Summary:

  • The positive trends in the local financial system continued during 2010, following the turnaround and rapid recovery from the global crisis in 2009.
  • The positive trends in the local financial system were influenced by the continuing stabilization of the global financial system in 2010. This process was hindered to some extent by the worsening debt crisis in a number of European countries during the year and by the persistent problems in the US housing market, as well as rates of growth in the developed countries that were slower than expected during the exit from a recession.
  • The low level of the interest rate in Israel and the expectation that economic activity would continue to expand, provided support for the continued increase in the prices of assets in the local markets. Thus, share prices rose to record levels while the prices of government and corporate bonds continued to rise and yields reached historically low levels, with spreads in the corporate bond market continuing to narrow. The price of housing continued to increase sharply, for the third consecutive year.
  • The resilience of the financial institutions, i.e. the banks and insurance companies, continued to improve for the second consecutive year. This was a result of the continued improvement in their capital structure, against a background of high levels of profitability and the regulatory requirements to increase their capital base.
  • During 2010, the Israeli economy experienced a major inflow of short-term capital from abroad, which primarily involved conversion and swap transactions of foreign currency into shekels and the purchase of makam. This was the result of the interest rate spread between Israel and the developed countries, in which the level of interest rates was still in the vicinity of zero.
  • The increased exposure of the economy to short-term capital inflows from abroad led to the increased exposure of the business sector to fluctuations in the exchange rate that are unrelated to the fundamentals of the economy. This represented a challenge to the managers of monetary policy and exposed the economy to the risk of a rapid outflow of capital, accompanied by a substantial depreciation.
  • The low yields on interest-bearing investments and the low rates of interest in the mortgage market intensified the demand for housing, including purchases for investment purposes, and this trend, alongside the problems on the supply side, led to a 54-percent increase in housing prices over the last three years, which has led to concern that a bubble is developing.
  • Despite the stabilization of the local financial market during the last two years, additional steps are needed to reinforce stability, primarily in view of the high level of uncertainty and fragility in the global financial system. These include continued efforts to increase the stability of the financial institutions and the management of macro-prudential policy in order to deal with risk in the financial system at an early stage, particularly the rapid increase in housing prices, and if necessary in the corporate bond market as well.