BANK OF ISRAEL
January 18, 2016
Press Release
The Bank of Israel publishes the semi-annual Financial Stability Report
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The domestic financial system has continued to demonstrate stability in recent months, against the background of accommodative monetary policy in Israel and abroad, and despite the gyrations in the global financial markets.
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The financial system is exposed to the risk of declines in asset prices as a result of an increase in yields if the latter is derived from an increase in the risk premium or if it is accompanied by weaker growth than previously estimated. In particular, the high exposure of banks to the construction and real estate industry and to mortgages remains a risk.
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The financial system is also exposed to the risk of international financial contagion. A series of examinations presented in the report leads to the conclusion that a potential crisis originating in the gyrations being experienced by the Chinese economy, commodity price declines, or the balance of the emerging markets that have borrowed high amounts abroad, particularly in foreign currency, can be expected to have only a limited effect on Israel, on condition that it does not spread to the advanced economies and does not become a global crisis.
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There is a box in the report regarding the issue of shadow banking, which emphasizes the importance of balanced prudential supervision of the shadow banking institutions, in addition to consumer oversight, mainly over entities that provide their own financing through the issue of bonds to the public.
The Bank of Israel is today publishing the semi-annual report on the stability of the domestic financial system. The analyses in the report relate to events that took place until December 2015. The publication of the Financial Stability Report is anchored in the definition of the Bank of Israel’s role pursuant to the Bank of Israel Law, 5770–
2010—to support the stability and orderly activity of the financial system—and is accepted practice among the central banks of advanced economies.
The Financial Stability Report includes a survey of the risks to financial intermediaries at the core of the financial system—the banks and insurance companies—and a survey of the risks faced by the nonfinancial business sector and households, and the exposure of the financial system to these risks. According to the report, notwithstanding the gyrations in the global financial markets, the stability of the banking system and the insurance companies has been maintained. In the first three quarters of 2015, the profitability of the banking system increased, and the capital ratios of the five major banking groups increased as well. The profitability of the insurance companies declined during that period, but their recognized equity increased. The report presents a box on the issue of shadow banking, which emphasizes the importance of balanced prudential supervision of the shadow banking institutions, in addition to consumer oversight, mainly on entities that provide their own financing through the issue of bonds to the public. Appropriate prudential supervision has the power to reduce the risks inherent in shadow banking, and to
The Bank of Israel publishes the semi-annual Financial Stability Report (Jan. 2016)

make it possible for the economy and the public to safely benefit from the advantages of such activity.
The domestic financial market continued to demonstrate stability in recent months, against the background of accommodative monetary policy in Israel and abroad, and despite the gyrations in the global financial markets. However, the financial system is exposed to two significant risks:
1.
The financial system is exposed to risk derived from the low interest rate over time. Similar to other advanced economies, the low interest rate and flattening of the yield curve in Israel have led to a sharp increase in asset prices, which has created risks. These risks may be realized in certain scenarios where the interest rate is increased. While, an increase in yields globally and in Israel is excepted to come against the background of healthy growth, if that growth is weaker than previously estimated, or if yields increase as a result of an increase in the risk premium, asset prices may decline, which will negatively impact investors, including the financial entities.
In particular, the financial system’s exposure to the housing market constitutes a significant risk, because the banks continue to have significant exposure to the construction and real estate industry and to mortgages. However, the limitations imposed by the Banking Supervision Department in recent years, are intended to reduce the risks that borrowers will face difficulties in making their mortgage payments, and to reduce the risks to the financial system derived from the housing market. And indeed, it seems that there is a continuing improvement in the quality of the housing credit portfolio. In parallel, the financial system is exposed to financial asset prices both directly through holdings in such assets, and indirectly through the effect of these asset prices on the ability of companies to service the debt they have received from the banks and institutional investors.
2.
The financial system is exposed to the risk of international financial contagion— the spread of sharp price declines in the markets from other countries to Israel.
The focus of risk to global financial stability has shifted from the advanced economies to the emerging economies. In particular, the risks derived from the
Chinese economy, from the continued decline in commodity prices, and from the emerging markets with high foreign currency debt, have come into sharper relief.
A series of examinations presented in the report leads to the conclusion that a possible crisis due to the gyrations being experienced by the Chinese economy, the decline in commodity prices, or the balance of emerging markets that have borrowed large amounts abroad, particularly in foreign currency, can be expected to have only a limited effect on Israel, on condition that it does not spread to the advanced economies and does not become a global crisis. Among the three risks examined, the risk of a crisis in China, which may spread to countries that have trade relations with China, was found to be more significant from Israel’s standpoint than the risk of a decline in commodity prices or the risk of a debt crisis. Among the potential contagion channels examined, the export channel was found to be more risky, particularly if a crisis in the countries at risk is accompanied by a significant depreciation of their currencies vis-à-vis the shekel.
The Bank of Israel publishes the semi-annual Financial Stability Report (Jan. 2016)