The Bank of Israel has published its semi-annual Financial Stability Report for the banking system. Its analyses apply to events that took place up until the end of June 2016. The Bank of Israel's main concern about the banks is regarding the real estate market and housing prices and their effect on the Israeli financial system.
The Financial Stability Report includes a review of the risks for financial mediators in the center of the financial system - the banks and the insurance companies - and the risks for the non-financial sector and households. It also examines the financial system's exposure to these risks.
According to the report, the local financial system has maintained its stability in recent years, given the expansive monetary policy prevailing in Israel and worldwide, despite the upheaval in the financial markets and continued local security events. Stability of the banks and insurance companies was maintained: in 2015, profitability rose, mainly as a result of individual one-time developments. The capital ratios of the five largest banking groups also rose.
An extreme macroeconomic test for the banking system shows that if a severe recession occurs in Israel, the banking system will remain stable. The insurance companies' profitability has declined, but their recognized equity increased.
Since the interest rate environment has already been low for a prolonged period - a necessary policy given the macroeconomic developments - and since it is having a long-term effect on property prices, the financial institutions are exposed to risk resulting from steep falls in the prices of housing and financial assets. Such a drop is liable to occur if the world's key economies experience another recession, or become financially unstable, and this spreads to Israel by affecting exports and the prices of financial assets. It could also occur if the central banks institute a rising trend in interest rates, regardless of whether Israel's geopolitical situation worsens, leading to an increase in the economy's risk premium.
Housing market - the main threat to stability
In its review, the Bank of Israel focuses on the housing market, describing the main trends in it. "The risk of sharp declines in home prices is derived from the fact that the banks are characterized by high exposure to mortgages and to the construction and real estate industry," the Bank of Israel's economists write. "The risk of declines in the prices of financial assets is derived both from the possibility of a direct impact - through holdings of those assets - and from the possibility of an indirect impact, through the effect of these asset prices on firms’ abilities to repay loans they took out from banks and from institutional investors, due to the difficulty of selling many properties within a short time."
The Bank of Israel economists mention that housing prices rose 7.8% in the 12 months beginning in April 2015. Prices have gone up 110% since the end of 2007, and "only when the market sat on the fence because of uncertainty (in the second half of 2011, following the social protest, and in mid-2014, following the never-implemented 0% VAT plan) did prices decline for several months."
The Bank of Israel economists also pointed out that the number of building starts "remained stable in recent months, and has been at the existing high level since mid-2013 more than 45,000 housing units per year. On the other hand, the inventory of unsold housing units is clearly on an upward trend, amounting to almost 27,000 in March. Since the pace of annual sales of firsthand housing units is over 30,000, the inventory of housing units is suitable for the coming year. Assuming that the high level of housing starts persists, however, this inventory could increase, unless the rate of sales speeds up substantially, as it did in late 2014, when the inventory reached a peak.
"The increase in the housing inventory in recent months is taking place simultaneously with a continued rise in prices, and it is therefore possible that the contractors believe that lively activity in the market will continue."
The Bank of Israel economists then discuss events in the mortgages market: "The lively activity in the housing market is affecting the rate at which mortgages are taken. This rate rose this year, with mortgages averaging NIS 5.25 billion a month over the past year, compared with NIS 58.3 billion over the preceding year (June 2014-June 2015). The risk indices for the new mortgages remained stable at low levels, but the interest rate on those mortgages rose."
Published by Globes [online], Israel business news - www.globes-online.com - on July 27, 2016
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