The Israeli government froze a bill Wednesday to give itself the authority to set interest rates, following a warning from the central bank’s governor that the bill was a “serious blow” to the bank’s independence and to “its ability to conduct monetary policy.”
The bill would have required commercial banks to pay interest on checking accounts at rates set by the central bank governor, but only with the approval of Bezalel Smotrich, Israel’s finance minister.
The protest letter by Yaron Amir, governor of the Bank of Israel (BOI), was made public Tuesday, just 24 hours before the government planned to bring the bill to the Knesset, Israel’s parliament, for a preliminary vote.
Israeli media outlets reported that Israeli Prime Minister Benjamin Netanyahu ordered his coalition to shelve the bill for now.
The bill had originally sought to pacify public criticism of the government for failing to combat Israel’s high cost of living. In May, annualized inflation reached 4.6%, and the country’s central bank responded by raising its benchmark rate to 4.75%, a dramatic increase over a record low of 0.1% in April 2022.
Banks are now reaping enormous profits, critics contend, but are not passing those benefits along to depositors.
Last week, Yaron Amir, the BOI governor, met with the heads of private banks in the country urging them to consider passing some of their gains from higher interest rates to depositors.
The rapid interest rate rise, coupled with inflation, has become a major headache for the government but also for Israelis, many of whom have hefty variable-rate mortgages.
The government wants to offer the public some relief, but the central bank is concerned that government control over interest rates might jeopardize the autonomy central to the bank’s role.
“There is always an inherent tension between the central bank and the government,” said Professor Benjamin Bental, chair of economics at the Taub Center for Social Policy Studies.
“The bank is mandated to protect the stability of prices and in times like today, the bank raises interest and this makes it difficult for the government to raise debt, burdening the budget and limiting the government’s freedom of movement,” Bental added.
Since his government came to power in January, Prime Minister Benjamin Netanyahu has defended the central bank against a series of attacks by his own cabinet ministers. Earlier this year, Israeli Foreign Minister Eli Cohen criticized the bank for raising interest rates. Netanyahu responded swiftly, promising the BOI would remain independent.
In this week’s letter, BOI Governor Amir asked Netanyahu to intervene once again, and he appears to have done just that.
The current coalition is Israel’s most right-wing ever, but its attempt to legislate sweeping institutional changes has stalled amidst widespread public protest. The furor has plunged the country into crisis and deepened its political and social fissures.
Critics of the coalition’s proposed judicial reforms refer to them as an attempted coup, saying they will weaken Israeli democracy by enhancing the government’s control over the Supreme Court, among other things.
The coalition, for its part, says the reforms are needed to reign in an activist judiciary that increasingly limits governments’ ability to implement their chosen policies.
Almost every move the coalition makes is met with opposition from within the Knesset and substantial portions of the public, as well as dire warnings from senior financial and business leaders about negative impacts to Israel’s economy.
The instability has taken an economic toll. The Israeli shekel weakened against the dollar this year, and recent reports suggest a sharp drop in foreign investments in Israeli tech firms, the economy’s main engine of growth.
“This could be another brick in the whole wall of the reform, the possible harming of a very important and strong institution that maintains Israel’s international standing and works for citizens to fight inflation,” Bental said. “Any threat to its independence is visible and sends a severe signal that adds to existing uncertainty.”
According to Bental, any such legislation would contradict the existing BOI law that upholds its independence and is a “real threat.”
Although the government appears to have shelved its plan for now to curtail the central bank’s autonomy, there is talk of political interventions that did not exist previously.
“I don’t think there is more tension because of the current government,” said Dr. Amatzia Samkai, an economist, and chief executive of TCG—Tel Aviv Consulting Group. “After years of being used to very low interest rates, suddenly the market is suffering from high inflation and high interest rates.”
“This pressure from citizens and businesses is directed at politicians because they are [politically] responsible.” But since interest rates are in fact set by the central bank, the only thing politicians can do is apply “pressure on the governor.” This pressure, in turn, creates “tension which is not healthy for the market,” Samkai added.
After Amir’s letter to Netanyahu was published Tuesday, the Tel Aviv Stock Exchange’s TA-125 index and TA-35 blue-chip index dropped by over 1%. Israel’s currency depreciated similarly, driving home the market’s vulnerability to political turmoil.
Critics see the proposed interest rate legislation as another government attempt to increase its power to intervene in institutions that are supposed to remain independent. Smotrich and the coalition may see the central bank as another hurdle preventing them from governing as they see fit.
Smotrich met with Amir and other senior officials on Wednesday to discuss several proposals to enhance the competitiveness of the banking sector. Initial discussions were also held regarding a proposal the Finance Ministry is considering to tax excessive banking profits.
Although the BOI governor appears to have successfully fended off this latest attempt to intervene in the bank’s business, he does acknowledge the need for changes. Specifically, he proposes offering more credit to private households and to small and medium-sized businesses.
“The way to do that is by removing barriers that prevent competition between existing players and those preventing the entrance of new players into the market,” he wrote to Netanyahu.
There are only ten local banks and four foreign banks with permission to operate in Israel, meaning that the country’s credit sector is not highly competitive.
Samkai, the economic consultant, agrees. The government should “increase competition between banks,” he argues, and the best way to do this is by making it easier to open new Israeli banks while permitting more outside competition.
According to Samkai, there is an unsolvable problem with the independence of the BOI.
“There is a gap between authority and responsibility,” he explained. “The independence must be retained, but government review on the bank’s policy is legitimate and even part of its job as the one responsible for the Israeli economy.”
Bental argues that the government’s shelved plan to force the bank to offer interest to checking account holders would not solve the problem. When banks are forced to spend more money, he says, “they will surely find creative ways to compensate themselves.”
The government, however, is committed to a populist policy that appears to reward ordinary people and attack institutions and economic elites. “There is no other explanation for this,” he says. The shelved legislation “must be seen as another example of the government’s rampant” attempts to undermine the country’s institutions.
It is unclear if or when the bill will be voted upon after this week’s deferral.