## FINANCIAL SECTOR ASSESSMENT PROGRAM UPDATE ISRAEL — BASEL CORE PRINCIPLES FOR EFFECTIVE BANKING SUPERVISION — DETAILED ASSESSMENT (MARCH 2012) ## Source details **Canonical URL:** [FINANCIAL SECTOR ASSESSMENT PROGRAM UPDATE ISRAEL — BASEL CORE PRINCIPLES FOR EFFECTIVE BANKING SUPERVISION — DETAILED ASSESSMENT (MARCH 2012)](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1285.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1285.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1285.pdf.json) --- ### Introduction and scope - Assessment prepared as part of the FSAP Update mission to Israel, which took place November 6-21, 2011. - Assessors: Thierry Bayle (Banque de France) and Joel Shapiro (formerly of the U.S. Federal Reserve). - Methodology: Conducted in accordance with the Core Principles (CP) Methodology published in October 2006 by the Basel Committee on Banking Supervision (BCBS). Both “essential” and “additional” criteria were considered; ratings were based on compliance with the “essential” criteria only. - Sources used: - Comprehensive and critical self-assessment received in October 2011. - Interviews with BOI and other government agency staff, anonymous supervisory materials, laws and regulations, questionnaire responses, meetings with banks, academics, accounting and audit profession, and other private sector participants. ### Institutional and macro-prudential setting; market structure - Financial system composition and post-reform structure: - Main financial institutions: banks and insurance companies; active markets in shares, corporate bonds, and government bonds; pension, provident, and mutual funds. - Result of Bachar reform (began mid-2005): banks divested most non-commercial activities and now focus on traditional banking business; non-bank financial sector has grown rapidly. - Banking sector size and structure: - Banks’ balance-sheet size: assets amounting to about 140 percent of GDP. - Most banks have relatively little overseas activity; dollarization greatly reduced. - Foreign institutions play a minor role; foreign ownership generally limited. - Banking and insurance sectors are concentrated. - Supervisory responsibilities: - Bank of Israel (BOI), Banking Supervision Department (BSD) — supervises banks and payments system oversight. - Israel Securities Authority (ISA) — securities sector. - Commissioner of Capital Markets, Insurance, and Savings (CCMIS) at the Ministry of Finance (MOF) — insurance and pension sector. - Tel Aviv Stock Exchange (TASE) — some supervisory responsibilities for its members. - Cooperation: - MOUs exist among BOI, ISA, and CCMIS; practice broadly satisfactory in normal times but may be over-stretched in crises. ### Recent developments and crisis response - System performance in global crisis: - No domestic financial institution got into serious difficulties during the global crisis. - Banks weathered the crisis though profitability suffered. - Contributing factors: conservative bank management; limited inter-connectedness due to small interbank and wholesale funding markets; lack of complex asset and securitized markets; strong and intrusive bank supervision. - Some insurance companies and investors in funds incurred losses; corporate bond market suffered large falls in prices and new issuance halted. - Authorities’ interventions: - BOI aggressively cut policy interest rates and expanded liquidity facilities. - BSD tightened supervisory measures in reporting, capital, and liquidity. - MOF measures: “safety net” program for provident fund savings; guarantee program to banks for raising capital; creation of government-established investment funds (“Manof” funds). - ISA set up a debt settlement framework. - Establishment of the Hodek committee; in February 2010 it presented recommendations to improve market transparency, conduct, and corporate governance of institutional investors. - Financial soundness indicators at time of mission: - Average capital ratio for major Israeli banks: 14 percent. - Tier 1 capital ratio: around 8.5 percent. - Banks remain mainly deposit-funded, with customer deposits exceeding loans. - Insurance companies: financial soundness indicators generally satisfactory. - Historical baseline: - 2001 Israel FSAP: compliant with 17 of 25 Core Principles; largely compliant with 6; materially noncompliant with two (CP15; CP24). ### Preconditions for effective banking supervision - Macroeconomic and fiscal framework: - Israel operates an inflation targeting framework; BOI independence strengthened by the 2010 BOI Law. - Budgetary policy strengthened with establishment of a fiscal rule supporting fiscal consolidation. - Legal, accounting, and judicial infrastructure: - Israeli legal framework for financial sector is comprehensive and regularly updated. - Auditing and accounting: listed companies and most nonbank financial institutions have applied International Financial Reporting Standards (IFRS) since 2008. - Israeli banking system reports under BSD directives and Israeli GAAP, close to U.S. GAAP with some IFRS elements for non-core activities. - Audit profession independence required by legislation; audit profession is self-regulating. - Judicial system, including bankruptcy and enforcement of property rights, is well-developed. - Legal framework for dealing with weak banks is stipulated in the Banking Ordinance, 1941 (no legal provision dedicated to bank bankruptcy). - Payment and settlement infrastructure: - BOI regulates payment systems and operates the Zahav real time gross settlement system, linked to BCH, Masav, and TASE clearing house. - Market discipline and disclosure: - Competition encouraged; market open to foreign participation; no significant non-prudential entry barriers. - Reforms underway after 2008 capital market freeze: August 2011 Companies Law amendments, Hodek recommendations, ISA provisions on mutual fund managers. ### Main findings and areas for improvement (high-level) - Overall assessment: - Banking sector regulation and supervision generally in line with international standards and described as “stringent.” - Authorities take a pro-active, stability-oriented approach; regulations generally up to date; extensive on-site and off-site information gathering and analysis; prompt correction of detected deficiencies. - Key areas for improvement: - Regulation and supervision of interest-rate risk, market risk, and liquidity risk. - Supervision of certain securities-related activities performed in Israel or abroad. - Flexibility and autonomy in personnel management and budgets to attract and retain financial sector experts with required skill mix. - Nature of remaining deficiencies: - Most remaining deficiencies relative to the standard are being addressed or are of relatively low materiality. ### Assessment methodology and ratings framework - Ratings scale: compliant; largely compliant; materially noncompliant; noncompliant; “not applicable” may be used. - Assessment reflects factual situation at completion date and notes regulatory initiatives not yet implemented. - 2006 BCP Methodology raised the bar; 2001 ratings not directly comparable. ### Recommended action planning and institutional response (overview) - Emphasis on addressing identified weaknesses in: - Interest-rate risk, market risk, liquidity risk regulation and supervision. - Supervision of securities-related activities domestically and abroad. - Enhancing supervisory capacity via personnel management and budgetary autonomy to retain necessary expertise. - Report contains a Recommended Action Plan and authorities’ response (detailed tables in full report). ### Corporate governance, reporting, and public safety nets - Corporate governance framework: - Governed by the Companies Law and the Securities Law; sectoral legislation for banks, mutual funds, provident funds, pension funds. - Banking-specific reporting set out in the Banking Ordinance, 1941 and BSD directives. - Authorities plan to transition the banking system solely to IFRS standards by 2013 or later. - Public safety nets: - Israel does not have formal deposit insurance. - Government and BOI have historically provided extensive de facto protection to depositors: - During the latest global crisis MOF stated BOI and government would protect depositors. - In non-systemic bank failures in 1985 and 2001 BOI compensated depositors almost in full. - In early 1980s crisis government nationalized the entire system and depositors did not suffer losses. ### Legal framework for supervision and supervisory powers (Principle 1 and related) - Primary legal instruments: - BOI Law, Banking Ordinance, 1941, Banking Licensing Law, Banking Service to Customer Law. - Section 5(c) 1 establishes power of Supervisor to issue Proper Conduct of Banking Business Directives. - Powers and enforcement: - Sections 8A–8D provide remedial and resolution powers (e.g., require remedial actions, prohibit dividends, appoint administrators). - Section 5(a) grants full access to information from banking corporations, subsidiaries and affiliates. - Section 15A.1/15A.2 provide legal basis for exchanging information with foreign and domestic supervisors under confidentiality conditions. - Independence and resources: - BOI autonomous by law but MOF influence on BOI salary scales compromises operational independence and recruitment/retention. - Staffing gaps noted in quantitative modeling, Basel II, market and interest-rate risk expertise. - Publication and consultation: - Directives are published and introduction of new regulations is subject to public consultation; no formal periodic law review process. ### Basel Core Principles: summary of compliance and selected key comments - Aggregate grading: - Compliant (C) – 18 - Largely compliant (LC) – 11 - Materially noncompliant (MNC) – 1 - Noncompliant (NC) – 1 - Not applicable (N/A) – 0 - Selected principle findings and key numbers: - CP1 Objectives, independence, powers, transparency, cooperation — Compliant (with CP1.1 and CP1.2 rated Largely Compliant in detail). - CP6 Capital adequacy — Largely Compliant; Pillar 1 minimum total capital ratio: 8 percent; complementary Pillar 2 buffer: 1 percent (total required: 9 percent in practice/system expectation); BSD introduced compulsory minimum requirement of 7.5 percent core capital from December 31, 2010. - CP13 Market risks — Materially non compliant: - Capital purposes allow only standardized methods while banks use VaR and stress tests for risk management. - BOI lacks sufficient independent capacity to challenge banks’ trading book eligibility policies, data systems, valuation methodologies and internal models. - CP14 Liquidity risk — Largely Compliant: - Regulatory limits only to overall liquidity over a one-month horizon; limits not broken down by major currencies; oversight based on solo-basis information. - CP16 Interest-rate risk in the banking book — Non compliant: - No specific regulatory provisions; BOI does not receive dedicated reporting; IRRBB not assessed on a stand-alone basis. - Other CP highlights: - CP7 Risk management process — Compliant. - CP8 Credit risk — Compliant. - CP9 Problem assets, provisions, and reserves — Compliant. - CP10 Large exposure limits — Compliant (amended limits effective January 2012, phased in over two years). - CP11 Exposure to related parties — Compliant (aggregate related-party indebtedness limit: 10 percent of bank‘s capital). - CP15 Operational risk — Largely Compliant (requirements fragmented across directives). - CP17 Internal control and audit — Largely Compliant. - CP18 Abuse of financial services (AML/CFT) — Largely Compliant (five banks fined aggregate NIS 16.9 million for AML breaches between 2008 and 2011). - CP19 Supervisory approach — Compliant (risk-based supervision implemented). - CP20 Supervisory techniques — Compliant. - CP21 Supervisory reporting — Compliant. - CP22 Accounting and disclosure — Compliant (combination of U.S. GAAP and IFRS; plan to transition to IFRS-only by 2013 or later). - CP23 Corrective and remedial powers — Largely Compliant (legal powers available but restrictive; enhancements under consideration). - CP24 Consolidated supervision — Largely Compliant (gap in supervision of certain securities-related activities in non-bank subsidiaries). - CP25 Home-host relationships — Compliant. ### Selected regulatory and supervisory specifics (key figures and rules) - Banking sector metrics and supervisory thresholds: - Banks’ assets: about 140 percent of GDP. - Average capital ratio for major banks: 14 percent. - Tier 1 capital ratio: around 8.5 percent. - Pillar 1 minimum total capital ratio: 8 percent. - Supervisory expectation floor after stress: capital ratio shall not fall below 9 percent. - BSD compulsory minimum core capital: 7.5 percent from December 31, 2010. - Limits on exposures (effective January 2012, phased in over two years): - Non-banking borrower net indebtedness ≤ 15 percent of bank‘s capital. - Borrower group net indebtedness ≤ 25 percent of bank‘s capital. - Banking borrower group net indebtedness ≤ (1) 25 percent of bank‘s capital or (2) NIS 250 million, whichever is greater. - Controlled borrower group net indebtedness ≤ 50 percent of bank‘s capital. - Total net indebtedness of all borrowers/groups exceeding 10 percent of bank‘s capital ≤ 120 percent of bank‘s capital. - Acquisition and ownership thresholds: - Acquisition of more than 5 percent of means of control requires Governor permit (Section 34 (a)). - Annual filing: holders of more than 5 percent (in presence of controlling shareholder) or more than 2.5 percent (widely held) must file ownership reports. - Licensing capital practical expectation: minimum paid-in capital in law NIS 10 million; in practice Governor requires US$ 150 million. ### Principal supervisory deficiencies and prioritized recommendations - Market risk (CP13) — Material deficiency: - Build independent capacity to challenge banks’ trading-book models, valuation methodologies, and internal models; allocate more on-site resources to market-risk examinations. - Interest-rate risk in the banking book (CP16) — Critical deficiency: - Introduce specific regulation and supervisory processes for IRRBB with separate measurement, stress testing, model validation, reporting and independent oversight. - Liquidity risk (CP14) — Improvements needed: - Expand liquidity oversight to consolidated/group basis, include major currency breakdowns and longer horizons beyond one month; allocate more resources to validate liquidity data and models. - Consolidated supervision and securities-related activities (CP24): - Close gaps in supervision of asset-management and underwriting activities in non-bank subsidiaries; formalize information sharing and supervisory approach with ISA. - Supervisory independence and capacity (CP1(2) and cross-cutting): - Address MOF influence on BOI salary scales to strengthen BOI independence and ability to attract/retain staff. - Expand personnel management flexibility and budget autonomy; develop in-house training, staff rotation, overseas secondments, cash bonuses, and targeted hiring. - Corrective and remedial powers and resolution tools (CP23; Section 8D): - Expand and clarify enforcement powers (Sections 8A, 8C, 8D) to enable broader remedial actions and going-concern resolution tools (rapid recapitalization, purchase-and-assume, bridge banks, good bank/bad bank structures). - Operational, internal audit and operational-risk consolidation (CP15, CP17): - Consolidate fragmented directives into comprehensive frameworks for operational risk and internal audit; require reporting of material operational losses and broaden coverage (outsourcing, correspondent banking). - Capital and Pillar II (CP6): - Strengthen Pillar II to be more forward-looking; enhance on-site capacity for capital adequacy reporting and permit Supervisor to require controlling shareholders to increase capital where necessary. - Reporting and accounting transition (CP21, CP22): - If converting fully to IFRS, adopt and monitor a definitive timeline and obtain banks’ readiness plans; consider dual-accounting transitional arrangements if needed. ### Authorities’ response (summary positions) - General: Authorities appreciate the assessment and will consider recommendations carefully; welcome overall high level of observance. - Selected responses: - CP1: Seek balance between principle-based and rule-based approaches. - CP5: Will consider lowering regulatory limit on investments in non-financial companies. - CP6: Supervisor announced adoption of Basel III; BSD required hybrid instruments to comply with Basel III; work on Basel 2.5 in process; BSD prefers dialogue-led capital strengthening in SREP. - CP14: Updated liquidity regulation to be issued; BSD will devote more resources to validate reported liquidity data. - CP15: New operational risk regulation issued shortly after mission; BSD will increase operational-risk on-site participation. - CP23: BSD preparing proposals to amend legal framework for bank resolution to give BOI flexible resolution tools. - CP24: BSD will map and close gaps in supervision of securities activities in cooperation with ISA. *International Monetary Fund — Monetary and Capital Markets Department, FINANCIAL SECTOR ASSESSMENT PROGRAM UPDATE ISRAEL, MARCH 2012.* ### 2012. The views expressed in this document are those of the staff team and do not necessarily reflect ### FINANCIAL SECTOR ASSESSMENT PROGRAM UPDATE ISRAEL ### BASEL CORE PRINCIPLES FOR EFFECTIVE BANKING SUPERVISION — DETAILED ASSESSMENT OF OBSERVANCE (MARCH 2012) ### Introduction and scope - Assessment prepared as part of the FSAP Update mission to Israel, which took place November 6-21, 2011. - Assessors: Thierry Bayle (Banque de France) and Joel Shapiro (formerly of the U.S. Federal Reserve). - Methodology: Assessment conducted in accordance with the Core Principles (CP) Methodology published in October 2006 by the Basel Committee on Banking Supervision (BCBS). Both “essential” and “additional” criteria were considered; ratings were based on compliance with the “essential” criteria only. - Sources used: - Comprehensive and critical self-assessment received in October 2011. - Interviews with BOI and other government agency staff, anonymous supervisory materials, laws and regulations, questionnaire responses, meetings with banks, academics, accounting and audit profession, and other private sector participants. ### Institutional and macro-prudential setting; market structure - Main financial institutions: banks and insurance companies; active markets in shares, corporate bonds, and government bonds; pension, provident, and mutual funds. - Result of Bachar reform (began mid-2005): banks divested most non-commercial activities (mutual funds, insurance, pension, and provident funds) and now focus on traditional banking business; non-bank financial sector has grown rapidly. - Banks’ balance-sheet size: assets amounting to about 140 percent of GDP. - Banks: most have relatively little overseas activity; dollarization greatly reduced. Foreign institutions play a minor role; foreign ownership generally limited. Banking and insurance sectors are concentrated. - Supervisory responsibilities shared: - Bank of Israel (BOI), Banking Supervision Department (BSD) — supervises banks and payments system oversight. - Israel Securities Authority (ISA) — securities sector. - Commissioner of Capital Markets, Insurance, and Savings (CCMIS) at the Ministry of Finance (MOF) — insurance and pension sector. - Tel Aviv Stock Exchange (TASE) — some supervisory responsibilities for its members. - Cooperation: - MOUs exist among BOI, ISA, and CCMIS, outlining basic information-sharing without specifics; practice broadly satisfactory in normal times but may be over-stretched in crises. ### Recent developments and crisis response - Global crisis impact: - No domestic financial institution got into serious difficulties during the global crisis. - Banks weathered the crisis though profitability suffered. - Contributing factors: conservative bank management; limited inter-connectedness due to small interbank and wholesale funding markets; lack of complex asset and securitized markets; strong and intrusive bank supervision. - Some insurance companies and investors in funds incurred losses; corporate bond market suffered large falls in prices and new issuance halted. - Authorities’ interventions: - BOI aggressively cut policy interest rates and expanded liquidity facilities. - BSD tightened supervisory measures in reporting, capital, and liquidity. - MOF measures: “safety net” program for provident fund savings; guarantee program to banks for raising capital; creation of government-established investment funds (“Manof” funds). - ISA set up a debt settlement framework. - Establishment of the Hodek committee; in February 2010 it presented recommendations to improve market transparency, conduct, and corporate governance of institutional investors. - Financial soundness indicators at time of mission: - Average capital ratio for major Israeli banks: 14 percent. - Tier 1 capital ratio: around 8.5 percent. - Banks remain mainly deposit-funded, with customer deposits exceeding loans. - Insurance companies: financial soundness indicators generally satisfactory. - Historical context: - 2001 Israel FSAP (1999 methodology): judged compliant with 17 of 25 Core Principles; largely compliant with 6; materially noncompliant with two (CP15 prevention of money laundering; CP24 information sharing with foreign supervisors). Recommendation then: make banking legislation more transparent. ### Preconditions for effective banking supervision - Macroeconomic framework: - Israel operates an inflation targeting framework; BOI independence strengthened by the 2010 BOI Law. - Budgetary policy strengthened with establishment of a fiscal rule supporting fiscal consolidation. - Legal, accounting, and judicial infrastructure: - Israeli legal framework for financial sector is comprehensive and regularly updated. - Auditing and accounting: listed companies and most nonbank financial institutions have applied International Financial Reporting Standards (IFRS) since 2008. Israeli banking system reports under BSD directives and Israeli GAAP, close to U.S. GAAP with some IFRS elements for non-core activities. - Audit profession independence required by legislation; audit profession is self-regulating. - Judicial system, including bankruptcy and enforcement of property rights, is well-developed. Legal framework for dealing with weak banks is stipulated in the Banking Ordinance, 1941 (no legal provision dedicated to bank bankruptcy). - Payment and settlement infrastructure: - BOI regulates payment systems and operates the Zahav real time gross settlement system, linked to paper-based clearing house (BCH), automated clearing house (Masav), and TASE clearing house. - Market discipline and disclosure: - Competition encouraged; market open to foreign participation; no significant non-prudential entry barriers. - 2008 capital market freeze revealed weaknesses in disclosure and transparency in non-bank financial institutions. Reforms underway: - Amendments to the Companies Law in August 2011 to strengthen corporate governance and bondholder protection. - Implementation of Hodek committee recommendations (for example, imposition of minimum covenants for new bond issues). - ISA provisions imposed on mutual fund managers to improve resilience of corporate bond issues. ### Main findings and areas for improvement - Overall assessment: - Banking sector regulation and supervision generally in line with international standards and described as “stringent.” - Authorities take a pro-active, stability-oriented approach; regulations generally up to date; extensive on-site and off-site information gathering and analysis; prompt correction of detected deficiencies. - In some areas, regulation and practice go beyond the standard. - Identified areas for improvement: - Regulation and supervision of interest-rate risk, market risk, and liquidity risk. - Supervision of certain securities-related activities performed in Israel or abroad. - Flexibility and autonomy in personnel management and budgets to attract and retain financial sector experts with required skill mix. - Nature of remaining deficiencies: - Most remaining deficiencies relative to the standard are being addressed or are of relatively low materiality. ### Assessment methodology and ratings framework (summary) - Ratings based on four-grade scale: compliant; largely compliant; materially noncompliant; noncompliant. A “not applicable” grading may be used in some cases. - Assessment reflects factual situation at completion date but notes regulatory initiatives not yet implemented. - The 2006 BCP Methodology raised the bar compared with pre-2006 assessments; 2001 ratings therefore not directly comparable. ### Recommended action planning and institutional response (high-level) - The report contains a Recommended Action Plan and authorities’ response (detailed tables referenced in the full report). - Emphasis on addressing identified weaknesses in: - Interest-rate risk, market risk, liquidity risk regulation and supervision. - Supervision of securities-related activities domestically and abroad. - Enhancing supervisory capacity via personnel management and budgetary autonomy to retain necessary expertise. *International Monetary Fund — Monetary and Capital Markets Department, FINANCIAL SECTOR ASSESSMENT PROGRAM UPDATE ISRAEL, MARCH 2012.* ### 25. The corporate governance of financial institutions in Israel is governed by the ### 25. The corporate governance of financial institutions in Israel is governed by the ### Legal and regulatory framework for corporate governance and reporting - Corporate governance is governed by the Companies Law and the Securities Law. - Sectoral legislation regulates each financial sector, including: - banks: the Banking Licensing Law, the Banking Ordinance, 1941, the Banking (Service to Costumer) Law and the BOI Law - mutual funds: Joint Investment Trust Law - provident funds: Provident Funds - pension funds: Pension Counseling and Pension Market Law - The Securities Law sets out the basic principles of financial reporting, addressing: - the contest of a prospectus - the prohibition against the use of insider information - penalties for breaches - contents of annual reporting requirements for non-bank listed companies - The ISA provides an online filing system accessible to the public to facilitate disclosure required by the Securities Law. - Banking-specific reporting is set out in the Banking Ordinance, 1941 and BSD directives for annual and quarterly financial reporting by banks. - Authorities plan to transition the banking system solely to IFRS standards by 2013 or later. ### Public safety nets - Israel does not have formal deposit insurance. - Historically, the government and the BOI have provided extensive de facto protection to depositors: - During the latest global crisis the MOF stated that the BOI and the government would protect depositors. - For non-systemic bank failure cases in 1985 and 2001, the BOI compensated depositors almost in full. - In the severe financial crisis of the early 1980s, the government nationalized the entire system and depositors did not suffer any losses. ### Legal framework for supervision and supervisory powers - Primary legislation underpinning BOI Governor and Supervisor powers: the BOI law, the Banking Ordinance, 1941, the Banking Licensing Law, and the Banking Service to Customer Law. - BOI Supervisor can issue Proper Conduct of Banking Business Directives, instructions, and letters to implement prudential requirements. - Accountability mechanisms are in place, but MOF influence in BOI employee salary scales compromises independence and raises questions about the long term capacity of banking supervision staff. ### Main findings (summary) - Table 1 provides an overview of assessment on a principle-by-principle basis. - Objectives, independence, powers, transparency, and cooperation (CP1): - Comprehensive set of laws and directives exists, though some legislation is old. - BOI has a great deal of de jure and de facto independence and accountability mechanisms. - MOF influence on BOI salary scales compromises independence. - Licensing and structure (CPs 2–5): - Legal framework is clear regarding permissible banking and non-banking activities. - Policies and processes are in place to evaluate bank license applications. - Transfer of ownership is well defined in law; explicit definitions for controlling interests are in policy rather than law. - Conditions for acquisition of a non-bank financial institution could be more formally set out. - Prudential regulation and requirements (CPs 6–18): - Regulatory framework is fairly comprehensive but dense and complex. - Capital adequacy framework is based on international standards for standardized approaches to credit, market and operational risk in Pillar I; Pillar II is a significant component though somewhat informal. - Credit and most other risks are subject to close and intensive scrutiny. - BOI exerts close oversight of concentrations (single name, sectorial, geographic, collateral, and product). - Areas for improvement include regulation and supervision of interest-rate risk in the banking book, market risk, and liquidity risk. - Methods of ongoing supervision (CPs 19–21): - BOI has implemented a risk-based approach to supervision. - Mix of on-site and off-site supervision with extensive communication and cooperation. - Extensive reporting requirements provide a wide range of data and risk management information, used appropriately in supervision. - Accounting and disclosure (CP 22): - Disclosure requirements are very strict; external auditors ensure adherence. - Accounting standards require a combination of U.S. GAAP and IFRS; core assets principally earning assets are accounted for under U.S. GAAP. - Authorities plan transition to IFRS-only by 2013 or later. - Corrective and remedial powers (CP 23): - Current law provides a restrictive list of remedies (e.g., eliminating dividends). - Expansion of powers and resolution strategies is under consideration to allow more creative approaches. - Consolidated and cross-border supervision (CPs 24–25): - BOI has an overall satisfactory program of consolidated supervision, but a gap exists in supervision of certain securities-related activities by banking corporations. - BOI engages in host-home country relationships commensurate with the size and complexity of Israeli banks abroad. - Foreign bank operations in Israel are at a relatively low level; home-host relations are more ad hoc. ### Basel Core Principles: summary of compliance and key comments (selected) - Aggregate grading: Compliant (C) – 18, Largely compliant (LC) – 11, Materially noncompliant (MNC) – 1, Noncompliant (NC) – 1, Not applicable (N/A) – 0 - CP1 Objectives, independence, powers, transparency, and cooperation — Compliant - Comprehensive laws and directives; some provisions should be more flexible to enable appropriate Supervisor responses. - CP1.1 Responsibilities and objectives — Largely Compliant - Comprehensive laws and regulations, but banking laws have not been amended promptly; piecemeal provisions from decades of amendments. - CP1.2 Independence, accountability and transparency — Largely Compliant - BOI has substantial independence and accountability mechanisms; MOF influence on salary scale compromises independence. - CP2 Permissible activities — Largely Compliant - Legal framework is clear but BOI must interpret banking activities broadly to enable new products (e.g., derivatives). - CP3 Licensing criteria — Compliant - Infrastructure, legal framework, policies and processes to evaluate applications are in place. - CP4 Transfer of significant ownership — Compliant - Transfer of ownership well defined; explicit definitions in policy. - CP5 Major acquisitions — Largely Compliant - Law is restrictive on acquisition of non-bank financial companies; bank investment limit in shares of a non-financial company is 15 percent of equity capital. - CP6 Capital adequacy — Largely Compliant - Framework based on standardized approaches in Pillar I with add-ons and emphasis on core capital; Pillar II significant but informal. - Banks use the “standardized approach” in determining risk weights. - CP7 Risk management process — Compliant - Regulatory framework comprehensive but complex; BOI moving toward a more principles-based rulebook. - CP8 Credit risk — Compliant - Detailed directives and supervisory guidance; credit risk under close scrutiny. - CP9 Problem assets, provisions, and reserves — Compliant - Rules fully adequate; harmonization under way. Accounting definition of impaired debts does not separately identify debts unlikely to repay regardless of collateral. - CP10 Large exposure limits — Compliant - Comprehensive regulation; oversight could be enhanced by paying more attention to correlation of risks. - CP11 Exposure to related parties — Compliant - Definition strictly delineated with limited Supervisor discretion. - CP12 Country and transfer risks — Compliant - BOI exerts proactive oversight. - CP13 Market risks — Materially non compliant - Capital purposes allow only standardized methods while banks use VaR and stress tests for risk management. - BOI has not committed sufficient resources to challenge banks’ trading book eligibility policies, data systems, valuation methodologies and internal models; independent capacity is strongly recommended. - Assessment of market risk is biased by amalgamation with interest-rate risk in the banking book. - CP14 Liquidity risk — Largely compliant - Intensive oversight but based on solo-basis information only; regulatory limits apply only to overall liquidity, without breakdown by major currencies, and only over a one-month horizon. - Relatively few resources allocated to on-site examination of information systems and models for liquidity. - CP15 Operational risk — Largely compliant - Rules scattered across directives; lack a comprehensive view. Reporting focuses on events and not related material losses. Few resources for on-site examination. - CP16 Interest-rate risk in the banking book — Non compliant - No specific regulatory provisions; banks must measure internally and disclose but BOI does not receive specific reporting. BOI assesses interest-rate risk using whole balance sheet including trading book. - CP17 Internal control and audit — Largely compliant - Piecemeal regulatory approach; BOI initiative to create a comprehensive rulebook is commended. Scope of compliance function needs expansion. - CP18 Abuse of financial services — Largely Compliant - Needed legal amendments expected to be passed shortly. AML/CFT provisions and practice generally of a high standard. A new regulation to complete and harmonize the regulatory framework was in process at the time of the assessment. - CP19 Supervisory approach — Compliant - Risk-based approach implemented; efficiency and pro-activity need improvement. - CP20 Supervisory techniques — Compliant - Integrated on-site and off-site supervision; risk assessment products are high caliber but sometimes duplicative and need streamlining. - CP21 Supervisory reporting — Compliant - Extensive reporting requirements provide consolidated and unconsolidated risk data used appropriately. - CP22 Accounting and disclosure — Compliant - Strict disclosure; external auditors enforce rules. Combination of U.S. GAAP and IFRS currently required; plan to transition to IFRS-only by 2013 or later. - CP23 Corrective and remedial powers — Largely Compliant - Remedial powers in law are restrictive; expansion of powers and resolution strategies under consideration. - CP24 Consolidated supervision — Largely Compliant - Overall satisfactory but gap in supervision of certain securities activities; underwriting oversight coordination with ISA needed. - CP25 Home-host relationships — Compliant - Host-home relationships commensurate with size and complexity; most foreign bank operations in Israel are low and relationships more ad hoc. ### Recommended action plan (overview) - Table 2 (not reproduced here) summarizes recommendations formulated during the assessment; some recommendations appear under core principles rated as fully compliant. - Specific priority areas implied by the findings include: - Strengthening BOI independence by addressing MOF influence on salary scales. - Formalizing conditions for acquisition of non-bank financial institutions. - Enhancing supervision and regulation of interest-rate risk in the banking book (CP16). - Building independent capacity to challenge banks’ market risk models and valuation methodologies (CP13). - Expanding liquidity oversight to include major currency breakdowns and longer horizons (CP14). - Consolidating fragmented rules on operational risk, internal control and audit (CP15, CP17). - Expanding remedial powers and resolution strategies for problem banks (CP23). - Closing gaps in supervision of securities-related activities and aligning approaches with ISA (CP24). *IMF assessment text as provided in the source document.* ### 1. Objectives, autonomy, ### 1. Objectives, autonomy, powers and resources ### Responsibilities and objectives (Principle 1(1)) - Description: - BOI has clear responsibility for bank supervision under two specific laws: the Bank of Israel Law, 5770 – 2010, and the Banking Ordinance, 1941. - The Banking (Licensing) Law, 5741 – 1981, authorizes BOI to license banks and revoke such licenses, identifies permissible activities and governs transfer of significant ownership and major acquisitions. - PCBB directives are adopted under Section 5(c1) to ensure sound management of a bank, safeguard customers’ interests, and avert impairment to a bank’s ability to meet liabilities. - BOI’s objective to “support the stability and orderly activity of the financial system” is stated in the BOI Law. - BOI is the sole supervisor of the banking system; other authorities (ISA, MOF) may directly or indirectly affect bank activities. - Assessment: Compliant - Comments and recommended actions: - The authorities should consider a more principles-based approach in directives guiding risk management (while recognizing the legal framework is principally rule-based). - Sections 8A and 8C of the Ordinance and directives governing relationships between affiliated entities should be strengthened to provide BOI greater flexibility in problem bank situations and in supervising affiliates. ### Independence, accountability and transparency (Principle 1(2)) - Findings: - Under the law, BOI is autonomous, but independence is compromised by the authority of the Ministry of Finance to influence the salary scale of BOI employees. - This influence could adversely affect BOI’s ability to attract or retain qualified supervisory staff. - The number of staff in the Banking Supervision Department may be insufficient to carry out all responsibilities. - Recommended actions to counter recruitment/retention challenges: - Develop a comprehensive in-house training program. - Program rotation of staff across the BOI. - Second staff to banking supervision agencies overseas. - Offer cash bonuses. - Hire retired bankers at entry- or mid-level positions. ### Detailed recommended actions by Reference Principle - 2. Permissible activities: - Add a provision to Section 10 of the Bank Licensing Law to enable BOI to approve the introduction of new banking activities. - 3. Licensing criteria: - Move definitions of control currently in policy into law or regulation. - Consider a directive requiring banks to inform the Supervisor of Banks of material facts compromising suitability of a controlling owner. - 4. Transfer of Significant Ownership: - Consider reducing permissible investment in a non-financial investment to 5 percent of a bank‘s capital. - Subject acquisition of non-bank financial companies located in Israel to formal criteria similar to foreign acquisitions. - 5. Major acquisitions: - Dedicate more BSD resources to independent checking of capital adequacy reporting. - Strengthen SREP to be more forward-looking and prescriptive; ensure timely bank responses when ICAAP is insufficiently prudent. - Empower the Supervisor to require controlling shareholders to increase banks' capital. - 6. Capital adequacy: - Streamline the regulatory framework (move from a piecemeal approach to a comprehensive one). - 7. Risk management process: - Update credit risk management regulation to be more comprehensive and incorporate guidelines for sound internal rating practices; strengthen BSD oversight and pave way for advanced approaches for capital purposes. - 8. Credit risk: - Ensure consistency of applicable rules (Directive 314 and new Reporting to Public directives). - Consider requiring banks to submit information that isolates borrower repayment assessment from collateral collection. - 9. Problem assets, provisions, and reserves: - Enhance oversight of concentration risk by systematically assessing concentration from distinct but correlated exposures. - Incentivize banks to analyze concentration of risk factors beyond single-name concentration and incorporate into ICAAP/SREP. - 10. Large exposure limits: - Extend BSD’s powers on exposures to related parties: give Supervisor more discretion to apply definitions, deduct exposures from capital, or require collateralization. - 11. Exposure to related parties: - Increase resources devoted to market risk in on-site examinations to assess data processing reliability, model design/implementation, and valuation methodologies. - Disentangle off-site assessment of market risk from interest-rate risk in the banking book within Risk-Based Supervision and SREP. - 12. Country and transfer risks: - Current oversight is based on solo-basis information only; regulatory limits apply to overall liquidity and could be usefully extended to breakdown by major currencies and a longer time horizon. - Devote more resources to checking quality of reported information that supports BSD oversight and banks’ liquidity management. - 13. Market risks: - Streamline regulatory framework using a Basel II-compliant definition of operational risk. - Broaden attention to all sources of operational risk beyond IT and internal control over financial reporting. - 14. Liquidity risk: - Introduce specific regulation regarding treatment of interest-rate risk in the banking book. - Assess interest-rate risk in the banking book on a stand-alone basis, disentangled from market risk in SREP. - 15. Operational risk: - Streamline legal and regulatory framework related to internal control and audit. - Use upcoming revision to fill gaps on: - organizational structure (segregation of critical functions such as business origination, payments and settlements, reconciliation), - scope of the compliance function, - internal audit access to outsourced functions. - 16. Interest-rate risk in the banking book: - Ensure adequacy of policies/processes to meet high ethical and professional standards and prevent criminal use on a consolidated basis. - Adopt and implement the new AML/CFT regulation. - 17. Internal control and audit: - Seek increased efficiency in application of risk-based supervision; eliminate duplicative processes/methods to streamline risk-based products. - 18. Abuse of financial services: - Expand staff so full implementation of risk-based supervision, Basel II, and other initiatives can be effected. - 19. Supervisory approach: - If converting fully to IFRS, obtain and monitor banks’ plans and progress to ensure readiness on the designated date. - 20. Supervisory techniques: - Consider rotation of external auditing firms to create competition given a minimal number of firms currently providing services. - 21. Supervisory reporting: - Amend Section 8C of the Ordinance to enable Supervisor of Banks to apply supervisory actions commensurate with deficiencies. - Consider a regulation governing relations with affiliates and intercompany transactions; expand and strengthen authority under Section 8D to allow flexible resolution strategies. - 22. Accounting and disclosure: - Reach a more detailed and operational agreement with the ISA on supervisory approach to securities-related activities housed in nonbank subsidiaries. - 23. Corrective and remedial powers of supervisors: - Consider a somewhat more principles-based approach in directives providing guidance to the banking industry on risk management. - 24. Consolidated supervision: - Formalize periodic review of banking law and regulation and consider reorganization of laws and directives into a comprehensive banking law. ### Authorities’ response to the assessment (paragraphs 38–41) - General response: - Authorities appreciate the IMF assessment and find the FSAP useful; recommendations will be considered carefully. - Authorities welcome the overall assessment indicating a high level of observance of the BCP in Israel. - Specific responses and positions: - CP 1 (principle-based vs rule-based): Authorities seek a right balance; adopt principle-based approach where suitable but note it can leave too much discretion in some areas. - CP 5 (investment limitation in non-financial companies): Authorities will consider recommendation to set a lower regulatory limit on such investments. - CP 6 (capital adequacy): Authorities agree with recommendations and note: - Supervisor of Banks announced he will adopt Basel III. - BSD required hybrid instruments to already comply with Basel III. - Work on Basel 2.5 is in process. - BSD preferred not to issue formal capital-strengthening requests following supervisory review but engaged in dialogue that resulted in strengthened capital adequacy for some banks. - Authorities are comfortable with standardized approach in Pillar I complemented by rigorous, risk-sensitive, forward-looking Pillar II; BSD encourages banks to progress in implementing Basel II IRB standards. - CPs 10, 11, 23, 24 (intra-group transactions and related parties): Supervisor is empowered to regulate such transactions; current regulation covers these issues adequately but authorities will consider strengthening regulation including ring-fencing. - CP 14 (liquidity risk): Updated regulation will soon be issued; BSD already examines quality of data for internal models through on-site and off-site processes and will devote more resources to validation of reported liquidity data. - CP 15 (operational risk): A new regulation concerning operational risk management was issued shortly after the mission to streamline the regulatory framework; BSD covers operational risk through on-site and off-site processes and will increase participation of the operational risk on-site unit in other examinations. - CP 23 (corrective and remedial powers): Authorities share recommendations; BSD is preparing proposals to amend the legal framework for bank resolution to give BOI flexible resolution tools for significantly deteriorated but still solvent banks. - CP 24 (consolidated supervision): Authorities accept comments related to securities activities performed by asset management and underwriting subsidiaries; BSD will map gaps and act to close them in cooperation with the Israeli Security Authority. *Source: _cr1285 - 1. Objectives, autonomy,* ### Section 5(c) 1 establishes the power of the bank supervisor to issue prudential ### _cr1285 - Section 5(c) 1 establishes the power of the bank supervisor to issue prudential ### Prudential standards and directives - Section 5(c) 1 of the Banking Ordinance, 1941 establishes the power of the Supervisor of Banks to set prudential standards. - Standards are issued as Proper Conduct of Banking Business Directives addressing: - risk management; - duties and responsibilities of boards of directors; - role and responsibilities of the external auditor; - treatment of problem assets; - credit relationships with related parties and large exposures. - Additional directives are under development or review for various banking risks, including operational risk and credit risk. - Supervisory letters: - issued to react to immediate needs or inform the banking industry of important issues; - address prudential issues and are subject to the same approval procedures as directives; - are ancillary to and supplement directives, and may contain operational instructions that are later converted into directives. ### Publication, consultation and disclosure - Banking laws and regulations are published in the form of directives and are revised or updated as necessary, but there is no formal review process. - BOI may recommend amendments or revisions to existing laws; changes in law require Parliamentary approval by the Knesset, but changes to regulations do not. - All new banking legislation and changes to existing banking laws are subject to a public consultation process prior to enactment and publication. - Introduction of new banking regulations in the form of directives is also subject to public consultation. - BSD provides an annual survey available to the public on BOI‘s website with detailed information on banking industry developments and supervisory and regulatory developments; aggregate data and links to each bank‘s complete annual and quarterly financial information are provided. - Directive 309, "Controls and Procedures Relating to Disclosure and Internal Control over Financial Reporting," requires each banking corporation to publish "clear, exact and timely" information enabling accurate assessment of the banking corporation‘s financial condition; disclosure requirements are based on United States requirements related to the enactment of the Sarbanes-Oxley Act. ### Risk-based supervision and supervisory strategy - BOI introduced a program of risk-based supervision enabling prioritization of risks for each banking institution. - Sources of supervisory information include prudential returns and publicly available financial statements. - A supervisory strategy takes the form of a work plan reflecting the institution‘s risk profile and influences supervisory attention and resource allocation for each banking corporation. ### Assessments and comments on legal framework and law revision - Assessment (overall for initial section): Largely Compliant. - Comments and observations: - Banking laws have not always been amended promptly; laws sometimes require broad interpretation to allow banks to engage in new activities. - Decades of amendments produced a somewhat confusing set of provisions; issues relating to particular activities may be found piecemeal in various laws and directives. - The Banking Ordinance, 1941 has been amended multiple times and several sections repealed; there has not been a comprehensive review since enactment. - Authorities may wish to undertake a comprehensive review of laws and directives pertaining to banking, subject to periodic review. - As part of the review, directives related to risk management and corporate governance could be established within banking law to close gaps in the Ordinance. - Certain rules currently in directives are more appropriately contained in banking law—for example, restrictions on related party lending should be developed as an express provision in law. - Assessment for legal framework (Principle 1(3)): Compliant. - Comments: Legal framework is reasonably comprehensive but lacks flexibility in some areas (permissible activities and remedial actions); gaps exist regarding comprehensive treatment of transactions among entities of a banking corporation and relations with affiliated companies. ### Independence, accountability and operational resources (Principle 1(2)) - Legal status and governance: - BOI is independent and autonomous in law; Section 5 of the Bank of Israel Law, 5770 – 2010 states the bank is autonomous in choosing its action and exercising its powers. - The Supervisor of Banks is appointed by the Governor of BOI and has a range of supervisory powers under the Banking Ordinance, 1941. - Advisory and licensing committees: - Supervisor consults with an Advisory Committee and a Licensing Committee prior to issuing directives or on licensing matters; Governor appoints committee members. - A representative of the Ministry of Finance and the Chairman of the ISA serve on the Advisory Committee, along with private sector representatives. - Operational independence and influences: - No evidence of government or industry influence on routine supervisory decisions, but the Ministry of Finance is consulted in practice on certain matters (e.g., approval of new permissible business activity). - The Supervisor must gain the Governor‘s approval for certain actions under law. - Planning and reporting: - Supervisor prepares an annual working plan based on at least a three year revolving plan; plan and annual budget for banking supervision are presented to BOI senior management for approval. - Semi-annual reporting to the Governor and BOI senior management on execution of the work plan. - Financing and staffing: - Supervisor operations financed from BOI budget, which is subject to parliamentary review annually. - Supervisor generally attracts and retains staff with requisite skills; gaps exist in quantitative modeling and Basel II, and evaluation of market and interest-rate risk. - Supervisory staff are well educated; management and mid-level staff possess a high degree of experience. - Remuneration and recruitment concerns: - Since 1985, supervision of wages and benefits of BOI employees is the responsibility of the Minister of Finance; this remains under the Bank of Israel Law 2010. - BOI can appeal Minister of Finance decisions to the Prime Minister; the Minister and Prime Minister are to take BOI needs into consideration. - December 2007 collective wage agreement equalized salary components closer to Government employees, reducing some benefits for existing and newly-hired employees; this hinders recruitment and increases turnover. - Concern that overall quality and skill levels of BOI staff may deteriorate and that shortages impede full implementation of risk-based supervision and Basel II and Basel III Accords. - Term and termination: - Governor appointed for a five-year term by law. - Supervisor of Banks‘ term of service is not set in law; in practice serves a four-year term; termination would be subject to judicial review. - Assessment: Largely Compliant. - Comments and policy recommendations: - Ministry of Finance influence over BOI salary scale compromises BOI independence; BOI should consider: - development of a comprehensive in-house training program; - rotation of staff to different units in banking supervision; - secondment of staff to banking supervisory agencies overseas; - cash bonuses; - hiring of retired bankers at entry- or mid-level positions. - Attrition is increasing; Public Service (Restriction after Retirement) Law, 5729-1969 requires a one-year cooling-off period for banking supervisors and other employees; where not applicable, BOI requires a cooling-off period ranging from three months to one year depending on position in BSD. - Consideration could be given to requiring the cooling-off period to be one full supervision cycle. - The Advisory Committee, though consultative, may be influential given its composition. ### Legal powers and enforcement (Principle 1(4)) - Legal tools and powers: - Banking Ordinance, 1941 and directives provide tools to address supervisory issues and prescribe specific remedial actions. - Sections 8A through 8C provide fundamental compliance powers; Supervisor can require remedial actions and impose sanctions for non-compliance. - Sanctions range from orders to discontinue activities, prohibiting dividends, suspending or limiting powers of board members, removal from office; under Section 8D the Governor may appoint an administrator or a special examiner. - Banking (Licensing) Law, 5741-1981 empowers the Governor to grant or revoke banking licenses (Section 4) and sets criteria for licensing (Section 6), minimum capital requirements for de novo operations (Section 7), and conditions for license revocation (Section 8). - Directives enable setting of capital adequacy ratio and standards for management of banking risks. - A range of fines and penalties are available and imprisonment is possible for certain malfeasance. - Information access: - Section 5(a) of the Ordinance grants the Supervisor full access to all relevant information from banking corporations, subsidiaries and affiliated companies; includes power to require delivery, examination, copying or photographing of documents and computer-stored information in required format. - Supervisors report having free access to required information in practice. - Assessment: Compliant. - Comments and enhancements recommended: - Enforcement powers could be enhanced by strengthening Sections 8A and 8C to give BOI greater flexibility and powers in problem bank situations (for example, clarifying that Section 8A authorizes actions based on any violation of law or regulations and that BOI may require affirmative remedial actions). - Consideration of a ring-fencing mechanism as a corrective measure in cases of abusive practices by affiliates of banking corporations. - In practice, more stringent enforcement powers are rarely invoked; most cases are handled informally and resolved satisfactorily. ### Legal protection for supervisors (Principle 1(5)) - Legal protection: - Section 7A (a) of the Damages Ordinance provides no liability for public servants in the discharge of public duties, covering acts of commission or omission unless taken knowingly with intent to cause damage. - Assessment: Compliant. - Comments: Provision has been tested in the judicial system and upheld by the courts. ### Cooperation and information sharing (Principle 1(6)) - Domestic cooperation: - BOI has formal and informal arrangements with other Israeli supervisory agencies; a 2007 Memorandum of Understanding regulates cooperation, information sharing and coordination of enforcement actions among the Supervisor of Banks, the Commissioner of the Capital Market, Insurance, and Savings Authority in the Ministry of Finance, and the ISA. - Beginning in 2011, the three supervisors formed a Liaison Committee meeting monthly to promote cooperation and information exchange; outcomes include a joint policy on a Fit and Proper regimen for directors and officers of financial institutions and work begun on anti-money laundering issues. - The Israeli Antitrust Authority participates in the monthly meetings but is not a signatory to the Memorandum. - International cooperation: - Formal Memorandum of Understanding with the Federal Reserve and the FDIC (United States) covering exchange of examination results, licensing issues, and cooperative efforts on anti-money laundering and terrorist financing. - Agreement with the FSA (United Kingdom) on exchange of information and cooperative framework relating to liquidity positions and liquidity issues; BOI receives supervisory information from US and UK regulators as a result. - Informal mechanisms exist with other supervisors, notably FINMA (Switzerland), involving meetings and formal visits; FINMA sends representatives to BOI. - These arrangements facilitated the recent acquisition of a Swiss bank by a large Israeli banking corporation. - Legal basis for information exchange: - Sections 15A.1 and 15A.2 of the Banking Ordinance, 1941 provide power to exchange information with other regulatory authorities notwithstanding secrecy provisions of Section 15A. - Section 15A stipulates that information cannot be divulged or shared unless in connection with a criminal investigation or with the banking corporation‘s consent. *Source: _cr1285 - Section 5(c) 1 establishes the power of the bank supervisor to issue prudential* ### Section 15A.1 of the Ordinance provides an exception to a supervisory authority in a ### _cr1285 - Section 15A.1 of the Ordinance provides an exception to a supervisory authority in a ### Section 15A.1 — Exception to foreign supervisory authorities - Permitted where: - (a) the information is needed for the discharge of the foreign authority‘s responsibilities in the supervision of the banking institution, and - (b) the foreign supervisor confirms that confidentiality requirements similar to Section 15A applies to it or it will not forward the information to a third party. - Assessment: Compliant - Comments: - With the exception of the United States and United Kingdom, cooperative arrangements with other foreign supervisors generally are the same as with Switzerland, but on a scale commensurate with the operations of banking corporations in the home or host country venue. ### Section 15A.2 — Exception to other supervisory authorities in Israel - Permitted disclosures: - The Supervisor of Banks may divulge information to representatives of the ISA and the Commissioner of the Capital Markets, Insurance and Savings at the Ministry of Finance if he is aware that the information is required in the discharge of the authority‘s functions. - Implementation framework: - The existing MOU between the three domestic authorities establishes the framework under which information may be exchanged. ### Principle 2 — Permissible activities (summary) - Legal definitions and restrictions: - The term “bank” or banking corporation is defined in the Banking (Licensing) Law, 5741 – 1981 and comprises several financial institutions empowered to accept deposits and grant loans (except for a joint service company). - Section 1 defines a banking corporation as a commercial bank, a foreign bank, a mortgage bank, an investment finance bank, a business promotion bank, a financial institution or a joint service company. - Section 21 prohibits institutions not defined as banking corporations from accepting deposits from 30 or more persons and granting credit at the same time. - Section 13 prohibits institutions that are neither banks nor foreign banks from accepting and maintaining demand deposits payable by check. - The Banking Ordinance, 1941 restricts the use of the word “bank” to a commercial bank, a foreign bank, a mortgage bank, an investment finance bank, and a business promotion bank. - The Governor may force an institution that uses the word bank but is not licensed as such to discontinue use of the term or expressions suggesting banking business. - Practical landscape: - In practice there are no investment finance banks or business promotion banks operating at present, and only one financial institution as defined in the law continues to operate. - Foreign banks have deposit gathering powers similar to commercial banks. - Joint service companies are restricted to services to banks or their customers (examples: an ATM operator and a check clearing company). - The BOI website maintains the list of all institutions defined as banking corporations operating in Israel, with contact information and a link to their websites. - Assessment: Largely Compliant - Comments / recommended legal fixes: - Add a provision to Section 10 of the Banking (Licensing) Law, 5741 - 1981 enabling the Governor, after consultation with the Supervisor of Banks and the Advisory Committee, to approve the introduction of new banking activities. - Tighten law to strengthen prohibition on misuse of the word "bank". - Address loopholes/inconsistencies: - Non-bank institutions are permitted to accept cash deposits (the Post Office can accept deposits and call itself a bank under a special law but is not allowed to issue credit). - While Section 13 prohibits acceptance of demand deposits by non-bank entities, there is no prohibition on acceptance of other types of deposits. - Remove references in law to certain institutions defined as banks that no longer exist. ### Principle 3 — Licensing criteria (summary) - Licensing authority and process: - The Governor has the power to license banks; the Licensing Committee (five representatives from the Advisory Committee) is consultative. - Section 6 of the Banking (Licensing) Law 5741 - 1981 establishes licensing criteria. - Licensing criteria include: - Financial strength and quality and reasonableness of strategic and business plans. - Suitability of prospective officers and directors under a “fit and proper” regimen. - Competitive factors and contribution to the level of service in the banking system, and the public good. - Reciprocity for a foreign bank (there must be reciprocity between Israel and the home country). - Supervisor practices: - Supervisors evaluate proposed strategic and operating plans, risk management and internal control processes, projections and budgets, and the financial strength of the applicant. - Supervisors assess the capacity of the owners to contribute additional capital; there is nothing in the law that necessarily sets as a condition for granting the license a requirement for owners to contribute additional capital. - The Governor may refuse to issue a license if criteria are not met, information is inadequate, or for other valid reasons; decisions are subject to judicial review. - Ownership and fit-and-proper testing: - Assessment includes investigation and evaluation of ultimate ownership and control on both a solo and consolidated basis. - Ultimate owners include all individuals who own the bank directly or indirectly. - Ownership structure cannot be changed once the license is granted without prior permission from the Governor. - All shareholders with an ownership interest of 5 percent or more are subject to the fit and proper regimen; owners who hold interest indirectly are also subject to fit and proper considerations. - Prospective directors, executive officers and the internal auditor must undergo the fit and proper test. - Director suitability includes knowledge of material banking activities and risks. - Directive: at least 20 percent of the board must have proven banking experience, and at least 20 percent must have expertise in accounting and finance. - If shares are widely held and there is no controlling owner (20 percent or more, depending on the size of the bank for purposes of licensing activities), only officers and directors are subject to the suitability test. - Suitability test includes integrity, experience, education relevant to banking, conflicts of interest investigation, and a criminal background check. - Capital requirements: - Section 7 requires a minimum paid-in capital of NIS 10 million, although in practice the Governor requires US$ 150 million at present. This requirement is not codified in the law. - The source of the capital contribution is traced and carefully examined to determine ultimate owners. - No license will be granted if the Governor is not comfortable with the ownership structure or the ultimate owner cannot be identified. - Foreign bank entries: - For a foreign bank establishing a branch or subsidiary, the Supervisor of Banks seeks written confirmation from the home country supervisor that there is no objection. - The Supervisor verifies that the home country supervisor practices consolidated supervision and meets international supervisory standards to a reasonable degree based on the Basel Core Principles; the World Bank and IMF websites are sources used. - Revocation: - Section 8(c) allows revocation of a license if obtained under false pretenses or breach in material terms; this power has been used. - Supervision intensity: - Newly licensed banking corporations receive intensive off-site attention in formative years; on-site examinations are more frequent to determine compliance with license terms and strategic goals. - Assessment: Compliant - Comments: - Authorities have reconsidered the policy of insisting a banking corporation have a controlling owner; in a small economy the number of applicants who could have a controlling interest is comparatively small. - Problems noted with controlling groups raising additional capital: tendency to issue Tier II capital instruments rather than equity capital to avoid diluting ownership. - “Marani” legislation addresses widely held ownership; provisions enable a Committee to nominate new directors to reduce influence of sitting directors or senior management. Committee would be appointed by the Governor; only the Chairman of this Committee, who must be a judge emeritus, would be appointed by the Minister of Finance after consultation with the Chief Justice of the Supreme Court. - Infrastructure and procedures to evaluate licensing applications are in place; few de novo bank applications in recent years. - Recent licensing case: an application by a large Israeli bank to acquire a bank abroad; Governor will require improvements in risk management and internal control systems in the foreign bank, including anti-money laundering, and institution of a reporting system to inform the Supervisor of progress. ### Principle 4 — Transfer of significant ownership (summary) - Legal framework: - Banking (Licensing) Law, 5741 – 1981 governs transfer of significant ownership and authorizes the Governor to reject a proposed transfer. - The Law defines significant ownership and controlling interest as “control” and “means of control.” Control is the ability, singly or in conjunction with others, to direct activity; means of control conditions include: - (a) voting rights; - (b) the power to appoint a director; - (c) the right to receive dividends; and - (d) the ability to assert claims on remaining assets of the bank, if any, when liquidated. - Notification and thresholds: - Section 34 (a) stipulates acquisition of more than 5 percent of means of control in a bank or bank holding company must receive the permit of the Governor prior to the acquisition. - Section 34 (b) stipulates acquisition of control in a bank or bank holding company must receive the permit of the Governor prior to the acquisition. - The Governor must consult with the Licensing Committee prior to granting approval for acquisition of more than 5 percent of means of control and for transfer of ownership or acquisition of control. - Enforcement and remedial powers: - Sections 34a and 35 give the Governor discretion to force divestment if interest acquired without prior approval or to revoke the permit of ownership under specified circumstances (e.g., false information). - Under Section 35, the Governor can nullify votes cast by an owner who did not seek approval, prohibit appointment of directors by that owner, and require divestiture. - Criteria and reporting: - Transfer proposals may be rejected if ownership criteria are not met. Section 34 (b1) criteria are similar to establishment of a de novo bank, including assessment of financial strength, source of funding, fit and proper test for new owners, and identification of ownership structure. - Annual filing requirement: - Any person holding more than a 5 percent interest in a bank where there is a controlling shareholder, or any person possessing more than 2.5 percent of a bank where shares are widely held and there is no controlling shareholder, must file a report stating the amount of shares held, whether held directly or indirectly, the ultimate or beneficial owner and the structure of ownership (such as holdings through a trustee or nominee). - The report must be filed as well when there is a change in the shares held by a controlling owner. - At present, banks are not required to inform the Supervisor of Banks of material information that could affect the suitability of a controlling shareholder. - Assessment: Compliant - Comments: - As a matter of policy, BOI considers a controlling interest to be 20 percent or greater for one of the five large banking groups, and 50 percent or more for other banks. - No other ownership interest can exceed 5 percent of the shares in a bank, with the exception of institutional investors (mutual funds and provident funds) permitted to hold 10 percent of the shares. - Best practice: terms defining control normally contained in law rather than policy; a law or directive reflecting definitions of controlling interests is warranted. - Recommendation: consider a directive requiring a bank to inform the Supervisor of Banks of a material fact or condition compromising the suitability of a controlling owner. ### Principle 5 — Major acquisitions (summary) - Legal powers and criteria: - Section 20 (a) 2 of the Licensing Law permits a bank to acquire another bank, in Israel or abroad, subject to certain criteria; Section 32 lists criteria for issuance of a permit to acquire an interest in a foreign bank. - Criteria are designed to ensure corporate affiliations or structures do not expose the bank to undue risks or hinder effective supervision. - BSD assesses whether criteria are met and reviews each application for wider implications in terms of stability, effective supervision, and conduct of business. - Non-bank investments: - Section 10 establishes permissible activities for banks. - Section 11 specifies non-bank financial investments a bank may control or invest in; list is restrictive and includes: - Bank service companies, non-bank subsidiaries that engage in permitted banking business, foreign corporations that would require a license under the Banking (Licensing) Law if conducting business in Israel, underwriting and asset management activities, and companies engaged in sale of homeowners insurance while serving as an agent. - Banks must obtain approval from the Supervisor of Banks prior to acquiring a non-bank financial subsidiary whose activities fall within Section 10. - Underwriting and asset management activities are licensed by the ISA but operate under a permit granted by the Supervisor of Banks; supervision of these entities is responsibility of the ISA. - Cross-border and foreign subsidiaries: - Under Section 11, a bank may gain a controlling interest in a foreign non-bank financial subsidiary that engages in a Section 10 activity. - Directive 306 addresses investments in such overseas companies: BOI must be notified at least 45 days prior to the investment, and the bank must submit strategic and business plan, information on management and monitoring, plan of risk management and internal controls, and organizational and ownership structure relative to the banking corporation. - The financial condition of the parent bank is assessed in connection with the proposed investment. - Management of the foreign entity is not subjected to a suitability test; the host country supervisor typically performs background investigations. - BOI uses World Bank, IMF and OECD websites as sources for evaluation of the host country supervisor. - Domestic non-bank financial companies: - No formal criteria in law for approval of non-bank financial companies located in Israel that will engage in Article 10 powers, but approval process follows criteria required of a de novo bank or foreign bank subsidiary; regulations related to banks cover these Israeli subsidiaries. - Controlling interest in other types of non-bank financial companies not specified in the Law (Section 11 (a) (5)) must receive prior approval of the Supervisor of Banks subject to consultation with the Licensing Committee; these are rare. - Example: holding shares in a non-financial company whose exposure, because of buy-back of shares by the investee, exceeds permissible equity interest — permitted for a defined period. - Insurance companies are not permitted to be acquired by banks. - Non-financial company investments: - Investments in non-financial companies do not require BOI approval, but aggregate exposure to such companies is limited to 25 percent of the bank‘s capital. - Investment in one Israeli corporation is limited to exposure equal to no more than 15 percent of equity capital. *Source: _cr1285 - Section 15A.1 of the Ordinance provides an exception to a supervisory authority in a* ### Section 23A allows a bank to invest up to 20 percent of its capital in non-financial ### _cr1285 - Section 23A allows a bank to invest up to 20 percent of its capital in non-financial ### Section 23A — investment limits and assessment - Section 23A allows a bank to invest up to 20 percent of its capital in non-financial companies, only if it does not hold more than 5 percent of the means of control in each company and has no right to nominate a director. - The remaining 5 percent can be invested in the equity of foreign non-financial companies with virtually no presence in Israel. - Assessment: Largely Compliant - Comments / Recommendations: - Acquisition of non-bank financial companies located in Israel should be subject to more formal criteria similar to those for investment in a financial company located in a foreign jurisdiction. - To prevent undue concentration, limit investment in one Israeli non-financial company to 5 percent of capital. ### Principle 6 — Capital adequacy: framework, requirements and supervisory practice - Legal/regulatory translations and directives: - The Supervisor translated Pillar 1 of Basel II into Israeli regulation through Directives 201 to 208. The Pillar 2 process introduced through Directive 211. - Directives apply on a consolidated basis to all banking corporations, credit-card companies, and auxiliary corporations, except exemptions and foreign branches. - Minimum requirements and composition: - Pillar 1 minimum total capital ratio: 8 percent. - Complementary Pillar 2 buffer: 1 percent (total required: 9 percent in practice/system expectation). - Core capital must be at least 70 percent of Tier 1 capital, after requisite subtractions from this tier of capital only. - BSD introduced (via supervisory letter) a compulsory minimum requirement of 7.5 percent core capital from December 31, 2010, onward. - Supervisory expectations and practice: - Since 2007 BSD encouraged banks to adopt internal capital targets rising to 12 percent by end-2009 (target path referenced). - Directive 201: Supervisor may require certain corporations to maintain a higher capital ratio. - Directive 211: Supervisor expects banking corporations to operate at capital ratios exceeding minimum supervisory ratios and may order retention of capital beyond minimum. - ICAAP / SREP: - Banks must carry out ICAAP and submit annual ICAAP reports (Directive 211). - SREP is used to evaluate individual bank capital adequacy; eight largest banks covered annually. - Supervisory expectation in stress tests: capital ratio shall not fall below 9 percent after stress scenarios are applied. - Banks were requested, in SREP letters, to submit by 31.12.11 an updated capital plan specifying a detailed trajectory that takes into account Basel III guidelines. - Powers and tools: - Supervisor has power to impose higher capital charges and limits; examples of sectoral supervisory letters introducing stricter capital treatment (March 2010, October 2010). - Supervisor may impose limits on material exposures (Directive 313) and order measures under Directive 211 (heightened monitoring, limit dividends, require recovery plans, order immediate capital raising). - Gaps, observations and recommendations: - Assessment: Largely compliant. - Regulatory framework mainly up-to-date and consistent with Basel II standardized rules; several national discretions used conservatively (examples noted). - BSD has not been able to conduct in-depth on-site examinations on capital adequacy reporting due to insufficient professional staff; in 2010 banks were instructed to commission external auditors to examine capital adequacy reporting (one-off, accounts as of December 31, 2010). - The uniform system-wide 1 percent buffer should not be viewed as synthesizing a Pillar II policy; Pillar II process needs to be heightened and made more forward-looking. - Legal limitation: Supervisor can order a bank to raise additional capital immediately but is not empowered to require controlling shareholders to increase banks' capital — given Israeli ownership structures this limits effectiveness. - The framework does not yet incorporate all advanced methodologies (Basel 2.5 by year-end 2011, Basel 3 applicable from 1 January 2013 with transitional arrangements). ### Principle 7 — Risk management process: requirements and supervisory oversight - Regulatory basis: - General risk-management directives: Directive 301 (board responsibilities, audit/control functions, reporting), Directive 339 (principles for identification/management/monitoring), Directive 211 (risk management within ICAAP/SREP). - Requirements and supervisory actions: - Banks must have comprehensive risk management policies and processes proportionate to size/complexity; board approval and periodic review required. - Dedicated on-site teams specialize by risk type (credit, market and liquidity, operational, compliance) and corporate governance team reviews overall effectiveness. - Off-site surveillance incorporates ICAAP-SREP, risk cards, and an expectation that boards receive concise exposures documents at least quarterly. - Model validation: banks using models for risk management must independently validate them (Directive 339); BSD focuses on governance of model validation rather than quantitative model validation. - Information systems: Directive 339 requires computerized MIS delivering comprehensive risk information to board/management; reporting to BSD and public required quarterly. - New products: board approval required after board considers all risks (Directive 339); risk-management function must be involved early. - Assessment: Compliant - Comments / Recommendations: - The rulebook is dense and complex; BSD is encouraged to overhaul towards comprehensive, principles-based rules and to more clearly specify segregation of functions and coverage of settlement risk. ### Principle 8 — Credit risk: policies, governance, monitoring and supervisory practice - Governance and policy requirements: - Directive 301: board sets overall strategy and credit policies; board must review adequacy at least once per year. - Directives addressing related parties (312), large borrower concentration (313), credit operations (316–319), collateral database (318). - Banks required to have computerized MIS for reporting and exposures document (Directive 339). - Core prudential metrics and actions: - Supervisory letters and directives tightened mortgage and adjustable-rate mortgage lending practices (2009–2011), including capital charge for housing loans with more than 60 percent LTV and adjustable-rate portion ≥ 25 percent (Letter October, 2010), disclosure and prohibition measures (2011). - Loan Review Unit required; internal ratings reliability examined (Directive 319). - Supervisory implementation: - BSD performs on-site and off-site examinations; 41 credit risk examinations since 2006; thematic examinations across mortgage, leveraged credit, large borrowers, problem debt detection. - Gaps and recommendations: - Assessment: Compliant. - Draft credit risk management regulation sent to banks; regulators encouraged to finalize comprehensive rulebook and include sound internal rating practice guidelines. - Regulation should require senior management approval for credit exposures exceeding specified amounts or unusually risky exposures (currently absent; included in draft directive). ### Principle 9 — Problem assets, provisions and reserves - Key regulatory features: - Reporting to Public and Proper Conduct of Business Directives define identification, classification, provisioning, write-off rules; substantial changes effective January 1, 2011. - Directive 319: Loan Review; Directive 316: ongoing borrower grading; Directive 698A / Directive 660: Measurement and Detection of Impaired Loans, provisions guidance. - Classification and provisioning rules and practices: - A debt is identified as impaired when it is probable that the bank will be unable to collect all amounts due; classified as impaired when overdue 90 days or more unless well-secured and in process of collection (specified conditions). - Write-offs: individual guidance for small homogeneous debts and large debts; timing rules (e.g., loans on individual basis written off when recovery conditioned on collateral or at latest two years after classification). - Off-balance-sheet exposures require appropriate provisions in accordance with FAS 5 rules. - Immediate report to BSD required whenever all or part of a debt that exceeds 5 percent of the banking corporation‘s capital is classified as doubtful (Directive 301). - Supervisory powers: - BSD may require increased provisions and may impose higher capital charges on certain assets (e.g., MBS exposures) if deemed necessary. - Assessment: Compliant - Comments / Recommendations: - Regulatory framework needs comprehensive review to ensure consistency (Directive 314 issues noted). - Current definition of impaired debt allows considerable discretion linked to collateral realization; BSD invited to fine-tune the classification regime to better align accounting impaired classification with borrower creditworthiness (facilitating IRB adoption in long term). ### Principle 10 — Large exposure limits and concentration risk - Regulatory limits (amended, effective January 2012, phased in over two years): - A (non-banking) borrower‘s net indebtedness shall not exceed 15 percent of the bank‘s capital. - A borrower group‘s net indebtedness shall not exceed 25 percent of the bank‘s capital. - A banking borrower group‘s net indebtedness shall not exceed (1) 25 percent of the bank‘s capital or (2) NIS 250 million, whichever is greater. - A controlled borrower group‘s net indebtedness shall not exceed 50 percent of the bank‘s capital. - The total net indebtedness of all ―borrowers‖, ―groups of borrowers‖, and ―banking group of borrowers‖, whose net indebtedness exceeds 10 percent of the bank‘s capital, shall not exceed 120 percent of the bank‘s capital. - Definitions and reporting: - Directive 313 defines ―borrower‖, ―group of borrowers‖ and related concepts; Supervisor empowered to define groups and exercise case-by-case discretion. - Indebtedness includes credit, investment in borrower securities, commitments, OTC derivatives, etc.; certain deductions and exclusions specified. - Banks must report to the Supervisor every three months on consolidated and solo basis; exposures exceeding limits reported within seven days. - Supervisory practice: - Banks must set internal, possibly stricter, limits; BSD verifies MIS, governance and monitoring in off-site and on-site examinations. - Assessment: Compliant - Comments: - Policy is comprehensive but focuses on single-name/entity/sector approach; BSD recommended to encourage banks to analyze concentrations of correlated exposures beyond single-name measures. ### Principle 11 — Exposures to related parties - Definition and scope: - Directive 312 provides a comprehensive but closed-end list of related parties, including controlling principals and affiliated companies. - Related-party regime applied uniformly across banks; some discretion for foreign-related banks. - Limits and arm's-length rules: - Aggregate indebtedness of all related parties shall not exceed 10 percent of the bank‘s capital at any time (Directive 312). - Transactions with related parties must not be on more favorable terms than those provided to others in similar transactions (Directive 312); exceptions for employees under collective labor limits. - Large related-party transactions/provision/write-off require board committee approval; conflicted board members excluded. - Reporting and supervision: - Banks must submit semi-annual records of related parties and amounts; related-party indebtedness designated in quarterly large-exposures reports to BSD and in public financial statements. - Assessment: Compliant - Comments / Recommendations: - Definition is closed and precise, which limits supervisory discretion (EC1); definition includes parties who control singly or in conjunction. - Supervisor should be able to demand that an officer (non-director) not be involved in origination/management of a related-party transaction. - Consideration could be given to rules for deduction of related-party lending from regulatory capital or explicit collateralization requirements. ### Principle 12 — Country and transfer risks - Requirements and supervisory measures: - Country risk managed within concentration and credit-risk framework (Directive 211 requires ICAAP to address geographic concentrations). - Reporting to BSD/public requires quarterly information on exposure to foreign countries, operating segments, foreign financial institutions, and activity of offices abroad. - BSD instructed banks (January 1, 2009) to treat borrowers active in high-risk countries with special conservative haircuts and provisioning. - Provisioning: - Effective January 2011, banks make discretionary individual and collective provisions that take into account indebtedness of less-developed countries; supplemental provision for less-developed countries became a minimum floor in collective allowance. - Assessment: Compliant - Comments: - Israeli regulation imposes demanding measurement and reporting; BSD remains proactive and scrutinizes banks' provisioning for country and transfer risk. ### Principle 13 — Market risk: measurement, limits and supervisory capabilities - Regulatory approach: - Market-risk capital measurement: standardized approach for regulatory capital (Directive 208). - For risk management, banks required to use VaR models and stress tests; model use must be validated internally. - Supervisory powers and practice: - Directive 208 and Directive 339 set valuation and trading-book eligibility requirements, independent price verification, valuation adjustments and reserves. - BSD can impose additional capital requirements for trading-book market risk (Directive 211) but has not used this to date. - Implementation gaps and assessment: - Assessment: Materially non-compliant - Reasons and observations: - Trading activity is modest and traditional, but BSD lacks sufficient experienced resources to independently assess banks' market risk exposures and models. - Low number and limited depth of on-site market-risk examinations; examinations focus on governance rather than quantitative validation of models, trading-book eligibility, data feed reliability, model design and implementation, and valuation prudence. - Off-site assessments may combine interest-rate risk in trading and banking books, potentially offsetting and understating market risk (see CP 16). ### Principle 14 — Liquidity risk: governance, metrics and consolidated approach - Regulatory framework and key requirements: - Directive 342: qualitative requirements (policy, surveillance, controls, contingency plans) and quantitative requirement: minimum liquidity ratio for one-month horizon based on bank internal models or standardized provisions; ratio shall be no lower than 1. - Banks must maintain daily solo liquidity measurement (including overseas branches) and submit monthly liquidity reports to BSD; more frequent reporting may be required in sensitive times. - Definition of liquid assets includes cash, Treasury deposits, deposits with Bank of Israel, marketable government bonds maturing in less than one month, deposits with banks, plus a proportion of other marketable government bonds; internal model banks may include additional assets per model. - Foreign currency and group issues: - Directive 342 requires systems for overall foreign-currency liquidity and main currencies; BSD does not currently set explicit foreign-currency liquidity limits, though banks calculate separate shekel and foreign-currency ratios and report to BSD. - BSD currently analyzes solo-based liquidity reports; group/consolidated liquidity is not yet fully integrated into supervisory limits or reporting. - Contingency planning and supervision: - Banks must have contingency plans and immediately report material breaches or liquidity problems to BSD. - BSD examines contingency plans, stress testing, funding diversification, information systems and early-warning mechanisms. - Assessment: Largely compliant - Comments / Recommendations: - Oversight is based on solo reporting only; BSD should develop consolidated/group liquidity approaches and anchor liquidity ratios for both currency groups and longer horizons in Directive 342. - BSD should allocate more resources to check data feed quality, internal models, treatment of non-contractual maturities and behavioral optionality, and to perform more on-site liquidity examinations. ### Principle 15 — Operational risk: framework, reporting and supervision - Regulatory basis: - Directive 206: operational risk measurement for capital purposes; most banks use the Basic Indicator Approach (BIA). - Directive 211: ICAAP requires operational risk framework and capital assessment for operational risk. - Complementary directives: Directive 309 (internal control over financial reporting), Directive 357 (IT), Directive 360 (rotation and leave), Directive 303 (external audit reports). - Supervisory practice: - BSD conducts on-site and off-site examinations; dedicated operational risk unit with seven auditors performs IT and operational risk reviews using questionnaires and toolkits. - External auditors report annually on internal controls; BSD receives these long-form reports. - Gaps and assessment: - Assessment: Largely compliant - Observations and recommendations: - Operational-risk requirements and guidance are fragmented across directives; a comprehensive operational-risk directive is under preparation and recommended. - Some operational risk sources not explicitly covered (external fraud, outsourcing beyond IT, correspondent banking). - Reporting requirements should be extended to include material operational losses by business line (banks collect internal loss data but do not currently report to BSD). - BSD encouraged to devote more resources to on-site operational-risk examinations. ### Principle 16 — Interest-rate risk in the banking book (IRRBB) - Regulatory status and requirements: - No specific BSD directives dedicated to interest-rate risk in the banking book; Directive 211 requires banks to consider IRRBB in ICAAP and include all material interest-rate positions and repricing/maturity data. - Public reporting requires disclosure of sensitivity of capital to a 100bp parallel shift in banking-book interest rates. - Supervisory practice and gaps: - BSD does not perform a distinct assessment of IRRBB separate from trading-book interest-rate risk in SREP or risk cards; sometimes banks measure combined trading and banking book exposure. - Assessment: Non compliant - Recommendations: - BSD is strongly recommended to introduce specific regulation and supervisory processes for IRRBB, including separate measurement, stress testing, model validation, reporting and independent risk-control responsibilities; otherwise banking-book positions may offset trading-book positions and mask true market risk. ### Principle 17 — Internal control and audit: governance, independence and coverage - Legal and regulatory foundations: - Companies Law and Directive 301 define board duties and corporate governance; Banking Ordinance and Banking (Internal Audit) Rules require appointment of internal auditor. - Directive 301, Directive 309 (financial reporting), Directive 357 (IT), new Directive 307 (issued December 2011) to serve as comprehensive internal-audit framework. - Key requirements and supervisory practice: - Internal audit is subordinate to board chair and accountable to board/audit committee; internal auditor appointment requires Supervisor approval. - Internal audit must base work-plan on risk mapping; BSD reviews audit plans and important audit reports. - Audit committee must be majority outside directors; at least two members with accounting/financial expertise. - Gaps and assessment: - Assessment: Largely compliant - Observations and recommendations: - Regulation is piecemeal and fragmented; BSD should consolidate into comprehensive directive and address gaps: segregation of critical functions (business origination, payments/settlements, reconciliation), broaden scope of compliance function beyond consumer regulations, and explicitly require internal-audit coverage of outsourced functions. - BSD working on new comprehensive internal audit directive (Directive 307). ### Principle 18 — Abuse of financial services (AML/CFT, KYC and correspondent banking) - Legal and supervisory framework: - Israel adopted FATF standards; Prohibition of Money Laundering Law and Prohibition on Financing of Terrorism Law underpin AML/CFT regime. - Governor enacted an Anti-Money-Laundering Order; Supervisor issued Directive 411. Israel established IMPA (Israel Money Laundering and Terror Financing Prohibition Authority). - Supervisory resources and practice: - Dedicated team of six examiners conducts AML/CFT on-site exams covering KYC, DO functioning, reporting to IMPA, account opening, training, monitoring high-risk customers; foreign branches/subs addressed via alternative tools. - BSD may require immediate reporting to BSD of material AML/CFT investigations affecting the bank. - Requirements and measures: - Directive 411 requires board-approved AML policy including customer due diligence, classification of high-risk customers, account monitoring, and retention of identification documents for at least seven years after account closure or relevant transaction. - Correspondent banking: enhanced due diligence required; senior manager approval for new correspondent relationships; bans on relationships with unsupervised institutions or shell banks. - Reporting: banks report to IMPA (Currency Transaction Reports, Suspicious Transaction Reports); banks must also send monthly reports to BSD on number of reports to IMPA (by type). - Enforcement and results: - Supervisor and sanctioning committee empowered to impose financial sanctions for AML breaches; between 2008 and 2011 five banks fined an aggregate amount of NIS 16.9 million for breaches of Prohibition of Money Laundering Law. - Assessment: Largely compliant - Comments: - New AML/CFT regulation for banks should be adopted and implemented (amendment to AML Order pending). - More cooperation with foreign supervisory authorities recommended to enhance consolidated/group AML/CFT oversight given limited on-site coverage abroad. ### Principle 19 & 20 — Supervisory approach and techniques (risk-based supervision, SREP, on-site/off-site) - Risk-based supervision framework: - BOI implemented risk-based supervision in 2008 with technical assistance; five-stage supervisory cycle produces risk matrix, risk map and supervisory plan (work plan). - Off-site units (five units, 27 analysts) assign analysts to specific banking corporations; on-site organized by risk type (five specialized units, 33 examiners). - SREP uses 19 risk cards covering six principal banking risks, capital management and corporate governance. - ICAAP used as bank self-assessment; annual meetings with board and management to discuss SREP/ICAAP outcomes. - On-site / off-site integration and contact: - Supervisory plan mixes on-site examinations, targeted visits and meetings; continuous contact with bank management and board (Governor/Supervisor quarterly meetings with CEO and Chair). - Assessment: Compliant - Comments: - Program is evolving and staff expansion is needed to fully implement risk-based supervision and to tackle in-depth topics (Basel II implementation, market risk). ### Principle 21 & 22 — Supervisory reporting, accounting and disclosure - Reporting system and standards: - Section 5(a) Banking Ordinance empowers Supervisor to require supervisory reports; 42 supervisory reports in aggregate (19 solo, remainder consolidated). - Reporting platform automated with logic checks; reports prepared under mix of U.S. GAAP and IFRS (core earnings assets under U.S. GAAP historically; non-core assets under IFRS). - Road map issued in June 2009 targeted 2013 for IFRS implementation for core issues, subject to US GAAP–IFRS convergence (date under reconsideration). - External audit and disclosure: - Banks required to have external audit; Directive 302 sets external-audit independence and quality standards. - Reporting-to-Public directives impose detailed Pillar 3-like disclosures, disclosure policy and quarterly/annual requirements. - Supervisor empowered to demand special audits by external auditors and access to working papers. - Assessment: Compliant - Comments: - Authorities should adopt a supervisory strategy with a definitive timeline for IFRS implementation, including progress reporting and a potential dual-accounting period. ### Principle 23 — Corrective and remedial powers - Legal powers and supervisory practice: - Sections 8A–8C of the Banking Ordinance enable prescriptive actions: require corrective measures, increase loan loss reserves, prohibit dividends/bonuses, suspend/remove directors/officers. - Supervisor commonly uses informal measures (meetings, progress reports) that have been effective. - Under Directive 211 and supervisory practice, Supervisor can require capital plans and capital raising, heightened monitoring, and other remedial steps. - Assessment: Supervisory tools and escalation mechanisms available and used in practice. *Source: Internal Monetary and Financial System Assessment and supervisory directives as presented in the provided content.* ### Section 8D of the Banking Ordinance, 1941, prescribes the involvement of BOI in ### _cr1285 - Section 8D of the Banking Ordinance, 1941, prescribes the involvement of BOI in ### Section 8D powers, administration and enforcement - Findings: - Section 8D of the Banking Ordinance, 1941 prescribes BOI involvement in administering a troubled bank, but only if the transaction includes the transfer of all liabilities. - Under Section 8D, the Governor after consultation with the Supervisor of Banks, and with the approval of the Licensing Committee, may appoint: - an administrator to manage the bank; - a special examiner to supervise the bank‘s management; and - a management committee to advise the administrator. - The administrator must manage the bank in accordance with directions from the Governor or the Supervisor of Banks and has the status of an executive officer in the bank. - After consultation with the management committee and with the Governor‘s approval the administrator may consummate the transfer of the assets and liabilities of the bank to another bank. - The special examiner is required to supervise the activities of the board of directors and manage the affairs of the institution. - BOI has not exercised its authority under Section 8D since 2002. - Related enforcement powers: - Section 8C prescribes explicit supervisory actions for formal enforcement. - Section 11A describes circumstances when officers can be terminated. - Section 15(a) (2) describes criminal liability for non-compliance with the ordinance. - Various other sections enumerate types and amounts of fines and penalties. - Inter-agency coordination: - Under the Memorandum of Understanding in effect with the ISA and the Commissioner of the Capital Market, Insurance and Savings at the Ministry of Finance, and based on the Banking Ordinance, 1941 provisions, the Supervisor of Banks can inform these supervisors of formal or informal enforcement actions and coordinate efforts when subsidiaries in the banking group are under their direct supervision. - Assessment: Largely Compliant ### Section 8D/8C/8A limitations and recommended legislative enhancements - Key comments and recommendations: - Authorities recognize that powers under Section 8D are limited and need to be expanded and strengthened. - Consider adding provisions to provide BOI greater flexibility (e.g., broaden administrator powers and add resolution tools). - Expand the list of permitted actions under Section 8C and add an additional provision enabling the Supervisor to apply other supervisory actions commensurate with identified deficiencies. - Enhance Section 8A by clarifying it authorizes actions based on any violation of law or regulations and that BOI may require affirmative remedial actions. - No laws explicitly guard against undue delay by the Supervisor in applying corrective measures; however, practice does not suggest such delays. Note: resolution may be protracted because banks can submit observations and objections under Section 8A (a). - The Supervisor may take remedial actions against affiliated companies supervised by BOI, but there is no explicit power to establish ring-fencing mechanisms as corrective measures for abusive affiliate practices. - Authorities should consider a comprehensive regulation governing relations with affiliates and intercompany transactions (see CP 24). - Beyond the BCP, the law should provide broader going-concern resolution powers by significantly expanding the administrator‘s powers and adding a number of resolution tools, which could include: - legislation to facilitate a rapid recapitalization of the bank by an administrator; - a purchase and assumption scheme; - legislation to require or facilitate a merger where a healthy bank is willing to take over a problem bank; - a scheme of payout priorities in the event of a liquidation; - the establishment of a bridge bank to extend the time to identify a qualified buyer; and, - the establishment of a good bank/bad bank structure operated by a government sponsored asset management company to liquidate bad assets and resolve certain types of liabilities. ### Principle 24 — Consolidated supervision: structure, reporting and practices - Description / findings: - Israel‘s five largest banking institutions are conglomerates combining one or more banking institutions with non-bank financial institutions, some domestic and some in foreign jurisdictions. - Majority of foreign activity is through branches and banking subsidiaries; non-bank financial institution activity is negligible. - Under Section 5 (a) of the Banking Ordinance, 1941, the Supervisor of Banks can require banking corporations to provide information on the banking group, activities of affiliated companies, and ownership structure. - Banking (Licensing) Law, 5741 – 1981 places restrictions on activities and types of companies a banking corporation may control; Supervisor must usually grant approval to establish a subsidiary (locally or abroad) and can condition the subsidiary‘s permitted activities. - Each banking institution must file an annual report with the Supervisor identifying entities where ownership interest is 20 percent or more; the report includes activities, principal financial data, and equity interest. - Reporting to the public directives require disclosure in annual reports of ownership interest in affiliates, description of main companies’ activities, and some discussion of principal affiliates’ financial condition. - Supervisors rely principally on off-site activities and use financial statements, management reports, external/internal audit reports, host country on-site examination reports, and meetings with senior management to understand affiliates. - For each banking group, supervisors have a dedicated consolidated supervision analyst in off-site supervision supported by a team of four analysts. - All material non-bank affiliates are subject to the same risk management processes as commercial banks; in practice non-bank subsidiaries are not material. - Certain non-bank activities (asset management and underwriting) are not subject to the same intensive BOI supervision due to materiality and ISA supervision; BOI relies on U.S. supervisory authorities for U.S. activities. - Directives require banking corporations to manage and account for risk exposures on a consolidated basis (Directive 339) and require internal audit verification of risk management adequacy at all group entities. - Supervisor of Banks may revoke permits to operate a foreign branch or subsidiary under Sections 30 (a) and 33 (a) of the Banking (Licensing) Law 5741 -1981 (Section 30 (a) for inadequate oversight by the parent; Section 33 (a) for insufficient information to supervise). - Ultimate owners are subject to an intensive fit and proper test. - Assessment: Largely Compliant - Comments and supervisory gaps: - Important gap: supervision of asset management and underwriting activities in non-bank financial subsidiaries supervised by the ISA but owned by banking corporations. - BOI and ISA must reach agreement on supervisory approach and the nature/type of supervisory information to be exchanged; without this BOI cannot take a full consolidated view of banking corporations. - Broker–dealer and trustee operations embedded in bank operations have received little supervisory attention; supervisors should gain a thorough understanding as they can be sources of large losses. - With Basel III liquidity scrutiny, supervision of liquidity must evolve to a more global approach for each banking corporation. - Operational enhancements implemented: - Supervisor required each group to establish a risk management unit, usually led by a Chief Risk Officer, to evaluate group risk on a consolidated basis and report quarterly to the board and to the Supervisor of Banks. - Risk Officer must report directly to the board and prepare a quarterly report on group risk management practices. ### Principle 25 — Home-host relationships: arrangements and practices - Description / findings: - The five large Israeli banking corporations have foreign networks, notably in the United States, the United Kingdom and Switzerland; relationships are governed by formal or informal arrangements facilitating necessary contact. - Five foreign banks operate in Israel; aggregate operations are immaterial to the Israeli system and parent institutions. - Formal written arrangements: Memorandum of Understanding with the Federal Reserve and the FDIC (United States); exchange of letters with the United Kingdom supervisor for liquidity positions and facilities. - Informal high-level arrangements with FINMA (Switzerland) are conducted as frequently as necessary. - Because foreign operations hosted by BOI are relatively immaterial, supervisory information is filed with home supervisors on an ad hoc basis; there is no routine forwarding of supervisory information such as examination reports. - BOI would provide information concerning material breaches, adverse developments, or poor risk management assessments; the home supervisor would be notified prior to formal enforcement action under Section 8C where practicable. - As home supervisor, BOI receives examination reports and other information from U.S., U.K., and Swiss regulators for material operations. - Israeli law states foreign banks operating in Israel are subject to the same prudential supervision as local banks; however, due to relative immateriality overall supervision is low (e.g., less frequent on-site examinations). - Commencing in March 2012, local branches of foreign banks will be required to post their financial statements on the BOI website similarly to Israeli banks. - Prior to licensing a foreign bank to operate in Israel, BOI requires the home country supervisor to affirm no objection to the parent establishing operations in Israel. - BOI uses OECD, IMF, World Bank and other sources to assess quality of home country supervision. - Home country supervisors are permitted to conduct on-site examinations in Israel, though none have occurred to date. - Israel does not license or provide an operating permit for shell bank companies or booking offices. - Assessment: Compliant - Comments and recommended actions: - Consider expanding types of information exchanged under the formal U.K. agreement; EU restrictions may inhibit full exchanges without a formal MOU. - BOI should consider more active engagement in supervisory colleges for foreign banks it hosts and consider setting up colleges for Israeli banks with relatively large foreign operations. - For a foreign bank operating a wholly-owned banking subsidiary in Israel that is under a resolution strategy in its home country, BOI should consider contacting the home supervisor about its strategy for overseas operations (especially Israeli operations) and attempt to coordinate supervisory efforts during resolution; consider an on-site BOI examiner visit to assess local operations. *Italic: Content extracted from the IMF supervisory assessment excerpt provided.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1285.pdf_