Bank of Israel voices concern over banks’ risks in lending to real estate market

A combination of low interest rates, land development incentives, and housing demand has meant that Israel’s banking sector has been loaning more money — to developers looking to finance new projects as well as individual buyers through record levels of mortgage borrowing.

With an expectation of rising interest rates later this year, the Bank of Israel has stepped in to express its concern at the increase in exposure that some banks are facing. It wants banks to take action by looking more closely at risks surrounding construction development.

The Supervisor for Banks at the Bank of Israel, Yair Avidan, sent a letter [Hebrew] on Sunday containing additional guidelines for banks’ management of real estate loans. Avidan expressed the central bank’s concerns that banks have been too ready to lend money and have not thoroughly considered the risks around repayment as the costs of projects and loans rise as a result of the rapidly rising costs of raw materials, plus higher interest rates. The fear is that, as happened in the subprime fiasco in the US over a decade ago, the bubble will burst and banks will not be able to cope.

“Given the increased appetite for risk and the banking system’s exposure to the construction and real estate industry, banks need to have proper discussions with their boards to examine risk appetite, credit policy, and adequate provision to manage risk,” Avidan wrote. “We want [the] finance [sector] to work with the real estate industry in developing the Israeli economy, but also to maintain a conservative and adequate approach to underwriting credit.”

Of particular concern is the financing of projects with guaranteed financial support, and the purchase of land in the hope of getting the right to develop it later. Based on the new guidelines, in the future, banks’ supervision reports will need to provide more detailed information about their real estate lending to make sure they are setting aside enough money to cover the risks.

The proposals are subject to consultation but there is a desire to implement a framework as soon as possible, and the Bank of Israel is already suggesting that it may well introduce additional safeguards as required at a later date.

But if the banks do become more cautious about lending money, it is likely to mean developers will have to pay more to get the funds to start projects.

They already need to budget for higher building costs, earlier ordering of raw materials, and potential delays caused by international disruption to construction materials supply lines. These pressures, in turn, will only reduce the speed of housing development, and are likely push the costs of new housing up further at a time when Israel is already battling sky-high prices for housing.