JERUSALEM, July 27 (Reuters) - Israel’s financial system remains stable but is exposed to the risk of a sharp decline in the prices of homes and financial assets, the Bank of Israel said on Wednesday.
Despite fluctuations in global financial markets and near-zero interest rates, the stability of banks and insurance companies was maintained in the first half of 2016, the central bank said in its semi-annual financial stability report.
“A macroeconomic stress test on the banking system shows that even if a serious recession were to take place in Israel, the banking system would maintain its stability,” the report said, noting profitability and capital ratios of Israel’s top banks grew in 2015.
“While the profitability of the insurance companies declined during the period, their recognised equity increased,” it added.
But since rates have been low for a prolonged period financial institutions are exposed to the risk of sharp declines in housing and financial asset prices.
“Such declines may take place if main economies in the world shift to a further recession, or suffer from a decline in their financial stability, and there is contagion to the Israeli economy through a negative impact on exports and the prices of financial assets,” the report said.
Prices could also fall, it noted, if the central banks return interest rates to an upward path, or if Israel’s geopolitical situation worsens and leads to an increase in the risk premium of the economy.
Israel banks have high exposure to mortgages and to the construction and real estate industry “and prices in the market continue to increase,” the central bank said.
The risk of declines in the prices of financial assets is derived both from the possibility of a direct impact - through holdings of those assets - and from the possibility of an indirect impact, through the effect of these asset prices on firms’ abilities to repay loans they took out from banks and from institutional investors, it said.
In the future, the financial system will be affected by which various financial reforms are implemented, it said, referring to a new banking reform that would make it easier for the entry of new banks while Israel’s largest banks would have to sell off their credit card businesses.
Reforms, the central bank said, “must be conducted cautiously since the financial system fulfills a central role in the economy, and a crisis in the system carries the potential of a significant negative impact to the economy.” (Editing by Jeremy Gaunt.)