Bank of Israel head urges lenders to pay fair interest on deposits, current accounts

Bank of Israel governor Prof. Amir Yaron on Tuesday called on Israel’s lenders, which have been enjoying huge profits from higher interest rates, to pass on those rates to customers and start paying interest on funds sitting in current accounts.

Yaron summoned the CEOs of the country’s banks to his office in Tel Aviv to discuss interest rate policies on deposits, current accounts, and loans. Also present at the meeting were outgoing Supervisor of Banks Yair Avidan and incoming banking regulator head Daniel Hahiashvili.

The country’s lenders have come under fire for not fairly passing on or being slow in passing on the benefits of higher interest rates to deposit holders, while fully profiting from the fruits of high rates on loans and mortgages.

During the meeting, Yaron acknowledged that the uptick in inflation and high interest rate environment is making the banking system highly profitable and expressed expectation that the banks will roll over the rate increase to the public by paying adequate interest on deposits and current accounts.

The interest rate that banks charge Israelis who take out household loans averages around 10%, while rates on deposits average between 2% and 4.5% depending on size and duration. The discrepancy, which has been fueling the banks’ hefty profits, has been causing outrage among the general public and some politicians in recent months.

“It is essential that the banks find the right balance that reflects fairness, between the interest policy on loans and the policy of interest on deposits and current account balance, with an emphasis on households and small businesses,” Yaron said.

Yaron noted that the banks have recently been benefiting from “very high profitability and a sharp increase in return on capital as a result of a combination of factors such as high current account balances, which constitute a source of zero cost for providing credit; insufficient transmission of interest rates to deposits in the household sector and a high concentration of floating-rate credit.” The latter boosts banks’ income as interest rates rise.

Specifically, the central bank chief remarked that the banks’ high profitability derives from the high volume of interest-bearing current account deposits and the “insufficient” transmission of interest on households’ deposits in the current interest rate environment, while on the loan side there is an almost full transmission.

“All of these have led to a very high return on capital that is not sustainable in the long run,” he cautioned.

The public has about NIS 1.4 trillion in local-currency bank deposits, of which more than NIS 500 billion is sitting in current accounts, according to the Bank of Israel. Depositors rarely receive interest on these balances, but the banks generate interest income from them.

Yaron called on the CEOs of the banks to come up with a number of solutions to achieve the goals he presented during the meeting. The governor urged the banks to adequately pass on and improve rates on household bank balances. He also called on the banks to actively encourage customers with current account balances above a certain threshold to divert funds to more lucrative channels such as term deposits or money market funds. In addition, he instructed the banks to provide active ongoing assistance to mortgage holders facing severe repayment difficulties and ease the burden for customers with a negative current account balance.

At the end of the meeting, Yaron instructed the CEOs of the banks to update the Supervisor of Banks on their preparations and plans for achieving the targets he presented within a short period of time. The central bank has previously warned the banks that in case they fail meet the objectives set forth, it will not hesitate to wield its regulatory tools for enforcement.

Earlier this month, Bank Leumi, one of the two largest banks in Israel, praised itself for being the first lender offering current account holders an annual interest rate of 1% on their credit balances but made the eligibility subject to a list of conditions. The interest will be paid on current account balances of up to NIS 10,000 to customers transferring salaries with a mortgage at the bank, or to customers transferring salaries with a monthly transaction turnover of at least NIS 3,000 on a Leumi credit card, or to customers transferring salaries with a securities portfolio at the bank. The move has been harshly criticized for offering too little when short-term investment vehicles to park cash such as money market funds pay more lucrative rates.

Last year, the banks posted the highest profits since 2006, according to the Bank of Israel annual banking report for 2022. Net profit of the banks in Israel in 2022 amounted to about NIS 24 billion, an increase of about 30% compared to a year earlier. Interest income ballooned to NIS 72 billion from NIS 45.2 billion during the same comparative period. Net interest income rose 33% to NIS 50 billion.

The Bank of Israel has steadily hiked the benchmark interest rate over the past year from a record low of 0.1% in April 2022 to 4.75% this year to try and cool inflationary pressure. This in turn has allowed banks to raise rates for borrowers and has rapidly fueled the costs of mortgage holders. The average cost of monthly mortgage payments has gone up by more than NIS 1,000 over the past year.

Leumi this year continued to benefit from successive interest rate hikes and rising inflation after earning a record NIS 7.7 billion in 2022, the biggest profit among Israel’s largest lenders. Net interest income in the first quarter of 2023 surged 36% to NIS 3.9 billion compared to NIS 2.7 billion in the corresponding quarter last year. Bank Hapoalim reported a net profit of NIS 2.01 billion for the first quarter bolstered by a 49% surge in net interest income year-on-year.