Financial Stability Report for the second half of 2018

All Press Releases In Subject:
Finacial Markets and Financial Stability

The Financial Stability Report for the second half of 2018 provides an assessment of the stability of the domestic financial system, based on an analysis of the environment in which the system operates—the macroeconomic environment, the asset markets, credit, and liquidity in the markets.  This assessment provides an indication of the various risks to the economy as a result of shocks in Israel and abroad.  The following are the main developments that took place during the reviewed period in the risks in the financial environment:


·         The country’s credit risks declined due to the continued increase in economic activity and the continued decline in the ratio of government debt to GDP.  However, the existence of a structural deficit narrows the possibility of conducting an anti-cyclical fiscal policy, and may have a negative impact on the main factors that have been acting to lower credit risks.

·         Developments in the global environment show an increase in the risks to the global economy, and indirectly to the Israeli economy.  The main risks are the weakness in the global debt market, and the trade war between the US and China, and the monetary tightening (mainly in the US) may worsen those risks.

·         Real estate prices in Israel declined slightly, which strengthens the assessment that the trend of price increases has been halted.  The pace of building starts reacted to this rapidly, declining during the reviewed period, and it seems to be no higher than the increase in demographic demand dictates.

·         The pace of expansion of credit in the economy increased during the reviewed period, mainly led by the business sector, thereby joining the prolonged upward trend in the pace of expansion of credit to households.  This trend exists even though the pace of expansion of non-housing credit declined from its high level of recent years.  Credit risks may increase in the coming years since changes were made to the legal environment regarding credit suppliers in Israel, and because the supply of credit may increase due to the many reforms to encourage competition in the credit market.

·         Trading volume on the Tel Aviv Stock Exchange was low by international comparison, and the liquidity risks tend to increase due to the increase in passive investment and the wide-ranging algotrading activity on the Stock Exchange.


In terms of exposures, the report funds that during the reviewed period, the risks are focused on asset prices—both real estate and financial assets, particularly corporate bonds.  Since monetary accommodation is being wound down globally, and since Europe and Israel are expected to join this trend, the risk of a sharp decline in asset prices, particularly financial assets that are more sensitive to the interest rate environment, has increased.  Some of this risk was realized beginning in October 2018, due to the increase in government bond yields in the US, with sharp declines in share prices and high volatility being recorded in most stock markets around the world.  Due to the marked increase in the public’s exposure to bonds in recent years through mutual funds—against the background of increasing volumes of passive investment and the effects of robotic trading on the stock markets, factors which have a negative impact on liquidity under increased uncertainty—we indicate an increased likelihood of financial distress as a result of a shock to financial asset prices.  The financial system’s exposure to the real estate market in Israel—both that of the banks and that of the institutional investors—continued to increase.  In contrast, the volume of building starts did not increase in accordance with the needs of the population, and developments in home prices and rents no longer show explosive behavior.


Exposure to nonhousing credit in the economy also continues to develop.  The changes in the legal environment in which credit suppliers operate, and the fact that nonbank credit suppliers continue to increase their share of total credit to households, may increase the credit risks on the part of households in the event of a serious worsening of financial conditions—for instance due to the winding down of accommodative monetary policy.


In the area of exposures to abroad, we find that the risks increases during the reviewed period as a result of the risk of increased bankruptcies against the background of the continued winding down of the accommodative monetary policy.


 This report focuses on four different issues, and outlines them in four different boxes:

 Box 1: The increase in Israel’s credit rating and its effect on the Israeli economy.  This box presents initial findings that show that there were positive developments in the Israeli capital markets around the time of the increase in the forecast regarding the country’s credit rating, and around the time of its actual increase.  These findings are consistent with global research literature.  Since there is a strong connection between the timing of the announcement of a rating increase and the timing of the positive developments, particularly the strength of the shekel, the box shows that the rating increase has the potential to contribute to economic activity in Israel.


Box 2: An analysis of the financial stability of public companies in the income-generating real estate industry (published separately).  This box focuses on an analysis of the risks inherent in the activity of income-generating real estate companies in Israel.  Global experience shows that this market is more sensitive than the residential housing market to the business cycle.  Activity in Israel is not exceptional compared to activity in Europe, the financial profiles of the companies improved, and the prices of income-generating assets increased in the past decade less than the prices of residential housing.  However, the financial system’s exposure to this industry is the highest of any industry in the economy.


Box 3: The effect of algotrading activity on the quality of trading.  This box shows that some of the strategies adopted by quote generators (trading robots) have a negative effect on the quality of trading on the stock market.  Accordingly, we recommend that regulatory measures be adopted, similar to measures that have been adopted in many stock markets around the world, in order to minimize the risks of sharp and rapid fluctuations in asset prices, since the latter increase liquidity risks and in the end reduce market depth.


Box 4:   The risks derived from the increase in passive investment in the economy (ETNs and mutual funds that mimic one of the asset price indices).  Passive investment volumes in Israel, as in the rest of the world, have increased greatly in the past decade.  Such investment has many advantages for small investors, but its disadvantages become greater as it increases among such investors.  These disadvantages are reflected in an increase in price volatility, in the fragility of the market, and in liquidity risk.  We recommend that the overall effect of an increase in passive trading volumes on the stock market be examined, and that it be ascertained that the increase in the number of indices of tradable asset prices—which makes it possible to create more such mimicking instruments—does not increase the liquidity risk in the stock market.

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