Bank of Israel Taking Steps to Fend Off Housing Crisis

Banks told they must set aside NIS 2.7 billion in extra capital to protect themselves against possible bad mortgage, construction loans.

Ofer Vaknin

In a dramatic effort to head off what it warned could spin into a financial crisis set off by an overheated real-estate market, the Bank of Israel said Sunday it wanted lenders to increase the capital they hold against future risk.

David Zaken, supervisor of banks, said in a draft directive that he wanted Israel’s banks to gradually add a combined 2.7 billion shekels ($740 million) by the start of 2017 to help ensure them against risks from growing portfolios of loans to home buyers and real-estate developers.

“We are concerned about an extreme scenario, which if it were to happen, you would call it the bursting of a bubble. There is a risk and against that risk there’s need to appropriate capital,” Zaken told reporters.

The bank presented figures showing that Israeli banks’ combined exposure to mortgages had reached 254 billion shekels at the end of July, an increase of about 100 billion shekels in five years. Real estate-related lending had grown to 31% of all bank lending in June, from 20% seven years earlier.

“Experience worldwide shows that crises in the banking system frequently develop as a result of the banks’ exposure to housing credit and to the real estate industry, mainly due to accelerated expansion of mortgage volumes,” the bank said.

Forcing the banks to set aside more capital will mean less money available to distribute to shareholders for dividends. As a result, bank shares tumbled in Tel Aviv Stock Exchange trading on Sunday, with Mizrahi Tefahot Bank leading the pack on a 2.2% decline to 43.70 shekels by close.

As Israel’s biggest mortgage lender, Mizrahi would have to set aside 940 million shekels, more than any other lender. But the other banks will have to each put aside in most cases hundreds of millions of shekels, too.

Bank Hapoalim, which had been seeking Bank of Israel approval to raise its dividend to 30% of net profit from 15%, will now have to devote profits to boosting its capital by 540 million shekels. Hapoalim’s shares fell 1.7% on Sunday to a close of 20.05 shekels.

Bank Leumi, which will have enlarge its capital cushion by 720 million shekels, dropped 1.8% to 13.85 shekels while Israel Discount Bank, which faces a 200 million-shekel capital increase, ended 1.1% lower at 6.19 shekels.

While the government has been preoccupied with trying to rein in rising home prices, the central bank’s principal concern has been to ensure that the banks don’t get caught with an overpriced portfolio of mortgages and construction loans because real estate prices suddenly turn lower and/or the economy slows.

The Bank of Israel has undertaken a series of steps over the last two years to discourage home buyers from taking out mortgages, but has faced a conflict of policy interests as it tries to shore up flagging economic growth and weaken an overstrong shekel. As a result, it has lowered its base lending rate twice in July and August to a record low, making borrowing even cheaper.

The central bank’s directives are actually a complementary step to the latest interest cut, Adi Scop, a banking analyst at IBI Israel Brokerage & Investments, told the financial daily Calcalist. Nevertheless he said that even a 20% drop in real estate prices would hurt the banks’ shareholders’ equity.

The central bank has already ordered banks to meet a minimum Tier 1 capital ratio to risk-weighted assets of 9% by the start of 2015, with the two largest banks – Hapoalim and Leumi – reaching the 10% mark by 2017.

But now the draft regulation will require banks to raise their Tier 1 ratios – a measure of a bank’s strength – by the equivalent of 1% of their outstanding housing loan portfolio by the start of 2017, the Bank of Israel said.

That will increase the banks’ capital costs, which will in turn raise the cost of loans for new mortgage borrowers, Zaken said. However, he insisted the extra costs would not be significant and those already holding mortgages won’t be affected by the change.

He stressed that the measures didn’t aim to reduce mortgage lending so much as ensure that the banks are adequately protected against the risk they are assuming.