The final assessment of the level of the economy’s financial stability is based on the conclusions from all three pillars together (see figure). The assessments and analyses in the report are based on a review of the economic and financial developments, an examination of the financial system’s structural characteristics, analytical models (including simulations and stress tests), findings from the Financial Stability Monitor and the assessment of the most updated background conditions in the Israeli and foreign economies. The report presents the risks whose realization is liable to markedly impact on the economy in the short term and medium term, with the goal of enhancing awareness of them among policy makers and the public and to allow appropriate preparations.
In the assessment of the economists in the Bank of Israel’s Finance Division, the magnitude of the risk to financial stability in the reviewed half year was Medium-High.
The coronavirus pandemic, which broke out during the half year reviewed, presented an extreme challenge to the financial system. Due to the solid state of the economy prior to the crisis—reflected in historically low rates of unemployment, continued growth above its potential rate, the high level of resilience in the financial system and close supervision of the financial system—the financial system is facing the event and continues to function. However, the configuration and pace of the recovery from the crisis are critical. A lack of employment security, high rates of unemployment and uncertainty in the labor market will lower the public’s expectations of their future income, and this can be expected to lower demand in the economy. The public’s wealth, which has been eroded as a result of the declines in the prices of financial assets, is also expected to negatively impact private consumption in the economy. Investment by the business sector, which was low in international comparison even prior to the crisis, is not expected to improve and the impact of global development on foreign trade will continue to weigh on the Israeli economy even if it recovers relatively quickly.
In the early stage of the coronavirus crisis, the uncertainty as to the severity of the adverse impact of the virus’s spread generated a major shock to the dynamic of the financial markets, thus creating a liquidity shortage in the major markets and raising notable concerns about the continued orderly provision of credit by the financial institutions. In response, the Bank of Israel took a range of steps intended to restore the markets to full functioning, to ensure that the financial institutions have sufficient liquidity and to provide households and businesses with access to credit. From a short-term perspective, it can be said that the steps taken by the Bank of Israel, against the background of the steps taken worldwide, succeeded in eliminating much of the panic in the markets and restored them to proper functioning.
The main and most imminent risk scenario is an increase in infections, limitations on movement and lockdowns, and with them a further increase in the severity of the adverse impact on economic activity. The ramifications of such a wave include an adverse impact on borrowers’ repayment capacity, particularly borrowers who deferred their repayments, the need for another wave of government incentives, the implementation of which will lead to a deterioration of the fiscal picture, and a further increase in uncertainty.