Israeli Banks More Inefficient Than in Most Developed Nations

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Supervisor of Banks David Zaken.Credit: Tomer Appelbaum

The Israeli banking system is more inefficient than that of the average developed nation. Despite steps taken by Israeli banks over the past 20 years to increase and diversify their income from sources other than interest on loans and despite attempts to cut operating costs, Israeli banks still operate less efficiently than their Organisation for Economic Co-operation and Development counterparts, according to an annual report released yesterday by the Supervisor of Banks in the Bank of Israel David Zaken.

The operating efficiency ratio of Israel’s five largest banks (Bank Leumi, Bank Hapoalim, Mizrahi-Tefahot Bank, First International Bank of Israel and Israel Discount Bank) was 69% in December 2013, compared to 62% for OECD countries.

Zaken said he is working to advance the creation of major competitor for the banks and to support the setting up of credit unions or banking cooperatives.

The Israeli banking system is relatively strong and stable due to a process undertaken by the central bank to increase the capital adequacy ratios of the banks — and the quality of the capital. Israeli banks are gradually implementing the Basel III capital requirements to “strengthen the stability of the banking system, a necessary condition for continued proper functioning of Israel’s economy and the security of the public’s deposits,” according to Zaken.

The capital adequacy ratio for Israeli banks has increased in recent years and reached 9.4% at the end of 2013. Return on capital was 8.7 percent, similar to the long-term average.

The main risks to Israeli banks derive from the state of large local borrowers and exposure to the construction and real estate industries, said Zaken. In addition, the slow and fragile global economic recovery presents another challenge, as do local economic problems such as Israel’s slowing economic growth, weakness in exports, and a slowdown in growth in investment, he said. On the plus side, he said, the labor market has improved and interest rates remained low — but home prices continued to rise in 2013.

As to the banks’ credit risk, Zaken said, “Past experience teaches that it is actually when indices are pointing to a bull market that extra attention needs to be placed on the proper classification of credit as well as on allowances and suitable reserve buffers. It is important to emphasize that in accordance with measurement and disclosure regulations, the allowance for credit losses needs to reliably reflect all the expected losses in the credit portfolio, even if they have not yet been identified.”

Given the continued increase in housing prices and in credit for housing, the Banking Supervision Department took additional steps to reduce the risk to both borrowers and lenders. In March 2013, guidelines were issued to increase the capital buffers for credit losses related to the increased risk in the housing credit portfolio. In August 2013, limitations were placed on the variable interest rate share of a housing loan and prohibitions were placed on granting housing loans with a payment to income ratio of greater than 50% or with a term to final payment of more than 30 years.

Banks were also instructed to ensure proper underwriting processes and a higher level of disclosure to customers, with the goal of reducing the risks, to both borrowers and lenders, inherent in housing loans. But both borrowers and lenders are still exposed to risks of changes in economic conditions, including in employment and interest rates.

To better understand the risk the banking system is exposed to, and to examine its resilience to crises, the Banking Supervision Department conducted stress tests on the banking system last year. The results of the tests indicate the main focal points of risks are credit to the construction and real estate industry, as well as housing credit, leveraged credit and concentration in the credit portfolio — in addition to the sensitivity of the securities portfolios to changes in interest rates and stock prices. The results also indicated that the banking system is relatively robust, due to measures taken over the years to strengthen capital adequacy.

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