Israel’s Capital Market Israel’s Capital Market ReformReform

Bank of Israel and the IMFBank of Israel and the IMF

Prof. Dan GalaiProf. Dan GalaiSigma PCM and the Hebrew Sigma PCM and the Hebrew

UniversityUniversityFeb. 27 2008Feb. 27 2008

What Were the Objectives of the What Were the Objectives of the ReformReform??

•**Lessening the dominance of the Lessening the dominance of the major banksmajor banks..

•**Enhancing competitionEnhancing competition..•**Reducing potential conflicts of Reducing potential conflicts of

interestsinterests•**Reducing operational costs to Reducing operational costs to

customerscustomers..•**Enhancing information flowEnhancing information flow

Efficiency-What does it meanEfficiency-What does it mean??

Three meanings of efficiencyThree meanings of efficiency : :

**Allocation (Pareto)Allocation (Pareto)

**InformationInformation

**OperationsOperations

The trade-offs between classes of The trade-offs between classes of “efficiency“efficiency””

How much Regulation is OptimalHow much Regulation is Optimal??

--Read Stigler’s Read Stigler’s Organization of IndustryOrganization of IndustryHis conclusion: at the end of the day His conclusion: at the end of the day regulators help the industry rather than regulators help the industry rather than the consumers. (e.g. the case of the consumers. (e.g. the case of restrictions on investments in the QQQ)restrictions on investments in the QQQ)..

--The “shadow price” of regulationThe “shadow price” of regulation..

--Not differentiating between more and less Not differentiating between more and less important issuesimportant issues..

““Hermon” as a Case StudyHermon” as a Case Study

--The reform’s intention was to enhance The reform’s intention was to enhance competitioncompetition..

--The incentives scheme to attract “starsThe incentives scheme to attract “stars.”.”--Competition is on Competition is on yields; risksyields; risks are usually are usually

ignoredignored..--Managers assume more risks to achieve Managers assume more risks to achieve

higher returns and maximize their higher returns and maximize their incentivesincentives!!

--How to align risks, returns and incentivesHow to align risks, returns and incentives??--Where are the control systemsWhere are the control systems??

On the Education of the Israeli On the Education of the Israeli InvestorInvestor

The Israeli investorThe Israeli investor--

**lacks the proper educationlacks the proper education

**is emotional about moneyis emotional about money

**believes in real estatebelieves in real estate

The Ostrich EffectThe Ostrich Effect

Can the Regulator be the EducatorCan the Regulator be the Educator??

What should be doneWhat should be done??

--Find the right balance between investors Find the right balance between investors protection and competitiveness in the protection and competitiveness in the financial markets. Avoid “corner solutionsfinancial markets. Avoid “corner solutions.”.”

--More transparencyMore transparency

--More responsibilities on board of directors More responsibilities on board of directors (e.g. the case of “Sharei Ribit”, or, (e.g. the case of “Sharei Ribit”, or, “regulatory arbitrage”)“regulatory arbitrage”) . .

--Align the regulators and make regulation Align the regulators and make regulation more uniformmore uniform..