Israel’s fintech (financial tech) ecosystem has been readying for potentially “dramatic” banking reforms that will pave the way for more competitive rates and new financial services for customers.
The proposed reforms are part of the Economic Arrangements Bill that accompanies the state budget, which passed its first reading on Thursday evening in a major milestone for the coalition of Prime Minister Naftali Bennett. It was the first time budget legislation was approved by parliament since 2018. Recurrent government collapses and repeated elections since the end of that year have left Israel without a budget for over two years.
The Knesset first passed the budget framework bill, then the accompanying Arrangements Bill — which determines how funds will be implemented — and finally the 2021 and 2022 budget bills themselves. All bills will now head to the Knesset Finance Committee and must pass their second and third readings in the plenum to become law.
Among the many proposals in the Arrangements Bill are open banking reforms (page 157 of a 215-page document in Hebrew on the Finance Ministry’s website) that are meant to inject competition into Israel’s financial sector by allowing non-banks to offer services at competitive rates, thus reducing costs for consumers, and by easing tight regulations on financial institutions.
Israel’s banking system is highly concentrated with two main banks, Leumi and Hapoalim, dominating the industry. These two have a combined share of nearly 60% of the market in terms of total assets in 2020 ($150.5 billion for Leumi and $150.2 billion for Hapoalim) and close to 70% of the total consumer credit of all of Israel’s five main banks (the other three being Israel Discount Bank, Bank Mizrahi-Tefahot and the First International Bank of Israel).
The proposals, circulating since 2016, are modeled after the Second Payment Services Directive (PSD2) in Europe which revises digital payments systems to promote competition and innovation by opening up the market to non-bank institutions, while boosting consumer protection, and allowing them to share information about how they operate their bank accounts with organizations that can offer a range of financial services.
The Ministerial Committee on Legislation approved the pair of proposals put forth by the Finance Ministry in July. The first calls for establishing “a unique regulatory sandbox” for fintech companies in which regulators will monitor their activities while hedging their risks, and allowing them to introduce products into the Israeli market to benefit consumers. The regulatory system proposal was coordinated by an inter-ministerial team led by the Justice and Finance ministries and included representatives from the Securities Authority, the Bank of Israel (BOI), the Capital Market Authority, the Anti-Money Laundering and Terrorist Financing Authority, and the Tax Authority.
The second proposal — the one watched closely by Israeli fintech startups and the legacy banks — requires banks and financial entities to transfer information about their customers, with the customers’ approval, to technology firms that can provide these customers with information about the financial services they consume, how much exactly they are paying for them and how much they could save if they switch to another financial services provider.
This will help strengthen customers’ position vis-à-vis financial entities, promote the entry of advanced technological financial entities into the market, increase competition in the banking system and reduce household and small business expenses in the banking system, according to the Finance Ministry.
“These measures will reduce regulation of non-banking entities within the financial system and promote innovation and effective competition. We will continue to develop measures that will lead to improved consumer service, cost reduction, and promotion of competition in Israel,” said Finance Minister Avigdor Liberman at the time.
There is no question that the banking sector in Israel is “centralized and very conservative,” and the open banking reforms could usher in “dramatic” changes, said Shmuel Ben-Tovim, an Israeli economist and president of the Fintech Community of Israel, an organization that promotes financial technologies and welcomes members from the whole industry including startups, regulators, and institutions.
“For each service that we get from the bank, fintech companies will be able to compete — loans, credit, mortgages, and so on [once these reforms go through],” he said.
The banks have been objecting (Hebrew) to the reforms, arguing that non-bank entities should pay them to share customer data and that the release of such information could pose risk as privacy violations, data theft, and cyber attacks. They have also pushed to limit the number of permitted requests for data sharing per customer.
“The banks have ruled the market for so many years, they naturally don’t want to lose market share and business,” Ben-Tovim told The Times of Israel this week. “They are playing both sides, adopting technologies if it helps them become more efficient and cuts their costs, but they don’t want their core business touched.”
The open banking reforms essentially posit that the data is the property of the consumer, not the bank, said Israeli fintech entrepreneur Yuval Samet, co-founder and CEO of RiseUp, a financial planning solution that helps people manage their cash flow and make more informed financial decisions.
Samet compared the banks’ approach to a scenario in which cellphone companies would let customers switch providers but insist on keeping the customers’ list of contacts.
“The banks (not all of them, yes) don’t really see the benefits of open banking. They don’t want things to change. They need incentives,” said Samet, who previously served as the chief technology officer (CTO) of Klarna, a Swedish fintech company that provides online financial services.
But things are moving in a positive direction, he told The Times of Israel. Over the past two years, the banks have been building the infrastructure to be able to share data with authorized third-party entities, using application programming interfaces (APIs), according to BOI guidelines on the “Implementation of Open Banking” published in 2019.
According to the guidelines, third-party access to customer accounts, with their approval, will occur in stages. In the first stage, which went into effect in April 2021, access can be shared on account balances and transactions. In the second stage, which is ongoing, access is provided to information related to card transactions, and approval can be given to initiate payments in the customer’s bank account. The third stage will include access to information on the customer’s credit and loans, deposits and savings, and securities portfolio. This phase will take effect in 2022, according to a timeframe (Hebrew) published by the BOI.
Providing value to customers
Fintech startups like RiseUp have so far been able to operate through what Samet called “screen scraping,” a process in which screen visual data is collected from one application so that another application can display it. Customers provide their usernames and passwords so that third-party entities can analyze the information and offer personalized recommendations and services.
RiseUp, founded in 2017, uses the data to provide customers with automated information on cash flow, answer their financial questions, and guide them on decisions, all on the messaging platform WhatsApp.
“In Israel, some 50 percent of households live in overdraft, so there is an illusion of money. People don’t know how much money they have, what they are spending on. They can see their accounts and that’s it. There’s a lack of transparency as well as financial products that benefit customers,” Samet said. “We want to give people the power to live well with the money they have, and help them make better decisions with that money.”
“We invest a lot in privacy and security but there is a perception of fear, fueled by the banks. The [screen scraping] technology is very robust and customer trust is very important to us,” said Samet, noting that if the open banking reforms go through in their entirety, access will be much more straightforward — and regulated.
He indicated that RiseUp has thousands of paying customers and has built an online community of financially conscious followers.
“There are few reforms that actually benefit all sides and provide value,” but the open banking reforms fall into this category, he argued. “It will create a tailwind for us.”
Reforms take time
Ben-Tovim said that the regulatory part of the reforms is equally important. “We have a very cumbersome regulation system influenced by incumbents who also have clout with the government.”
Regulators can limit innovations in whole sectors even when reforms are initiated like in the insurance market, he said. “Take Lemonade, for example — it is doing wonders in the US market. But we can’t use it in Israel. Why? Because of the regulators,” said Ben-Tovim. Lemonade is an Israeli insurance tech company, publicly traded in the US, that offers homeowners’ and renters’ insurance through an app.
“Reforms can take a long time,” he noted.
In the next weeks, Ben-Tovim’s Fintech Community of Israel will be part of the steering committee that is to set up the regulatory framework for fintech companies, where regulators are also represented. “We’ll be able to speak and deal with them directly,” he said.
The role of the first digital bank
Another player set to play a key role in the financial sector in the coming months is the First Digital Bank (FDB), Israel’s first new bank in more than 40 years. It was first approved in 2019 by the BOI and started a pilot run in March, in hopes to open up services to the wider public toward the end of the year.
The bank is owned by Professor Amnon Shashua, the co-founder of Mobileye, a maker of self-driving technologies that was bought by Intel Corp. in 2017 for $15.3 billion, and of OrCam, a maker of devices to assist the visually impaired. Shashua invested $60 million of his own capital into the initiative.
The branchless bank is set to operate by integrating human bankers — who provide around-the-clock customer service through online chat and a call center — with advanced artificial intelligence-based technology that aims to create customized service experiences for customers. It will offer all existing banking services, including personal accounts, joint accounts, loans, deposits, credit cards, stocks, guarantees, standing orders, and foreign currencies. Mortgages will be added to the list of offerings in the future.
The process of opening an account will be completely online, will not require the services of a human representative, and will come with an immediate credit limit approval process, the FDB has indicated.
Mor Grisariu, head of strategy at FDB, told The Times of Israel that the open baking reforms would be a welcome development in the sector, “giving power to the customer so they can look for better services and prices.”
Grisariu previously worked as a consultant for several banks in Europe and watched closely as open banking reforms passed there. “The banks got a huge shock because it deals with their core business,” she said.
In Israel, banks are similarly putting up obstacles wherever they can, she said, and even trying to scrap the open banking reforms from the Arrangements Bill.
But arguments about privacy are moot, she said. “There is no danger because everything is regulated. No one wants to jeopardize data. The Bank of Israel has closely studied regulations elsewhere, specifically the UK which has a similar system to ours. Europe introduced open banking after the General Data Protection Regulation (GDPR), which puts a premium on privacy, went into effect,” argued Grisariu.
Right now, “when fintechs ask for account data, people hesitate; open banking aims to solve precisely this issue.”
“Introducing more competition into this market is an amazing step forward,” she added.
The FDB, which called itself a “technology company with a banking license,” will also provide financial direction, advise people proactively on how to save and how to assess different loans, and offer competitive rates, said Raheli Bindman, communications manager at FDB.
“Traditional banks don’t help people with these things, they send them to figure it out on their own,” she said. “People don’t believe the banks because the system is designed to benefit them.”
The issue is so acute that just “2.5% of people switch banks every year, because there is not much difference between them,” said Bindman. “Dealing with finances is complicated and this [lack of competition] makes people more aloof and they stay where they are even if they are unhappy.”
FDB aims to be profitable, of course, but there is a focus on transparency and simplicity, she added.
The bank is also looking to cater more closely to Israel’s non-Hebrew-speaking communities with announced plans to offer services in English and “remove barriers” in order to make “banking services accessible to a significant portion of the public,” Arik Chicotay, VP of Banking at FDB, said in a statement in August.
Crucially, FDB will also allow Israeli citizens who also hold an additional tax residency or American citizenship to open a bank account, whether individual or joint, without having to make their way in to bank branches — the current practice today.
“No one should have to spend half a workday opening a bank account in 2021,” said Chicotay. “As a technology-based bank, we created an infrastructure that will make it possible for any citizen to open a bank account easily and receive customer service, at any time, from anywhere.”
Bindman said there is a huge demand for this service, not just among native English speakers, but also among Spanish and French speakers and anyone whose mother tongue is not Hebrew.
Israel’s fintech ecosystem
Israel’s financial tech sector has been booming over the past several years. Investments in the industry surged to a record high in the first half of 2021, with fintech firms raising a record $2.3 billion in venture capital in the first half of the year, according to a July report by Start-Up Nation Central, a nonprofit that tracks Israel’s tech industry.
The sum represented a leap of 260 percent over fintech investments in the first half of last year, and was 28% higher than the $1.8 billion invested in the sector in all of 2020.
Firms providing payment solutions accounted for the plurality of investments in the first half of the year, with 35%, followed by anti-fraud and insurtech companies. The three subsectors account for 70% of fintech funding over the past two years.
There are currently over 500 companies operating in the fintech space, according to the Start-up Nation Finder database.