• After two years of positive trends and rapid recovery from the negative impacts of the 2008 global crisis, the domestic financial system took a turn for the worse in 2011. 
     In several respects, the financial system was in better condition in 2011 than before the 2008 crisis; in others, it was in worse condition: a low debt ratio both relative to the past and relative to other countries; a strong increase in the foreign currency reserves, higher bank capital ratios; a functioning infrastructure for debt restructuring in the corporate-bond market; and an upgraded domestic payment and settlement system. However, in contrast, geopolitical risks grew, as did the quantity of problematic debt that had to be recycled in the corporate-bond market. Additionally, the situation of the business groups-the largest borrowers in the corporate-bond market and from the banks-worsened, and there is concern about a downturn in the residential construction sector, to which the banks have been increasingly exposed in recent years.  
  • The adverse developments in the domestic financial system in 2011 were abetted mainly by increases in risks in the global macro-financial environment, due to the escalation in Europe's debt crisis, and in domestic risks: growing regional geopolitical uncertainty and concern about the implications of the social protests for the budget and for corporate profits.  
  • The intensity of the shock that struck the domestic financial markets resembled that which buffeted the markets of Europe and the emerging markets. It focused on the stock market and the corporate-bond market, both of which responded to the crisis very vigorously, reflecting concern about the implications of the crisis for firms' profitability and their ability to pay their debts on time. In the last quarter of 2011 and in early 2012, the domestic financial markets underperformed most markets abroad, evidently due to the influence of domestic risks.  
  • Risk to the domestic financial system in 2011 focused on the corporate bond market, which expanded rapidly in 2005-2007 amid deterioration in the quality of debt issued. Risk spreads widened, foremost for below-investment-grade paper, real estate bonds, and instruments issued by large business groups. In the second half of the year, bond issues tapered off and the level of problematic debts rose.  
  • The rapid expansion of the corporate bond market allowed an increase in leveraging and in risk attributable to borrowings by business groups and industries that, had it not been for the nonbank market, could not have increased their exposure at such rates. Due to the concentration of credit and the fact that the largest nonbank borrowers are also the largest users of bank credit, the banks' exposure to these borrowers also increased.  
  • After two quarters of strong earnings, the banks' profitability declined in the third quarter as market risks in their securities portfolios materialized and the state of the real economy worsened. The banks' capital ratios decreased in the third quarter-mainly, however, due to the implementation of new directives regarding employee rights and impaired debts. The banks' direct exposure to the peripheral countries in Europe is minuscule.  
  • The insurance companies posted an overall loss and their net worth was eroded in the first three quarters of the year, reflecting their acute exposure to market risks. Despite the erosion, their capital ratios at the end of the third quarter exceeded the level mandated by the Supervisor of Insurance.  
  • The rate of increase in home prices slowed significantly in the second half of 2011 and prices even fell slightly in the third quarter, after uninterrupted rapid upturns that totaled 60 percent since 2008. The moderation of price increases in the housing market came against the background of interest rate increases and macroprudential measures by the Bank of Israel, measures which the government encouraged and which were accompanied by the government's own steps to increase housing supply; and growth in the supply of dwellings in response to the increase in prices.  
  • If the global slowdown continues (and, of course, if it worsens) and if regional geopolitical risk increases further, credit supply may tighten. This, against the background of the vulnerability of the corporate bond market and preparations by the banks to raise their Tier 1 capital ratios in the coming years in order to meet international standards.  

The Financial System and its Stability - PDF file