High market concentration increases risk of crisis

Bank of Israel report outlines the lessons to be drawn from the crisis and how they can be applied to monetary, fiscal and economic policy.

By NADAV SHEMER
October 6, 2011 00:06
2 minute read.
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The control a small number of companies hold over a large portion of the economy is unhealthy, and the collapse of one of those companies would rock the Israeli financial system, the Bank of Israel said in a report released Wednesday on lessons from the 2008 global financial crisis.

The lengthy report, co-edited by Bank of Israel Governor Stanley Fischer, Deputy Governor Karnit Flug and former deputy governor Zvi Eckstein, outlines the lessons to be drawn from the crisis and how they can be applied to monetary, fiscal and economic policy.

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“The Israeli economy is stricken by the high concentration of the business sector, both in the non-financial and financial sectors, and by the control by only a few companies of a sizable portion of the sector’s activities,” the report said, referring to the fact that 20 companies control some 25 percent of firms listed on the Tel Aviv Stock Exchange.

“This high concentration raises the risk to the financial system, in that these controlling companies pose the biggest risk to the banks, and the collapse of one of the companies is likely to rock the entire banking system,” the report said.

Two preventative measures were suggested by the central bank to protect against such a crisis: restrict the exposure of banking corporations to single or group borrowers; and increase supervision or regulation of large companies.

Looking at the crisis in retrospect, the report concluded that Israel had weathered the storm and that its financial institutions, including the banks, “showed resilience relative to the intensity of the crisis.”

“However,” it said, “there were real fears at the time concerning the stability of some financial institutions and the continued proper functioning of the financial system. The main effect of the crisis was in the non-bank credit market, which was essentially paralyzed and became the focus of risk for Israel’s financial system during the crisis.”

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The report divided the lessons from the crisis into two main categories: one for reducing the risk of a crisis developing and for its early detection; and the other for how to act during the crisis and in its aftermath.

On reducing risks, it said: “Emphasis is being placed on the need for macroprudential policy for maintaining financial stability and reducing the risk of a crisis… In particular, there is increasing awareness of the importance of supervision of non-bank entities, instruments and markets.”

Regarding conduct during the crisis, it said: “The emphasis here is on the need for quick and determined action to stabilize systemically important financial institutions, including non-bank entities, and to inject liquidity into the financial system and relevant institutions.

This is in addition to the need for a quick and large-scale response by monetary policy, which includes quantitative tools.”

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