On October 7, Israeli prime minister Benjamin Netanyahu declared that the country was at war with Hamas. On October 8, the Tel Aviv Banking Index (TA-Banks5) fell by 8%.
The index, containing the five largest banks in Israel Bank Hapoalim, Bank Leumi, Israel Discount Bank, Mizrahi Tefahot and First International Bank of Israel, continued to drop. By October 23, it was down 20% from the day before the conflict started.
It has since recovered to around 9% lower than at the outset of the war as the initial shock subsides and investors adjust to the new reality.
All ratings agencies have the banks on rating watch negative thanks to a downgrade of the sovereign after more than 300,000 reservists, nearly 10% of the labour force, were called up to fight.
Israel's banks are in reasonable shape to weather the initial storm thanks to rate rises
The Bank of Israel has asked banks and credit-card providers to adopt relief programmes, including easing the credit and fee burden for customers directly impacted by the war. That list covers reservists, households and businesses within 30 kilometres of the Gaza border, evacuees and close relatives of Israelis killed, abducted or missing.
There will be a lot of concern about the performance of other borrowers, particularly those in sectors such as tourism and services, which have shrunk considerably as discretionary spending has slowed.
But of primary concern is the construction industry, which has been a big source of lending growth for the banks. Between 2020 and March 2022 alone, Leumi expanded its construction and real-estate portfolio by 45%.
In March 2022, domestic large construction and real-estate exposures accounted for 20.9% of total domestic loans for Israel’s banks. In 2023, almost half of bank commercial lending was to the construction industry.
This sector already faced one challenge when interest rates rose from 0.1% in April 2022 to 4.75% in June this year. A second is that around a quarter of the nation's construction workforce is Palestinian. They have been placed on security lockdown in the West Bank and had their work permits removed since the outbreak of the conflict.
The Israeli Building Association has asked the government to allow companies to hire up to 100,000 workers from India to replace them.
Room to move
Israel’s banks are in reasonable shape to weather the initial storm thanks to rate rises. In its second-quarter results, the largest lender, Hapoalim, posted a profit of NIS1.92 billion ($500 million), up 43% from the same quarter the year before. Likewise, Israel Discount Bank posted a profit of NIS1.19 billion, up 75% on the second quarter of last year.
Both banks have greatly increased credit-loss provisions. Hapoalim set aside NIS579 million in the quarter, against NIS91 million in the second quarter of last year; while Israel Discount Bank set aside NIS312 million in the second quarter, compared with NIS131 million in the same period last year.
All the large banks tell a similar story.
Banks have now been directed by the Bank of Israel to set aside additional provisions to account for the cost of the war in their third-quarter results, due at the end of November.
Leumi has already announced it will set aside a loan-loss provision between NIS800 million and NIS1.1 billion. The bank’s excess capital of NIS3.3 billion as of the end of the second quarter is expected to cover this, according to analysts at Jefferies.
The banks are also under pressure to rethink third-quarter dividend payments.
The Israeli government also announced measures on November 6 to support small companies impacted by the war. The central bank will set up a NIS10 billion credit line to help small companies by offering two-year loans at lower interest rates – the benchmark rate minus 150 basis points, currently 3.25%.
The crucial question is how long the war will last. Many analysts view the conflict as a contained, shorter-term event that banks should be able to weather.
“Our baseline at the moment assumes the Israel-Hamas war will remain centred in Gaza and will last around three to six months,” observes Maxim Rybnikov, director, EMEA sovereign ratings at S&P Global. “But clearly there are risks that it could spread more widely.”
This includes the risk of conflict in the West Bank and across the region.
“Gauging the impact of the war on Israel’s economy remains difficult both due to still very high uncertainty about the scale and duration of the conflict and the lack of high-frequency data at hand,” notes Anatoliy Shal, macroeconomist at JPMorgan.
Similar military escalations in Israel in recent years, such as the 2006 Israel-Hezbollah War, had little impact on the country’s wider economy and banking sector.
“This is not the first time that military escalation is happening, but at the same time it’s very clear that the scale we are witnessing now is significantly larger,” says Rybnikov. “It’s the biggest attack on Israeli soil in decades, and the scale of the response is very significant and much bigger than what we have seen before.”