S&P Keeps Its Outlook on the Risks of the Israeli Banking Sector

SadaNews Economy Translation - The credit rating agency S&P has maintained its outlook on the risks of the Israeli banking sector at a "stable" level.

The economic report warned of the danger posed by the real estate and construction sector to the operations of Israeli banks, which represents about 21% of the total credit portfolios in the banking system.

The report considered the real estate and construction sector to be the focal point of the main risks in the Israeli banking system, attributing this to a stressful combination of rising financing costs, increased prices of construction materials, and a labor shortage due to the replacement of Palestinian workers with foreign labor. This leads to squeezing contractor profitability and increasing financial pressure on the ground. The SadaNews Economics section translated this from the Hebrew economic newspaper Calcalist.

According to economists at the credit rating agency, these conditions have led to a real contraction of 2.6% in housing prices in 2025, and this trend is expected to worsen in 2026 with a sharp real decline of 4.1%.

The decline in demand is reflected in a decrease in monthly transaction volume to an average of only 7,500 transactions (compared to 8,600 transactions in 2024), and an unprecedented accumulation of inventory of about 85,000 unsold new apartments by March 2026, a figure that forces developers to offer financing advantages and promotional offers that reduce the actual price and burden their cash flows.

Despite this, S&P rushed to reassure investors about the stability of banks, maintaining the risk rating of the local banking system within the fourth group.

This rating relies on the company's international risk scale, which ranges from 1 to 10 (where 1 represents the lowest risk level and safest, and 10 the highest), placing Israel in the low-medium risk category, alongside countries such as Poland and Iceland, and just one degree lower than countries like the United States, the United Kingdom, and Spain, which are classified in the third group.

This is due to two key indicators: the first being the exceptional improvement in the operational efficiency of banks according to international standards, as data on the performance of the banking system shows that the cost-to-income ratio of banks in Israel, which was around 65% in 2018, has decreased to about 35% in the period 2025-2027. This means that banks currently spend only about 35 agorot on operational processes for every shekel they earn.

The second indicator is the quality of bank assets, as the volume of non-performing loans remained low at just 0.84% at the end of 2025, and is expected to remain below the 1% threshold during the period 2026-2028.

Credit losses for banks are expected to rise only slightly, from a low level of 0.15% on average during the period 2024-2025 to a level ranging between 0.2% and 0.25% during the period 2026-2028.

The agency stated: Furthermore, the level of provisions that banks have set up in recent years is relatively conservative, such that banks maintain a reserve of one and a half shekels for every shekel of non-performing loans in the banking system, to cover credit losses (with a coverage ratio of 150% by the end of 2025).

In addition to stability data, the report presents a concerning process for banks in their funding structure, which directly affects their profit margins. The Israeli public is seeking higher-yield investment alternatives in light of the current interest rate environment (such as money market funds), significantly reducing its cheap deposits in banks, with the share of deposits from individuals dropping to only 31.9% (about 730 billion Israeli shekels) by March 2026, compared to about 42% at the end of 2020.

To compensate for the public deposit flight and support credit growth, banks have had to rely increasingly on concentrated and costly deposits from corporations and institutions, raising the share of interest-bearing deposits and term deposits to about 79% of total deposits by the end of 2025 (compared to 63% in 2021).

This sharp rise in the cost of funding sources weakens banks' net interest margins, which peaked at around 3.1% in 2023, and is expected to decline to about 2.4% by 2027, prompting banks to increase their use of international debt financing.

The problem is that raising funds from abroad exposes banks to significant refinancing risks. While institutions in Israel have become accustomed to the security situation and will continue to buy bank bonds even amid fighting, foreign investors tend to be the first to withdraw when geopolitical tensions escalate.

On the macroeconomic front, the rating agency estimates that if there is no further security escalation, the economy will experience a sharp recovery with a growth of 5.9% in 2027, but in the long term (2028-2029) growth will remain below pre-war trends, averaging only about 3.5% due to labor supply constraints, prolonged military service, and high reconstruction costs that will leave the net government debt at a high level of 68% of GDP by 2029. This was also translated by the SadaNews Economy section.

The agency stated: The government's need to finance these deficits translates directly into an impact on the profitability of banks; after imposing a special tax of 6% on their profits during the 2024-2025 period, the government recently imposed an additional exceptional tax of 3 billion Israeli shekels for 2026 and 250 million Israeli shekels for 2027, and this tax is expected to push the capital return for the banking system down to 13.1% in 2026 (compared to about 15.5% in 2025).