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A new study by the Taub Center for Social Policy Studies in Israel finds that the treatment of debtors who fall behind on their debts in Israel is harsh relative to other countries. The sanctions imposed are severe, and the opportunities for debtors to extricate themselves from debt and to proceed with their lives are limited. In light of this, the study presents a recommendation for comprehensive reform in the credit market that will be an improvement for both debtors and the credit market as a whole.
- As of 2012, debtors with household debts languished an average of about 12 years in the debt enforcement and collection process before even applying for bankruptcy, and even those who obtain a bankruptcy discharge had to wait an average of around five years. In all, very few Israelis received a discharge from household indebtedness.
- Sanctions on debtors in Israel are harsh compared to all of the many European and North American countries studied, and they do not appear effective in improving debt collection rates.
- The reform in the credit market should include three components: establishing an effective credit rating system; the cancellation of sanctions imposed on debtors; and the adoption of effective methods for allowing those who are insolvent to obtain a fresh start after making reasonable efforts to repay their debt.
In the past few years, the Knesset has dealt with several aspects of consumer indebtedness, including the cancellation of the sanction of imprisonment for debtors who are unable to make their payments (2014), a temporary order to allow a widespread exemption from debt for those of limited means (2015), improving access to bankruptcy relief (2015), and establishing an effective credit rating system (2015). A new study by Dr. Asher Meir conducted for the Taub Center examines the subject in depth and compares treatment of insolvents in Israel with accepted practices in other countries.
According to the study, the treatment of debtors in Israel is exceptionally harsh. Meir found that it is very hard for those in debt to continue with a normal life due to invasive sanctions and obstacles in the bankruptcy process. These difficulties prevent debtors from getting a fresh start, forcing them to remain tied to an unlimited repayment schedule.
In light of the findings, the Taub Center study recommends a comprehensive reform for dealing with insolvency and the credit market in Israel. The reform must include three components: (A) a complete elimination of sanctions against debtors of limited means; (B) adoption of a simple and comprehensive track for a fresh start that will enable debtors to continue with their lives after making a reasonable effort to repay their debt; (C) the creation of a credit rating database that includes both positive and negative credit history.
The Problem: A shortage of information in the credit market.
The Solution: Sharing information
In all credit markets there are gaps between the information available to the lender and that which is available to the borrower. These gaps create a situation in which problematic borrowers may receive loans at competitive rates even though their chances of repaying such loans are poor because the lender is unaware of the potential borrowers’ credit behavior and history. In contrast, all borrowers – even those with a good chance of repaying the loan – pay a “risk premium” to the lender, which insures against failure to repay. Another example of difficulties arising from information gaps is that experienced lenders, such as banks, are likely to offer credit to borrowers who are unfamiliar with the credit market at relatively high interest relative to their actual risk level. According to the Taub Center research, these information gaps move Israel further away from having a perfectly competitive credit market, one in which competition results in charges that reflect the true risk to the lender, and in a fair and reasonable degree of responsibility on the part of the borrower.
Meir notes that sharing credit information about the customer would improve the functioning of the market in several ways. First, it would limit the number of loans given to problematic borrowers, since the information on individual borrowers and their habits, as well as information on the overall borrowing population, will be translated into qualitative estimates of the risk to the lender. In addition, cooperation can be an educational tool for borrowers; poor repayment habits will be reflected in a credit report and a low credit rating, and such information sharing will encourage the client to engage in responsible fiscal management. The result will be higher overall rates of loan repayment, which will also bring about cheapening of the credit given to households.
From the perspective of the borrower, as his credit information is more transparent, his bargaining power will be raised in two ways. First, when the client knows his credit rating, he can better identify excessively high interest rates. Furthermore, when credit information reaches other lenders, competition will be created, resulting in more borrowing opportunities for the borrower.
The Taub Center study points out that Israel already has the Credit Information Service Law whose purpose is to provide credit information and repayment history about borrowers. The law, however, does not allow lenders to see highly valuable positive credit information (what bills were paid in a timely fashion), because collection of this information is possible only when customers sign a special waiver. As of 2012, fewer than 100 people had signed such a release form. As a result of the low quality of credit information, the number of requests for consumer credit reports has been quite low: in 2012 it was just one million – that is, one for every five citizens in the adult population of Israel. In the US, by contrast, there are 13 credit reports for each adult, that is, 80 times more than in Israel. To turn the information-sharing system into an effective one, Meir notes, it is important to add a critical mass of citizens and businesses to it.
The solution, according to Meir, is to adopt the recommendations of the government committee which called for the establishment of a centralized credit data base including positive information, which will enable all those who extend credit access to information enabling them to better evaluate credit risk. This is in contrast to the current system in which the majority of financial information and credit history is held by the bank. “The more we improve the flow of information on the individual borrower’s behavior, as well as on the risks for all borrowers, the closer we approach a true competitive market.” says Meir.
The Problem: Harsh sanctions against debtors
The Solution: Eliminating sanctions and reliance on credit information
Meir found in his research that the sanctions against debtors who are unable to repay their loans in Israel are draconian relative to accepted practice in other countries. Specifically, in Israel there are two particularly painful sanctions against those classified as “of limited means,” that is, those who are unable to repay their debts in full. These two sanctions are a prohibition from leaving the country and restrictions on financial activities such as holding bank accounts and using credit cards. In a detailed examination of practices in other countries, Israel was unique in its dealings with debtors. Among the countries studied, the harshest sanctions are taken against those who fail to pay child support, and even in these cases, the use of the sanctions noted above is not common.
The Taub Center study notes that the “limited means” status does not indicate guilt or fault in repayment, only an inability to pay in full, and as such, it is particularly problematic to impose sanctions that damage earning power and the ability to conduct a normal life. In addition to harming the borrower himself, a system based on sanctions is likely to harm the credit market as well. The average client may also hesitate to take credit knowing that routine incidents, like the loss of one’s job or an economic crisis, are likely to have harsh repercussions – and so the demand for credit is subdued. According to Meir, these defects are intensified by the fact that these sanctions have not been found to have any real influence on the repayment rates.
In this context, the study notes that in the past years there has been a trend of relaxing the sanctions of imprisonment and revocation of driver’s licenses of those in debt. Nevertheless, Meir recommends removing punitive sanctions altogether, and in their place, relying on information sharing as a way of preventing problematic borrowers from taking loans that they cannot repay.
The Problem: A slow and complex bankruptcy system
The Solution: Establishment of an effective path towards a fresh start
Today, the law in Israel recognizes bankruptcy as the only way for debtors to start over. Despite this, Meir shows in his research that the bankruptcy process does not provide a practical solution to households that have sunk into debt. In 2007, there were over 50,000 Israelis recognized as of limited means, yet only a few thousand started the bankruptcy process. Of these, only a few hundred received bankruptcy status after five years, and this after a long and exhausting process.
According to the Taub Center study findings, based on a random sample (and calculated as an estimate for all bankruptcy cases), about a third of household bankruptcy cases are rejected, and about half were still in process five years after the first filing.
Opening a bankruptcy file is not the beginning of the lengthy legal route for debtors who find themselves in trouble. In almost all cases, prior to bankruptcy filing there is a lengthy collections process. On average, of those who filed for bankruptcy in 2007, procedures for collections began as early as 1995 – an average time frame of about 12 years for dealing with collections on these cases. There is no doubt that this is a long and frustrating process that is not accessible as a solution for someone who is unable to pay back his debt.
The solution to this problem, according to Meir, is opening an effective route to a fresh start, based on a time-limited repayment period set in advance. This procedure could take place within the Enforcement and Collection Authority without the involvement of the courts. In this way it would be simplified and streamlined and would be transparent to all parties. The study notes that many Western European countries have adopted a procedure of this type in the past decades and have found it an effective and successful model. In Belgium, Denmark and Sweden, for example, repayment periods are limited to five years, and in France the ceiling for repayments is being reduced from eight to seven years beginning in 2016.
In conclusion, Meir says “the existing institutional structure in Israel, its economic characteristics and the example of insolvency policies from other countries all point to moving towards a policy of cancelling debt. According to the most desirable model, declaring that a debtor is of limited means would result in a structured process, and at the end of the legally prescribed period the debtor would be absolved of his debt automatically.” Meir notes that a similar idea was brought forward in Amendment 47 to the Enforcement and Collection Law, and in the temporary order “to absolve debtors of limited means.” This legislation would advance absolving debtors for simple cases or in cases that do not justify filing for bankruptcy. Similar arrangements should be made in the civil law on a permanent basis.
The Taub Center for Social Policy Studies in Israel is an independent, non-partisan institution for socioeconomic research based in Jerusalem. The Center provides decision makers, as well as the public in general, with a big picture perspective on economic and social areas. The Center’s interdisciplinary Policy Programs – comprising leading academic and policy making experts – as well as the Center’s professional staff conduct research and provide policy recommendations in the key socioeconomic issues confronting the State.
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