Financial inclusion: Mainstreaming capital access for growth
Jan 14, 2014
Publisher: Milken Institute

The price of inequality in Israel is a barrier to productivity and growth for the larger economy. Israel's future growth will continue to be inadequate and shared unequally without broader access to financial services to increase savings, reduce income and asset poverty, and enable social cohesion required for economic security. As recently appointed Bank of Israel Governor, Karnit Flug noted in her inauguration speech, ". . .it is very important that the fruits of growth are divided more equally by all parts of the population, so that they will support the reduction of poverty and of inequality in income distribution. We want inclusive growth, which supports the cohesion between various population groups, and within the groups themselves. Social cohesion is a prerequisite for national strength."

Just as increasing labor force participation among Ultra-orthodox and Arabs in Israel could help increase our flagging GDP growth rate by 1-2% and lower income inequality; expanding capital access to the underserved segments of the population would enable them to bridge growing gaps in asset poverty as well by enabling access to education, training, housing, and starting new businesses to support themselves.

The mismatch in supply and demand for credit is a distinct market failure for capital access that is restraining aggregate demand and slowing growth in the domestic economy. Small and medium-sized businesses represent 96% of all businesses, employ 60% of the workforce, but receive only 20% of bank financing. As the report on banking competition by the Bank of Israel noted in its report released this March, the supply of credit to households and small businesses needs to be expanded. While large, concentrated corporate borrowers benefit from a broad supply of credit from both banks and institutions, the retail sectors is dependent almost entirely on the banking system. Even though the total credit rose in Israel (as seen in the Figure below), the portion provided by banks has declined significantly worsening credit access conditions for small and microbusinesses, the household sector, and community development.

Recent research indicates that significant segments of Israel's population are not served by formal financial institutions. Over the last seven years, over 22% of Israeli households are living in poverty, making it the most impoverished country among the world's thirty-four economically developed countries. Small and micro business represents 96% of all business in Israel, employ 60% of the workforce but receive only 20% of bank financing. According to the World Bank, over 12% of the population in the bottom 40% of the income distribution are unbanked and only 25% of that population has savings accounts. Only 17% of that population has access to consumer credit and only 25% have savings accounts.

Furthermore, PlaNet Finance documented the characteristics of micro-enterprise businesses in Israel. They found that the vast majority (80%) were self-financed, and that only 2% have tangible real property to utilized as collateral, creating a limited capacity for bank lending and indicating widespread asset poverty undocumented by the Central Bureau of Statistics. Chagit Rubenstein, microfinance program manager, at the Koret Israel Economic Development Fund (KIEDF) has documented that the supply of micro-enterprise loan facilities for Isarel's distressed populations (low income, women, Arabs, Ethiopians, and Ultra-Orthodox are underfunded.

A number of market, financial, institutional and regulatory barriers can be removed to increase capital access to expand financial inclusion. Increasing liquidity for small borrowers, reducing concentration in the loan and credit card market, and enabling better positive credit scoring and expanding sources of funds are all suggestions that the Zaken Committee have proposed and require action by business and public financial policy innovation. Expanding the market through financial education, technical assistance, and new internet portals for financial services could carve new credit channels. Allowing and encouraging the creation of non-bank lenders or liquidity providers could expand the creation of new competitive sources of credit access of disadvantaged populations. By opening individual development accounts and promoting incentivizing savings, capacity for new credit would increase. Deregulation that would permit investment activities by institutional funds, including pension pools, to include small business lending and expand community development investment, credit unions, and bond banks might also increase competition, make credit scoring more transparent (as proposed by the Bank Supervisory), lower limits and fees for small business credit, and allow new lenders to enter the market.

Glenn Yago and Steven Zecher are economists at the Milken Institute. The Institute's Israel Center recently released a Policy Brief, "Financial Inclusion: Increasing Access for Underserved Populations in Israel," Click here for the full report published following the workshop on this subject.

A version of this article appeared in The Marker (Hebrew) on December 13, 2013 here.