The year reviewed was characterized by the marked expansion of banking activity,
ex-pressed in a 13 percent rise in the credit aggregate and a 10.5 percent increase
in total deposits of the public. Several factors contributed to the growth of credit,
including the rise in uses, primarily credit-intensive ones such as investments and
exports, the rally in GDP growth in the second half of the year, and an increase in
funding requirements for working capital and inventories, acquisitions of firms, and
activities of borrowers’ abroad.
The rise in banking activities in 1999 was also expressed in the persistent increase
in profits and return on capital, despite the economic slowdown of the last few years.
The return on equity attained by the five major commercial banks was 11.2 percent
in 1999 above the long-term average of the last decade. Nonetheless, the
performance of Israel’s banking system is similar to that of the industry elsewhere in
the world. Thus, for ex-ample, the return on equity and financial margin attained by
the commercial banks resemble the average in western countries that are
comparable with Israel. The rise in profits in 1999 was due principally to the increase
in net interest income that resulted from the expansion of activity in each of the
intermediation segments, alongside stability in the overall financial margin. Thus,
loan-loss provision declined in most industries in 1999, despite the economic
slowdown that had an adverse effect on the quality of credit. The share of loan-loss
provision in total credit to the public at the banks’ responsibility has been declining
for several years, and in 1999 it was only 0.5 percent. The rates of loan-loss
provision in Israel are slightly lower than the average in comparable countries.
In the background to developments in 1999, the banks’ exposure to credit risks grew
due to the steep rise in the extent of credit (also relative to their capital), the share of
problem loans in total credit also increased, and this applied particularly to the credit/
product ratio in most industries. The latter indicates a decline in the repayment
ability of the business sector, and is particularly notable in the real estate industry, a
situation that increases banks’ exposure to credit risk. Thus, the level of specific
loan-loss provision in 1999 may not indicate the banks’ risk level in the credit
portfolio, and banks must care-fully examine the adequacy of their provisions.
Another aspect of the banks’ exposure to credit risks and the ability to contend with
this is the risk-based capital ratio. This rose slightly, from 9.2 percent in 1998 to 9.4
percent at the end of 1999, inter alia due to the Supervisor of Banks’ decision to
raise the required minimum capital ratio from 8 percent to 9 percent. Nevertheless,
the capital ratio in Israel is lower than the accepted level in most western countries.
The mix of capital-based components in Israel has changed in the last few years,
with the share of less stable Tier-2 capital rising consistently at the expense of Tier-1
capital. The formal capital requirement in Israel is currently based solely on credit
risk. Nonetheless, the Basle Committee’s January 1996 recommendations about
holding additional capital against exposure to market risks will be implemented in
Israel in the year 2000.
In the last few years there has been considerable activity in Israel on the part of
foreign representatives and investment banks, chiefly in the areas of securities,
examination of the prudent conduct of banking business, and the provision of
consultancy services to domestic companies and foreign investors prior to mergers
and acquisitions. The success of the investment banks has created an infrastructure
that spurs commercial banks to penetrate the domestic market, so that banks such
as Citibank and HSBC have declared their intentions of opening branches in Israel
in the second half of 2000. This development was influenced by the liberalization of
the foreign-currency market, economic stability, increase in issues abroad by Israeli
firms, expansion of high-tech activity, improvement in Israel’s credit rating, and
robustness of the domestic banking system. The entry of foreign banks into Israel’s
banking system may serve to stimulate competition in the next few years.
The way bank managements dealt with Y2K issues, under the watchful eye of the
Supervisor of Banks, contributed to the smooth transition to the new millennium.
Within the framework of these preparations, the banks were given instructions in line
with inter-national criteria. The systems were converted in accordance with the
predetermined time-table, and all the banks were successful in attaining the
objective. The resources devoted by Israel’s banking system to converting I.T.
systems in the last three years have been assessed at about $ 100 million.
Technological developments in the field of telecommunications and the PC
revolution have enabled banks to offer a growing number of services without the
customer having to be physically present in the branch. As a result, there have been
changes in the traditional functions and structure of bank branches. Among other
things, banks have begun providing private banking services and unmanned service
centers on a 24-hour basis. Technological developments have also led to the
development of Internet banking, which embodies immense potential benefit for both
banks and customers through the greater flexibility of use and reduction of costs, as
expressed in the steep rise in the number of users. This development is also
expected to bring about far-reaching changes in the number and structure of
branches. Notwithstanding, it should not be forgotten that at present the number of
persons per branch in Israel is above the average in western countries, inter alia
because of the sharp increase in the population in the 1990s, the period of mass
immigration from the former USSR, which was not accompanied by an equivalent
increase in the number of branches. The introduction into the new environment of
Internet technology must be done cautiously; the Supervisor of Banks has hence
imposed rules and frameworks on the banks’ Internet activities, and has not yet
given free rein to the full potential of this sphere of activity.
In recent years the possibility of restricting the areas of banking activity in order to
prevent conflicts of interest and encourage competition in the money and capital
markets has been considered. This has been expressed in several developments:
the Banking (Licensing) Law has been amended to reduce the extent of banks’
holdings in nonfinancial corporations; the inter-ministerial committee preparing a
provident fund law has recommended restricting the banks’ market share in the
management of provident funds; the Supreme Court is currently reviewing the
subject of the mortgage banks’ involvement in the area of insurance; and proposals
have been made regarding the banks’ market share in managing mutual funds, as
well as restricting their activities (on their own behalf) in the capital market. With
regard to the structure of the banking system and the capital market there are
several models, each one of which has advantages and disadvantages; the most
extreme are the classical American ones of several years ago, which permit banks
to act solely in the sphere of classical banking, and the European model, with
universal banking. In the US, classical banking enabled a very efficient capital
market to develop, but at the price of creating a rather vulnerable banking system. In
Europe, on the other hand, and in Germany especially, the universal banking system
was found to be very stable, but apparently held back the development of the capital
market. The conclusion to be drawn from this is that it is preferable to find the
correct balance that enables the development of the capital market, on the one
hand, and maintains the stability of the banking system, on the other, than to choose
a banking model that is at one extreme or another. The authorities should also
examine the desired structure and areas of activity of Israel’s banking system in
view of the current situation as regards concentration and the capital market. The
object of this would be to dispel uncertainty, for investors and others, about the
authorities’ intentions with respect to the banks’ scope of activity.
In determining the latter, it is necessary to reach a carefully-considered view, taking
into account current and expected trends in Israel and abroad as regards
globalization, liberalization, risk management, technology, kinds of financial
services, and the relationship between them.
Jerusalem Dr. Yitzhak Tal
July 2000 Supervisor of Banks
Chapter 1 (Resume) - Israel's Banking System: A Long-Term View
The full Chapter, in PDF format - 308KB
In 1999 the return on equity of the five major banking groups (Leumi, Hapoalim, Discount,
Mizrahi, and First International) was 11.2 percent, higher than in 1998 (9.9 percent), and
also higher than the average of the eight years from 1992 to 1999 (9.5 percent). Most of
the increase may be attributed to the rise of 11 percent in the level of the banking groups’
activity, the continuation of the downward trend of the loan-loss provision which started at
the end of the 1980s, and the increase in non-interest income-mainly from fees and
which also derived from the expansion of activity. The return on equity (ROE) -commissions
of Israel’s banking system since 1992 has ranged from 7.9 percent to 12 percent, and this
stability has been one of the banking system’s outstanding features.
The stability of the ROE in Israel’s banking system in the last decade is also notable in the
context of an international comparison encompassing many other western countries, some
of which experienced crises which harmed the stability of their banking systems. The
stability of the banking system’s ROE is also unusual when compared with that in other
principal industries in Israel, most of which show a positive correlation with the business
cycle.
The general economic environment in which Israel’s banking system operates underwent
many changes in the 1990s: years of economic growth were followed by periods of
slowdown; slumps in the money and capital markets succeeded booms; the process of
liberalization (including the government’s reduced involvement in financial intermediation)
accelerated, resulting in increased competition and greater customer welfare on the one
hand, but higher risks to the banking system on the other; there were periods when the
exchange rate and the various rates of interest fluctuated widely; there was a persistent
decline in the rate of inflation in the wake of the Bank of Israel’s tight monetary policy; the
process of globalization boosted capital flows between countries, on the one hand, thereby
making markets more efficient, but on the other hand increased exposure to risks related
to international crises. In the context of these developments, the stability achieved in the
return on equity of the banking groups in recent years is even more noteworthy.
The stability of the ROE was achieved mainly by virtue of the universal nature of the
activity of the banking groups, expressed in their ability to spread their sources of profit by
diversifying investments in subsidiaries (commercial banks, mortgage banks, overseas
subsidiaries, companies active in the capital market, and nonfinancial companies). The
advantage of such diversification lies in the low (sometimes even negative) correlations
between such sources of profit, which serve to counteract the effect of the frequent
changes in the environment in which the banking system operates.
In the 1990s banking became more competitive, and this was reflected inter alia in a
continued reduction of the overall net interest margin, which at the end of the decade
approached the level in the banking systems of the industrialized countries, about 2
percent. Increased competition led to the narrowing of the spreads between interest rates
and margins of different banks, mainly relating to large customers (wholesale banking),
and was also reflected in a decline in the conventional indices of concentration (e.g., the H
index). Although the credit-card market has become more competitive in the last three
years, retail banking (which serves households) is still uncompetitive. The introduction of
the latest technological advances in banking, together with the possibility of performing a
range of banking transactions via the Internet will increase competition between banks in
the future, thereby increasing customer welfare.
Nevertheless, since 1997 a rise in banks’ total credit risks has been evident. This
assessment is based on several developments: the continued rapid rise of the credit/GDP
ratio, which also occurred in most of the principal industries; the increase in the share of
problem loans (excluding agriculture) in most banks; the rise of the risk-weighted assets
ratio and of the concentration of credit by borrower, and the stabilization of the
concentration of credit by industry at a relatively high level. The assessment is also
supported by the fact that in the last three years part of the credit was granted to finance
working capital and involuntary inventories, as a result of the slowdown in the economy
(which continued in 1999 for the third successive year). The marked increase in credit to
the construction industry and in foreign currency in this period was especially notable.
A long-term analysis covering the last decade shows that risk-weighted assets and market
risks rose, as did the return on equity (which jumped to new levels twice in the period, in
1992 and 1997). Since 1991 the risk-based capital ratio (capital adequacy) has been
falling, while the share of tier-2 (supplementary) capital (the characteristics of which make
it less stable in the long run than tier-1 capital) has been rising, so that banks are less
capable of confronting possible future realizations of bank risks. In this context, it is
appropriate to note that although the Supervisor of Banks raised the minimum capital ratio
from 8 percent to 9 percent at the beginning of 1999, Israel’s risk-weighted capital ratio is
one of the lowest among the banking systems in western countries. On the other hand, the
tier-2 capital component is still relatively low, despite its rise since 1997.
The performance and the risks of Israel’s banking system in the next few years will be
affected by the following factors: the continued liberalization of the capital markets,
including the expected expansion of activity in Israel by large foreign banks; developments
in banking technology and financial innovation, also covering activity in derivatives; and
reforms on the domestic front, such as of the provident funds and taxation.
Against the background of the situation described above, the target facing banks’
management is to manage assets, liabilities, and risks prudently, so that the profitability
and stability of the banking system will be maintained.
Chapter 2 (Resume) - Financial Activity of the Commercial Banks
The full Chapter, in PDF format - 215KB
The commercial banks’ activity expanded considerably during 1999, by 11 percent. At the
end of the year, the banks’ assets totaled NIS 573 billion and the proportion of short-term
assets within the public’s asset portfolio continued to grow. The credit aggregate increased
by 13 percent, which was more than the financing requirements deriving from the
economic growth rate. The rise in the credit aggregate resulted mainly from increased
financing requirements in respect of working capital and inventories, the finance of
corporate acquisitions and, in the second half of the year, the expansion of economic
activity. Concurrently, there was a clear-cut rising trend in the proportion of large
borrowers within the banking credit portfolio.
During the second half of the year under review balances of liquid assets in local and
foreign currency increased, largely due to Y2K-associated apprehensions and the banks’
function as (almost exclusive) market-makers in the foreign-currency market. The public
also increased its short-term local-currency deposits to a considerable extent. This
development resulted from the decline in inflation and its variance, as well as from liquidity
considerations, against the background of the substantial growth in trading turnover on the
Tel Aviv Stock Exchange. Unindexed deposits of the public grew by 26 percent in the
course of the year. However, the proportion of assets at the banks within the public’s asset
portfolio fell from 49 percent in 1998 to 45 percent in 1999, mainly as a result of the rise in
share prices.
After rising in the last quarter of 1998, short-term interest rates fell during 1999, in line with
the decline in inflation. But due to the marked decline in inflation expectations in the
second half of the year-and especially towards the end of 1999-real (ex post) interest
rates increased during those months. Longer-term interest rates rose during the year as a
result of the public’s tendency to prefer short-term assets, the government’s increased
borrowing requirements, and the rise in interest rates abroad. The interest-rate spread in
the unindexed local-currency segment narrowed slightly. While the interest-rate spread on
CPI-indexed local-currency activity expanded during the year, in the foreign-currency
segment it remained stable.
Chapter 3 (Resume) - Financial Results
The full Chapter, in PDF format - 601KB
In 1999 the banking system was characterized by a continued rise in profit and
return on equity (ROE): the total profit of the five major banking groups increased
from NIS 3.1 billion to NIS 3.6 billion, reflecting the growth of ROE from 9.9 percent
in 1998 to 11.2 percent in 1999-above the long-term average of the last decade. In
the last three years the five major banking groups appear to have shifted again to a
higher ROE plateau, even adjusting for nonrecurring profits, as occurred chiefly in
1996 and 1997 due to sales of excess nonfinancial holdings (Table 3.1). The ROE
achieved by the five major banking groups in recent years is not exceptional in
global terms, as is indicated by comparing their performance and operating indices
with those of banking systems elsewhere. The risk-weighted assets ratio in Israel,
on the other hand, is lower than in the peer-group countries (Table 3.2).
Profitability in 1999 was affected to a great extent by the expansion of the financial
activity of all segments, leading to an increase in net interest income alongside a
decline in specific loan-loss provision and its share in credit to the public.
Concurrently, operating ratios improved in 1999 (Table 3.3), as the rise in
non-interest income-from both commissions and from the capital market-
exceeded that in operating expenses. There were no significant changes in the other
components of the banks’ income and expenditure compared with 1998.
Chapter 4 (Resume) - The Subsidiaries of the Five Major Banks
The full Chapter, in PDF format - 175KB
The five major banks have many subsidiaries, in which they have invested
extensively and which have contributed significantly to the profits of the banks that
head the groups. The principal areas of activity of the subsidiaries are mortgages,
activities abroad, and holdings of nonfinancial companies. The contribution of all the
subsidiaries to profits declined from about NIS 1.8 billion in 1998 to NIS 1.5 billion in
1999. The mortgage banks, the return on which has been more stable and higher in
recent years than that in subsidiaries in other sectors, increased their net profit by 25
percent in 1999. The rise in profit and profitability is noteworthy in the context of the
continued economic slowdown in general, and in construction in particular, and
stems from the sharp increase in credit (both directed and nondirected) extended in
the second half of 1999 to households as well as for other purposes.
The contribution of subsidiaries abroad to net profit (after conversions into local
currency and accounting adjustments) is volatile, depending to a great extent on real
NIS appreciation/depreciation against the dollar and the European currencies. In
1999 the contribution of these companies to net profit amounted to NIS 204 million-
less than a quarter of their contribution in 1998. The reasons for the decline in profit
and profitability are the real NIS appreciation against the dollar and the European
currencies as well as developments of a nonrecurring nature (e.g., tax refunds and
the sale of some of the overseas offices) in 1998. If the effect of hedging against
investment in banking companies abroad is taken into account, however, the decline
in the contribution to net profit is smaller in 1999. Ordinary before-tax dollar profit
grew by 17 percent, in line with the trend of the last few years, as a result of the
expansion of classic banking activity and the steep drop in loan-loss provision made
possible by the continued economic boom in the countries where the overseas
offices are located.
The process of selling off the excess nonfinancial holdings of Leumi and Hapoalim
banks ended in 1999, the proceeds generally being used to buy smaller nonfinancial
companies in various industries. These developments, which are characteristic of
universal banking, may stabilize the banks’ profit sources.
This chapter consists of three sections: the first reviews the structure of the principal
holdings of the five major banks in subsidiaries; the other two sections analyze the
activities, financial results and risks of the mortgage banks and the overseas offices.
Chapter 5 (Resume) - Risks and Capital Adequacy
The full Chapter, in PDF format - 308KB
Liberalization processes in Israel in recent years and the impact of globalization
have increased the economy’s sensitivity to shocks and changes in the international
financial markets. The banks’ exposure to credit risk and market risks increased in
1999. The capital adequacy of the five largest banking groups, which is intended to
cushion them against losses should certain risks materialize, rose slightly in the
course of the year reviewed. The increase in the ratio of capital to risk-weighted
assets resulted mainly from a rise in the banks’ Tier 2 capital, the characteristics of
which are less stable than those of Tier 1 capital.
Exposure to credit risk grew due to the continued marked expansion of bank credit,
despite the economic slowdown, which has the effect of reducing borrowers’
repayment ability. Although foreign-currency credit continued to expand, it did so
more slowly than in 1998. The year under review was notable for an increase in the
concentration of the bank credit portfolio by borrower, as well as for a rise in the
share of problem loans in total credit at most of the banking groups.
The banks’ exposure to market risks also increased during the year under review:
Interest-rate risk in the three indexation segments rose at most of the banking
groups; indexation basis risk (exposure to changes in the inflation and exchange
rates) increased in 1999, although it did not develop in a uniform way among the
major banking groups.
Chapter 6 (Resume) - The Banking System and the Activities of the Banking
Supervision Department
The full Chapter, in PDF format - 166KB
Much of the work of the Banking Supervision Department relates to controlling the
exposure of banking corporations to existing and expected risks in the banking
system and maintaining the propriety of bank-customer relations. In 1999 the
Department dealt with the following subjects in addition to its routine activities:
continued preparation to avoid the Millennium Bug problem; examining the eligibility
of groups of candidates wishing to purchase controlling interests in banks; and the
effect of technology on the banking system and on its regulation.
Advances and innovations in technology, computers, and communications which
enable service to be provided from afar have affected the structure of the banking
system for several years. In 1999 the banks extended the range of services they
provided via the Internet, and began offering online services related to deposits and
securities trading. This was made possible after the Supervisor of Banks extended
the permit covering this activity at the beginning of the year so that it included the
performance of transactions in customers’ accounts. Assimilation of technological
changes is quite a lengthy process, and the reduction in the number of branches
and staff which occurred in 1999 is likely to be the start of a trend expected to
continue in the future.
In the last few years there has been lively activity by foreign representative offices
and investment banks, mainly in the areas of securities, underwriting, and
distribution services. Foreign commercial banks also expanded their activity in Israel
in 1999, and two of them officially announced that they intended to open branches in
Israel in the second half of 2000.
