Italians protesting - AP - 07102011
Italians protesting against planned austerity measures in Rome last month. Photo by AP
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Steps must be taken to minimize the risk of a crisis situation developing, to identify early warning signs of this occurring, and reduce the economy's vulnerability, as well as move swiftly to take proper action if a crisis does develop. These are the lessons that need to be learned from recent experience, according to a report issued Wednesday by the Bank of Israel: "Israel and the Global Crisis of 2007-2009." The report was prepared by the bank's governor Prof. Stanley Fischer, deputy governor Dr. Karnit Flug, and former deputy governor Prof. Zvi Eckstein.

"There are numerous lessons to be learned from the crisis that are relevant to policy issues," the report says. "The process of determining these lessons and implementing them is still ongoing, both in Israel and worldwide. Emphasis is being placed on the need for macroprudential policy for maintaining financial stability and reducing the risk of a crisis. Such a policy should be based on an integrative view of the financial system and the interrelationships among its various components.

"In addition, the importance of a high level of capital adequacy is being emphasized alongside the need to improve risk management in all financial institutions and the regulation of those institutions," the report continues. "In particular, there is increasing awareness of the importance of supervision of non-bank entities, instruments and markets."

While the report addresses the watchdogs, the central bank believes that overall responsibility for financial stability should be concentrated within itself. Moreover, it concludes that supervision of the stability of all financial institutions should be added to its responsibilities. "This, for various reasons, takes into consideration the need that has arisen throughout the world for central banks to inject liquidity to non-bank financial entities - having proved themselves as the lenders of last resort to such institutions," argues the report. "The legal framework needs to be adjusted so that the Bank of Israel can also supervise these other entities and serve them as a lender when necessary."

Regarding steps to be taken if a crisis does develop, the report advises: "The emphasis here is on the need for quick and determined action in order to stabilize systemically important financial institutions, including non-bank entities, and to inject liquidity into the financial system and relevant institutions. This is in addition to the need for a quick and large-scale response by monetary policy, which includes quantitative tools."

Systemic risk

One factor identified in the report as a significant contributor to systemic risk is Israel's high level of business concentration. "Twenty business groups control 25% of publicly traded companies and about 50% of their total market value," states the report. "The high level of concentration increases the systemic risk in the financial system since these same controlling groups comprise the largest risk groups of the banks, and the collapse of a large business group could rock the entire banking system.

"The solution to this problem back at the beginning of the previous decade was to impose restrictions on exposure by banks to individual borrowers or borrowing groups," the report continues. "But, notwithstanding these restrictions, the existence of large business groups raises institutional and systemic risk in the financial system, and therefore their supervision and regulation require strengthening, along with negative incentives against the creation of more of these groups."

On the grounds of confidentiality the central bank, like the commercial banks themselves, refrains from divulging the amount of debts owed by large borrowing groups. The only bank offering transparency on this issue is Bank Leumi, revealing in its reports that its six largest borrowers owe it a total of NIS 30.26 billion. It may be assumed that the scope of debts from large borrowing groups is relatively similar for the other banks too.

With Bank Leumi providing 28% of the economy's credit, it can be extrapolated that the largest borrowing groups owe a total of NIS 108 billion of the overall NIS 750 billion in credit available to the public. Leumi's largest single borrower owes it NIS 8 billion, and the debt of its six largest borrowing groups equals 74% of the bank's equity as measured for purposes of capital adequacy.