Australia could learn much from robust example

WHAT do Australians really know about Israel? The Gaza Strip, the West Bank, the names of its leaders Peres and Netanyahu all sound familiar. But what about its financial system? How does it compare to Australia?

I have just spent a frenetic week-long visit exploring this question and, although a little bit of knowledge is a dangerous thing, I think there is definitely an X-factor when it comes to improving its financial system and implementing (often bold) reforms.

Israel is a small country with a population of less than eight million and a GDP of about $US240 billion. Formed in 1948, it developed a brand of socialist Zionism in which there was relatively little in the way of private investment. Until the 90s, pensions were all in government hands, and its banking system was highly concentrated and dominated all aspects of the financial system.

In 1993, the government created a venture-capital market through a program called Yozma (initiative) in which it would provide equity to fund start-ups.

If venture capitalists could raise $US16 million, the government would contribute $US8m, and it was decided also that foreign investors would not be taxed.

Yozma was a runaway success, resulting in something like 240 venture-capital firms investing in Israeli start-ups from the early 90s to 2009. Of Israel's exports, 40 per cent now comes from the hi-tech sector, with innovations such as Intel's Pentium chip.

But Israel is different from Australia. It is surrounded on all sides by hostile neighbours and has always fought for its survival, which must give Israelis a different appetite for risk.

And, according to the OECD, Israel ranks first in the world in expenditure on research and development as a percentage of GDP and has a ratio of about 13 engineers per 1000 employees: the highest in the world.

Israel has compulsory military service for everyone over 18: men serve for three years and women for two years.

This makes a big difference because by age 25 the average Israeli has worked with a tight-knit team in demanding environments, made decisions that have real consequences and been required to solve problems fast using diverse skills and a lot of technology. This translates into an amazing propensity for technological innovation after military service.

When it comes to regulatory change, the same dynamic pragmatism applies. If people thought the Cooper Review prefaced big changes, it was nothing compared with Israel's Bachar Committee reforms recommended in 2003.

These reforms sought to address two fundamental issues: a highly concentrated and uncompetitive banking industry and conflicts of interest arising out of a vertically integrated model where almost all activities were connected to those banks.

Bachar recommended, among other things, a structural separation of mutual funds and pension funds from those banks.

Banks were told they had to divest their interests and were given a timetable within which to do so.

The jury is still out on whether Bachar was a success and it is too detailed a topic to analyse here, but there is no doubt it was a bold reform that went straight to the heart of the problem. No mucking around with disclosure and other "wet lettuce" solutions.

Unlike Australia, Israel has a domestic corporate bond market that it can be proud of, but this did not happen by accident.

It was consciously planned by the Israeli government to improve the financial system and today the Tel Aviv stock exchange has more bonds listed than equities.

There are 574 listed companies and 670 series of corporate bonds adding up to about $US94bn in corporate bonds, compared with Australia's $230bn, of which only about $44.3bn is domestically issued non-financial paper.

Israel's corporate bonds do not trade over the counter as they do in the US, Europe or here, but are transacted in a transparent and liquid on-exchange market.

Israel carried out major pension reforms in 2008.

Like many developed northern hemisphere economies, annuities are an important component of the Israeli pension system, guaranteeing payments equivalent to half the minimum wage for life: about $US12,500 a year.

Israel also has a 17.5 per cent contribution model shared between employer (6 per cent), employee (5.5 per cent) and a severance payment (6 per cent) payable by the employer. Also of interest is that so-called new pension funds come with inbuilt life and TPD insurance, but it is funded collectively by the members: another innovation we have not embraced in Australia.

For a country that was only invited to join the OECD in 2010, Israel can be proud of its willingness to confront shortcomings in its financial system and deal with them in a characteristically purposeful and robust manner.