Bank of Israel warns on collapse in bond prices

Bank of Israel photo: Ariel Yerusalimsky

In its financial stability report, the Bank of Israel expressed concern over the public's increased exposure to bonds through mutual funds.

A scenario of continued steep falls in the financial markets involves a high risk of financial instability, according to the Bank of Israel's stability report for the second half of the year published today.

The Bank of Israel outlined in red the risk of a major decline in bond prices. "The risk caused by a sharp drop in asset prices, particularly financial assets that are more sensitive to the interest rate, began to materialize in October 2018, following the increase in yields on US government bonds. Most of the world's stock markets posted steep falls in share prices and great volatility. Due to the public's increased exposure to bonds through mutual funds in recent years as a result of growing passive investment and the effect of automated trading on the stock exchange, factors that detract from liquidity at times of greater uncertainty, we draw attention to the likelihood of irregularities caused by shocks in the prices of financial assets," the Bank of Israel writes.

The Bank of Israel's semiannual financial stability report takes note of the main risks to stability. The report tries to estimate the main risks to which the financial system in Israel is exposed if the pessimistic scenarios materialize in a number of sources: the international financial system, the global economy, the real estate market, and household debt.

An increase in the risk from two of these sources stands out in the latest report: the likelihood of a collapse in bond prices on the financial markets has increased, as has also the likelihood of a crisis in the global economic environment, which will have an effect on the Israeli economy.

Writing about the risk in the financial markets, the Bank of Israel explains, "The pricing of corporate bonds remains high, and the public holds a large proportion of them through the mutual funds. The liquidity risk in the economy has risen; after a prolonged period of especially low interest rates, the expansionary monetary policy has begun to slow."

Writing about the global economic environment, the Bank of Israel writes, "The combination of enormous debt and the process of reining in the expansionary monetary policy" has increased the risk that the scenario will materialize. Among other things, the Bank of Israel cites an increase in the risk of many companies around the world going bankrupt as a result of the halt in the expansionary monetary policy.

In the real estate market, on the other hand, the Bank of Israel states in its report that the risk has eased, writing, "The moderate fall in housing prices continued over the past 12 months. Price development in the market does not show volatility. Investments in the housing sector have declined, and there is a clear fall in housing starts."

Concerning household debt other than for housing, the fourth risk, the Bank of Israel writes, "Credit taking has declined slightly, especially non-housing credit, but non-banking institutions increased their share of credit activity." The changes in the legal environment in which the credit providers operate, and the fact that non-banking credit providers continue to increase their share of total household credit, are liable to increase the credit risk from households in the event of a severe worsening of financial terms, for example as a result of reining in the expansive monetary policy."

Published by Globes, Israel business news - en.globes.co.il - on December 23, 2018

© Copyright of Globes Publisher Itonut (1983) Ltd. 2018

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Bank of Israel photo: Ariel Yerusalimsky
Bank of Israel photo: Ariel Yerusalimsky
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