Banks need to cut costs to stay profitable, regulator says

Central bank warns about mortgage repayment difficulties among borrowers.

Hizkiyahu 311 (photo credit: Israel Hadari)
Hizkiyahu 311
(photo credit: Israel Hadari)
Despite sound financial earnings in 2009, the country’s banks need to cut expenses, improve efficiency and seek alternative revenue routes to maintain profitability, Rony Hizkiyahu, the Bank of Israel’s supervisor of banks, said on Tuesday.
“The banks’ earnings and profitability indicators improved considerably. However, unlike the steady improvement that occurred in the rapid-growth years preceding the crisis, the improvement now was predicated on factors external to the banking system that, in all likelihood, will not act in the same direction and with the same intensity in the near future,” Hizkiyahu said at a press conference in Jerusalem on the central bank’s report on the banking system in 2009.
“In view of the singularity of the macroeconomic conditions and developments in regulation and risk management, the banking system is facing many challenges – foremost the creation of revenue sources that will accommodate their high level of expenses. Therefore, the banks should aim to improve their operating efficiency by examining their expenditure function such as salary costs and cutting their operating expenses,” he said.
On the hand, the banks had to contend this year with a lowland stable-interest environment – brought on by the Bank of Israel’s expansionary monetary policy – and the regulation and reduction of bank fees, which led to a steep decrease in financial earnings from classic inter-mediation activity.
While on the other hand, the banks were helped by positive developments in the domestic and foreign capital markets, which boosted their financial earnings from the capital markets and enhanced their operating revenues. The banks’ operating efficiency improved this year, but this was largely due to the sensitivity of various indicators to domestic business cycles via the banks’ revenues.
“In international comparison, the efficiency ratio of the Israeli banking system is low and needs to improve,” Hizkiyahu said.
The efficiency index among local banks is at 1.54 percent compared with an average of 1.66% in developed countries.
At the central bank’s presentation on the banking system in 2009, Hizkiyahu said that the completion of the implementation of the Basel II principles in the banking system created the need for appropriate corporate-governance principles.
“The Banking Supervision Department treats this as a matter of the utmost importance due to its centrality in bolstering the public’s confidence in the banking system and reinforcing the system’s stability,” he said.
“Within this framework, I instructed the banks to prepare for the completion of an appropriate remuneration policy by the end of 2009, on the basis of principles that I set forth such as long-term profitability, risk-taking, and long-term achievements.”
In December, Hizkiyahu instructed each bank to appoint a chief risk officer who would direct an independent risk-management function.
“This measure is expected to improve the banks’ understanding of their risks and ensure that the risks are managed cautiously,” Hizkiyahu said on Tuesday.
Furthermore, Hizkiyahu reiterated the central bank’s concern regarding the surge in household, and in particular, mortgage credit amid a low-interest rate environment fueling the threat of a bubble in housing prices, which could destabilize the financial system “The problem today is that more than the majority of home-buyers – up to 80% – are taking out high-leverage, variable- interest mortgage loans, and are effectively financing the long-term with short-term low interest [payments], while in the past it was most common to take out a mortgage for 25 years linked to the CPI. Therefore, I instructed the banks to act with due caution when extending adjustable-interest-rate mortgage loans,” Hizkiyahu said.
“This intervention, necessitated by the increase in such lending, was meant to prevent a situation in which an upturn in interest [rates] would increase borrowers’ monthly paybacks and induce payback difficulties among some borrowers.”
Hizkiyahu said that in the past few months, in view of macroeconomic developments and the low-interest rate environment, demand in the housing market has escalated and so, in turn, have housing prices, which have increased by 20% to 30%.
“Due to concern about the development of a real-estate bubble, I issued a draft for consultation that instructs the banks to maintain a supplemental loan-loss reserve at the rate of at least 0.75% of outstanding loans that have a loan-to-value ratio in excess of 60%,” Hizkiyahu said. “These actions are expected to restrain undesired developments that would ultimately harm public welfare.”
Commenting on the current economic climate, Hizkiyahu said that even though the adverse trend in the real economy has ended and many indicators of activity improved earlier than had been expected, much uncertainty remained as the effects of the stabilization programs in many countries wane and adverse developments continue to loom in the euro-zone.
“Amid these changes, the Israeli banking system maintained its resilience and stability, improved its performance and its business results, and reduced its exposure to risk,” he said.
Several measures were taken in the past year to improve the resilience of the banks and the banking system, mainly concerning the strengthening of the system’s capital adequacy and credit quality even beyond the 12% target.
The central bank’s report showed that the capital ratio of the five large banking groups climbed to 13.6%, similar to the level in many banking systems abroad.
“One reason for this has to do with supervisory actions that we took during the year such as limits on the distribution of dividends, offering of government guarantees for capital issues, and encouragement of capital issues,” Hizkiyahu said.
Other factors that contributed to the improvement in capital adequacy in 2009 were actions taken by the banks to recompose their assets.
“The extent of risk assets was reduced and, for the first time in five years, the banking credit portfolio contracted,” Hizkiyahu said. “This happened mainly due to a decrease in lending to corporate clients occasioned by a decline in total demand for bank credit, mainly due to the recovery of the non-bank credit markets. Conversely, consumer credit to households, chiefly for housing, expanded.”
Moreover, the banks’ exposure to credit risk declined during the year, for reasons including the expansion of real activity and the recovery in the capital and labor markets, which included an improvement in credit quality.
“However, this activity is still typified by a high level of risk, mainly due to the uncertainty associated with developments abroad,” Hizkiyahu said.