The real estate market presents the main risk to Israel's financial system, the Bank of Israel says in its Monetary Report for the second half of 2014, released today. This continues the line taken by the central bank in its recently published Financial Stability Report.
The Monetary Report states that the members of the Monetary Committee, which sets interest rate policy, estimate that "the primary financial risk originates from the housing market," but adds, " the steps taken by the Supervisor of Banks in recent years are working to constrain that risk in view of the significant improvement in the risk characteristics of mortgages."
The Monetary Report states explicitly that the Bank of Israel is concerned that a rise in interest rates could make it difficult for mortgage takers to make their monthly repayments: "One of the main risks to financial stability created by the low interest rate environment involves the stimulation of demand for credit and the fear that when the interest rate eventually begins to rise borrowers will find it difficult to repay their debt."
The report also mentions a fall in the risk level in the home mortgage market thanks to the mix of the banks' mortgage portfolios, and a fall in the loan to value ratio, again as a result of the mortgage restrictions that have been introduced by the Supervisor of Banks in recent years. The Bank of Israel admits that the rise in the mortgage market has been a factor weighing against reducing the interest rate, but says that the mortgage restrictions give it greater room for maneuver.
"The quantity of mortgages continued to grow at a high rate but their risk profiles were less risky as a result of various directives issued by the Supervisor of Banks in recent years. In particular, there was a moderate decline in the loan-to-value ratio and in the ratio of monthly mortgage payments to income… The continued increase in housing prices does not provide support for maintaining a low interest rate environment; however, the steps taken by the Supervisor of Banks reduce the risk to households and the banking system of default on mortgages. Thus, these measures provide monetary policy makers with greater room to maneuver in order to adopt measures that will achieve the Bank’s main goals, i.e., to support a rate of inflation that is consistent with its target and which supports economic activity," the central bank writes.
Another risk mentioned by the Bank of Israel is the corporate bond market and the low spreads on corporate bonds. The low rate of interest on its own should not affect the level of risk of bonds; however during a period of low rates of interest investors tend to search for investment channels with higher returns and this reduces the spread of risky assets. Therefore, the spreads on bonds constituted a consideration against reducing the rate of interest," the report states.
On the whole, the Bank of Israel sees the drop in the price of oil as favorable for the Israeli economy, both directly by reducing energy costs, and indirectly by raising global demand: "the economy's principal export destinations are oil importers," the report notes. The only major drawback the Bank of Israel finds is a possible loss of incentive to explore for new Israeli gas fields and to develop existing ones.
Published by Globes [online], Israel business news - www.globes-online.com - on February 2, 2015
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