Effects of Macroeconomic Stress Scenario on Housing Credit
Excerpt from the forthcoming Annual Survey of Israel’s Banking System:
Effects of Macroeconomic Stress Scenario on Housing Credit:
The expected impact of a sharp increase in the interest rate and in unemployment on mortgages borrowers and on banks
- This year, as well, the Banking Supervision Department conducted a macroeconomic stress test for the banking system, as commonly done around the world. The test is based on a uniform scenario applied to all banks, with the goal of contributing to understanding the focal points of risks to which the system is exposed. It is based on assessments and models, and does not constitute a forecast. (For more information, see box "Macroeconomic stress tests for the banking system, 2018".)
- As part of this test, we extensively reviewed risk in the housing credit portfolio, based on granular data (at the individual loan level). Housing credit is a significant focal point when examining the risk faced by the banking system. This is due to the strong correlation with the construction and real estate industry, which may exacerbate loss due to feedback effects, and due to the significant share of this portfolio out of the entire banking credit portfolio, due to the rapid expansion of housing loans in the past decade.
- The share of the housing credit portfolio out of total credit extended by banks has gradually increased in recent years, but from a global perspective, the ratio of household housing debt to GDP in Israel is lower than in other advanced economies.
- This year's stress scenario reflects two key influences on borrower repayment capacity—a marked increase in interest rates (by 5 percentage points) and rising unemployment (to 9.3 percent).
- The test outcome, similar to those of previous stress tests, indicates that risk in the housing credit portfolio remains low compared to other credit segments and that the portfolio’s quality has even improved in recent years.
- The improved quality and lower risk in the mortgage portfolio are due to stricter criteria applied to mortgage origination (underwriting), based on directives issued by the Banking Supervision Department over the years (with regard to the loan to value ratio (LTV), payment to income ratio (PTI), restrictions on adjustable interest and so forth).
- The test further indicates that the higher interest rates in the scenario have a significant impact on all mortgage borrowers in the market, due to the more onerous debt to income ratio—higher by 20 percent on average. However, only a small share of borrowers reach default due to the higher monthly payment associated with the higher interest rates. This is the outcome of a range of macroprudential measures applied over the years with regard to housing credit, and in particular—measures designed to reduce borrower exposure to higher interest rates.
- The increase in unemployment (by a considerable rate, in the scenario) is the key cause of borrower default: this increase would result in 5 percent of mortgage borrowers having difficulty making their debt payments, and those with lower income are the most vulnerable.
1 Bottom two quintiles in net income: Households with net monthly income of up to NIS 10,612.