The increase in demand for credit, the banks’ manner of assisting customers during the coronavirus crisis, and the main factors in the increased interest rates on bank credit
· The coronavirus created a global macroeconomic crisis, which impacts almost every business and household, as well as the banking system. The impact on banking areas is reflected in, among other things, a marked increase in demand for credit and in parallel an increase in interest rates on some credit to the public. The Bank of Israel understands well the difficulties deriving from the situation and is working through numerous channels to make things easier for households and the business sector during these times. The banking system is also enlisting for the public’s benefit and is taking a proactive, but cautious, approach with the goal of assisting households and businesses at this time—within this framework the banks are continuing to extend credit to the public at considerable scopes in view of the high demand from all the borrowers (large and small businesses, and households) and are allowing the deferral of mortgage payments and businesses’ loan repayments by several months.
· The interest rate on bank credit is impacted by several main factors: the risk-free interest rate in the economy for the relevant term (the Bank of Israel interest rate for short terms, Israeli government bond yields for long terms); the banks’ cost of raising resources (the spread between bank bond yields and parallel government bonds); the risk premium of the customer—the household or the business that is taking the loan; and an additional spread which is impacted by the level of competition in the economy, among other things.
· In recent years there has been a prolonged decline in government bond yields, and with the onset of the crisis their level was low from a historical perspective. With the beginning of the crisis, government bond yields in Israel increased sharply, and in addition the bank bond spreads rose to relatively high levels. For example, the 10-year government bond yield increased by 0.6 percentage points since the outbreak of the crisis, and the bank bond spread increased by an additional 0.4 percentage points. Note that the Bank of Israel’s decision to purchase government bonds totaling NIS 50 billion moderated the increase in yields recorded since the beginning of the crisis. The sharp increases in yields and spreads impacted directly and immediately on the interest rate on bank loans to households and businesses.
· In parallel, the level of risk in the overall economy increased. The steep rise in the number of unemployed people and the effect of the economic closure increase the risk that households will encounter difficulties in repaying the loans they took out. In addition, the difficulties faced by companies in a range of industries increase the risk in extending credit to businesses. Of course the risk level is not uniform, and it varies among industries and businesses in accordance with the effect of the crisis on the businesses. The risk is that there will be borrowers who will be unable to make their loan repayments, and banks’ credit losses will increase markedly relative to the starting point right before the crisis. Some indication of the possible losses can be seen in analyses published by the Banking Supervision Department in recent years in regard to stress scenarios.
· Against the background of all these factors, the Bank of Israel expects the banks to price the loans as reflecting the risk that increased and the rise of the cost of raising resources, and to avoid to the extent possible increasing interest rates beyond what is derived from that. The Bank of Israel follows the developments on an ongoing basis.
· Note that the assistance from the Bank of Israel and the banks to households and businesses in deferring loan repayments or through increasing credit helps borrowers at this time, but in parallel, and more than that, there is great importance in government assistance at this time, for example through funds for extending credit to small and medium sized businesses and through other ways that are planned within the framework of the government economic plan.
Within the framework of dealing with the spread of the coronavirus, many countries worldwide, including Israel, are taking extensive steps to moderate the pace of the spread of the coronavirus and even to halt it. These steps lead to the shut-down of many industries. The various limitations on the labor market led to many employees being placed on unpaid leave or encountering a situation of unemployment. Thus, from the beginning of the crisis, more than 780,000 new work-seekers registered at the Employment Service. The coronavirus created a global macroeconomic crisis, which is reflected as well in capital markets, which are pricing in the increasing risk in the economy as well as the lack of certainty regarding the continued developments which characterized this crisis. The high risk also impacts on the pricing of resources for the banking system, as well as the pricing of loans to the public.
In order to assist at this time households and businesses that are the banking system’s borrowers, the Bank of Israel sent the banking system a clear message, according to which it can continue to offer credit to those who on the eve of the crisis were creditworthy borrowers (who had a reputation for repaying debts) and who are expected meet their loan repayments when the crisis ends, as well as to assist these borrowers by deferring payments and rescheduling loans, even at the cost of eroding the banks’ capital cushions. In parallel, the Banking Supervision Department announced on March 29 that it will reduce the banks’ required capital adequacy ratios by one percentage point, and at the same time called on banks to halt the distribution of dividends in order to increase the sources of capital that will subsequently be available to the banks for providing credit. At this time, companies are facing great difficulty in raising funds from the capital market, many nonbank entities have stopped extending new credit to households and to small businesses, and the banking system is filling a central role in assisting the economy to get through the crisis. Thus, from the beginning of March, the banking system has extended credit to the public at a scope similar to the scope of credit during routine times in the banking system over several quarters. In addition, the banking system is working via additional channels to make things easier for borrowers. For example, all the banks are enabling households with a mortgage to request to defer payments by 3–4 months. The average monthly mortgage repayment is approximately NIS 5,000 per household in Israel, and therefore this is a deferral of payments and a reduction in household expenses of NIS 15,000–20,000, on which the household pays interest, which is a low interest rate compared to other loans existing in the market. Due to this possibility, the demand for deferring mortgage payments increased sharply—to date, approximately 55,000 households received an approval to defer mortgage payments, and the assessment is that by the eve of Passover (which begins April 9) the number will increase to over 140,000 households. The banks prepared in a short time to increase the efficiency of the process for handling the numerous requests, despite the reduction in the number of employees in the banking system against the background of the limitations and health aspects, and thus, within a few days each customer receives a final answer about the bank’s decision related to the request. A similar process is carried out vis-à-vis business customers—for whom the banks defer loan repayments and coordinate a financial response for the situation of each customer. Note that customers who were in a problematic economic situation before the crisis, or that did not make their payments to the bank, are customers at high risk to whom the banks cannot extend additional credit.
The interest rate on bank credit is impacted by several main factors: the risk-free interest rate in the economy for the relevant term (the Bank of Israel interest rate for short terms, Israeli government bond yields for long terms); the banks’ cost of raising resources (the spread between bank bond yields and parallel government bonds); the risk premium of the customer—the household or the business that is taking the loan; and an additional spread that represents the bank’s profit, which is impacted by the level of competition in the economy. During this challenging time, in view of the numerous health and other impacts, borrowers’ risk has increased markedly, and a significant increase in credit losses is expected, in view of the sharp decline of activity in the economy, the increased uncertainty overall around the economy at this time, and in particular the unprecedented increase in the number of employees and companies whose income has been adversely impacted. The increase in the risk is also reflected in the increase in corporate bond spreads in the various industries (Figure 1). In addition, there is a marked increase in the cost of banks’ sources of funding, which have gone up markedly in view of the developments in the capital market.
Corporate bond yields, including those of banks, depend on the price of government bonds plus a risk premium. Since the beginning of the crisis, in addition to government bond yields, which increased markedly and rapidly, bank bond spreads increased to high levels (Figure 2). Thus, for example, the 5-year government bond yield increased by 0.4 percentage points since the beginning of March, 10-year government bond yields increased by 0.6 percentage points over the same period, and bank bond spreads increased by approximately 0.4 percentage points (Figures 3 and 4). All these sharp increases impact directly and immediately on the cost of loans. Note that the decision by the Bank of Israel’s Monetary Committee to purchase government bonds totaling NIS 50 billion moderated the increase in yields considerably, but did not offset them completely.
The impact of the increased cost of funding sources for the banking system is expected to be more significant the longer a loan’s term to repayment is. Thirty-five percent of unindexed bank credit (which makes up about 80 percent of bank credit) is for a term to repayment of up to 1 year, 30 percent is for a period of up to 5 years, and the remaining 35 percent is for a period exceeding 5 years. The longer the period to repayment of the loan is, the more financing the loan depends on bonds and less on the public’s deposits (deposits are for shorter terms, and are therefore less expensive for the banks), and the yield on bonds in the capital market is higher the longer the term to maturity. The past years were characterized by a continued decline in government bond yields, which was seen in a marked decline in interest rates on bank credit. This connection is particularly notable in the mortgage market, as they are for longer periods to repayment.
Against the background of all these factors, the Bank of Israel expects the banks to price the loans to reflect the risk that increased and the rise of the cost of raising resources, and to avoid to the extent possible increasing interest rates beyond what is derived from that. The Bank of Israel follows the developments on an ongoing basis.