·    The stability of the banks
and insurance companies was maintained during the period surveyed in the
report, despite the gyrations in the global financial markets and domestic
events. The banks and insurance companies continued to improve their capital ratios.

·    The public and financial
institutions are exposed to the risk that home and financial asset prices will
decline sharply as a result of global recession, a change in the interest rate
environment, an increase in Israel’s risk premium, or shocks that may lead to a
significant decline in households’ disposable income.

 The
Bank of Israel today published the semi-annual report on the stability of the
domestic financial system, and its analyses relate to events that took place
until the end of December 2016. 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 stability in recent months, against the background
of the accommodative monetary policy in Israel and globally, and despite the
gyrations in the financial markets. The banks and insurance companies remained
stable: The banks continued the trend of accumulating and strengthening
capital, the leverage level is adequate, the banking system is profitable, the downward
trend in concentration of the credit portfolio and exposure to large borrowers
continues, the rate of impaired debt is low, and there has been an improvement
in liquidity. The profitability of the insurance companies declined during the
period, mainly due to significant provisions for insurance reserves due to the
continued decline in the yield curve. But in parallel, the insurance companies
increased their recognized capital in order to meet the new repayment ability
regime.

 

Home prices in Israel continue to increase,
and in the 12 months ending in November 2016, they increased by 8.1 percent. It
is common to assess pricing in the housing market by examining prices in
relation to fundamental factors, particularly rent and wages or income. Compared
to the past, these two indices are at peak highs.

 

Since the interest rate environment has been
low for a prolonged period—a policy that is necessary in view of macroeconomic
developments—and since it is having a prolonged effect on asset prices, the
public and financial institutions are exposed to the risk of sharp declines in
home and financial asset prices. Such declines may take place if major
economies move into further recession or if their financial stability weakens,
and may infect the Israeli economy through a negative impact on exports and
financial asset prices. They may also take place if Israel’s geopolitical
situation worsens and leads to an increase in the economy’s risk premium, or if
shocks lead to a significant decline in households’ disposable income.

 

The risk of sharp declines in home prices is
derived from the fact that the banks are characteristically highly exposed to
mortgages and credit to the construction and real estate industry, as well as
to consumer credit that is correlated with these other types of credit. A sharp
decline in asset prices may lead to reduced economic activity and reduced
consumption, a process that may have a negative impact on the entire Israeli
economy. Such an impact may make it difficult for mortgage borrowers to meet
their repayments or to sell assets in order to overcome the repayment
difficulty.

 

The increase in home prices in recent years
took place in tandem with the decline in long-term yields and in mortgage
interest rates. The yield on a dwelling continues to decline, and for the first
time it declined to below 3 percent. In parallel, the yield on government bonds
continued to decline more rapidly. As a result, the gap between the yield on
owning a dwelling and the yield on government bonds widened. In contrast, the
interest rates on mortgages increased recently, and it will act to moderate the
pressure on home prices.​

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