Israeli Bank Shares Arrangement (Hesder Hamenayot Habankayot)

The Bank Shares Arrangement was negotiated through the mediation of Member of the Knesset (MK) Avraham Shapira during an 18-day stock market closure that began on October 6, 1983 (Sargent and Zeira 2011). During the 18-day closure, the government devalued the shekel by 17% and expressed intentions to take a majority stake of the four banks and one related bank holding company that were accused of stock price manipulation (Blass and Grossman 1998). The stocks of these banks were delisted (OECD 2011).

The Bank Shares Arrangement was executed by an independent government corporation, M.I. Holdings, and specifically M.I. Holdings’ Board of Assets (Prager 1996; State Comptroller of Israel 1993). Subsidiaries within each of the nationalized banks, known as “trust companies” or “safe companies,” were created to purchase eligible shares from the public (Prager 1996). These trust companies were funded by loans from M.I. Holdings, collateralized by the bank shares that the trust companies bought (Blass and Grossman 1998; Prager 1996). By 1993, M.I. Holdings had taken over all of the shares from the trust companies (Prager 1996).

M.I. Holdings Ltd. was created in 1969 for the purpose of managing “assets that were granted to the state . . . and that the state intends to” privatize (State Comptroller of Israel 1993). In November 1988, a former deputy finance minister became chairman of M.I. Holdings’ Board of Assets and the executing of the Bank Shares Arrangement became the goal of the board (State Comptroller of Israel 1993). Initially, in November 1988, the board included two public representatives and four senior Treasury officials; in January 1989, three other public representatives were added to the board, bringing the total number of members to nine with five members being public representatives (State Comptroller of Israel 1993).

Oversight included two commissions. First, the Commission of Inquiry into the Regulation (manipulation) of Bank Shares, headed by retired Supreme Court Justice Moshe Bejski, released a report in 1986 detailing the bank share manipulation and the various legal violations that the banks committed (Blass and Grossman 1996). Second, the Ministry of Justice formed a commission headed by MK Meir Gabai to propose legislative and regulatory adjustments for the capital market (Ofer 2004).

The main component of the Bank Shares Arrangement was the purchase of the publicly held shares of four of the five largest banks: Bank Leumi, Bank Ha’Poalim, Israel Discount Bank (IDB), and Mizrahi Tefahot Bank (Sargent and Zeira 2011), plus two banks affiliated with the four and one of their holding companies. (One of the five largest banks, First International Bank of Israel [FIBI], did not engage in share manipulation and so avoided nationalization [OECD 2011].) The shares of the seven companies were delisted from the Tel Aviv Stock Exchange (TASE) from 1983 until 1993, when the privatization began (OECD 2011).

The government purchased the shares in waves: approximately NIS 1 billion in October 1985 from pensioners (senior citizens), NIS 5.6 billion in October 1988, NIS 0.85 billion in October 1989, and NIS 3.4 billion in October 1991 (Sargent and Zeira 2011) (see Figure 2). In 1983 US dollars, this represented an increased government obligation of $5.44 billion, or 22.6% of 1983 Israeli GDP (Sargent and Zeira 2011). The total value of the shares of the banks included in the Bank Shares Arrangement totaled $6.9 billion (Sargent and Zeira 2011).^FThere are differing estimates of the total cost of the program. Prager 1996 estimates the government purchased $9.2 billion in noncontrolling bank shares from the public, held in the trust companies until 1993 (Prager 1996).

The government gained majority stakes in four of the five largest banks: Bank Ha’Poalim, Bank Leumi, Israel Discount Bank, and Mizrahi Tefahot Bank (OECD 2011).

At the beginning of the Arrangement, the government offered investors to exchange their shares for “locked savings schemes” of two, four, or six years.

When investors were ready to redeem their shares or locked savings schemes, the banks purchased them through subsidiaries called trust companies or safe companies. The government lent the trust companies the funds for those purchases, using the shares themselves as collateral.

The government funded much of the purchases by offering new savings schemes to shareholders. For example, in October 1985, NIS 984 million of “arrangement” bank shares that investors had converted into locked savings schemes were redeemed by senior citizens. The investors reinvested 42% of this amount in special, nontradable government bonds issued for this purpose (BOI 1985).

The companies that were nationalized under the Bank Shares Arrangement were the banks that participated in share price manipulation in the lead-up to the banking crisis of 1983 (Blass and Grossman 1998). The nationalized banking companies were: Bank Ha’Poalim, Bank Leumi, Discount Bank, Bank Mizrachi, Union Bank (Bank Igud, a subsidiary of Bank Leumi), General Bank (Bank Clali, a subsidiary of IDB), and IDB Holding Company (the holding company of Discount Bank) (Blass and Grossman 1996; State Comptroller of Israel 1993). A later study found strong evidence of share price manipulation by looking at the correlation between bank share returns and market returns; the “beta” risk premium for bank shares approached zero from 1977 to 1983 (Blass and Grossman 1998) (see Figure 3).

Figure 3: Evidence of Share Price Manipulation

Source: Blass and Grossman 1998.

FIBI was the only large bank—5.4% of total banking sector assets in 1992—to not participate in share manipulation and the largest bank to avoid nationalization (Prager 1996). The nationalized banks represented more than 90% of total banking sector assets in 1983 (Prager 1996) (see Figure 4). Three of the largest banks were associated with nongovernmental institutions: Bank Leumi with the World Zionist Organization, which formed Israel’s first Labor government; Bank Ha’Poalim with the financial subsidiary Hevrat Ha’Ovdim of Histadrut, the national labor federation; and Mizrahi Tefahot Bank with the National Religious Party (Ofer 2004).

Figure 4: Concentration in Banking Sector, 1964–1992

Source: Prager 1996.

Only noncontrolling shareholders received the government bonds for their shares, and all bank executives, controlling shareholders, and stakeholders were disqualified from the arrangement (OECD 2011; Sargent and Zeira 2011; State Comptroller of Israel 1993). The government acquired shares with and without voting rights, though the majority of shares that the government purchased under the arrangement were nonvoting, which hurt the potential return on the government’s eventual exit (State Comptroller of Israel 1993). The government did not exercise its voting rights, and the management of the banks stayed in the same hands as precrisis (State Comptroller of Israel 1993) (see Figure 5). Upon selling the shares, the government equalized voting rights by imposing a “one share, one vote” rule (Prager 1996).

Figure 5: Shares Redeemed as of October 13, 1991

Source: State Comptroller of Israel 1993.

There was no debt restructuring plan as the Israeli banks were not insolvent; their balance sheets were healthy (Prager 1996).

The Bank of Israel and the Ministry of Finance left the management of the banks in the same hands as precrisis, hoping to maintain the independence of the nationalized banks from political interference (State Comptroller of Israel 1993). In December 1991, the Ministry of Finance asserted: “Exercising control of banks would have resulted in deep and unwanted involvement, both in the management of banks and in all areas and industries in which banks have subsidiaries or related companies” (State Comptroller of Israel 1993).

However, some actors that directly contributed to the crisis were found guilty of violating securities and corporate ordinances (Fisher 1994). After the Bejski investigation into the bank share manipulation, a court case, State of Israel vs. Bank Leumi LeIsrael, Ltd. et al., removed executives at the banks that engaged in share price manipulation and banned them from the Israeli banking system (Fisher 1994). The court case was opened in 1990 but settled in 1994 (Fisher 1994).

Shareholders were given two options. First, they could keep their shares as tradable with an option to sell them to the government-funded trust companies in October 1988 for bonds valued at their October 6, 1983, value indexed to the dollar, with an interest of a cumulative rate of 4% over the next five years (Sargent and Zeira 2011). Second, shareholders could keep their shares as nontradable with an option to sell them to the government in 1987 for bonds valued at their October 6, 1983, value indexed to the dollar with an interest rate of a cumulative 12% over the next four years (Sargent and Zeira 2011). Most of the public chose to keep their shares tradable for five years, indicating a public distrust of the government’s ability to bail out the shares (Sargent and Zeira 2011). Face value of the bonds ranged between 85% and 117% of the pre-closure dollar value of the shares (Blass and Grossman 2001).

Shares declined in value 30% overnight when the Bank Shares Arrangement went into force (BOI 1984). Share value declined an additional 16% in the first few days after the TASE reopened (BOI 1984). Blass and Grossman suggest that of the gross damages from the crisis totaling $10 billion, one-third represented a decline in shareholder wealth, and the remainder constituted a hit to the government and efficiency loss (Blass and Grossman 2001).

Only noncontrolling shareholders received the government bonds for their shares, and all bank executives, controlling shareholders, and stakeholders were disqualified from the arrangement (OECD 2011; Sargent and Zeira 2011; State Comptroller of Israel 1993). Pensioners were able to sell their shares after only two years (Sargent and Zeira 2011).

An exit strategy was not clearly stated in 1983 when the Bank Shares Arrangement was announced. However, by 1991, the Knesset had begun discussing the sale of government-owned shares (State Comptroller of Israel 1993).

In preparing to sell the government-owned shares, the Ministry of Finance and Treasury were concerned to not set conditions “that would make it difficult for other potential buyers to compete for the acquisition of a controlling core in the bank,” thereby prioritizing the precrisis shareholders (State Comptroller of Israel 1993). They were also concerned about the distribution of voting rights: the majority of shares that the government purchased under the arrangement were nonvoting, which hurt the potential return on the government’s eventual exit (State Comptroller of Israel 1993). The government did eventually sell control of the banks, at which point voting rights of the government-owned shares turned on (State Comptroller of Israel 1993).

Between 1988 and 1990, the minister of finance and the Bank of Israel engaged in talks with the controlling shareholders of the nationalized banks to “equalize voting rights” by “eliminating the inferiority of the rights of the large majority of the shares which the Government [purchased] . . . as opposed to those of the special shares of the controlling shareholders” (State Comptroller of Israel 1993). Initially, the government attempted to Between 1988 and 1990, the minister of finance and the Bank of Israel engaged in talks with the controlling shareholders of the nationalized banks to “equalize voting rights” by “eliminating the inferiority of the rights of the large majority of the shares which the Government [purchased] . . . as opposed to those of the special shares of the controlling shareholders” (State Comptroller of Israel 1993). Initially, the government attempted to enter into voluntary agreements with the controlling shareholders to equalize voting rights (State Comptroller of Israel 1993). By January 1990, the government placed a bill on the Knesset table to equalize voting rights (State Comptroller of Israel 1993). The Bank of Israel continued to favor a voluntary arrangement and offered an incentive: controlling shareholders would be given 2%–3% of the shares owned by the government in return for voting right equalization (State Comptroller of Israel 1993).

Eventually, voting rights were equalized: Discount Bank and Mizrahi Tefahot Bank in May and September 1990, respectively; and Bank Ha’Poalim, Bank Leumi, and Bank Igud in the last quarter of 1991 (State Comptroller of Israel 1993). Equalization took the form of “one share, one vote” (Prager 1996). In August 1992, the Board of Assets sold IDB shares back to the precrisis controlling entity—the Recanati family (Gurkov 2007; State Comptroller of Israel 1993).^FThe sale back to the Recanati family was conditioned on the separation of IDB Holdings from Israel Discount Bank, given the criminal indictment of Rafael Recanati, a principal of IDB Holdings (Prager 1996).

In 1993, the Bank Shares Arrangement Temporary Provisions Law established a framework for privatizing the banks: the government appointed a five-member Public Committee, which in turn appointed five-member Committee for Bank Stocks for each nationalized bank to facilitate the sale of government shares (Prager 1996). This structure was intended to keep the sale of bank shares independent and nonpolitical (Prager 1996).

The first public offering was made on the TASE in May 1993, when 21% of the shares of Bank Ha’Poalim were sold, at a total cost of $307.4 million (Gurkov 2007). This first offering was oversubscribed at the maximum price, indicating the recovery of Israel’s capital market from the 1983 crisis (Gurkov 2007). A few days later, the government executed the sale of 60% of the shares of Bank Igud (totaling $85.5 million) to four domestic institutional investors (Gurkov 2007). As of 2009, the government the government had privatized all banks excluding Bank Leumi (OECD 2011) (see Figure 6).

Figure 6: Privatization of Banks as of 2009

Source: OECD 2011.

The definition for “stakeholders” was established based on the 1968 Israeli Securities Law but occasionally changed to accommodate economic entities that “held bank shares as part of their policies or as a long-term investment, and who were not” involved in share price manipulation (State Comptroller of Israel 1993).

Over the course of the Bank Shares Arrangement, the government changed the definition of “stakeholder” to allow further redemption of shares by groups previously excluded (State Comptroller of Israel 1993). For example, Discount Bank shares totaling $52.3 million, which before the crisis Discount Bank intended to issue to other banks, were declared eligible for redemption under the arrangement as public shares (State Comptroller of Israel 1993). In July 1987, the Bank of Israel agreed on a recommendation of the minister of finance that Hevrat Ha’Ovdim (The Worker’s Company) be allowed to redeem shares of Bank Ha’Poalim as nostro shares, for an amount not exceeding $15 million (State Comptroller of Israel 1993).