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The processes which occurred in global financial markets and in the local economy presented a challenge to Israel’s banking system and its performance in the changing risk environment. The global economy grew only slightly, and Israel’s economic growth was only 3.1 percent. Israel’s growth rate, although greater than the growth rate of advanced economies, is low from an historical perspective. Domestic developments have been accompanied by, among other things, continued appreciation of housing prices and a decline in interest rates and alternative yields in the economy, as well as by growing geopolitical threats. Against this background, the banking system continued to improve its capital adequacy in 2012 while presenting adequate levels of risk-adjusted profitability. This progress is enhancing the banking system's ability to absorb shocks deriving from global developments and from developments in the domestic economy, and thereby protect the financial assets which the public have deposited with it.

The improvement in capital adequacy derives from an integrated and complex international process, which is intended to set a new standard for strengthening the capital adequacy in the banking system (the Basel III recommendations), in view of the weaknesses that were revealed in the global financial system during recent years. The Basel III recommendations include recommendations for improving the quality and level of capital while redefining the capital components and changing the allocation of the required capital against certain assets. Given these international processes and as part of the continued supervisory effort which we have made in recent years, back in March 2012 we required the banking corporations in Israel to increase the minimum core capital ratio to 9 percent by January 1, 2015. The two largest banks, Bank Leumi and Bank Hapoalim, were ordered to increase the ratio to 10 percent by January 1, 2017. This decision was based on the need to ensure the stability of the banking system and the banks’ ability to increase their capital adequacy even as they concurrently further expand—moderately—their credit to support activity and growth in the economy. In addition, we adopted the Basel III recommendations. The target date for the adoption of these recommendations in Israel is January 1, 2014, the same as the date scheduled for their adoption in the European Union.

The very process of strengthening the adequacy, quality and level of capital poses a challenge to the banking corporations in Israel. This is because while strengthening the banking system's resilience to shocks, the process could make it difficult for them to maintain present levels of profitability over time. The banking corporations therefore have to continue increasing their operational efficiency and reach the levels typical of the banking systems in the OECD countries. An improvement in operational efficiency will enable them to continue showing adequate levels of profitability while at the same time maintaining a high level of service at a fair price to customers.

As the result of a continued series of developments in the capital market during 2012, companies in the economy were unable to repay their debt, and entered into debt restructuring proceedings. As these proceedings are liable to undermine the public's confidence in the bodies that manage their money, the Minister of Finance and the Governor of the Bank of Israel established a committee for examining debt restructuring proceedings in the economy. Regarding the risks faced by the banks, the Banking Supervision Department works on a routine basis to enhance the management of these risks—especially credit risks—and to improve credit underwriting, credit management and credit disclosure processes. In this respect, it should be noted that since January 1, 2011, banks in Israel have been operating in accordance with the regulation concerning the measurement and disclosure of impaired debts, credit risk, and the allowance for credit losses, which must reliably reflect all the losses expected in the credit portfolio even before these have been identified. In 2012, we published a Proper Conduct of Banking Business Directive concerning the credit risk management structure required of banking corporations and the allocation of authorities between the different entities within them. Subsequently, and in order to attain optimal risk management, the banks were required to improve the methods and data bases which they use for managing risks and conducting stress tests. These processes are expected to enhance the resilience of the banking system and to raise the public's confidence in it.

In recent years, the Banking Supervision Department and the banking system have acted to reduce borrower concentration in the bank credit portfolio, by cutting back exposure to large borrowers and to large business groups, and by concurrently increasing the proportion of retail credit in the credit portfolio. Moreover, prior to 2012, we tightened the limits on credit to a borrower group. These activities have yielded results and recent years have seen a decline in borrower concentration in the bank credit portfolio, reduced exposures to large business groups, and a reduction in credit granted for the purpose of acquiring means of control and other leveraged credit.

Against the background of the continued price increases in the housing market and concern over the growing risks to borrowers and lenders, a number of measures were taken. In November 2012, the LTV ratio on mortgage loans was limited in order to reduce households' leverage. In March 2013, guidelines were published concerning the capital allocation and the credit loss allowance in respect of housing loans. These guidelines were intended to augment capital cushions and the allowances required in respect of the increased risks in the housing credit portfolio. The measures in question are a direct continuation of actions taken in recent years, and are aimed at reducing the potential loss resulting from adverse developments in the housing market and an increase in unemployment, at protecting mortgage-takers and at strengthening the banking system.

In view of increased geopolitical threats and the growth of cyber crime in banking systems worldwide, we acted during the year to enhance the banking system's ability to cope with attacks of this type via the upgrade of the security, monitoring and response measures at the banking corporations and credit card companies. We also acted during the year to improve the banking system's preparedness for emergency situations. These processes enhance the banking system's ability to respond to negative developments and to rapid changes in the working environment, and thereby assist it in maintaining the continuity of banking services to its customers.

In line with the Banking Supervision Department's ongoing activity with respect to the promotion of competition and the assurance of fairness in the relations between the banks and their customers, the Team to Examine Increasing Competiveness in the Banking System—an inter-ministerial team that I headed—submitted its recommendations to the Minister and Finance and the Governor of the Bank of Israel. The team found that competition can indeed be increased and thereby enhance the power of the retail customer and improve his position, by taking measures in three areas: structural measures for increasing the number of players within and outside the banking system in the medium and long terms; measures to increase the competition between the existing players, including a reduction of transition barriers and information gaps, and increasing transparency and fairness; and complementary measures including regulatory involvement for the purpose of solving market failures by means of price supervision and tighter enforcement. The team also focused on measures that will improve the access to credit and banking services for the small businesses segment, a segment that makes a considerable contribution to the economy. The Banking Supervision Department is promoting the team's recommendations and has already applied some of them.

To conclude, I will note that we are facing a dynamic and very eventful period, with developments that could have major implications for the banking system in Israel: the rapid change of banking regulation worldwide and policymakers' growing involvement in the management of the banking corporations’ business activity. These present challenges to the banks in Israel, because they make it necessary for them to operate in accordance with international standards and to be aware of developments in the local economy and responsive to public sentiment, while doing their utmost to improve the banking services which they offer.


David Zaken
Supervisor of Banks