- In the last year, the financial system in Israel continued to maintain its strength and strengthen its stability against the background of the low interest rate environment and supportive macroeconomic conditions—a higher growth rate than in the previous four years, a decline in the unemployment rate, and the expansion of private consumption.
- The financial system’s exposure to the housing market continues to pose the main significant risk. However, in recent months, there has been some apparent moderation in activity and in the pace of price increases, and if this continues, it will lower the risk.
- Against the background of the high liquidity in the markets and the search for returns, the yield spreads on corporate bonds continued to decline, to all-time lows. Furthermore, there was a significant increase in the volume of bond issuances, and mutual funds recorded significant net new investment and increased their share of the bond market.
- The continued growth in consumer credit to households exposes them to the risk of default as a result of a worsening in economic conditions. The realization of this risk will have a negative impact on the financial system to a certain extent. Competition in the industry is expected to increase, which may lead to further growth of this credit.
The Bank of Israel today published the semi-annual report on the stability of the domestic financial system. The report analyzes events that took place during the first half of 2017.[1] The publication of the Financial Stability Report is anchored in the definition of the Bank of Israel’s functions pursuant to the bank of Israel Law, 5770–2010—to support the stability and orderly activity of the financial system—and it is common among the central banks of advanced economies. The Financial Stability Report includes a survey of the risks to financial intermediaries at the center of the financial system—the banks and insurance companies—and of the risks to the nonfinancial business sector and to households. It also examines the financial system’s exposure to these risks.
According to the report, the domestic financial system maintained its strength and continued to strengthen its stability against the background of the low interest rates and supportive macroeconomic conditions—a growth rate higher than the average of the previous four years, a decline in the already low unemployment rate, and expansion of private consumption. With that, an assessment of the systemic risks to the economy shows that the financial institutions and households continue to be exposed to the risk of a possibility that there may be a sharp decline in home prices. Housing credit and credit to the construction and real estate industry as a share of total domestic credit to the nonfinancial private sector increased from about 37 percent in 2008 to about 52 percent in 2016, although the growth rate moderated significantly in the past year.
The risk is increasing in view of the large exposure to nonhousing consumer credit, which is highly correlated to housing credit. In the event of a shock leading to a sharp increase in the interest rate or a significant negative impact to borrowers’ income, with a sharp decline in home prices, it may have an effect on the stability of the financial system, and particularly the banking system within it.
However, in recent months, there has been some moderation in activity in the housing market. This is apparent in the more moderate pace of home price increases, some decline in the volume of residential housing transactions for both new homes and second-hand homes, a significant decline in investors’ share of housing transactions, and a continued decline in the number and volume of mortgages issued each month since June 2015. The factors that have apparently influenced the decline in activity include the increase in mortgage interest rates, against the background of the regulatory measures instituted by the Banking Supervision Department, and the taxation measures adopted to rein in investors—the increase in purchase tax and the taxation of third apartments.[2] A continuation of the apparent moderation in activity in the real estate market and in the pace of housing price increases in recent months will lead to a decline in the risk level of the financial system.
In addition, the report shows that the continued significant increase in nonhousing credit to households may expose the financial system to credit risks on the part of households, particularly if the upward trend continues as a result of, inter alia, the reform being implemented due to the Increased Competition in Banking and Other Financial Services Law. This reform, which includes a number of measures intended to increase competition in the credit market, is expected to change the structure of the market, and may significantly increase credit to households, as well as debt repayments.
Against the background of the high liquidity in the markets and the search for returns, the yield spreads on corporate bonds continued to decline, reaching all-time lows. There was also a significant increase in the volume of bond issuances, and mutual funds recorded significant net new investment and increased their share of the bond market. The high corporate bond prices expose the financial system to a greater risk of a turnaround in the trend accompanied by a sharp decline in prices. A scenario that would lead to a turnaround in the trend of corporate bond prices will also lower the cost of shares.
There has been high growth in the import and sale of new vehicles, and the issue of financing such purchases has attracted a lot of attention, both because of household exposure to this industry and due to business sector exposure. Since 2008, the rate of new vehicle purchases by private customers has increased at the expense of purchases by corporations and rental companies. This has led to a diversion of financing for this activity from business credit to household credit, as households leverage themselves through bank or nonbank loans, including from the leasing companies, in order to finance the purchase. However, the direct effect of difficulties in this industry would be limited and would not constitute a prudential risk to the entire financial system, even though exposure in 2016, particularly of the credit card companies, but also of the banking system and the institutional investors, was not negligible. The total exposure of the financial system to this credit area in the third quarter of 2016 was NIS 39 billion.
[1] The data are up-to-date to varying degrees based on their availability at the time of publication.
[2] As of the date of the Report, the Supreme Court is discussing appeals concerning the legislative process of the Multi-Dwelling Tax Law.