Israel's Banking System - Annual Survey, 2009

04/11/2010 |  Bank of Israel
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The Banking System
Israel's Banking System - Annual Survey 2009
Letter of the Supervisor of Banks

Letter of the Supervisor of Banks submitted with the 2009 Survey of Israel's Banking System In 2009, the Israeli economy and its counterparts abroad began a modest recovery from one of the greatest crises that the global economy has ever known. The intervention measures that many central banks and governments around the world invoked stanched the downslide and even led to first indications of change and the onset of stabilization.

Although the Israeli economy, as a small and open economy, is heavily exposed to developments in the global markets, the recovery in Israel preceded that in most Western countries. The credit for this belongs to two factors: the favorable macroeconomic conditions that prevailed in Israel when the global crisis began and the stability and credibility of the domestic financial system. However, even though the adverse trend in the real economy has stopped and many indicators of activity improved earlier than had been expected, much uncertainty remains due to concern about the continuation of the positive global economic developments as the effects of the stabilization programs in many countries wane and adverse developments in the eurozone loom.

Amid these changes, the Israeli banking system maintained its resilience and stability, improved its performance and its business results, and reduced its exposure to risk. Concurrent with the improvement in the state of the banking system this year, the Banking Supervision Department completed a three-year process of assimilation of the Basel II rules in the banking system and at the Department itself.

Several measures were taken this year to improve the resilience of the banks and the banking system, mainly concerning the strengthening of the system's capital adequacy and quality even beyond the 12 percent target. Thus, the capital ratio of the five large banking groups climbed to a record 13.7 percent in Basel I terms and 13.6 percent in Basel II terms-resembling the level in many banking systems abroad. One reason for this has to do with supervisory actions that we took during the year, mainly at its beginning, against the background of developments in foreign markets and uncertainty about the continuation and intensity of the crisis: limits on the distribution of dividends, offering of government guarantees for capital issues, and encouragement of capital issues.

During the year, the Banking Supervision Department put together a series of scenarios that reflected a range of events of various degrees of severity, including macroeconomic and financial shocks, and tested their effect on the stability of the banking system. The Department found that the system's average capital ratio continued to surpass the requisite minimum even after accounting for the effect of the shocks that we examined.

Pursuant to these actions and against the background of the publication of the Basel Committee's consultative proposals to strengthen the resilience of the banking sector in December 2009, I instructed the banks in June 2010 to present the Banking Supervision Department with a systematic program that would boost the risk-weighted ratio of core capital to at least 7.5 percent by the end of 2010.

Other factors that contributed to the improvement in capital adequacy in 2009 were actions taken by the banks to recompose their assets. Thus, the extent of risk assets was reduced and, for the first time in five years, the banking credit portfolio contracted. This happened mainly due to a decrease in lending to corporate clients occasioned by a decline in total demand for bank credit, mainly due to the recovery of the nonbank credit markets. Conversely, consumer credit to households, chiefly for housing, expanded.

The banks' exposure to credit risk declined during the year for reasons including the expansion of real activity and the recovery in the capital and labor markets, which included an improvement in credit quality. However, this activity is still typified by a high level of risk, mainly due to the uncertainty associated with developments abroad.

Loan-loss provisions increased slightly this year and were stable relative to the previous year's level. Since the provisions should also reflect uncertainty about economic activity, they should be conservative and should assure an appropriate level of provisions in the future as well. To satisfy this need and strengthen the relationship between credit risks and credit losses while improving the risk-monitoring process, I issued a directive titled "The Measurement and Disclosure of Impaired Loans and Debt Securities, Credit Risk, and the Allowance for Credit Losses". The directive, scheduled to go into effect in January 2011, is the outcome of lengthy work at the Department in conjunction with the banking system.

The banks' earnings and profitability indicators improved considerably this year. However, unlike the steady improvement that occurred in the rapid-growth years preceding the crisis, the improvement now was predicated on factors external to the banking system that, in all likelihood, will not act in the same direction and with the same intensity in the near future. The banks had to contend this year with a low and stable interest environment-brought on by the Bank of Israel's expansionary monetary policy-which led to a steep decrease in financial earnings from classic intermediation activity. Conversely, the banks were helped by positive developments in the domestic and foreign capital markets, which boosted their financial earnings from the capital markets and enhanced their operating revenues. The banks' operating efficiency improved this year, but this was largely due to the sensitivity of various indicators to domestic business cycles via the banks' revenues. In view of the singularity of the macroeconomic conditions and developments in regulation and risk management, the banking system is facing many challenges, foremost the creation of revenue sources that will accommodate their high level of expenses. Therefore, the banks should aim to improve their operating efficiency by examining their expenditure function and cutting their operating expenses.

As we completed the assimilation of the Basel II principles in the banking system, we continued to encourage the introduction of appropriate corporate-governance principles. The Banking Supervision Department treats this as a matter of the utmost importance due to its centrality in bolstering the public's confidence in the banking system and reinforcing the system's stability. Within this framework, I instructed the banks to prepare for the completion of an appropriate remuneration policy by the end of 2009 on the basis of principles that I set forth. The Department is monitoring the handling of this matter and intervenes where necessary. In December 2009, I instructed each bank to appoint a chief risk officer who would direct an independent risk-management function. This measure is expected to improve the banks' understanding of their risks and ensure that the risks are managed cautiously.

The new Bank of Israel Law, which went into effect this year, mobilizes the Banking Supervision Department, among other institutions, for the attainment of its objectives, including maintenance of the stability of the entire financial system and assurance of its orderly activity. For this purpose, the Department is called upon, among other things, to promote a macro-prudential policy geared to improving the financial system's resilience to shocks and alleviating the effect of the eventuation of a financial risk on the real economy. Within this ambit and as part of the Banking Supervision Department's defined objectives in the field of consumer protection, I took several measures to attenuate undesirable developments in the real-estate market and the financial system in the past year.

During the year, I instructed the banks to act with due caution when extending adjustable-rate mortgage loans. This intervention, necessitated by the increase in such lending, was meant to prevent a situation in which an upturn in interest would increase borrowers' monthly paybacks and induce payback difficulties among some borrowers. Later on, I apprised the banks of the risks posed by the activities of purchasing groups both to group members and to the banks that finance them, and I issued an instruction about the appropriate treatment of loans of this kind. In the past few months, in view of macroeconomic developments and the low-interest environment, demand in the housing market has escalated and so, in turn, have housing prices. Due to concern about the development of a real-estate bubble, I issued a draft for consultation that instructs the banks to maintain a supplemental loan-loss reserve at the rate of at least 0.75 percent on account of outstanding loans that have a loan-to-value ratio in excess of 60 percent. These actions are expected to restrain undesired developments that would ultimately harm public welfare.

The primary goal in supervising the financial system is to protect the public welfare. Such protection means, among other things, assurance of the assets that the public holds, maintenance of continuity in financial activity, and fair pricing of financial services. We will continue to make efforts to introduce international practices and standards in the banking system and at the Banking Supervision Department in order to assure the stability of the banks and the banking system and to bolster the public's confidence in them. We will also continue to supervise the quality of the banks' assets, capital, and management in order to support economic activity that relies heavily on the banking system as a main supplier of liquidity and capital.


Rony Hizkiyahu
Supervisor of Banks

Letter of the Supervisor of Banks and table of contents
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Chapter 1 - Developments in the Activity and Structure of the Banking System in 2009
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Chapter 2 - The Financial Results of the Five Major Banking Groups
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Chapter 3 - Risks and Capital Adequacy
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Chapter 4 - Activity of the Banking Supervision Department
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