaining additional loans. A bank is liable to discover that a customer to whom it granted a NIS 30,000 loan also took a loan from a credit card company at the same time, and possibly also from another bank or other institution. The bank will realize that this customer's risk is far higher than it previously thought, and is likely to reduce its exposure to him or her, and to press the customer to reduce his or her loans. Exerting pressure will be particularly relevant in view of the concessions granted to bankrupts, which has led banks to step up their debt collection actions in recent years.
In the longer term, weak customers will be unable to obtain credit easily. Even if they do get a loan, it will be at high interest. Is this positive or negative? On the one hand, it is better for people with poor repayment capability not to drown in a sea of debt. On the other hand, exerting pressure on customers with poor repayment capability to reduce their loans is liable to be painful and difficult. The banking system believes that the credit database will enlarge the group of people denied credit. Who will profit from this? More people denied credit by institutions will intensify the competition for stronger customers, to whom everyone will want to grant loans.
3. Concern that a credit rating will become like an identity card
Together with the positive potential of the credit database, there is also considerable concern about the consequences of publishing our credit data. In the US, for example, there is widespread criticism of the credit database. Use of a customer's credit rating is not confined to granting loans; it is becoming an identity card. For example, it is quite common for an owner of a housing unit to ask for the tenant's credit rating before the lease is signed. Some say that credit ratings are even affecting dating and matchmaking by becoming a criterion for finding a suitable partner.
The Bank of Israel tried to avoid any resemblance to the detested US model. In the US, the banks and financial concerns can buy information about customers, track those suitable for them, and offer them credit according to their situation: high interest rates for customers in a difficult situation, for example. In Israel, concerns will be barred from receiving information about all customers in advance for use as a marketing tool for loans. Receiving information about a customer will be subject to his permission.
Although the Bank of Israel is striving to make the credit database as sterile as possible, with customers exercising control over their information, it cannot be ruled out that in the long term, credit ratings will spread to other areas unrelated to loans. According to the rules, customers can ask the credit agency for their ratings, and can then use them in other spheres of life. It is therefore questionable whether use of this information can be banned.
Published by Globes, Israel business news - en.globes.co.il - on March 4, 2019
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