## _cr1269

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---

### FSAP overall assessment and key vulnerabilities
- Financial sector robustness and concentration:
  - Analysis suggests that Israel’s financial sector is robust, although concentration in the financial and nonfinancial sectors could amplify systemic effects.
  - The boom in housing prices and construction in recent years represents a further vulnerability; recent evidence points to a soft landing partly in response to authorities’ policy actions.
- Immediate and systemic vulnerabilities:
  - Most immediate vulnerabilities: possible shocks in global financial markets and regional geopolitical events.
  - Stability analysis: systemic financial vulnerabilities to severe shocks in line with historical experience are manageable; in aggregate, buffers (including those in the household sector) are at comparatively comfortable levels.
- Stress testing summary:
  - A variety of stress tests for banks, insurance companies, and long-term savings funds were undertaken.
  - Calibration demanding; only a few individual institutions projected to suffer major losses or become relatively short of liquidity.
  - Further development warranted with emphasis on cross-sectoral linkages and network effects.

### Regulation, supervision, and oversight — findings and recommendations
- General findings:
  - Financial regulation and supervision are strong; level of observance of international financial sector standards is high.
  - Further enhancement needed in areas such as liquidity regulations and supervision of groups as international practice evolves.
- Specific supervisory and regulatory needs:
  - Attention needed on liquidity risk and group inter-connectedness.
  - Gaps in coverage and potential inconsistent treatment exist (e.g., certain securities markets activities).
  - Authorities should consider the burden of complex and rapidly changing regulations on financial institutions and clients.
  - Retention of supervisory staff with specialized skill sets, with commensurate compensation, is required.
- Banking supervision priorities:
  - Strengthen regulation and supervision of interest rate risk and market risk; develop liquidity risk regulation as international practice evolves.
  - Prepare for Basel III given current importance of Tier 2 capital.

### Macroprudential coordination and institutional arrangements
- Recommendation: establish a standing Financial Stability Committee (FSC):
  - BOI best suited to lead coordination of macroprudential oversight.
  - FSC composition: chaired by the BOI with representatives for monetary policy and banking sector stability, and comprising the ISA, CMISD, and the MOF.
  - Mandate/functions: monitor systemic risk, establish policy agenda to mitigate risks, address competition and consumer protection as relevant to systemic importance, ensure information-sharing and accountability (e.g., joint Financial Stability Report).
  - Consensus-based approach preferred; if unwieldy, mechanisms for quick and firm decisions may be needed.

### Liquidity framework, payments, and market infrastructure
- Central bank and payment system improvements:
  - Authorities enhanced central bank liquidity framework and introduced RTGS system Zahav.
  - Central bank liquidity framework changes: loan quota system replaced with standing credit and deposit facilities; interbank settlement practices revamped.
- Remaining actions to strengthen market infrastructure and resilience:
  - Remove remaining barriers to repo market development (repos are thin; repo taxation legislation pending).
  - Strengthen payments system oversight; ensure project completion by the 2013 target date.
  - Further develop a comprehensive business continuity plan and coordinate disaster recovery with Zahav counterparties.

### Crisis management and safety-net recommendations
- Key gaps and needed reinforcements:
  - Better articulation of conditions under which Emergency Liquidity Assistance (ELA) will be provided.
  - Complete the set of tools for early intervention and a special framework for going-and-gone concern resolution of banks and possibly certain NBFIs.
  - Clarify the fiscal backstop for bank solvency support and depositor protection.
- Specific policy recommendations:
  - ELA: define predictable conditions and safeguards so solvent but illiquid banks (or systemically important NBFIs) can count on central bank funding while protecting the central bank from losses.
  - Early intervention: establish a complete legal set of tools for early intervention in troubled banks.
  - Resolution and solvency funding: consider a resolution fund, a deposit guarantee scheme (DGS), or a government line of credit, possibly combined with a bank levy and depositor preference in resolution.
  - Fiscal role: solvency support is essentially fiscal and should rest with the government, not the central bank.
  - Coordination: prepare the FSC to convert into a crisis management steering committee when needed; agree protocols for coordination and responsibilities.

### Main recommendations (summary)
- Strengthen institutional framework for macroprudential oversight by formally establishing a Financial Stability Committee (FSC).
  - Authority: All; Priority: High; Time-frame: Near-term; Para.: 46
- Further improve stress testing techniques, including capacity to analyze systemic, credit, and liquidity risk.
  - Authority: BOI, CMISD; Priority: High; Time-frame: Near-term; Para.: 20, 23, 24, 47
- Eliminate gaps and overlaps in supervisory responsibilities to ensure like activities face like regulation and supervision.
  - Authority: BOI, ISA, CMISD; Priority: High; Time-frame: Near-term; Para.: 28-30
- Systematically undertake cost-benefit analysis of regulatory changes and streamline regulations where possible.
  - Authority: BOI, ISA, CMISD; Priority: Medium; Time-frame: Near-term; Para.: 26
- Strengthen AML/CFT legal and regulatory framework, especially for designated non-financial businesses and transparency of beneficial ownership.
  - Authority: Government; Priority: High; Time-frame: Near-term; Para.: 43
- Crisis management specific items:
  - Establish an ELA policy framework.
    - Authority: BOI; Priority: High; Time-frame: Immediate; Para.: 50
  - Enact full set of early intervention tools and special framework for going-and-gone concern resolution.
    - Authority: BOI, MOF; Priority: High; Time-frame: Near-term; Paras.: 51-55
  - Establish mechanism for solvency support and funding of bank resolution, protecting BOI from quasi-fiscal activities.
    - Authority: BOI, MOF; Priority: High; Time-frame: Near-term; Paras.: 56-58
  - Agree protocol for coordination and assignment of responsibilities for system-wide crisis management.
    - Authority: All; Priority: High; Time-frame: Immediate; Paras.: 59-60
- Time-frame definitions from Table 1:
  - "Immediate" is within one year; "near-term" is within 1–3 years.

### Financial supervision framework and market developments
- Supervisory responsibilities:
  - BOI supervises banks and is responsible for payments system oversight.
  - ISA oversees securities sector.
  - CMISD (MOF) oversees insurance and pension sector.
  - TASE has some supervisory responsibilities for its members.
  - Only the BOI has an explicit mandate to promote financial system stability.
- Effects of the global crisis and policy response:
  - No domestic financial institution got into serious difficulties during the crisis; banks weathered the storm although profitability suffered (one bank made large losses on U.S. MBS).
  - Authorities’ crisis measures included BOI policy rate cuts, expanded liquidity facilities, tightened supervisory measures; MOF established back-stop mechanisms including a “safety net” program for provident funds and guarantees for banks raising capital; ISA set up a debt settlement framework.
- Macroeconomic context:
  - After a mild recession in early 2009, output recovered mid-2009 and grew strongly through early 2011; house prices increased rapidly (more than 40 percent in real terms since 2008).
  - From September 2011 BOI began monetary easing as global growth slowed.

### Vulnerabilities: household, corporate, and market structure
- Households and housing:
  - Households have relatively little mortgage or consumer debt; financial assets built up strongly.
  - By mid-2009 deterioration in mortgage lending standards noted (increase in unindexed floating rate mortgage loans).
  - Authorities’ measures: higher capital requirements for housing loans, supplemental reserve requirements, and variable interest rate mortgage limits.
- Corporate sector and bond market:
  - Total corporate bonds outstanding: 32 percent of GDP.
  - Commercial real estate-related corporate bonds: 12 percent of GDP.
  - Corporate bond market is somewhat shallow relative to its size; disruptions abroad could quickly affect corporates’ financing conditions.
- Concentration:
  - Five banking groups provide universal banking services and account for 95 percent of banking sector assets; two largest constitute more than half the system.
  - Insurance: four largest groups have dominant market share (e.g., life insurance market share over 80 percent).
  - Corporate concentration: turnover of the six largest groups accounts for about a quarter of GDP; 88 percent of all Israeli public companies have a controlling shareholder.

### Banking sector risk assessment and stress-testing outcomes
- Bank fundamentals:
  - Capitalization ratios have been rising, much of increase in Tier 2 capital.
  - NPLs are low and well provisioned.
  - Deposits make up over two-thirds of total liabilities and in aggregate exceed loans.
- Stress-testing framework coverage:
  - Coverage: five major banks; projection to end-2014.
  - Methodologies: top-down balance sheet stress tests, single-factor sensitivity tests, and Contingent Claims Analysis (CCA).
- Balance-sheet scenario stress test results:
  - Banks’ capital would remain adequately capitalized under the Base and Adverse 1 and 2 scenarios.
  - Reasons: comfortable initial capitalization and profitability; low housing default risk; favorable starting point for corporate credit losses; no large changes in RWA due to standardized approach.
  - Caveat: some banks significantly more exposed to certain risks.
- CCA results:
  - Under Adverse scenario 2, banks’ estimated credit spreads increase to about 400 basis points (bps).
  - Total expected losses to bank creditors for the five largest banks as a percent of GDP: under Adverse scenario 2, increases to about 1.4 percent of GDP.
- Single-factor shocks and concentration:
  - Largest impacts on capital from credit shock to each bank’s largest borrower group and to the largest three borrowers.
  - Exposures to European sovereigns and banks are negligible.

### Liquidity stress test results (selected figures from Table 2)
- Metric: regulatory ratio of unencumbered high quality short-term assets to expected liquidity needs over one month; ratio meant to exceed unity.
- All currencies — Baseline: 1.63 ; Average: 1.62 ; Minimum: 1.48
- Foreign currency — Baseline: 1.59 ; Average: 1.49 ; Minimum: 1.04
- A 10 percent outflow of short-term deposits:
  - All currencies: 1.28 ; Foreign currency: 1.25
  - Average change from baseline: All currencies 0.35 ; Foreign currency 0.33
  - Worst change from baseline: All currencies 0.36 ; Foreign currency 0.50
- A 20 percent outflow of non-resident deposits:
  - All currencies: 1.53 ; Foreign currency: 1.30
  - Average change from baseline: All currencies 0.09 ; Foreign currency 0.27
  - Worst change from baseline: All currencies 0.12 ; Foreign currency 0.50
- Memorandum items (percent):
  - Short-term assets/total assets: All currencies 33.32 ; Foreign currency 40.26
  - Short-term foreign currency assets/total short-term assets: 22.72
- Note: Baseline excludes Israeli treasury bills.

### Insurance sector and long-term savings (LTS) stress test results
- LTS weighted average portfolio: Local investments 84.8 ; Foreign investments 15.2 (In percent).
- Market shock results (Change in assets value, percent, weighted average portfolio):
  - Stress test scenario Q4 2008 = -4.3
  - Local Shock Stress Test Scenario = -7.7
- LTS average loss under scenarios:
  - Historical-based scenario (4th Quarter 2008) weighted average loss: 7.70 percent
  - Simulated local shock scenario weighted average loss: 4.43 percent
- Insurance sector:
  - Market-based measures of soundness back to “normal” levels; a few firms lag.
  - Some companies see capital position improve via reserve release and tax credit after claims deterioration; two companies face challenges meeting new, higher capital requirements.
  - Supervisory stress testing by firms needs to be more stringent and combine insurance and market risks.

### Cross-border crisis preparedness and system structure
- Finding: authorities need to strengthen preparations for dealing with a cross-border crisis in a financial institution.
- Total financial system assets:
  - 2005: 1,526.9 (in billions of NIS) — 254.0 percent of GDP
  - 2008: 1,778.0 (in billions of NIS) — 245.7 percent of GDP
  - 2010: 2,136.8 (in billions of NIS) — 262.8 percent of GDP
- Five major banks, consolidated total assets:
  - 2005: 859.2 (in billions of NIS) — 142.9 percent of GDP
  - 2008: 1,012.8 — 140.0 percent of GDP
  - 2010: 1,068.8 — 131.5 percent of GDP
- Selected macroeconomic indicators (annual percent change and levels):
  - Real GDP: 2011: 4.7 ; 2012 (Est.): 2.8 ; 2013 (Projections): 3.8
  - Unemployment rate (percent): 2011: 5.7 ; 2012 (Est.): 6.0 ; 2013 (Projections): 5.8
  - Overall CPI (end period): 2011: 2.2 ; 2012 (Est.): 2.0 ; 2013 (Projections): 2.0
  - General government debt (percent of GDP): 2011: 74.4 ; 2012 (Est.): 73.5 ; 2013 (Projections): 72.3
  - Exchange rate NIS per U.S. dollar: 2011: 3.6
- Financial Soundness Indicators: Five Major Banks (selected)
  - Regulatory capital to risk-weighted assets: 2011: 13.6 ; 2011 Q3 Prel,: 13.6
  - Regulatory Tier I capital to risk-weighted assets: 2011: 8.3 ; 2011 Q3 Prel,: 8.2
  - Capital as percent of assets (leverage ratio): 2011: 6.3 ; 2011 Q3 Prel,: 6.7
  - Nonperforming loans to total gross loans: latest reported: 3.1 ; 2.5 ; 2.5 (end periods shown)
  - Households: share of bank credit 2011: 39.4 ; Of which mortgages 2011: 25.3
  - Return on average assets (after tax) 2011: 0.7
  - Return on average equity (after tax) 2011: 12.0

### Stress testing framework (Appendix III) — key parameters and assumptions
- Coverage and baseline:
  - Coverage: five largest banks (93 percent of assets; 95 percent of total sector lending).
  - Baseline data: End-June 2011; projection period through end-2014.
  - CAR hurdle rate: 9 percent ; CT1 threshold: 5 percent.
- Macro scenarios (selected values, In percent):
  - Real GDP growth Base: 2011 3.6 ; 2012 3.1 ; 2013 3.4 ; 2014 3.7
  - Real GDP growth Adv. 1: 2011 3.4 ; 2012 1.2 ; 2013 2.5 ; 2014 2.8
  - Real GDP growth Adv. 2: 2011 1.9 ; 2012 -2.8 ; 2013 1.2 ; 2014 2.5
  - Inflation Base: 2011 3.0 ; 2012 2.3 ; 2013 2.2 ; 2014 1.8
  - Inflation Adv. 2: 2011 2.8 ; 2012 0.6 ; 2013 -1.4 ; 2014 -4.8
  - Exchange rate depreciation Adv. 2: 2012 12.0
  - Bank of Israel interest rate Adv. 2: 2012 1.0 ; 2013 0.5 ; 2014 0.5
  - Unemployment Adv. 2: 2012 9.9 ; 2013 11.1 ; 2014 10.8
  - Change in TA100 Index Adv. 2: 2012 -57.3 ; 2013 33.9 ; 2014 21.7
  - Long-term/short-term yield spread Adv. 2: 2012 5.6 ; 2013 4.7 ; 2014 4.1
- Single-shock sensitivity impacts (percent of CT1):
  - Credit shock to largest corporate group: Impact 8.5 to 12.6 percent of CT1.
  - Credit shock to largest three borrowers: Impact 4.3 to 6.6 percent of CT1.
  - Stock market decline of 25 percent: Impact 0.3 to 3.8 percent of CT1.
  - Exchange rate depreciation of 15 percent: Impact 0.2 to 3.1 percent of CT1.
  - Interest rate increase of 200 bp.: Impact -5.0 to 5.0 percent of CT1.
  - European peripheral exposures shock: Impact 0.4 to 1.4 percent of CT1.
- Behavioral adjustments in top-down balance sheet tests:
  - Dividend rules: if ROE>6 percent and CT1 between 8 to 8.5 percent dividends = 35 percent; if ROE>6 percent and CT1 > 8.5 percent dividends = 50 percent; if ROE<6 percent dividends = 0.
- Liquidity tests:
  - Metric: unencumbered high quality short-term assets to expected liquidity needs over one month; ratio meant to exceed unity.
  - Base period: end-2011.

*Source: IMF FSAP Update (team lead Daniel Hardy) as presented in the provided content.*

### 2011. The FSAP findings were discussed further with the authorities during the Article IV

### _cr1269 - 2011. The FSAP findings were discussed further with the authorities during the Article IV

### FSAP team and acknowledgments
- The FSAP team comprised: Daniel Hardy and included Anna Ilyina, Dale Gray, Kotaro Ishi, Rodolfo Wehrhahn, Peter Lindner, Virginia Rutledge (all IMF), as well as external experts Joel Shapiro, Thierry Bayle (Banque de France), Chris Mann, Lawrie Savage, and Malcolm Rodgers.
- Mr. Amit Friedman, (Office of the Executive Director), took part in meetings as an observer.
- The FSAP Update team is thankful for the excellent cooperation it received from the authorities and market participants.
- The main author of this report is Daniel Hardy with contributions from the rest of the FSAP team.

### Overall assessment and key vulnerabilities
- Analysis suggests that Israel’s financial sector is robust, although concentration in the financial and nonfinancial sectors could amplify systemic effects.
- The most immediate vulnerabilities are to possible shocks in global financial markets and regional geopolitical events.
- Stability analysis suggests that systemic financial vulnerabilities to severe shocks in line with historical experience are manageable; in aggregate, buffers (including those in the household sector) are at comparatively comfortable levels.
- The boom in housing prices and construction in recent years represents a further vulnerability, although recent evidence points to a soft landing, partly in response to the authorities’ policy actions.
- Stress testing summary:
  - A variety of stress tests for banks, insurance companies, and long-term savings funds were undertaken.
  - The calibration of these tests was demanding, but only a few individual institutions were projected to suffer major losses or to become relatively short of liquidity.
  - Further development of stability analysis, with particular emphasis on cross-sectoral linkages and network effects, is warranted.

### Regulation, supervision, and oversight findings
- Financial regulation and supervision are strong, and the level of observance of international financial sector standards is high.
- Further enhancement is needed in some areas, such as liquidity regulations and supervision of groups, as international practice evolves.
- Specific supervisory and regulatory needs:
  - Various risk factors, such as liquidity risk and group inter-connectedness, deserve more attention.
  - There are a few gaps in coverage and the possibility of inconsistent treatment, for example, related to certain securities markets activities.
  - The authorities need to take into account the burden on financial institutions and their clients of complex and rapidly changing regulations.
  - Retention of supervisory staff with specialized skill sets, with commensurate compensation, is required to keep up with an evolving financial sector.

### Macroprudential coordination and institutional arrangements
- Establishment and operation of a cross-sectoral financial stability committee would enhance the coordination and effectiveness of micro- and macro-prudential analysis and policy.
- Recommended institutional roles and actions:
  - The BOI seems to be best suited to continue to play the leading role in coordinating macroprudential oversight.
  - If a consensus-based approach proves ineffectual, further institutional changes may be needed to achieve fully coherent and decisive financial sector policy-making.

### Liquidity framework, payments, and market infrastructure
- The authorities have enhanced the central bank liquidity framework and introduced a real time gross settlement system (Zahav).
- Remaining actions to strengthen market infrastructure and resilience:
  - Remove remaining barriers to the development of the repo market.
  - Strengthen payments system oversight.
  - Further develop a comprehensive business continuity plan.
  - These measures would contribute to both stability and efficiency.

### Crisis management and safety-net recommendations
- The framework for financial crisis management needs to be reinforced through:
  - Better articulation of the conditions under which emergency liquidity support will be provided to financial institutions;
  - Completing the set of tools for intervention including early intervention;
  - Clarifying the fiscal backstop for bank solvency support and protection of depositors.
- Specific policy recommendations:
  - The framework for the provision of emergency liquidity assistance (ELA) needs to be better defined. Solvent but illiquid banks (or a systemically important NBFI such as a clearing house) should be able to count on the central bank to provide funding, but under predictable conditions that provide appropriate incentives and protect the central bank from losses.
  - There needs to be a complete set of tools for early intervention in a troubled bank, and then a special framework for going-and-gone concern resolution of banks and possibly certain NBFIs. Using normal bankruptcy proceedings (at least for a major bank) would be very disruptive to the provision of financial services, credit to the economy, and the protection of retail depositors.
  - Means must be available to meet solvency needs and fund bank resolution, and at the same time protect less financially sophisticated savers. Options could include establishment of a resolution fund, a deposit guarantee scheme, or a government line of credit, possibly combined with a bank levy and depositor preference in resolution.
  - Solvency support is essentially a fiscal activity with which the central bank should not be saddled.
  - Responsibilities and mechanisms for coordination in times of crisis are needed. One element could be to prepare the FSC for conversion into a crisis management steering committee when the need arises.

### Main recommendations (summary of Table 1)
- Strengthen the institutional framework for macroprudential oversight and policy setting by more formally establishing a Financial Stability Committee (FSC) and initiating its operations.
  - Authority: All
  - Priority: High
  - Time-frame: Near-term
  - Para.: 46
- Further improve stress testing techniques, including the capacity to analyze systemic risks, credit risk, and liquidity risk.
  - Authority: BOI, CMISD
  - Priority: High
  - Time-frame: Near-term
  - Para.: 20, 23, 24, 47
- Eliminate gaps and overlaps in supervisory responsibilities, ensuring that like activities are subject to equally stringent regulation and supervisions.
  - Authority: BOI, ISA, CMISD
  - Priority: High
  - Time-frame: Near-term
  - Para.: 28-30
- Undertake more systematically cost-benefit analysis of regulatory changes, and streamline regulations where possible.
  - Authority: BOI, ISA, CMISD
  - Priority: Medium
  - Time-frame: Near-term
  - Para.: 26
- Strengthen the AML/CFT legal and regulatory framework, in particular with regard to the designated non-financial businesses and professions, and the transparency of beneficial ownership.
  - Authority: Government
  - Priority: High
  - Time-frame: Near-term
  - Para.: 43
- Further banking oversight priorities include strengthening regulation and supervision of interest rate risk and market risk, and developing regulation of liquidity risk as international practice in this area evolves.
  - Authority: BOI
  - Priorities: High
  - Time-frames: Immediate (interest rate and market risk), Near-term (liquidity risk)
  - Paras.: 33 (interest rate/market), 32 (liquidity)
- Crisis management specific items:
  - Establish a policy framework for ELA.
    - Authority: BOI
    - Priority: High
    - Time-frame: Immediate
    - Para.: 50
  - Establish by law and make operational a full set of early intervention tools and a special framework for going-and-gone concern resolution.
    - Authority: BOI, MOF
    - Priority: High
    - Time-frame: Near-term
    - Paras.: 51-55
  - Establish mechanism for providing solvency support and for funding bank resolution, protecting the BOI from quasi-fiscal activities.
    - Authority: BOI, MOF
    - Priority: High
    - Time-frame: Near-term
    - Paras.: 56-58
  - Agree on a protocol for the coordination of, and assignment of responsibilities for system-wide crisis management.
    - Authority: All
    - Priority: High
    - Time-frame: Immediate
    - Paras.: 59-60

- Time-frame definitions from Table 1:
  - "Immediate" is within one year; "near-term" is within 1–3 years.

*Source: IMF FSAP Update (team lead Daniel Hardy) as presented in the provided content.*

### 2.      Financial supervision responsibilities in Israel are shared among several

### _cr1269 - 2.      Financial supervision responsibilities in Israel are shared among several

### Financial supervision framework
- The BOI supervises banks and is responsible for payments system oversight.
- The Israeli Securities Authority (ISA) oversees the securities sector.
- The Capital Markets, Insurance, and Savings Division (CMISD) at the MOF is responsible mainly for oversight of the insurance and pension sector.
- The Tel Aviv Stock Exchange (TASE) has some supervisory responsibilities for its members.
- Only the BOI has an explicit mandate to promote the stability of the financial system.

### Effects of the global crisis
- No domestic financial institution got into serious difficulties during the crisis; banks weathered the storm although profitability suffered.
  - Footnote: One bank made large losses on U.S. mortgage-backed securities (MBS), but losses on domestic business were small.
- Contributing factors to relatively robust bank performance:
  - Short-lived recession.
  - Banks’ conservative management.
  - Reliance on deposit funding and the small interbank and wholesale funding markets.
  - Lack of complex asset and securitized markets.
  - Strong and intrusive bank supervision.
- Corporate bond market and NBFIs were hard hit:
  - Primary market shrank and largely “froze” in late 2008.
  - Corporate bond yields rose sharply, particularly in the real estate industry.
  - Some long-term savings products made significant losses.
  - Mutual and provident funds faced large redemptions as public confidence in asset quality was shaken.
  - Underlying infrastructure weaknesses included an inadequate framework for evaluating and monitoring credit risks and poor transparency.
  - Footnote: Pension funds were protected by regulation penalizing early withdrawals.
- Authorities’ crisis measures:
  - BOI cut policy interest rates and expanded liquidity facilities; tightened bank supervisory measures in reporting, capital, and liquidity.
  - MOF established back-stop mechanisms, including a “safety net” program for provident fund savings and a program offering guarantees to banks for raising capital.
  - ISA set up a debt settlement framework.
  - Hodek committee established and in 2010 presented recommendations to improve market transparency, conduct, and corporate governance of institutional investors.
  - Footnote reference: See IMF Country Report No. 10/23.

### Macroeconomic performance and outlook
- After a mild recession in early 2009, output recovered in mid-2009 and continued to grow strongly through the first part of 2011.
- Economic developments through early 2011:
  - Unemployment fell to comparatively low levels.
  - Inflationary pressures became apparent.
  - House prices increased rapidly (more than 40 percent in real terms since 2008).
  - Strong capital inflows continued even during periods of heightened regional tension.
- From September 2011 the BOI turned to a monetary easing cycle as global growth slowed and Israel’s growth momentum was expected to weaken.
- External exposure notes:
  - Israel is a small open economy; Europe and the U.S. are largest trading partners.
  - Direct exposures to European periphery countries are negligible, but European financial markets turmoil in fall 2011 negatively affected Israel’s financial markets as evidenced by rising risk premia on corporate bonds.
  - An increasing share of exports goes to emerging market economies.
- Public debt and contingent pension liabilities risk factors have diminished in relative importance since earlier recessions.

### Implementation of 2001 FSAP recommendations
- Original FSAP findings:
  - Financial system generally robust; system largely bank-based; corporate bond and money markets nearly nonexistent; state assumed insurance and pension fund risks.
  - Most supervisory components relatively strong, but coordination was weaker; payment and settlement system safety and oversight inadequate.
- Post-crisis:
  - Many FSAP recommendations implemented (Appendix I referenced).
  - Supervision in all sectors including payment system strengthened.
  - Framework for financial crisis management still lacks certain elements.

### Vulnerability analysis — key macroeconomic and financial risks
- Identified risk factors (Appendix II referenced):
  - Global recession risk: main trading partners (especially Europe and the United States) may slip back into recession, contracting trade and tightening funding conditions (including the corporate bond market where substantial rollover is expected in 2012). Capital flows to Israel could appreciate the currency and hurt the tradables sector.
  - Geopolitical risk: Israel is unusually exposed; prolonged regional turmoil could lead to large increases in energy prices, inflation, and much higher real interest rates globally.
  - Concentration risk: nonfinancial, banking, and insurance sectors are concentrated; idiosyncratic shock to a major institution or operational failure in one bank could weaken confidence system-wide. Difficulties in a major conglomerate could have unpredictable cross-economy effects and raise risk premia.
  - Housing and construction: rise in housing prices and construction boom could pose renewed risks if momentum is regained or if prices fall sharply; much credit growth concentrated in these sectors and a sudden reversal could produce NPLs in mortgages and loans to construction companies.
- Historical note: Such inflows (capital) were seen in 2010–11 (accompanying Staff Report on the 2012 Article IV consultation).

### Household and corporate sector vulnerabilities
- Households and housing market:
  - Households have relatively little mortgage or consumer debt; financial assets built up strongly in recent years.
  - Large share of assets and liabilities are indexed or carry variable interest rates.
  - Mortgage loans have not generated significant bank losses in the past decade; mortgages carry recourse and loan-to-value ratios are typically low.
  - Residential construction boomed; mortgage lending increased rapidly.
  - By mid-2009, deterioration in mortgage lending standards noted (increase in unindexed floating rate mortgage loans).
  - Authorities’ measures: higher capital requirements for housing loans, supplemental reserve requirements, and variable interest rate mortgage limits.
  - House price inflation recently leveled off, but vulnerability remains.
- Corporate sector:
  - Corporate sector recovering from the 2008–09 global crisis; market indicators for corporate default probability have begun to rise though still below 2008–09 levels.
  - Corporate bond market:
    - Total corporate bonds outstanding amounts to 32 percent of GDP.
    - Commercial real estate-related corporate bonds amount to 12 percent of GDP.
    - These levels are far above those seen in most advanced economies.
    - Hodek committee recommendations and ISA provisions (e.g., minimum covenants for new bond issues) likely improved quality of new issues.
    - Bonds restructured following the 2008 crisis are falling due in the coming period.
    - Large fraction of real estate-related debt linked to overseas activities, exposing Israel to shocks from abroad.
    - Corporate bond market is somewhat shallow relative to its size—little market making or foreign involvement—raising risk of sudden price movements and market illiquidity.
    - Disruption in bond markets abroad could quickly affect corporates’ financing conditions.

### Banking sector risk assessment and stress-testing
- Bank fundamentals:
  - Financial stability indicators for banks are satisfactory and broadly in line with comparator countries.
  - Capitalization ratios have been rising, much of the increase in Tier 2 capital.
  - Nonperforming loans (NPLs) are low and well provisioned.
  - Deposits make up over two-thirds of total liabilities and in aggregate exceed loans.
  - Profitability has been adequate and fairly stable after allowing for exceptional items.
    - Footnote: For example, banks made one-off profits from the sale of provident funds in 2005-07.
  - Noninterest expenses (mainly staff remuneration) are a relatively high share of gross income, which may limit resilience if interest spreads compress.
- Stress-testing framework:
  - Banking sector assessment includes top-down balance sheet stress test and single factor tests by BSD, and a contingent claims analysis (CCA) stress test by BOI and IMF staff (Appendix III referenced).
  - Coverage: the five major banks, with results projected to end-2014 to capture full effects of shocks.
  - Methodology:
    - Balance sheet-based tests project balance sheet items and profitability (which feeds back into capitalization) using satellite models linking credit quality to macro variables.
    - CCA uses market and accounting information to project risk-adjusted balance sheets and ultimately credit spreads.
- Stress-test scenarios:
  - Base scenario: BOI staff’s forecasted path of the economy, relying on the BOI macro-model; it is more conservative than the IMF WEO October 2011 forecast.
  - Adverse scenario 1: domestic recession caused by geopolitical concerns leading to economic disruption, declining demand (especially in real estate), an increase in unemployment, and a rising risk premium.
  - Adverse scenario 2: global recession and difficulties in Europe sharply affecting the Israeli economy; Real GDP declines relative to the baseline by about 2½ standard deviations.

### Structural concentration and competition concerns
- Banking concentration:
  - Five banking groups provide universal banking services and account for 95 percent of banking sector assets.
  - The two largest alone constitute more than half the system.
  - Remaining system: three independent banks and four branches of foreign banks.
  - Footnote: Each of five largest banking institutions represents a “bank holding company,” typically comprising the main bank, one or more wholly-owned boutique banks, and several nonbank financial subsidiaries.
- Nonbank financial concentration:
  - Insurance sector: four largest groups have a dominant market share in most business lines (e.g., life insurance market share over 80 percent).
  - Greater foreign involvement in the nonbank sector than in banking; one major insurer is foreign owned.
- Corporate concentration:
  - Israel’s corporate sector generally dominated by large conglomerate groups.
  - Turnover of the six largest groups accounts for about a quarter of GDP.
  - 88 percent of all Israeli public companies have a controlling shareholder (ISA).
- Policy response to competition concerns:
  - Committee on Increasing Competitiveness in the Economy created.
  - One key recommendation: prohibition of control or holding in a “significant” financial institution (over NIS 50 billion in assets) by a significant real entity or by the controlling shareholder of a significant real entity (over NIS 8 billion in sales or assets of NIS 20 billion).

*Source: _cr1269 - 2.      Financial supervision responsibilities in Israel are shared among several*

### 16.      The balance sheet scenario stress test results suggest that banks’ capital would

### _cr1269 - 16.      The balance sheet scenario stress test results suggest that banks’ capital would

### Balance-sheet scenario stress test results
- Banks’ capital would remain adequately capitalized under the Base and Adverse 1 and 2 scenarios (Figure 6).
- Reasons for robust results include:
  - relatively comfortable initial capitalization and profitability;
  - low housing default risk;
  - favorable starting point for corporate credit losses reflecting recent good corporate performance;
  - no large changes in risk-weighted assets (RWA) because banks are under the standardized approach.
- Caveat: some banks appear significantly more exposed than others to certain risk factors, indicating supervisory attention should be directed to such cases.
- Footnotes (as presented in source):
  - The effects under Adverse scenario 2 are indeed more severe than those seen in 2008-09 after allowing for the exceptional valuation losses on U.S. MBS suffered at that time.
  - There is small reduction in RWA due to exchange rate effects under the standardized approach rules.

### Single-factor shocks and concentration risk
- Single factor shock results show concentration risk has the largest potential impact on capital.
- Largest impacts on capital:
  - credit shock from each bank’s largest borrower group;
  - credit shock of the largest three individual borrowers is significant for several banks.
- Exposures to European sovereigns and banks are so small as to have a negligible impact.

### CCA (contingent claim analysis) results
- CCA results are consistent with balance-sheet stress test results (Figure 7).
- Under the Adverse 1 scenario, estimated credit spreads “do not rise much above those of the baseline.”
- Under Adverse scenario 2:
  - banks’ estimated credit spreads increase to about 400 basis points (bps), a level somewhat higher than those seen during the worst periods of the financial crisis in 2008/09 (which, for Israel, proved manageable).
  - some banks seem more vulnerable than others in these scenarios.
  - total expected losses to bank creditors for the five largest banks as a percent of GDP: under Adverse scenario 2, the total expected losses to bank creditors increases to about 1.4 percent of GDP.
- Footnote clarifications:
  - A rise in bank spread means a rise in bank marginal funding cost (in basis points).
  - Expected loss to bank creditors refers to the expected loss associated with bank debt (in million NIS), equal to default probability times loss given default.

### Liquidity stress test results
- All major banks would be able to maintain the liquidity ratio above unity under strong stress scenarios (Table 2).
- However, for foreign currency liquidity positions alone, some banks would not be able to maintain an excess of foreign currency short-term assets over liabilities.
- Deposit outflows are potentially the main source of liquidity risk because banks do not rely on market funding and hold relatively few securities.
- Selected figures from Table 2 (Change in ratios unless indicated):
  - All currencies — Baseline: 1.63 ; Average: 1.62 ; Minimum: 1.48
  - Foreign currency — Baseline: 1.59 ; Average: 1.49 ; Minimum: 1.04
  - A 10 percent outflow of short-term deposits: All currencies 1.28 ; Foreign currency 1.25
    - Average change from baseline: All currencies 0.35 ; Foreign currency 0.33
    - Worst change from baseline: All currencies 0.36 ; Foreign currency 0.50
  - A 20 percent outflow of non-resident deposits: All currencies 1.53 ; Foreign currency 1.30
    - Average change from baseline: All currencies 0.09 ; Foreign currency 0.27
    - Worst change from baseline: All currencies 0.12 ; Foreign currency 0.50
  - A bank's largest interbank claim becomes illiquid: All currencies 1.61 ; Foreign currency 1.52
    - Average change from baseline: All currencies 0.02 ; Foreign currency 0.10
    - Worst change from baseline: All currencies 0.04 ; Foreign currency 0.16
  - Short term securities become illiquid: All currencies 1.57 ; Foreign currency 1.38
    - Average change from baseline: All currencies 0.05 ; Foreign currency 0.18
    - Worst change from baseline: All currencies 0.10 ; Foreign currency 0.38
  - Memorandum items (percent):
    - Short-term assets/total assets: All currencies 33.32 ; Foreign currency 40.26
    - Short-term foreign currency assets/total short-term assets: 22.72
- Note: Baseline excludes Israeli treasury bills.

### Insurance sector and long-term savings (LTS) risk assessment
- Financial soundness indicators for insurers show recovery from the global crisis, with a few firms lagging.
  - Capitalization, profitability, and liquidity comparable to international peers; market-based measures of soundness back to “normal” levels.
  - Insurance sector is a major holder of Israeli corporate bonds.
- Long-term savings stress test results:
  - Market shocks of similar magnitude as those during Q4 2008 and a simulated severe local shock would result in an average 7.7 percent loss on the LTS portfolio of individuals.
  - LTS portfolio composition (In percent):
    - Participating policies: Local investments 79.4 ; Foreign investments 20.6
    - Provident funds: Local investments 88.2 ; Foreign investments 11.8
    - New pension funds: Local investments 82.1 ; Foreign investments 17.9
    - Weighted average portfolio: Local investments 84.8 ; Foreign investments 15.2
- Scenario results (Change in assets value, percent) — selected entries (as presented):
  - Participating policies: RF drop 20% = 1.4 ; RF increment 20% = -1.4 ; Spread +50 bps = -0.4 ; Spread +100 bps = -0.9 ; Spread +200 bps = -1.8 ; Equity drop 20% = -3.5 ; Equity drop 30% = -5.2 ; FX gain 20% = 4.2 ; FX loss 20% = -4.2 ; Stress test scenario Q4 2008 = -3.3 ; Local Shock Stress Test Scenario = -9.4
  - Provident funds: RF drop 20% = 1.7 ; RF increment 20% = -1.7 ; ... ; Stress test scenario Q4 2008 = -5.4 ; Local Shock Stress Test Scenario = -7.5
  - New pension funds: RF drop 20% = 0.9 ; RF increment 20% = -0.9 ; ... ; Stress test scenario Q4 2008 = -2.5 ; Local Shock Stress Test Scenario = -5.8
  - Weighted average portfolio: RF drop 20% = 1.5 ; RF increment 20% = -1.5 ; ... ; Stress test scenario Q4 2008 = -4.3 ; Local Shock Stress Test Scenario = -7.7
- Insurance business excluding saving products stress test:
  - Did not expose large vulnerabilities overall.
  - Some companies see capital position improve via reserve release and tax credit following deterioration of claims.
  - Two companies face challenges meeting new, higher capital requirements.
- Supervisory stress testing by firms:
  - Need to be more stringent; insurance and market risks should be combined in single stress scenarios (e.g., a historical scenario combined with an insurance shock such as an earthquake).

### Insurance own funds stress test (selected outcomes)
- Own funds portfolio composition as of June 2011 includes Gov. bonds & deposits, Corporate bonds, Other, Loans, Equity, Cash (maximum, unweighted mean, minimum shown in Figure 11).
- Change in insurers’ capital surplus (In percentage points) — selected companies (scenarios as presented):
  - Company A: Mortality -0.9 ; Motor -0.3 ; Property -0.4 ; Mortality+motor -1.2 ; Mortality+motor+property -1.6 ; 2008Q4 1.5 ; 2008Q4+mortality 0.6 ; 2008Q4+motor 1.2 ; 2008Q4+property 1.2 ; 2008Q4+motor+property 0.9 ; 2008Q4+mortality+motor 0.3 ; 2008Q4+mortality+motor+property 0.0
  - Company B: Mortality -0.4 ; Motor -0.5 ; Property -0.6 ; Mortality+motor -0.8 ; Mortality+motor+property -1.4 ; 2008Q4 -4.0 ; 2008Q4+mortality -4.4 ; 2008Q4+motor -4.5 ; 2008Q4+property -4.6 ; 2008Q4+motor+property -5.1 ; 2008Q4+mortality+motor -4.9 ; 2008Q4+mortality+motor+property -5.4
  - Company C: Mortality -0.6 ; Motor -0.4 ; Property -0.6 ; Mortality+motor -1.1 ; Mortality+motor+property -1.6 ; 2008Q4 -10.9 ; 2008Q4+mortality -11.5 ; 2008Q4+motor -11.3 ; 2008Q4+property -11.5 ; 2008Q4+motor+property -11.9 ; 2008Q4+mortality+motor -11.9 ; 2008Q4+mortality+motor+property -12.5
  - Company D: Mortality -1.3 ; Motor -0.8 ; Property -1.3 ; Mortality+motor -2.1 ; Mortality+motor+property -3.4 ; 2008Q4 -3.5 ; 2008Q4+mortality -4.9 ; 2008Q4+motor -4.3 ; 2008Q4+property -4.8 ; 2008Q4+motor+property -5.6 ; 2008Q4+mortality+motor -5.6 ; 2008Q4+mortality+motor+property -6.9
  - Company E: Mortality -0.7 ; Motor -0.7 ; Property -0.8 ; Mortality+motor -1.4 ; Mortality+motor+property -2.2 ; 2008Q4 -2.8 ; 2008Q4+mortality -3.5 ; 2008Q4+motor -3.4 ; 2008Q4+property -3.5 ; 2008Q4+motor+property -4.2 ; 2008Q4+mortality+motor -4.2 ; 2008Q4+mortality+motor+property -5.0
  - Company F: Mortality -0.2 ; Motor -1.5 ; Property -1.8 ; Mortality+motor -1.7 ; Mortality+motor+property -3.5 ; 2008Q4 -9.6 ; 2008Q4+mortality -9.7 ; 2008Q4+motor -11.1 ; 2008Q4+property -11.4 ; 2008Q4+motor+property -12.9 ; 2008Q4+mortality+motor -11.3 ; 2008Q4+mortality+motor+property -13.1

### Financial sector oversight and supervisory recommendations
- Overall assessment:
  - Financial regulation and supervision is generally sophisticated and thorough; international supervisory standards are assessed to be observed to a high degree.
  - Authorities take a pro-active, stability-oriented approach; regulations generally up to date; substantial on-site and off-site information gathering and analysis; prompt correction of deficiencies is demanded.
- Risks and recommended enhancements:
  - Avoid over-complication and undue regulatory burden; consider a medium-term project to streamline and systematize legislation and regulations.
  - Provide more detailed and publicly available assessment of costs and benefits of new regulations when feasible.
  - Maintain effective supervisor independence and up-to-date skill sets; supervisors need flexibility in personnel policies and budgets to attract specialized quantitative skills.
  - Improve cross-sectoral cooperation and information-sharing, especially given a relatively large NBFI sector and securities markets; consider institutionalizing arrangements and operational MOUs to define information-sharing and confidentiality boundaries.
  - Address gaps and overlaps arising from division of responsibilities among three supervisors to ensure like activities are subject to like regulation and supervision; work to contain regulatory arbitrage and coordinate taxation and regulation of close substitutes.
- Banking supervision specific recommendations:
  - Enhance liquidity management and funding supervision (including foreign currency liquidity); use more on-site inspection resources; revise the existing directive on liquidity management.
  - Strengthen supervision of interest rate risk and aspects of market risk affecting the banking book and direct effects on earnings and capital.
  - Recognize challenges from the BOI policy of requiring a “controlling shareholder” as banks grow or need capital.
  - Prepare for Basel III: given importance of Tier 2 in current capital structures and limited credit risk mitigation techniques, banks will need to raise additional equity or shrink balance sheets; monitor for signs that credit supply is being unduly affected during the transition and consider offsetting measures (monetary policy stance or conditions supporting sustainable non-bank credit supply).
- Insurance and LTS supervision recommendations:
  - Strengthen cross-border supervisory cooperation and information-sharing; establish MOUs and regular communication with supervisors in jurisdictions with significant investment in the Israeli insurance sector or where Israeli insurers operate.
  - Develop formal policies and tools to supervise groups effectively: group capital adequacy, reinsurance and risk concentration, internal control mechanisms, risk management systems, and specific group-wide reporting; address supervision of holding companies.
  - Continue ongoing work to strengthen group supervision in line with evolving international best practice.
- Capacity building:
  - The stress testing capacity built up in the BOI forms a good basis for further refinement and extension.
  - Continue to refine and extend BOI stress testing, including enhanced liquidity, profitability and corporate credit risk stress testing.
  - Note: robustness of some estimated satellite models is weakened by shortness of available data samples.

*Source: BOI, and staff estimates, as presented in the IMF chapter text.*

### 36.      The capacity of insurers and pension funds to assess credit risk may become a

### _cr1269 - 36.      The capacity of insurers and pension funds to assess credit risk may become a

### Regulation of Securities Markets
- Regulatory regime has been strengthened in recent years, but deficiencies remain.
- Significant gap: broker-dealer activity can be undertaken outside of the regulatory framework if:
  - the activity does not involve membership of the stock exchange, or
  - the provision of advice services to retail clients, and
  - is not undertaken by a bank.
- Certain over-the-counter derivatives activity, including the sale of products to retail investors, can take place outside the regulatory regime.
- Absence of a licensing framework for such intermediaries—currently modest in volume—could have serious implications for investor protection and, if grown, market stability.
- For the bond market:
  - Consideration should be given to eliminating the possibility of issuing under previously filed prospectuses: some companies are using the possibility of reopening outstanding issues in order not to provide bond covenants that abide by the Hodek committee’s recommendations.17
- TASE, as a self-regulatory organization, is responsible for licensing and supervision of its members, but:
  - bank members of TASE are wholly supervised by the BOI;
  - responsibility for detecting and dealing with insider trading and market abuse remains with the ISA;
  - arrangements for coordination and communication are in place, but high degree of practical day-to-day interaction is needed.

### Regulation of Payments and Settlement Systems
- System transformation:
  - Introduction in 2007 of a real time gross settlement high-value payment system, Zahav;
  - Enactment of a Payment Systems Law in 2008 and the BOI Law in 2010 have transformed operations and legal framework.18
  - System is now technically more efficient and stable, and better administered.
- Remaining gaps and risks:
  - Multilateral net settlement systems that settle in Zahav (Masav, BCH and TASE-CH) could be a source of instability to Zahav if settlement on one such system is disrupted by the illiquidity of a major participant.
  - Legal provisions and oversight could be strengthened to guard against this risk.
- Oversight priorities and timelines:
  - Now that Zahav is operational, focus is on establishing effective oversight of payment systems (Zahav, Masav, the Israeli ACH, and BCH).
  - Authorities need to ensure this project is completed by the 2013 target date.
- Business continuity and disaster recovery:
  - Efforts need to be accelerated in the payments system and the BOI more generally.
  - Technical business continuity planning is well advanced, but further coordination is needed with parties on which Zahav depends, such as provision of intra-day liquidity via TASE-CH or BOI monetary operations.

### Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT)
- Framework continues to be strengthened; authorities cooperate actively with counterparts and international organizations.
- Moneyval assessment in 2008 found an overall working AML/CFT regime but identified gaps; several gaps have been addressed as shown in 2009 and 2011 progress reports.
- Authorities are amending regulations for each category of financial institution in areas such as customer due diligence, recordkeeping, and supervision.
- Draft legislation is pending before the Knesset to impose AML/CFT obligations on certain designated non-financial businesses and professions currently not covered.
- Consideration is being given to ensure greater transparency with respect to beneficial ownership of legal persons and arrangements.

### Macroprudential Framework
- Progress made:
  - Financial Stability Group consisting of representatives from the three supervisory agencies was set up in mid-2011.
  - The group meets regularly and produces an internal report every quarter, providing an overview of macrofinancial stability issues together with policy options.
- Need for a more coherent approach:
  - All financial regulatory agencies should be involved in macroprudential supervision, but the BOI is best positioned to play the leading role due to mandate, powers, and capacity.
  - ISA has progressed in monitoring build-up of risks in market segments and instruments.
  - CMISD has improved stress-testing capacity, including analysis of potential feedback effects from distress in insurance and pension funds into the rest of the financial system.
  - Current activities are insufficiently coordinated.
- Recommendation: establish a standing Financial Stability Committee (FSC):
  - FSC should be chaired by the BOI, with representatives for both monetary policy and banking sector stability, and comprise the ISA, CMISD, and the MOF.19
  - The FSC would aim to work by consensus; if unwieldy, mechanisms for quick and firm decisions may be needed.
  - Mandate/functions: monitor sources of systemic risk, establish policy agenda to mitigate risks, address competition in the financial sector, consumer protection, and market conduct insofar as these are of systemic importance.
  - Address any legal or other impediments for information-sharing or the use of microprudential tools for macroprudential purposes during FSC establishment.
  - Ensure accountability through duties to communicate major policy decisions; joint publications such as a Financial Stability Report could be used.
  - Aim: an animated forum for cooperation at policy and technical levels, not a fully autonomous agency.
- Stress testing:
  - Should guide micro- and macroprudential policy to enhance financial stability.
  - Integrated stress testing should be expanded to analyze macroprudential risks and policies (e.g., through risk transfer among corporate groups, insurance companies, savers, and government).
  - Authorities’ project to assemble data on inter-connectedness in the corporate and financial sectors is commendable.20
  - Build hypothetical scenarios incorporating other countries’ crisis experience.
  - Stress testing can analyze potential benefits (i.e., reduced vulnerability from lower default risk and implied credit spreads) of possible new financial sector policies and other changes, such as proposed changes in ownership structure of conglomerates.

### IV. LIQUIDITY, CRISIS MANAGEMENT, AND SAFETY NETS

H3: Liquidity Management — Monetary operations and money markets
- Central bank liquidity operational framework has been significantly strengthened in recent years:
  - loan quota system replaced with standing credit and deposit facilities;
  - interbank settlement practices revamped.
- Repurchase (repo) markets:
  - Repos are thin; further development efforts merited.
  - Thinness partly reflects currently ample liquidity due to BOI’s recent large-scale foreign exchange purchase policy.
  - Efforts to develop repo markets have included introduction of a central trading and clearing facility for repos at TASE.
  - A new tax legislation defining repo transactions as lending has yet to be enacted.

H3: Emergency Liquidity Assistance (ELA)
- Need for an explicit ELA policy framework to avoid BOI’s liquidity assistance slipping into quasi-fiscal solvency support.
- Risk: without well-articulated criteria and procedures, BOI may provide liquidity to (and possibly take on credit risk on) institutions of doubtful solvency or immediate systemic importance.
- New BOI Law has broadened central bank’s power to provide ELA in principle to all NBFIs; generally, ELA is most relevant for institutions directly involved in the high-value payment system, suggesting ELA to nonbank financial institutions only under very exceptional circumstances.

H3: Early Intervention and Orderly Resolution of Problem Banks
- Importance: concentrated financial system makes efficient and effective crisis framework essential.
- Early intervention enhancements suggested:
  - provide more flexible grounds for requiring corrective measures;
  - ensure BOI may require a bank to take specific actions to correct identified problems;
  - broaden the list of other measures the BOI may impose on a bank.
- Going concern resolution recommendations:
  - Administrator should have a broad range of resolution techniques including:
    - mergers with a healthy bank;
    - rapid recapitalization with or without existing shareholders;
    - conversion of subordinated debt to equity;
    - dispose of assets and liabilities.
  - Law should grant administrator considerable discretion in dealing with different assets and liabilities, unlike current law requiring any transfer apply to all liabilities.
- Gone concern resolution recommendations:
  - Consider incorporating liquidation into a special resolution regime provided for in the Banking Ordinance.
  - A special bank resolution regime should include:
    - authority of the liquidator to organize rapid transfers of assets, liabilities, and combined portfolios (P&A transactions);
    - depositor preference;
    - power to establish a “bridge bank”;
    - ex post judicial review so liquidation is administratively handled rather than court-controlled.

H3: Early Intervention and Orderly Resolution of Problem Nonbank Financial Institutions
- Existing legislation provides nonbank supervisors powers to intervene and resolve NBFIs.
- General insolvency regime can normally apply, but exceptions may include settlement systems and clearing houses due to importance of ongoing functionality and rapid exposure changes.
- Review recommended of legal and operational capacity to deal promptly with a problem NBFI, especially where institution belongs to a conglomerate; consider ability to impose ring-fencing.

H3: Solvency Support and Funding of Banks in Resolution
- Current legal framework allows the BOI to guarantee public deposits and other bank liabilities with government approval, allowing BOI to incur a large contingent liability; this responsibility should rest squarely with the government.
- Precedent and expectations exist that depositors (and often other creditors) are bailed out; examples during the recent global crisis:
  - MOF and BOI issued statements assuring government would stand behind financial system stability and BOI would use all tools to protect depositors;
  - Provident fund investors were protected ex post from downside risk.
- Current arrangement does not protect BOI from quasi-fiscal potential liabilities nor ensure adequate sharing of costs among government, financial sector, and creditors.
- Possible complementary measures to consider:
  - amending Banking Ordinance to allow the government to guarantee public deposits and other bank liabilities after consultations with the BOI;
  - introducing a formal DGS;
  - introducing depositor preference.
- These measures aim to make implicit government support explicit and shift part of the burden back to institutions.
- Value of a formal DGS should be kept under review:
  - Objectives: contribute to stability by preventing panic withdrawals or providing funding for resolution tools; protect less financially sophisticated depositors; create a level-playing field between large and small banks.
  - Disadvantages: may reduce flexibility in dealing with problem banks; pre-funding requires premia on banks and depositors; a useful reserve level would be comparatively large given concentration of the banking system.
  - Without a formal DGS, other crisis management framework elements need to be stronger.
  - Depositor preference can be a substitute for and complement to a DGS.

H3: Coordination and Information-Sharing
- BOI has internal guidelines setting out procedures for dealing with weak/troubled banks, including establishment of a steering committee, but further organizational preparations are worthwhile.
- Recommendations:
  - Agree in advance a protocol for establishing a committee for coordinating crisis management preparations and allocating crisis management responsibilities.21
  - Consider preparing an operational crisis management MOU covering information sharing and allocation of specific responsibilities.
  - Hold joint “fire drills” occasionally, perhaps coordinated by the FSC.

*Source: IMF content unit _cr1269 - 36. The capacity of insurers and pension funds to assess credit risk may become a*

### 59.      The authorities need to strengthen their preparations for dealing with a

### _cr1269 - 59.      The authorities need to strengthen their preparations for dealing with a

### Cross-border crisis preparedness
- Finding: "The authorities need to strengthen their preparations for dealing with a cross-border crisis in a financial institution."
- Context: "While foreign operations of Israeli financial institutions are currently limited in aggregate, a few are more exposed, and interconnections with abroad may rise over time."
- Institutional note: "The proposed FSC could for the basis for this committee, but the structure would need to be adapted, for example, to take into account the role of the fiscal backstop."

### Structure of the financial system (selected items from Table 3)
- Total financial system assets:
  - 2005: 1,526.9 (in billions of NIS) — 254.0 percent of GDP
  - 2008: 1,778.0 (in billions of NIS) — 245.7 percent of GDP
  - 2010: 2,136.8 (in billions of NIS) — 262.8 percent of GDP
- Five major banks, consolidated (total assets, in billions of NIS; percent of GDP):
  - 2005: 859.2 — 142.9
  - 2008: 1,012.8 — 140.0
  - 2010: 1,068.8 — 131.5
- Selected individual bank total assets (in billions of NIS; percent of GDP where shown):
  - Bank Leumi Le Israel: 2005: 272.8 — 45.4; 2008: 310.8 — 43.0; 2010: 328.2 — 40.4
  - Bank Hapoalim: 2005: 273.3 — 45.5; 2008: 306.8 — 42.4; 2010: 320.9 — 39.5
  - Israel Discount Bank: 2005: 154.8 — 25.7; 2008: 182.2 — 25.2; 2010: 185.8 — 22.9
  - Mizrahi Tefahot Bank: 2005: 86.3 — 14.4; 2008: 114.0 — 15.8; 2010: 133.3 — 16.4
  - First International Bank of Israel: 2005: 71.9 — 12.0; 2008: 98.9 — 13.7; 2010: 100.7 — 12.4
- Non-bank financial institutions total assets:
  - 2005: 667.7 (in billions of NIS) — 111.1 percent of GDP
  - 2008: 765.2 (in billions of NIS) — 105.8 percent of GDP
  - 2010: 1,068.0 (in billions of NIS) — 131.4 percent of GDP
- Memorandum GDP (NIS billions): 2005: 601.2; 2008: 723.6; 2010: 813.0

### Selected macroeconomic and social indicators (from Table 4)
- Real economy (annual percent change):
  - Real GDP: 2007: 5.5; 2008: 4.0; 2009: 0.8; 2010: 4.8; 2011: 4.7; 2012 (Est.): 2.8; 2013 (Projections): 3.8
  - Domestic demand: 2007: 6.6; 2008: 2.2; 2009: 0.0; 2010: 4.4; 2011: 7.2; 2012 (Est.): 3.3; 2013 (Projections): 2.9
  - Private consumption: 2007: 6.3; 2008: 2.8; 2009: 1.4; 2010: 5.3; 2011: 3.6; 2012 (Est.): 1.5; 2013 (Projections): 2.5
  - Gross capital formation: 2007: 11.7; 2008: 0.9; 2009: -7.0; 2010: 4.0; 2011: 22.8; 2012 (Est.): 7.8; 2013 (Projections): 4.9
- Labor and prices:
  - Unemployment rate (percent): 2007: 7.3; 2008: 6.2; 2009: 7.6; 2010: 6.6; 2011: 5.7; 2012 (Est.): 6.0; 2013 (Projections): 5.8
  - Overall CPI (end period): 2007: 3.4; 2008: 3.8; 2009: 4.0; 2010: 2.6; 2011: 2.2; 2012 (Est.): 2.0; 2013 (Projections): 2.0
- Savings and investment (percent of GDP):
  - Gross national saving: 2007: 23.1; 2008: 19.6; 2009: 20.3; 2010: 18.1; 2011: 18.1; 2012 (Est.): 18.7; 2013 (Projections): 19.7
  - Foreign saving (percent of GDP): 2007: -2.7; 2008: -0.9; 2009: -3.6; 2010: -2.9; 2011: 0.6; 2012 (Est.): 1.0; 2013 (Projections): 0.2
  - Gross domestic investment: 2007: 20.3; 2008: 18.7; 2009: 16.7; 2010: 15.2; 2011: 18.7; 2012 (Est.): 19.7; 2013 (Projections): 19.9
- Public finance (percent of GDP):
  - Central government revenues and grants: 2007: 34.0; 2008: 31.4; 2009: 28.0; 2010: 28.8; 2011: 29.6; 2012 (Est.): 29.8; 2013 (Projections): 30.8
  - Central government total expenditure: 2007: 34.0; 2008: 37.7; 2009: 33.3; 2010: 32.6; 2011: 32.9; 2012 (Est.): 33.2; 2013 (Projections): 33.1
  - Central government overall balance: 2007: 0.0; 2008: -2.3; 2009: -5.3; 2010: -3.7; 2011: -3.3; 2012 (Est.): -3.4; 2013 (Projections): -2.3
  - General government overall balance: 2007: -1.3; 2008: -3.3; 2009: -6.0; 2010: -4.6; 2011: -4.0; 2012 (Est.): -3.5; 2013 (Projections): -2.6
  - General government debt: 2007: 78.1; 2008: 77.0; 2009: 79.4; 2010: 76.1; 2011: 74.4; 2012 (Est.): 73.5; 2013 (Projections): 72.3
- Balance of payments (percent of GDP):
  - Exports of goods and services: 2007: 42.4; 2008: 40.3; 2009: 34.7; 2010: 36.9; 2011: 36.9; 2012 (Est.): 33.6; 2013 (Projections): 33.8
  - Current account: 2007: 2.7; 2008: 0.9; 2009: 3.6; 2010: 2.9; 2011: -0.6; 2012 (Est.): -1.0; 2013 (Projections): -0.2
- Exchange rate:
  - Exchange rate regime: Free floating
  - NIS per U.S. dollar (annual): 2007: 4.1; 2008: 3.6; 2009: 3.9; 2010: 3.7; 2011: 3.6

### Financial Soundness Indicators: Five Major Banks (selected items from Table 5)
- Capital adequacy (percent):
  - Regulatory capital to risk-weighted assets: 2005: 10.6; 2006: 10.7; 2007: 11.1; 2008: 11.3; 2009: 13.6; 2010: 13.9; 2011: 13.6; 2011 Q3 Prel,: 13.6
  - Regulatory Tier I capital to risk-weighted assets: 2005: 7.2; 2006: 7.4; 2007: 7.7; 2008: 7.5; 2009: 8.3; 2010: 8.5; 2011: 8.3; 2011 Q3 Prel,: 8.2
  - Capital as percent of assets (leverage ratio): 2005: 5.6; 2006: 5.9; 2007: 6.1; 2008: 5.8; 2009: 6.3; 2010: 6.5; 2011: 6.3; 2011 Q3 Prel,: 6.7
- Asset quality and exposure:
  - Nonperforming loans to total gross loans: latest reported: 3.1; 2.5; 2.5 (end periods shown)
  - Sectoral distribution of bank credit (percent, selected sectors):
    - Industry: 2005: 13.7; 2006: 13.0; 2007: 12.4; 2008: 13.0; 2009: 11.1; 2010: 10.5; 2011: 10.6
    - Construction and real estate: 2005: 15.7; 2006: 15.2; 2007: 15.8; 2008: 16.9; 2009: 16.8; 2010: 16.7; 2011: 16.5
    - Households: 2005: 30.3; 2006: 33.5; 2007: 31.2; 2008: 32.8; 2009: 37.1; 2010: 38.3; 2011: 39.4
    - Of which: mortgages: 2005: 19.3; 2006: 20.5; 2007: 18.7; 2008: 19.8; 2009: 22.8; 2010: 24.2; 2011: 25.3
- Earnings and profitability:
  - Return on average assets (after tax): 2005: 0.7; 2006: 0.9; 2007: 0.9; 2008: 0.1; 2009: 0.5; 2010: 0.6; 2011: 0.7; 2011 Q1: 0.6
  - Return on average equity (after tax): 2005: 13.0; 2006: 15.1; 2007: 15.6; 2008: 2.3; 2009: 9.0; 2010: 9.4; 2011: 12.0; 2011 Q1: 9.7
- Liquidity:
  - Liquid assets as percent of total assets: latest reported values include 30.1; 32.4; 28.9; 59.6 (periods shown)
  - Customer deposits as a percent of total (non-interbank) loans: 2005: 129.2; 2006: 125.7; 2007: 119.5; 2008: 113.8; 2009: 117.6; 2010: 111.0; 2011: 110.0; 2011 Q3 Prel,: 107.9
- Foreign exchange risk (selected):
  - Foreign currency-denominated loans as percent of total loans: reported series include 18.1; 16.7; 14.1; 12.5
  - Foreign currency-denominated deposits as percent of total loans: reported series include 31.2; 28.1; 26.9; 24.4
  - Of which: non-residents (percent): reported: 12.4; 11.0; 10.2; 8.5

### Financial Soundness Indicators: Insurance and Pension (selected)
- Insurance (Table 6, selected life sector figures, end period, in billions of NIS):
  - Life total assets: 2005: 122.2; 2006: 135.3; 2007: 150.0; 2008: 144.8; 2009: 184.1; 2010: 210.2; 2011 Q3: 211.8
  - Life investments (of which Government securities): Government securities in life investments: 2005: 50.5; 2006: 48.7; 2007: 47.9; 2008: 58.0; 2009: 61.0; 2010: 65.6; 2011 Q3: 67.8
  - Non-life total assets: 2005: 44.5; 2006: 44.7; 2007: 46.7; 2008: 47.6; 2009: 51.7; 2010: 53.2; 2011 Q3: 56.4
- Pension (Table 7, selected, in billions of NIS):
  - Total assets (end period): 2005: 424.7; 2006: 457.1; 2007: 502.2; 2008: 528.3; 2009: 640.0; 2010: 704.6; 2011: 725.0
  - Provident funds total assets: 2005: 237.3; 2006: 255.6; 2007: 278.4; 2008: 220.1; 2009: 279.8; 2010: 306.0; 2011: 294.0
  - "New" pension funds total assets: 2005: 30.8; 2006: 38.0; 2007: 47.3; 2008: 49.0; 2009: 71.1; 2010: 90.0; 2011: 102.0

### Nonfinancial sector and markets (selected from Table 8)
- Household debt as percent of disposable income: 2005: 62; 2006: 58; 2007: 59; 2008: 61; 2009: 60; 2010: 62; 2011: 62
- Non-financial sector borrowing (NIS billions):
  - Total: 2005: 97; 2006: 97; 2007: 104; 2008: 103; 2009: 96; 2010: 94; 2011: 89 (2011 Q3)
  - From residents: 2005: 79; 2006: 79; 2007: 86; 2008: 85; 2009: 79; 2010: 78; 2011: 74 (2011 Q3)
  - From non-residents: 2005: 18; 2006: 19; 2007: 18; 2008: 17; 2009: 17; 2010: 16; 2011: 15 (2011 Q3)
- Real estate: Average prices of owner occupied dwellings (annual percent change):
  - 2005: 11.3; 2006: -3.2; 2007: 2.5; 2008: 6.5; 2009: 22.4; 2010: 17.0; 2011: -1.2

### Payment system transactions (Table 9, selected)
- ZAHAV (RTGS) total value (in billions of NIS):
  - 2008: 21,874; 2009: 62,304; 2010: 75,784; 2011: 88,944
- ZAHAV average value (in NIS thousands) for Interbank:
  - 2008: 31,688; 2009: 24,417; 2010: 20,986; 2011: 19,334
- MASAV (automated clearing house) debits and credits (volume, in thousands):
  - 2009: 260,622; 2010: 276,542; 2011: 289,734

### FSAP 2001 recommendations and implementation status (selected)
- Monetary policy:
  - Recommendation: "adjust the design and use of monetary policy instruments to improve the implementation of monetary policy and to boost money market development (standing facilities, reserve requirement, open market operations)"
  - Implementation: "2005: Introduction of new monetary instruments - monetary loan window, monetary deposit window; 2009: Start of open market operations in the secondary market with government debt of various types and maturities; numerous other reforms, such as the introduction of primary dealers and the expansion of the Treasury bill market"
- Banking supervision and policies:
  - Recommendation: "allow banks to broaden scope but with prudential and customer protection restrictions"
  - Implementation: "From 2005, banks’ activities are effectively restricted to traditional banking, with limited ancillary services such as financial investment advisory services; the BOI is responsible for prudential supervision and consumer protection"
  - Recommendation: "improve bank reporting on collateral"
  - Implementation: "Quarterly Report on Large Exposures that elaborates on the collateral of large borrowers by types"
  - Recommendation: "adopt explicit deposit insurance"
  - Implementation: "Explicit deposit insurance considered and not adopted"
- Payment system:
  - Recommendation: "establish clear BOI oversight of payment systems; develop a large value system compliant with the Core Principles; establish a National Payments Council"
  - Implementation: "Legal basis provided and in process of operationalization; RTGS introduced in 2007; The Council for Payment and Settlement Systems was established during 2009"
- Insurance and pension supervision:
  - Recommendations included transferring supervision, liberalizing investment options, strengthening supervision staff, and giving Commissioner of insurance more independence.
  - Implementation: "Provident funds are supervised by the CMISD (they are now more like pension funds); Done; Done (see main text and detailed assessment report); Laws amended to this end"

### Risk Assessment Matrix (selected threats, likelihood, and expected impact)
- Sharp global growth slowdown
  - Likelihood: "Staff assessment: High"
  - Expected impact: "Staff assessment: Medium"
  - Key points:
    - Global growth momentum, notably in the United States and the euro area, could deteriorate sharply, leading to a decline in trade.
    - As a small open economy, Israel’s growth is highly dependent on the performance of the global economy, and especially that of Europe and the U.S.
    - Lower GDP growth would dampen corporate profits, household income, reduce employment, weaken credit quality and financial institutions’ profits.
    - Funding conditions may become more difficult, with higher risk premia on private and sovereign debt.
    - Direct exposure to the most vulnerable European countries is limited; banks no longer have substantial exposure to U.S. “toxic assets.”
- Severe escalation in regional geopolitical security concerns
  - Likelihood: "Staff assessment: Low/Medium"
  - Expected impact: "Staff assessment: Medium/High"
  - Key points:
    - Severe escalation could hit tourism, consumer confidence, and possibly capital inflows; in extremes, banks could face deposit withdrawals.
    - Impact greater if regional tensions provoke stagflation in Israel’s main trading partners and higher inflation domestically.
    - "The Israeli economy has proven resilient to past episodes of heightened regional tensions."
- Failure of an individually important institution or conglomerate
  - Likelihood: "Staff assessment: Low"
  - Expected impact: "Staff assessment: Medium/Low"
  - Key points:
    - Sudden failure of one bank is unlikely but cannot be ruled out.
    - Large conglomerates connect different sectors; rising corporate bond risk premia and substantial projected rollover volumes in 2012-13 create vulnerabilities.
    - "Each one of the major banks is important, and confidence effects could lead to spillovers."
- Sharp reversal of a housing boom
  - Likelihood: "Staff assessment: Low"
  - Expected impact: "Staff assessment: Medium/Low"
  - Key points:
    - House prices rose substantially since 2008; residential construction and mortgage lending increased rapidly.
    - Households’ indebtedness is relatively low and stable (about 60 percent of disposable income), but debt service capacity would deteriorate if interest rates rise sharply given many variable-rate mortgages.
    - Banks have increased exposures to mortgages and construction sectors (about 25 and 15 percent of total loans, respectively).
    - Historically, defaults on residential mortgages have been very low, and recoveries relatively high.

*Source: IMF staff compilation from the provided document content.*

### APPENDIX III. STRESS TESTING FRAMEWORK

### APPENDIX III. STRESS TESTING FRAMEWORK

### Banking — Solvency tests
- Coverage and scope
  - Coverage: the five largest banks, which constitute 93 percent of assets and 95 percent of total sector lending.
  - Baseline data: End-June 2011; projection period extends through end-2014.
  - Metrics: total capital adequacy ratio (CAR) hurdle rate of 9 percent; Core Tier 1 (CT1) capital ratio threshold of 5 percent; profitability (ROE) also used as metric.
- Methodologies
  - Top-down balance sheet stress test (BSD) using supervisory data and satellite models for: housing and corporate credit, household non-housing credit, profit components, profit retention behavior, and haircuts on government and foreign financial institution bonds.
  - Single factor sensitivity tests for market risk (interest rate, exchange rate, stock market shocks) and idiosyncratic credit shocks (largest borrower group and three largest corporate borrowers).
  - Contingent Claims Analysis (CCA) stress test (BOI and IMF): bank-by-bank CCA models combined with a macroeconometric factor model; uses Moody’s KMV CCA expected default probabilities (EDFs) and market plus accounting information to form risk-adjusted balance sheets.
- CCA specifics
  - Time series of expected default probabilities (Moody’s KMV CCA) combined with past macroeconomic variables to estimate a macroeconometric model; regression parameters used with three stress scenarios to project bank EDFs, market capitalization, and bank credit spreads (including effect of changes in risk appetite in the most severe scenario).
- Caveats
  - Results subject to model risk and reliance on historical data; projections used conservative satellite model estimates.

### Macro scenarios and variables
- Scenario construction
  - Baseline GDP growth: output of the BOI’s dynamic stochastic general equilibrium model aligning with BOI RD Staff Forecast.
  - Adverse scenario 1: set by IMF, BOI RD, and BSD (domestic shock).
  - Adverse scenario 2: very severe negative shock; first six quarters (2011Q4–2013Q1) based on growth path observed in 2008 crisis but extending contraction to four quarters (doubling size and term of GDP contraction).
  - Other macro variables (inflation, exchange rate depreciation, BOI short interest rate, unemployment): outputs of BOI staff forecast conditional on GDP path and shocks (risk premium, global recession).
  - TA100 stock index: baseline uses vector autoregression including domestic and foreign variables; Adverse 1 uses 2001 recession changes; Adverse 2 uses 2008 crisis changes.
  - Long-term/short-term yield spread: baseline long-term yield set at average rate (5 percent); Adverse 1 uses 2001 spreads with convergence in last six quarters; Adverse 2 uses 2008 spreads extending highest long interest rate for a year (2012).

### Stress testing scenario parameters (selected values)
- Real GDP growth (In percent)
  - Base: 2011 3.6; 2012 3.1; 2013 3.4; 2014 3.7
  - Adv. 1: 2011 3.4; 2012 1.2; 2013 2.5; 2014 2.8
  - Adv. 2: 2011 1.9; 2012 -2.8; 2013 1.2; 2014 2.5
- Inflation (In percent)
  - Base: 2011 3.0; 2012 2.3; 2013 2.2; 2014 1.8
  - Adv. 1: 2011 3.1; 2012 3.2; 2013 2.8; 2014 3.1
  - Adv. 2: 2011 2.8; 2012 0.6; 2013 -1.4; 2014 -4.8
- Exchange rate depreciation (In percent)
  - Base: 2011 3.0; 2012 1.7; 2013 1.3; 2014 -0.4
  - Adv. 1: 2011 4.1; 2012 6.8; 2013 3.6; 2014 1.2
  - Adv. 2: 2011 3.6; 2012 12.0; 2013 -1.2; 2014 -8.3
- Bank of Israel interest rate (In percent)
  - Base: 2011 3.0; 2012 3.0; 2013 2.8; 2014 2.3
  - Adv. 1: 2011 3.1; 2012 3.6; 2013 2.6; 2014 2.1
  - Adv. 2: 2011 2.9; 2012 1.0; 2013 0.5; 2014 0.5
- Unemployment (In percent)
  - Base: 2011 5.6; 2012 5.7; 2013 5.9; 2014 6.1
  - Adv. 1: 2011 5.7; 2012 6.5; 2013 7.3; 2014 7.3
  - Adv. 2: 2011 5.9; 2012 9.9; 2013 11.1; 2014 10.8
- Change in TA100 Index (In percent)
  - Base: 2011 -24.9; 2012 -1.6; 2013 -0.2; 2014 7.5
  - Adv. 1: 2011 -30.7; 2012 -8.7; 2013 -25.6; 2014 7.5
  - Adv. 2: 2011 -36.4; 2012 -57.3; 2013 33.9; 2014 21.7
- Long-term/short-term yield spread (In percent)
  - Base: 2011 1.9; 2012 2.0; 2013 2.2; 2014 2.7
  - Adv. 1: 2011 2.2; 2012 3.3; 2013 3.2; 2014 3.0
  - Adv. 2: 2011 2.2; 2012 5.6; 2013 4.7; 2014 4.1
- Selected bond spreads (In percent)
  - AA rated bonds spread Base: 2011 1.1; 2012 1.2; 2013 1.2; 2014 1.2
  - AA rated bonds spread Adv. 2: 2011 1.3; 2012 3.1; 2013 2.2; 2014 1.7
  - A rated bonds spread Base: 2011 2.7; 2012 3.4; 2013 3.4; 2014 3.4
  - BBB rated bonds spread Base: 2011 6.1; 2012 7.8; 2013 7.8; 2014 7.8
  - Non-rated bonds spread Base: 2011 7.7; 2012 8.9; 2013 8.9; 2014 8.9
  - Real estate sector bonds spread Base: 2011 4.7; 2012 5.6; 2013 5.6; 2014 5.6
  - (Adv. 1 and Adv. 2 values for these spreads are in the table.)

### Israel: Stress Test Matrix — Banking Sector (Solvency Risk) — key assumptions and results
- Institutions included: 5 largest institutions (market share: 93 percent of assets; 95 percent of total sector lending).
- Data and baseline:
  - Top-down balance sheet ST: supervisory data; End-June 2011; consolidated banking group.
  - CCA ST: balance sheet data (public) plus market data (MKMV inputs); End-June 2011; banks have quoted market capitalization.
- Methodology:
  - Balance sheet ST: BSD models for corporate, household, and government debt solvency.
  - CCA: macro-econometric factor model combined with MKMV data on EDFs and market value of bank assets.
- Stress test horizon: End-June 2011 to end 2014.
- Shocks and scenarios:
  - Scenarios: Base, Adverse 1 (domestic shock), Adverse 2 (serious international shock).
  - Macros conditioned on GDP, inflation, interest rates, exchange rate, unemployment, short and long-term rates, equity prices, bond spreads (AA, A, BBB, unrated, real estate).
  - Adverse 1: 1.9 percent GDP decline from Base in 2012; Adverse 2: 5.9 percent decline from Base in 2012 (see table).
- Sensitivity (single shock) analysis applied in balance sheet:
  - Credit shock to largest corporate group: Impact is 8.5 to 12.6 percent of CT1.
  - Credit shock to largest three borrowers: Impact is 4.3 to 6.6 percent of CT1.
  - Stock market decline of 25 percent: Impact is 0.3 to 3.8 percent of CT1.
  - Exchange rate depreciation of 15 percent: Impact is 0.2 to 3.1 percent of CT1.
  - Interest rate increase of 200 bp.: Impact is -5.0 to 5.0 percent of CT1.
  - European peripheral exposures shock (vulnerable sovereign debt): Impact is 0.4 to 1.4 percent of CT1 (30 and 10 percent write off scenarios referenced).
- Behavioral adjustments
  - Top-down balance sheet: constant balance sheet assumption; dividend policy rules: if ROE>6 percent and CT1 between 8 to 8.5 percent then dividends are 35 percent; if ROE>6 percent and CT1 is > 8.5 percent dividends are 50 percent; if ROE<6 percent dividends are 0.
  - RWAs changed according to standardized approach rules (only exchange rate affects RWA).
  - CCA: constant CCA balance sheet (constant debt default point).
- Regulatory standards and reporting
  - Total Capital hurdle rate: 9 percent CAR.
  - Core Tier 1 threshold: 5 percent.
  - Results presented as ranges and number of banks above various thresholds.
- Results summary
  - Balance sheet scenario analysis: CAR for all banks is above 9 percent hurdle rate; one bank has CT1 of 6.9 percent under Adv. 2 scenario in 2012.
  - CCA scenario analysis: CCA capital ratios, expected losses and implied spreads are higher than 2008/2009 crisis under Adverse 2. Using a threshold of 300 bps for implied credit spread, spreads for two banks go above or are very close to this threshold in 2012.

### Liquidity tests (banking)
- Focus and metric
  - Focus: change in short-term assets and liabilities based on BOI supervisory model.
  - Tests carried out by BSD for four severe stress scenarios, separately for total currency positions and foreign currency positions.
  - Metric: regulatory ratio of a bank’s unencumbered and high quality liquid assets to its expected liquidity needs over a one month horizon; ratio meant to exceed unity.
- Base period: end-2011.

### Insurers and Long-Term Savings (LTS) providers — tests and approach
- Rationale and scope
  - Investment risk on over 60 percent of life and other LTS products is born by policyholders; shocks may have large macroeconomic impact via households.
  - Tests run on LTS portfolios of life insurers, pension funds, and provident funds excluding guaranteed-return government bonds (deemed risk free) to capture household exposure via LTS.
  - Nonlife and pure risk life business vulnerability to market risks and insurance risks impacting claims ratios assessed.
  - QIS-5 exercise results reviewed to evaluate companies’ stress testing capacity.
- Market coverage and data
  - Whole market of long-term savings included (differentiated by provider).
  - Market sizes: NIS 140 billion insurance providers; NIS 300 billion provident funds; NIS 95 billion new pension funds.
  - Regulatory data as of June 2011.
- Methodology and shocks for LTS providers
  - Supervisory models applying immediate shock on the value of the portfolio; mark-to-market valuation preferred.
  - Historic-based scenario (4th Quarter 2008):
    - Foreign investments -15%
    - Loans -4.4%
    - Corporate bonds -9.4%
    - Government bonds and deposits 4.6%
    - Equity -29.8%
  - Simulated local shock scenario:
    - FX depreciation -20%
    - Corporate spread 200 bp
    - Risk free interest + 20%
    - Equity -30%
  - Behavioral adjustments: none for one-year horizon.
  - Accounting: mark-to-market valuation.
- LTS results (asset losses)
  - Historic-based scenario: 4th Quarter 2008
    - 9.45% loss in LTS provided by insurers
    - 7.47% loss in LTS provided by provident funds
    - 5.58% loss in LTS provided by pension funds
    - Weighted average 7.70% loss
  - Simulated local shock scenario:
    - 3.28% loss in LTS provided by insurers
    - 5.43% loss in LTS provided by provident funds
    - 2.55% loss in LTS provided by pension funds
    - Weighted average 4.43% loss

### Insurance sector — top-down stress tests and sensitivity analysis
- Institutions and market share
  - Top 6 insurers assessed.
  - Market share: 70 percent in nonlife and 99 percent in life premium.
  - Own funds, nonlife capital, and life excluding unit-linked products amount to NIS 100 billion.
  - Regulatory data as of June 2011.
- Methodology highlights
  - Supervisory models supplemented with IMF suggestions.
  - Own funds in nonlife and life excluding LTS, and capital, were stressed and new surplus positions determined.
  - Liabilities assumed unchanged for nonlife and risk life in scenario analysis due to short policy duration, but liabilities change with deterioration of claims in life, motor and property portfolios.
  - Capital used to top-up own funds reduction to assess new solvency position; all claims net of reinsurance.
  - Mortality (life) includes mortality and morbidity; motor includes compulsory Body injury liability; property includes motor, business interruption and home owners insurance.
  - Value changes are after tax adjustments; lower asset values reduce capital requirements; earmarked bonds treated as regular government bonds.
- Stress horizon and shocks
  - Horizon: 1 quarter — immediate shocks on capital and own funds.
  - Scenario: historical 4th quarter 2008 market shock plus multiple single insurance shock permutations (mortality, motor, property claims increases by 10 percent in various combinations).
- Risk factors
  - Equity prices, yield curve, mortality, claims motor and property.
  - 4th quarter 2008 historical market shock used as reference.
- Behavioral adjustments: none for one-quarter horizon.
- Accounting: IFRS; liabilities short and not discounted.
- Results — solvency position
  - The most severe scenario (deterioration of all main lines of business during a market shock similar to the 4th quarter of 2008) resulted in capital surplus changes that varied across insurers from 131 bps to no change after own funds are topped up to cover the existing new liabilities.

*Source: APPENDIX III. STRESS TESTING FRAMEWORK (End-June 2011 data and scenario tables as presented in the source).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2012/_cr1269.pdf_