JERUSALEM, July 13 (Reuters) - Israel's financial system is stable amid a challenging global environment and as interest rates are low but the corporate bond market and banks face some risks, the Bank of Israel said.
The central bank a year ago established a financial stability division in its research department. In its first report, it said on Monday the domestic financial system has demonstrated "impressive resilience both during the global financial crisis of 2008 and following it".
As a result of the crisis, authorities supervising the financial system have tightened cooperation between them and the use of macro-prudential tools to identify and handle systemic risks has been increased, it said.
Also, the banking regulator implemented policies to reduce banks' exposure to the rapid rise in the volume of mortgages, while initiating stress tests to asses banking system risks.
But there is high exposure of banks to the construction and real estate industries and to mortgages, and housing comprises a sizable share in the household asset portfolio, the report said.
As a result, the main risk to the financial system is the possibility of a domestic or external shock that may lead to a sharp increase in interest rates or a recession. That may have a negative impact on borrowers' income and be accompanied by a sharp turnaround in the housing market.
"In such a scenario, there would be a heavier repayment burden on households, a decline in borrower quality, and a negative impact on the banks' capital ratios and profitability. Such a scenario is expected to also have an impact on contractors and to further harm the banks' financial results," said the report, slated for publication once or twice a year.
The other risk to which the financial system is exposed is the underpricing of risks in Israel's corporate bond market.
"This risk may negatively impact the process of resource allocation in the economy, and in the case of a sharp turnaround in the markets, it may have a negative impact on pension savings, banks exposed to companies that have issued bonds, and the supply of credit in the nonbank market," the report said.
Last month, results of a Bank of Israel stress test showed there is no danger to the stability of Israel's banking system should there be a severe recession, although the hit to banks' profits could be significant. (Reporting by Steven Scheer)