The Bank of Israel, with headquarters in Jerusalem, began operations as the central state bank in December 1954. Total banking assets at year-end 2001 were NIS 435 billion. The bank issues currency, accepts deposits from banking institutions in Israel, extends temporary advances to the government, acts as the government's sole banking and fiscal agent, and manages the public debt. Among the largest commercial banks are the Bank Leumi, the Israel Discount Bank, and the Histadrut-controlled Bank Hapoalim. There were 24 licensed commercial banks in 1997; one investment bank; and nine mortgage banks. There are also numerous credit cooperatives and other financial institutions. Among the subsidiaries of commercial banks are mortgage banks (some of which were also directly established by the government). The largest of these specialized institutions, the Tefahot Israel Mortgage Bank, provides many loans to home builders.
Industrial development banks specialize in financing new manufacturing enterprises. The Industrial Bank of Israel, formed in 1957 by major commercial banks, the government, the Manufacturers' Association, and foreign investors, has received aid from the IBRD and has played a major role in the industrial development of the Negev area. The government-owned Bank of Agriculture is the largest lending institution in that sector. The Post Office Bank, similar to France's La Poste, is concerned mainly with clearing operations, savings, sale of savings certificates, and postal orders.
The structure of the banking industry is based on the central European model of "universal banking," whereby the banks operate as retail, wholesale, and investment banks, as well as being active in all main areas of capital market activity, brokerage, underwriting, and mutual and provident fund management. However, the banks are barred from insurance operations, other than as owners of insurance agents, and have only recently been allowed to enter the pension market.
The Bank of Israel's power to fix the liquidity ratio that banks must maintain against deposits has been an important instrument in governing both volume and types of loans. Legal interest rate ceilings formerly were 10% on loans to industry and agriculture and 11% for commercial loans, but in the early 1980s, rampant inflation caused the large commercial banks to raise the interest rate to 136%.The International Monetary Fund reports that in 2001, currency and demand deposits—an aggregate commonly known as M1—were equal to $9.0 billion. In that same year, M2—an aggregate equal to M1 plus savings deposits, small time deposits, and money market mutual funds—was $114.2 billion .In the financial sector, the banks have benefited from a very slow program of financial deregulation and the absence of foreign competition; until 2000, the only foreign bank licensed to operate in Israel was the Polish PKO Bank, more of a historical curiosity than a serious commercial consideration. However, as deregulation progressed, the prospect of foreign ownership of Israeli banks, in part or whole, grew more real. In 2000, Citibank set up a full branch in Israel, the first major international bank to do so; HBSC followed soon afterward, and Bank of American has also set up a branch office there.
Growing activity on the Israeli securities market made it necessary to convert the rather loosely organized Tel Aviv Securities Clearing House into the formally constituted Tel Aviv Stock Exchange (TASE) in 1953. A further expansion took place in 1955, when debentures linked either to the US dollar or to the cost-of-living index-with special tax privileges-made their first appearance on the market. The market is largely devoted to loans of public and semipublic bodies, with provident funds and banks acquiring most of the securities placed. There is only one quotation daily for each security.
By 1983 the price of bank shares was steadily becoming more detached from their true value. When it became obvious in 1983 that the government would have to devalue its currency, many people began to liquidate their holdings of shekel-denominated assets in favor of foreign currency. The assets most widely held and most easily liquidated were bank shares. The selling wave began in the summer of 1983 and peaked in October, forcing the government to intervene. The closing of the TASE, on 6 October 1983, became known as the "economic day of atonement" and represented the end of the speculators' paradise created and supported by leading Israeli banks.
By the mid-1990s, as Israel moved to liberalize its economy, the banking sector underwent significant reconstruction which continues as 2002. In two sell-offs in 1997 and 1998, the government divested itself of a majority of Bank Hapoalim. It also sold sizeable shares of United Mizrahi Bank, Israeli Discount Bank, and Bank Leumi, in the hopes of shedding all remnants of ownership in these banks. In addition to bank privatization, the Israeli government moved to reduce capital markets regulations.
In 1994 the Palestinian Authority (PA) began to take over the management of an economy with a limited capacity to support its expanding population. The PA has acted within the constraints of the economic protocol to revive the financial sector. The reconstruction effort requires the creation of financial markets and institutions that perform the key functions of supplying liquidity, encouraging savings and investments, and facilitating the management of risk.
In expectation of a boom in the financial sector, a number of Jordanian and Palestinian banks opened, or reopened, branches in the West Bank and Gaza. By 1996, 42 branches of 10 banks were operating. The banks have mainly limited themselves to establishing checking accounts and accepting deposits, specifically non-interest bearing accounts. Despite their success in attracting deposits from Palestinians, the banks have maintained a limited role in lending; at the end of March 1995, total outstanding loans by the banks accounted for only 30% of total assets and 35% of total customer deposits. The reluctance to invest locally stems from doubts over the political environment and it is widely believed that banks are investing abroad, particularly in Central Bank of Jordan treasury bills.
A key factor in the success of the banks will be the supervisory activities of the Palestinian Monetary Authority (PMA), set up as a result of the Paris protocol. The PMA has most of the functions of a central bank. It is empowered to act as the PA's adviser and sole financial agent; to hold its foreign currency reserves; to regulate foreign-exchange dealers; and to supervise the banking sector, as the self-rule areas come under PA jurisdiction. However, in the absence of a Palestinian currency, the PMA's ability to be a lender of last resort is questionable. In 1996 the reality was that the PMA had no influence over the areas still under Israeli control and lacked a proper regulatory framework. Yet, since 1995, all money-changers have been required to put up capital of between $200,000 to $1 million, to pay permit and other fees, and to deposit 30% of their capital with the PMA.
At the end of 1996, plans for a Middle Eastern Development bank, supported by Jordan, Egypt, Israel, and the PA, were close to collapse, just a few weeks after the bank's official registration at the UN. This was the verdict following the US Congress's refusal to include provision for financing for the bank in an appropriations bill.
The Arab Palestine Investment Bank (APIB), scheduled to open in early 1997, held its first annual general meeting in Ramallah on 15 September 1996 and its first board meeting in Amman the next day. The bank, with paid-up capital of some $15 million, has four principal shareholders, Jordan's Arab Bank (55%), the International Finance Corp. (25%), the German Investment and Development Co. (15%), and the Palestinian private-sector Enterprise Investment Co. (5%). Total deposits of the Palestinian banking system expanded by over 125% during the year ended June 1996, reaching $2.06 trillion. However, it is estimated that over half the local deposits are invested abroad, while only $300 million have been loaned internally to the Palestinians.