In the event of a recession, half the losses Israel’s banking system will suffer in its credit portfolio will come from real estate and housing credit, according to a Bank of Israel stress test of the banking system released Tuesday. All in all, however, the system would not face collapse.

The stress test, conducted by the central bank’s Banking Supervision Department, examined how Israel’s banking system would fare through a tough recession like the one it experienced in 2002 at the height of the second intifada.

“The exposure to credit risk was emphasized – primarily the risk deriving from the state of large borrowers in the economy and exposure to the construction and real-estate industry,” Supervisor of Banks David Zaken wrote in the introduction to the report. “The results also indicated that the banking system is relatively robust due to measures taken over the years to strengthen the capital adequacy.”

According to the report, losses from the credit sector would amount to NIS 27 billion over two years, NIS13b. of which would come from housing.

Last year, the Bank of Israel passed new regulations to help insulate the banking system from sharp changes in the real-estate market, placing new limitations on how much of a mortgage can be subject to a variable interest rate, length of the mortgage and ratio of income to the loan of a mortgage.

More generally, it has been increasing capital adequacy standards in accordance with the international Basel III standards, and plans to raise liquidity buffers in January 2015 as well.

The International Monetary Fund has warned of asset bubbles – particularly real-estate bubbles – and in February released a detailed report warning that Israel’s real-estate market was hovering 20 percent to 25% above its longterm fundamental value. The price of Israeli housing has nearly doubled over the past seven years.

Instead of sharing the central bank’s concern that a recession would lead to a drop in home prices, among other things, the report cautioned that a sudden drop in housing prices could lead to a two-year recession.

“A slow correction would allow the economy to escape a recessionary episode, but economic prospects would be weak for a prolonged period of time,” the report said. “By contrast, a rapid adjustment would lead the economy into recession, with consumption and output recovering two years after the shock.”

It estimated the prospects of an all-out housing bust at 20%.

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