Israel’s Treatment of Insolvent Debtors
Author: Taub Center Staff
September 10, 2013
A new Taub Center study on Israel’s treatment of debtors finds that the current system imposes unnecessary hardship on debtors and that relief is elusive.
A study on Israel’s treatment of insolvent debtors by Dr. Asher Meir, a Research Fellow at the Taub Center for Social Policy Studies in Israel and Senior Lecturer in economics at the Jerusalem College of Technology, presents new findings on the functioning of the consumer credit market in Israel.
It turns out that a large number of Israelis face formal collection actions for falling behind on their debts. The Taub Center study found that one out of seven Israeli adults – about 15 percent of the adult population of Israel – has an open collection file at the Enforcement and Collection Authority. The 2012 report of the Authority puts the number of people with open files at around 755,000. While some cases are resolved promptly, many drag on for years. Dr. Meir found that about half of the collection files remain open four years after they are opened.
Not only do large numbers of Israelis face collection actions, the severity of these actions is quite unusual on an international basis. Many debtors – currently over 70,000 – are formally recognized as being of “limited means,” meaning that the collection registrar acknowledges that in their current circumstances they have no realistic chance of ever paying back their debts in full and are required to make reduced monthly payments that match their current ability to pay. Yet even when these debtors adhere scrupulously to the payment schedule, thus fulfilling all the conditions demanded by law, they generally face intrusive sanctions. These include limitations on use of bank accounts and credit cards, which in the modern economy create a degree of economic exclusion. Another widespread sanction is prohibition on leaving the country. This is in sharp contrast to Europe and North America, where restrictions of this nature apply only to debts relating to child support. The sanctions are not only difficult, compared with other developed countries, but also prolonged; debtors often face these constraints for years and even decades.
Another relatively harsh and unusual sanction found in Israeli law is imprisonment. If the collection registrar is convinced that a debtor is able to pay but is evading his creditors, Israeli law allows him to be put in jail for short periods of time. This sanction was temporarily limited to child support and alimony for two years starting in May 2011, and is now being extended for an additional year, but the underlying law has not been amended and will be implemented again by default if left unchanged. On an international basis, this is a very exceptional punishment. Most countries in Europe, and most states of the United States, never imprison citizens for non-payment of routine debts. Outside experts who have studied this topic, including Israeli NGOs, find that many debtors deemed evasive are really just impoverished. Many are compelled by the threat of jail to borrow money from relatives or on the black market, while others are unable to raise the money and must spend time in jail. Furthermore, the threat is felt to some extent by every debtor since creditors are able to claim that the ability to pay exists and thus compel the debtor to defend himself, or herself, against imprisonment.
A severe punishment like imprisonment can be justified only if the benefits are clear and extensive. Yet Dr. Meir found no evidence that imprisonment of debtors improves the efficiency of the credit market and even claims that it is liable to harm this market. He explains: “Besides the suffering accompanying these steps, sanctions and the threat of imprisonment result in a drag on credit demand and thus on the total level of demand in the economy.”
Evidence of the ineffectiveness of Israel’s debtors’ prison policy comes from the market reaction to two far-reaching leniencies introduced into this policy: the imposition of means tests in 1993 and the policy’s temporary cessation in 2011. The study shows that neither step was accompanied by any noticeable negative effect on the credit market, such as reduced availability of credit or even reduced rates of collection. The first figure shows that in recent years, the extent of household loans other than mortgages has continuously grown even as the threat of imprisonment has continuously declined.
Another area included in the study is bankruptcy policy. According to Israeli law, one objective of the bankruptcy procedure is to provide a fresh start for people who find themselves unable to pay back their household debt. But the Taub Center study found that in practice the bankruptcy process is onerous, prolonged, and uncertain. Dr. Meir found that out of over 50,000 Israelis officially recognized in 2007 as of limited means, only a few hundred were able to obtain such a fresh start by 2012. Many bankruptcy filings are rejected, and those that are accepted take many years. A figure uncovered for the first time by Dr. Meir is that among the bankruptcy filings, only a minority are for personal debts. In a random sample from 2007, the majority of filings, about 55 percent, were for business debts (generally for small and medium-sized businesses).
A common justification for Israel’s unusually harsh strictures on debtors is that these measures are necessary because Israelis are unusually irresponsible with credit. Dr. Meir’s study addresses this claim and refutes it. He finds that Israeli households hold an extremely low level of debt on an international basis. For example, the second figure shows that the ratio of household debt to disposable income in Israel is lower than any country in the G7 and is less than half the average level for these countries. Various measures of payment problems were also compared and found well within the range of other developed Western countries.
While Israel resorts to intrusive and exceptional measures to protect lenders, it fails to make use of a widespread and effective measure: credit scoring. Allowing lenders access to a borrower’s credit history through a credit score would enable better access to the credit market for most Israelis, while those few problem borrowers with a poor credit record would obtain some protection from over-indebtedness. Yet the current Credit Information Service Law has not enabled such a service to develop effectively. The Taub Center study discovered that only about a million credit reports were provided in 2012, a tiny fraction of the rate of usage in the United States. According to Dr. Meir, an additional benefit of credit scoring would be improved competition. The current situation gives the bank a monopoly on the payment information of their customers, which increases rather than reduces concentration in the market for loans.
Dr. Meir concludes that the sanctions faced by Israelis who are unable to pay their debts are not only harsh – they are not effective. He states that far-reaching sanctions on debtors who are in compliance with their legal obligations should be eliminated, and the temporary ban on imprisonment should be made permanent. The criteria for obtaining a fresh start should be made transparent. In Dr. Meir’s opinion, the heightened transparency will enable those who are entitled to a fresh start to obtain it without the stress and uncertainty accompanying the current procedure. Protection of creditors is important, says Dr. Meir, but it would be advanced more effectively and more compassionately by stimulating the development of credit reporting.