Israel's Banking System -First Half of 2019

All Press Releases In Subject:
The Banking System

During the reviewed period, the banking system continued to improve its performance, maintain its level of resilience and stability, and support economic activity. These results were directly attributable to the efficiency measures carried out by the banking system in recent years, which have included a major reduction in manpower, savings in real estate costs, and the improvement of internal processes, alongside the assimilation of technologies in customer and operational interfaces. In short, there has been an improvement in the banking production function without any major adverse effects during the reviewed period. Among other things, the banking groups' performance reflects developments in the housing market, the increase in the CPI, and the appreciation of the shekel, as well as the separation of the credit card companies from the two largest banking groups.[1]

The streamlining of the banking system in recent years led S&P Global Ratings to raise the classification of the Israeli banking system to the higher-quality Risk Group 3 category, which includes such countries as the US, UK, France, Australia, and Holland. This change in classification provides a higher anchor for the ratings of the banks in Israel (the starting point for rating). Among the factors leading to this decision according to the rating agency are the supportive economic environment in which the banks operate, a stable financing base that relies on core retail deposits, and the high level of banking supervision and regulation in Israel.

The business results of the banking groups showed improvement in most indices, which was reflected in an adequate return on equity level (10.7 percent) and an improvement in the efficiency ratio to 58 percent (expense to income ratio), a very low level relative to recent years. Net interest revenue contributed significantly to the increase in net profit for all the banking groups, which was the result of stronger core activity and the expansion of credit to the public (the “quantity effect”). The separation of the credit card companies had both positive and negative effects on net profit, which tended to offset one another. Thus, while revenue from fees fell sharply this year, other financing income rose as a result of the proceeds from the sale. On the cost side, there was a slight improvement as a result of the reduction in past provisions for investigations by the US authorities, the separation of the credit card companies, and the continuing streamlining in the system. In this context, the efficiency ratio declined significantly this year and converged to a level of 58 percent, compared to 67 percent in 2016.

Total credit to the public continued to grow this year, and facilitated the continued expansion of economic activity. It grew by 3.8 percent this year, which is similar to the average in recent years and slightly higher than the economy’s rate of growth. The developments in the credit portfolio are similar to those observed last year, reflecting developments in the housing market, with steady provision of banking credit to home buyers and to construction and real estate companies (for further details on mortgages, see Box 1), and in the banks’ policy to increase exposure to the business sector (which is weighted by higher risk weights) once they had reached their capital targets. Credit to private individuals remained unchanged following several years of growth[2], in view of various measures introduced by the Banking Supervision Department in this context with the goal of ensuring fair practices in the marketing of credit.

All of the Israeli banks recorded an improvement this year in the Common Equity Tier 1 Capital ratios and they exceed the capital targets set by the Banking Supervision Department. The achievement of the capital targets is a direct result of the banks' ongoing implementation of measures to improve their capital ratios, as part of the lessons learned from the Global Financial Crisis and the requirements and measures introduced by the Banking Supervision Department. The Common Equity Tier 1 Capital ratios of the banking groups increased again this year, to 11.3 percent. This increase during the reviewed period was affected by one-off events, including the separation of the credit card companies, which worked to reduce the quantity of risk-weighted assets, and the temporary halt in the distribution of dividends among some of the banking groups.

The quality of the banking groups’ credit portfolio remained high, reflecting the stable economic situation. The rate of impaired credit remains low in historical terms and the coverage ratio remains high, evidence of an improved ability to absorb losses. Nonetheless, the rate of credit losses grew somewhat, as a result of the drop in collection from midsized and large businesses.

The bank share indices continued to reflect over-performance relative to the Tel Aviv 125 Index, and also relative to the bank share indices in the US and Europe, an indication of investors' continued confidence in Israeli banks. This is based on healthy profitability, high levels of equity, and the high quality of the credit portfolio. At the same time, there was a downward trend in the spreads on the banks’ bonds, as there was among corporate bonds in other industries, with the spreads on the banks’ bonds remaining much narrower than other industries. In this context, and in view of the fact that real yields on government bonds have been trending downward since the end of 2018, and were even negative since the beginning of 2019, the index of real yields on the banks’ bonds reached negative levels during the year. This resulted in the first bond issued by an Israeli bank (First International) with a negative real yield (-0.1 percent).

The banking system continued to increase its readiness for changes in technology, the business and competitive environment in which they operate, and consumer preferences. In addition to the conventional financial risks, including credit, market, and liquidity risks, the banks have to deal with new and growing risks, chiefly cyber and technology risks. These risks have been realized in many organizations abroad, and involve data breaches, a threat to business continuity, regulatory fines for the violation of privacy, etc. There is also the risk arising from increasing competition from nonbank entities, including the possible entry of technological giants into the banking services market in Israel. Looking to the future, and in addition to the technological risks that may materialize, the changes in the global macroeconomic environment due to the trade war, an increase in economic uncertainty, and an increase in the volatility of the financial markets may affect the banks' results. An analysis carried out by the Banking Supervision Department indicates that the banks are prepared for various stress scenarios from the standpoints of equity and liquidity.

1.      Business results and efficiency

The net profit of the five largest banking groups grew significantly during the first half of 2019 relative to the same period last year (Table 2). The banks continued to show adequate profitability and the return on equity stood at about 10.7 percent (in annual terms), the highest level since the last financial crisis in 2008 (Figure 1). The business results of the banking system during the first half of 2019 were a result of growth in net interest income (8.5 percent) and a decline in operating expenses (of about 3 percent). On the other hand, there was a drop in revenue from fees (of about 7 percent), alongside an increase in credit losses (of about 33 percent), although its proportion of expenses remained relatively low from a long-term perspective (for further details, see the section on credit).

The increase in net interest income encompassed all of the banking groups, and was primarily the result of an increase in the volume of credit that the banks provided to the public, as well as growth in income from other interest-bearing assets, including bonds, which contributed to a moderate increase in the financial spread (Table 3 and Figure 2). Similarly, interest income grew even though the proportion of income from credit activity remained basically unchanged in the various activity segments (and even fell somewhat in the business segments). The interest rate gap[3] declined relative to the same period last year, due to the growth in the banks’ rate of expenses on the public’s deposits, which was higher than the increase in the banks’ rate of income from credit to the public (Figures 3 and 4).

Noninterest financing income grew by about 2.5 percent relative to the same period last year, and was positively affected by the sale of shares by Leumi group, and negatively affected by a drop in income from fees (of about 7 percent), due to the separation of Leumi Card from the Leumi group. Net of this effect, income from fees remained basically unchanged (a drop of 0.8 percent). Operating expenses fell by about 3 percent relative to the same period last year, a decline that encompassed most of the banking groups. The decline in operating expenses is due to a one-off expense for investigations in the US recorded by the Mizrahi group last year[4], as well as the sale of Leumi Card by the Leumi group. Net of these one-off effects, operating expenses increased by about 2 percent relative to the same period last year. Salary and related expenses increased slightly (1.4 percent), due mainly to the positive results of the banking groups during the reviewed period.

Operating efficiency indices for the five largest banking groups continued to improve this year and were positively affected by factors that influenced the banking system’s results. The operating efficiency ratio[5] declined from about 64 percent[6] to about 58 percent and the cost of a unit of output[7] fell from about 2.01 percent to about 1.82 percent (Table 5 and Figure 5). The improvement in the efficiency ratios encompassed all five banking groups and, as in previous years, was due to the more rapid growth in the banks' income than in their costs (Figure 6). The improvement in the efficiency indices is a result of the streamlining by the banking system in recent years with the encouragement of the Banking Supervision Department, which began with the Banking Supervision directive on streamlining in 2016. During the reviewed period, these results were highlighted by the absence of excessive negative effects.

[1] As part of the implementation of the Increasing Competition and Reducing Concentration in the Israeli Banking System Law (the “Strum Law”).

[2] Not including the separation of the credit card companies from the largest banks. If this effect is included, there was a large decline, although it is technical in nature.

[3] The gap between the rate of interest income on credit to the public and the rate of interest expenses on the public’s deposits.

[4] During the same period last year, the Mizrahi group recorded a provision of NIS 425 million due to the investigation by the US Department of Justice.

[5] The ratio between total operating and other expenses and total net interest and noninterest income (cost to income ratio).

[6] Excluding provisions by the Hapoalim and Mizrahi-Tefahot groups last year, the operating efficiency ratio stood at about 61.8 percent in June 2018.

[7] The ratio between total operating and other expenses and total average assets (average cost ratio). 

The Full Survey in PDF Format​

Israel's banking system - First half of 2019 - Tables​

Israel's ​​banking system - First half of 2019 - Figures​