Israeli Small Banks Reform Faces Challenges as Isracard Withdraws Digital Bank Acquisition
The recent cancellation of Isracard's acquisition of the digital bank esh highlights the gap between Israel's small banks reform vision and market realities. This development comes weeks after the reform was finalized by the Bank of Israel and the Ministry of Finance, aiming to diversify the banking sector by easing entry for new banks. Despite regulatory incentives, industry experts say key barriers remain, including high costs, risks, and consumer reluctance to switch accounts.
Isracard remains a leading candidate to become a small bank but now faces a longer path to licensing, delaying the anticipated synergy between esh's technology and Isracard's customer base and financial backing. The reform introduces a phased licensing model allowing non-bank entities, such as credit card companies, to offer banking services under lighter conditions, including relaxed ownership rules and capital requirements. However, new banks must still comply with most traditional banking regulations.
Four main structural challenges impede new entrants: consumer inertia in switching accounts, the absence of a government-backed deposit insurance scheme, the financial trade-offs for companies converting to banks, and the high costs of establishing banking operations. For example, credit card companies have access to cheaper funding than they would through deposits, complicating their incentive to become banks. The lack of deposit insurance in Israel, unique among OECD countries, also disadvantages new banks without established brands.
While the Bank of Israel prefers a few strong new players over many small ones to avoid failures that could undermine public trust, the reform's success depends on multiple factors. These include customer willingness to adopt new banking products, availability of funding sources, and operational capabilities of new entrants. Fintech firm Revolut is expected to be the first to receive a banking license under the new framework by year-end, with other foreign and domestic players showing interest.
Former competition regulator Dror Shtrom remains optimistic, noting that despite Isracard's withdrawal from esh, the company has not abandoned its banking ambitions. He emphasizes that the regulator's willingness to ease rules further will be crucial to attracting more entrants. Meanwhile, Deloitte Israel's Shai Teshuva points out that the reform has already advanced product unbundling and competition, citing the growth of non-bank credit card providers and mortgage advisors. Overall, the reform aims to reduce concentration in Israel's banking sector but faces a complex and gradual path ahead.
