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Full Report

The Bank of Israel has decided to publish a periodic Financial Stability Report on the domestic financial system, as common among central banks in advanced economies.  This decision is anchored in the definition of the Bank of Israel’s role as per the Bank of Israel Law, 5770–2010. The analysis in this report relates to events that took place until the end of June 2014.

The domestic financial system has demonstrated impressive resilience both during the global financial crisis of 2008 and following it.  However, like other countries, there is a need in Israel as well to identify and assess the systemic risks faced by the financial system and to provide warnings of such risks, and the Financial Stability Report is intended to serve this purpose.

The focus on systemic risks developing in the financial system—meaning the risks that hold the potential to significantly impact real economic activity—reflects one of the main global lessons of the 2008 crisis, since that crisis emphasized the importance of strengthening the financial system’s ability to withstand shocks and to moderate the impact of such shocks on economic activity.

The Israeli economy also went through several changes as a result of the crisis, with the objective of identifying systemic risks in the financial system and improving the ability to deal with them when necessary: The authorities supervising the financial system have tightened cooperation between them; the use of macroprudential tools to identify and handle systemic risks has been increased; the Supervisor of Banks took the initiative in the use of policy tools to reduce the banks’ exposure to the rapid increase in the volume of mortgages, and alongside this has used stress tests for banks to assess risks in the banking system. The continuing increase in coordination between all of the regulators responsible for the proper functioning of the financial system is essential for the implementation of effective macroprudential policy, and the establishment of a joint financial stability committee, as recommended by the International Monetary Fund, could contribute to this.

The report now being published includes an outline of the principal risks that the Bank of Israel has identified in the financial system.  It contains a survey of the risks in the various components of the financial system—the banks, the insurance companies, other institutional investors, the financial markets, and the payment and settlement systems—as well as four boxes that deal with the household sector, the business sector, direct loans granted by the institutional investors, and the ETF market.

The report indicates that the domestic financial market has remained stable in recent months, in a challenging global environment and in view of the low interest rates in Israel and around the world, and warns about two main risks: 

  1. Due to the high exposure of banks to the construction and real estate industry and to mortgages, and due to the sizable share that housing occupies in the household asset portfolio, the main risk to which the financial system is exposed derives from the possibility of a domestic and/or external shock that may lead to a sharp increase in interest rates and/or to a recession and a negative impact to the income of borrowers, and that would be accompanied by a sharp turnaround in the housing market.  In such a scenario, there would be a heavier repayment burden on households, a decline in borrower quality, and a negative impact on the banks’ capital ratios and profitability.  Such a scenario is expected to also have an impact on contractors and to further harm the banks’ financial results.

  2. The other risk to which the financial system is exposed, according to the report, concerns the underpricing of risks in the corporate bond market.  This risk may negatively impact the process of resource allocation in the economy, and in the case of a sharp turnaround in the markets, it may have a negative impact on pension savings, banks exposed to companies that have issued bonds, and the supply of credit in the nonbank market.