The close similarity in the composition of investment portfolios containing the public's savings and managed by the financial institutions exposes Israel's entire financial system to a high degree of systematic risk, according to a study released Sunday by the Bank of Israel. With the recent spate of debt restructurings in the Israeli economy, the central bank set off to determine how the institutionals diversify the public's long-term savings.
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The results of the study were disturbing. Because of the similarity in the public's investment portfolios a financial crisis could have a profound impact on markets and on all financial institutions through the erosion of real asset values. This would lead to a sharp decline in private consumption. "In extreme cases this could even lead to government intervention," states the report.
Total assets managed by profit-sharing life insurance portfolios, provident fund and pension funds, were equivalent to 99% of Israel's gross domestic product as of the end of 2011. But that total has been increasing by about 10% a year, it seems, well beyond Israel's pace of economic growth.
But the overall investment is highly concentrated: NIS 77.6 billion – which accounts for 40.3% of these savings – are exposed to the same five business groups. This, along with exposure to Israeli government debt, could lead to systematic failure down the road. "The situation necessitates a thorough discussion regarding investment strategies followed by the institutional investors," the bank concludes.
"An analysis of the stock and corporate bond portfolio compositions of these institutionals shows that each one complies with investment restrictions aimed at ensuring a proper distribution of assets," the report says. "But a high degree of uniformity in the composition of the managed portfolios can be found, not just in the assets they include but even in the weight given each asset."
The report attributes this to the limited supply of financial products in the local market as well as on the concentrated ownership structure of companies issuing securities.
"A varied supply in the assets market reduces the probability of similar choices in structuring a financial portfolio, but supply in the Israeli market is low and therefore the probability of similarly-structured portfolios is higher," it explains. "Moreover, there is also high interdependence between managed assets as a result of common ownership. This boosts the chances of simultaneous movement of assets when exposed to any given shock."
One way to decrease this risk, according to the central bank, is for financial institutions to diversify their portfolios by increasing their foreign investments. The bank also supports reducing complex business ownership structures – a proposal put forward by the committee studying competition in the economy – which would likely lead to an increased supply of assets and less interdependence among them. These actions, the bank states, could provide protection to everyone with savings and strengthen the resilience of the financial system.