Israel's Banking System - Annual Survey, 2019

08/11/2020
All Press Releases In Subject:
The Banking System
This survey is being published at the height of the global coronavirus crisis, which has been defined by the IMF as the worst economic crisis since the Great Depression of the 1930s. In Israel, GDP is expected to contract significantly in 2020 while unemployment is expected to increase considerably, and there is major uncertainty as to the duration of the health crisis and its implications for the economic situation.

This survey primarily relates to developments in the banking system during 2019: actions taken by the Banking Supervision Department in recent years in order to promote competition, and in particular the granting of the first banking license in 40 years, the completion of the separation of two credit card companies from the banks, the launch of a credit data system at the Bank of Israel, support for the establishment of a computer service bureau for new banks which was led by the Ministry of Finance, and the advancement of the “open banking” project; the promotion of innovation and digital transformation in banking and the payments systems; and the encouragement of efficiency in the system, and the significant progress made in these three areas. This is in addition to a description of the additional steps taken by the Banking Supervision Department in 2019 to reinforce the management of developing risks, and in particular, the management of cyber risk and technology risk in general, including the signing of a memorandum of understanding with the National Cyber Directorate.

However, and against the background of the exceptional developments that took place after the end of 2019, I will also relate to the current crisis, namely the coronavirus crisis, in this letter, including the extent to which the banking system was prepared for it, the goals defined by the Banking Supervision Department at the beginning of the crisis and the numerous steps that it took in order to ensure the ability of the banking system to support the economy during the crisis.

At the onset of the crisis, the coronavirus was met by a resilient Israeli banking system that was prepared to endure a major crisis and that had the ability to support the Israeli economy.

The strength of the Israeli banking system is a result of the banks’ prudential management, which can be attributed to the tight supervision of the banks over the years. Since the financial crisis of 2008, the Banking Supervision Department has significantly increased the capital and liquidity requirements that apply to the banks and has put in place requirements to prepare system-wide for stress scenarios. These requirements strengthened the stability of the system and the extent of its preparedness for a major economic crisis. Thus, the capital ratios of the banks in Israel rose as a result of these requirements from 7.6 percent in 2008 to 11.2 percent at the end of 2019 (furthermore, the capital in the banking system in Israel is calculated conservatively and the capital ratios are solid relative to banks in other countries). At the same time, the Banking Supervision Department tightened the restrictions and regulations regarding the exposure of the banking system to large borrowers and led the way to a reduction in credit risk during the past decade, including a drop in the quantity and share of credit to large borrower groups, an increase in retail credit, which is dispersed among many borrowers, and an increase in housing credit, which was carried out in parallel to numerous other macroprudential steps, resulting in a situation in which leverage and the risk to the banks and to households from mortgages is not high relative to other countries. In addition, the Banking Supervision Department issued detailed directives regarding business continuity and activity during an emergency.

The digital transformation undergone by the banking system in recent years, which was supported and guided by the Banking Supervision Department, facilitated the continuation of banking service provision to the public during the crisis. Thus, despite the limitations imposed by the government on leaving one’s home and the need to close branches to the public during the crisis, most customers were able to carry out day-to-day banking activities remotely, without having to visit a branch and thus avoiding the health risk involved.

At the beginning of the crisis, the Banking Supervision Department defined three main objectives:

1.      Protecting the public’s bank deposits and maintaining the stability of the banks during the crisis

The Banking Supervision Department, immediately at the onset of the crisis, required that the banks submit an analysis of the expected developments at each bank under two stress scenarios. The first was a major crisis but a quick recovery beginning at the end of April 2020; the second was a continuation of the crisis into 2021. Based on these scenarios, we analyzed the stability of the banks and the possible implications of the crisis on capital ratios, credit losses, liquidity, profitability, etc. The overall conclusion from these scenarios is that even though the banks are expected to suffer large losses in credit and in their nostro portfolio, which will worsen the longer the crisis continues, the system and each of the banks within it will remain stable.

On the basis of the information in our possession when this survey was written, in the main scenario for the coming year, which assumes that the recovery of the economy has already begun and will continue, although only gradually, the rate of credit losses in the banking system, which stood at 0.3 percent of the credit portfolio in 2019, is expected to increase significantly, with high variation among the banks according to the mix of each bank’s activity. Credit losses, alongside losses due to the realization of market risk, are expected to affect the banks’ bottom lines significantly. Nonetheless, the capital ratios are expected to remain high and the banks will be able to absorb the damage.

I would emphasize that the ability to estimate currently what the full effect of the crisis will be is limited, since there is a high level of uncertainly with respect to economic developments, which is the result of the uncertainty as to the future trajectory of the health crisis. In the economic discourse, it is common to describe various scenarios of recovery schematically—for example, a “V” scenario describes a rapid recovery from a crisis; a “U” describes a slow recovery; and a “W” describes a scenario in which there is a second wave of the crisis before there is a full recovery. At this stage, it is too early to predict which of the scenarios will be realized and in any case it is difficult to estimate the full effect of the crisis on the banks; however, the analyses that have been carried out show that the banks have an ability to endure the crisis and to remain stable even in the gravest scenarios. This assessment is also evident in the behavior and confidence of the public during the course of the crisis, which despite the intensity of the event and the sharp drop in the share prices of the banks in March, significantly increased their deposits in current accounts at the banks.

In order to continue to maintain stability, the Banking Supervision Department is closely watching developments at the banks on a daily and weekly basis. We are holding regular conversations with the CEOs of the banks and with board chairs. We have instructed the banks to raise the group allowance for credit losses already in the first quarter of 2020 based on a future-looking approach, and we have required that they strengthen and modify the management of cyber risk and information leakage, against the backdrop of the major expansion of remote activity in the banking system and of digital banking activity.

2.      Assistance to businesses, households and the economy during the crisis

Based on the stability of the banking system, we decided already at the beginning of March 2020 to encourage the banks to support the economy by increasing the supply of credit to households and to businesses and to provide the option of deferring credit repayments, based on a balanced approach and despite the risks that are expected from the default on credit payments by customers. To this end, we have taken a large number of steps to prevent a credit shortage and to make things easier for customers: Already at the beginning of the crisis, we called on the managements of the banks to exploit the capital surpluses in order to provide credit to businesses which prior to the crisis had paid back their debts on time and which were now experiencing liquidity problems; we reduced the capital ratios required of the banks by a percentage point, with the goal of enabling them to increase the supply of credit to the economy; and in parallel we instructed the banks to evaluate their dividend policy during the crisis; we clarified that the accounting rules permit the banks to defer credit payments by borrowers without classifying the credit as being under special supervision, and in this way we encouraged the banks to defer the repayment of loans by their customers; we allowed customers to increase the amount of consumer credit they took on for whatever purpose, using their home as collateral; and we raised the industry concentration restriction in the construction and real estate industry from 20 to 22 percent of the credit portfolio, with the goal of allowing the banks to continue to support companies in the industry, some of which are suffering from an inability to raise funds in the capital market, something that they relied on to a great extent in recent years. All of these measures were carried out by temporary directives for the period of the crisis, while playing close attention to the steps taken by parallel regulators abroad.

At the same time, the Bank of Israel utilized a large number of monetary tools in order to stabilize the capital market, increase shekel and dollar liquidity and reduce the cost of credit. This was accomplished by intervention at an unprecedented level in the government bond market, the injection of foreign currency liquidity by means of dollar-shekel swap tenders and the reduction of the Bank of Israel interest rate by 0.15 percentage points.

The steps taken by the Bank of Israel, including the Banking Supervision Department, made it possible for the banks to assist businesses and households and during the first two months of the crisis (March–April) an unprecedented NIS 21 billion of credit was provided, an increase of 12 percent at an annualized rate, although the increase was not uniform across industries. The main increase in credit was due to midsize and large businesses who made use of credit lines that had been allocated to them prior to the crisis and to mortgages. Nonetheless, total credit to small businesses dropped during the months of March and April, against the background of a sharp rise in risk in the provision of credit to these businesses and the fact that the banks were waiting for the launch of the Fund for Providing Credit to Small Businesses, which had been adjusted in order to deal with the crisis, under the guarantee of the Ministry of Finance. From the moment that the Fund was launched (with a total guarantee of 15 percent), on the 1st of April, the banks began providing credit to small businesses at a rapid pace, and the demand significantly exceeded the supply of funds allocated by the Ministry of Finance to the Fund. By mid-May, the banks had provided NIS 7.2 billion in credit to about 20,000 small businesses. At the same time, there was a sharp drop in consumer credit during the first two months of the crisis totaling about NIS 7 billion (without mortgages) which was primarily the result of the drop in consumer demand (which was also manifested in a decline of about 40 percent in credit card expenditure during the month of April).

Alongside these changes in credit, the banks deferred credit payments for a number of months for a large number of households and small businesses that applied for it, which amounted to about 450,000 customers. In addition, the banks responded to the call by the Banking Supervision Department for a freeze on dividend distributions, in order to ensure their sources for expanding credit to the economy.

Against the background of the major difficulties experienced by the banks’ customers as a result of the crisis, public anger with the banks began to develop in reaction to reports of an increase in interest rates. The increased risk in the providing of credit to businesses and households, in view of the worsening of the economic situation, and the increase in yields in the capital market, which make it more expensive to raise funds, worked toward an increase in the interest rate on credit. Therefore, we made it clear in a letter to the chairmen and CEOs of the banks that the Banking Supervision Department expects that the banks will make an effort to assist the economy and that they will price loans using a system-wide perspective, even if that harms the bank’s profit margins. The actual data showed that the interest rates on credit to commercial and large companies did not increase during the first two months of the crisis and that the same was the case for consumer credit. In contrast, the interest rates on mortgages rose by approximately 0.5 percentage points while those on credit to small businesses declined significantly (from 5 percent prior to the crisis to 3.8 percent at the end of April), due to the activity of the Government-Guaranteed Fund for Small Businesses and designated monetary loans offered by the Bank of Israel to the banks at an interest rate of 0.1 percent, for the purpose of extending credit to small and micro businesses.

3.      Ensuring essential banking services to the public during the crisis

Immediately with the onset of the crisis, the Banking Supervision Department worked to ensure the business continuity of the banking system, in order that the provision of routine banking services to the public would not be disrupted. We instructed the banks to modify their workforce arrangements in order that entire units of the bank would not be paralyzed even if a large proportion of the workers would get infected. The banks were instructed, in accordance with the directives of the Ministry of Health, to close a large proportion of the branches to the public, in order to reduce the health risk to customers and workers. At the same time, they were required to continue providing the lion’s share of essential services remotely—by telephone and digitally. We removed regulatory and legal barriers in order to streamline the process of applying for online banking services, in order to make it easier to receive services by telephone, and in order to sign on a mortgage remotely. We instructed the banks to issue debit cards to recipients of National Insurance assistance and individuals in bankruptcy, who prior to the crisis were not eligible for a debit or credit card, in order to make it possible for them to avoid coming to a branch in order to carry out transactions or withdraw cash; and we decided to suspend the restriction of accounts of customers due to bounced checks, with the goal of assisting businesses and households with cash flow problems.

 

The crisis has presented the Banking Supervision Department with more than a few dilemmas and challenges, and a different style of thinking was required than during normal times. For example, we asked ourselves whether we should encourage the banking system to take on increased risk, at a time when the overall level of risk is rising.

Many businesses may not survive the crisis and there is concern that some of the workers that were placed on unpaid leave will not be able to return to their jobs quickly, such that the rate of unemployment will remain high for a relatively extended period.

How can the supply of credit to the economy be increased while at the same time ensuring that the deposits of the public, which are the main source for the provision of credit, remain safe? The Bank of Israel’s approach is that in order to reduce the risk of a major and prolonged recession, encourage economic activity and ensure a rapid recovery, it is important that the banks increase their appetite for risk, while adopting a policy of high-quality underwriting and informed risk management. In view of the high level of risk that currently exists in the providing of credit, the Banking Supervision Department created conditions and regulatory incentives that increase the supply of credit, but which did not require the banks to provide credit under any circumstances. The underwriting and business decisions will, as always, be made by the banks, which are the ones with the knowledge and the tools to evaluate which borrowers will be able to repay credit and to evaluate the level of risk. It should be emphasized that while the banking system can provide cash flow assistance to individuals and businesses in crisis, it cannot replace the government assistance that is required by businesses and households that are experiencing a major crisis. In this context, government guarantees are important in the provision of credit to small businesses in various industries, at a rate that is adjusted to the risk resulting from the crisis, as has been done in various other countries.

 

Conclusion

The Banking Supervision Department, with the onset of the crisis, made use of a large variety of tools, some of them for the first time, with the goal of supporting the effort to minimize the economic harm brought about by the crisis. Nonetheless, there are many businesses and households that are currently experiencing serious financial difficulties and the solutions provided by the banking system can only complement the solution based on government assistance. The Banking Supervision Department will continue to maintain the stability of the banking system and protect the public’s deposits, it will enable and encourage the banks to assist the economy by providing credit and it will ensure the continuity of essential banking services to the public and the economy.

In conclusion, and on a personal note, I will soon be completing five years in which I have had the privilege of being part of the Bank of Israel and serving the public. I wish to thank the workers and managers of the Banking Supervision Department and the Bank of Israel as a whole and I wish all of them and the incoming Supervisor of Banks, Yair Avidan, that they are able to continue to serve as a beacon of economic professionalism, for the benefit of the Israeli economy.

 Dr. Hedva Ber                        

Supervisor of Banks​