Full Study (Hebrew)

·         This study provides an empirical analysis of the characteristics of the two main interest rate markets in Israel—the Telbor market and the makam market—in order to support the selection of the preferred platform for setting the reference interest rate.
·         The main finding of the study is that the Telbor rate is more informative than the yield to maturity derived from the makam series, and more efficiently reflects the prevailing short-term interest rate on each business day.
·         An important characteristic of the Telbor market is the banks’ commitment to execute transactions on the basis of published quotes, which serve to set the interest rate, as opposed to the global Libor market, where the quotes are indicative and not binding.
 
A new study by Dr. Roy Stein of the Bank of Israel Research Department examines the functioning of the Telbor market as a reference rate market, both compared to reference rates in the Libor market and compared to the yield on makam.  The reference markets—not only the fixed or variable nominal interest rates, but also the rates that vary over longer and predefined terms—are an important and central feature of the capital markets around the world, through which the financing possibilities for the business sector can be increased.  The reference rate is also the foundation for the interest rate derivative market, where companies and the public can minimize, and even neutralize, interest rate risks.  The main objective of this study, which deals with market structure, is to determine which of the two main interest rate markets in Israel—Telbor or makam—is the preferred platform for determining the reference rate in Israel.
 
In most economies, there are two common types of financial products based on the reference rate: (1) Deposits, loans and bonds at floating nominal interest rates for various terms; and (2) Interest rate derivatives.  In Israel, as opposed to many other advanced economies, activity is currently conducted only through nontradable derivative financial instruments.  It is important to note that even though activity in interest rate derivatives based on the Telbor rate has increased significantly in recent years, and even surpassed the widespread activity in foreign exchange derivatives, it is low by international comparison, and additional financial products based on the reference rate, commonly accepted around the world, have not yet been developed in Israel. These differences indicate the under-use of financial defenses against interest rate risk in Israel relative to the average among advanced economies.
 
In contrast to the Libor rate, there is a commitment in setting the Telbor rate to execute certain transactions (transactions that are, as much as possible, clear of credit risk) in accordance with the quotes that serve to determine the interest rates each business day.  This commitment creates a well-defined anchor for the Telbor interest rate, which is the most beneficial for representing risk-free interest rates, and which does not expose investors to the risks of the banking system. Therefore, the market structure in which the Telbor rate is set is a more appropriate reference than that of the Libor market for other financial products and assets.
 
As part of the study, an international comparison was made, based on a number of indices, to assess the relative level of development of the capital market in Israel.[1]  According to these indices, the level of development of the stock market in Israel is relatively good.  In contrast, the domestic debt market, and particularly the interest rate derivatives market, is not highly developed.  These differences point to the possibility that continued development of the capital market in Israel, particularly the reference rate market, will contribute to long-term economic activity, both by increasing the variety of sources of credit, and by reducing interest rate risk in the market.
 
A comparison of the Telbor rate to the yield-to-maturity of makam found that from the second half of 2010 to the beginning of 2015 (the end of the sample period in the study), the 3-month Telbor rate was similar to the yield on the makam term closest to 3 months.  The spreads between them were small and random.  However, there is a marked difference between the development of the Telbor interest rate and the makam yield.  The high standard deviation found in the makam series, in addition to the negative serial correlation of the daily changes in that series, make it difficult for the makam market to provide stable and credible reference rates.  It was also found that the Telbor rate is a leading indicator of makam yields, and reacts more rapidly to new developments and trends in the market.  Therefore, the study concludes that the 3-month Telbor rate is more informative, and more efficiently reflects the prevailing interest rate in the economy on any business day.
 
In order to continue contributing to economic activity in Israel, and particularly in order to enable the business sector to increase the variety of credit alternatives, lower the cost of credit and reduce the inherent interest rate risk, it is important to continue to develop the Telbor market, while regulators continue to monitor activity in this market, particularly in view of the manipulations of the Libor market abroad.

[1] There are many different indices for the level of development of the capital market, and these can be divided into four categories: 1. Depth indices—the size of the financial institutions and the volume of the capital and money markets; 2. Access to the market—level of access by individuals (households and firms) to financial services; 3. Efficiency of the financial intermediaries and the capital market—making access to sources of financing and the allocation of sources easier; and 4. Stability—the stability of the financial institutions and the capital market.