Excerpt from the forthcoming Annual Survey of Israel’s Banking System:

Macroeconomic Stress Tests for the Banking System, 2018

  • The Banking Supervision Department carried out a macroeconomic stress test for the banking system again this year, as is the practice in other countries. The test is based on a uniform scenario and its goal is to determine whether the banks can absorb the losses in an extreme macroeconomic event without endangering their stability and the deposits of the public.
  • As part of the stress test, each bank estimates the results of the scenario using a variety of models and methods that are commonly used in the industry, and in parallel the Banking Supervision Department carries out the test for each one of the banks using a uniform method.
  • The stress test is carried out under several assumptions that affect the results of the scenario, including: static balance sheet, no additional raising of capital; and no account taken of actions that the banks’ management is likely to take in response to the crisis in order to minimize damage.
  • Each year, the Banking Supervision Department builds a different macroeconomic scenario, with the goal of examining the resilience of the banks and of the banking system as a whole to various economic developments. This year, the Banking Supervision Department chose to test the resilience to a severe domestic macroeconomic scenario resulting from geopolitical events that lead to an increase in the interest rate in the economy, together with a major crisis in the housing market and the collapse of a large business group of borrowers. The scenario is based on estimates and models and is not a forecast.
  • The results of the test show that the scenario will have a considerable impact on the banking system and although some of the banks will suffer losses, the scenario does not threaten the banking system’s stability and resilience. The Common Equity Tier 1 Capital ratio of the banks is not expected to decline below the minimum required by the Banking Supervision Department in a stress scenario. Similarly, it is found that the banks’ capital ratios in the scenario are higher than those in previous stress tests, which were used by the Banking Supervision Department to estimate their resilience.
  • This result, which is evidence of the banks’ stability even in a stress situation, reflects the efficacy of the requirements imposed by the Banking Supervision Department in recent years to strengthen the banks’ stability and in particular to reinforce their capital. This is in addition to steps that resulted in more conservative risk management, including a significant reduction in the exposure of the banks to large and leveraged groups of borrowers, an improvement in the characteristics of the housing loan portfolio and the improvement in the profitability of the banks due to increased efficiency.
  • The main losses in the stress test this year were in the credit portfolio, which is the main domain of activity of the banks in Israel. Another source of losses in the stress scenario this year was the securities portfolio, primarily due to the sharp rise in interest rates.
  • Although this stress test indicates that the system maintains its stability, this has not led to complacency. The system is exposed as well to a variety of risks that have intensified in recent years, including operational risks, and in particular cyber and technology risk, which call for an examination of the system’s stability in facing risks of that type.