Israel's Banks May Get a Profit Boost From Their Chief Adversary

(Bloomberg) -- Israel’s banks may soon get an unexpected boost from one of their biggest critics.

Since he took office in 2015, Finance Minister Moshe Kahlon has passed reforms aimed at curbing the power held by the nation’s biggest lenders, clipped industry salaries and publicly questioned whether they’ll exist after a decade. Now a feud with Bank of Israel Governor Karnit Flug could end up lifting profits at the country’s lenders.

Kahlon is considering replacing Flug when her term ends in November with someone more supportive of his goal to lower house prices. He has criticized the central bank for its low interest rates, suggesting he’s keen on higher rates to help cool the real estate market. For the country’s banks, that would be good news as long as borrowers don’t start to default in large numbers.

When interest rates rise, so does the difference between what banks charge for loans and what they pay savers. The last time Israel raised interest rates, under then-governor Stanley Fischer, profit margins at lenders in the main banking index rallied from almost zero to 18 percent. Industry-wide cost cuts then kept margins up as the central bank lowered rates again to weaken the currency and boost exports.

Deposits at Israel’s biggest banks, meanwhile, soared in the past years, though new regulations limited how much of that money they could turn into new loans. The central bank ordered lenders to hoard capital and create a bigger buffer against credit risk. After clearing those hurdles, lenders such as Bank Hapoalim Ltd. and Bank Leumi Le-Israel Ltd. are now in a position to capitalize on higher borrowing costs.

The Bank of Israel’s research department is projecting that the base rate will rise to 0.25 percent this year and 0.5 percent the next, though some economists say that macroeconomic data argue for faster rate increases. While it’s not clear who might succeed Flug, Kahlon is likely to favor someone less dovish, Mizrahi Tefahot strategist Modi Shafrir wrote in a recent note to clients.

A look across the Atlantic Ocean shows just how quickly tighter monetary policy can translate into profit growth. At JPMorgan Chase & Co., the largest bank in the U.S. by assets, net interest income rose 15 percent in the two years after the Federal Reserve started increasing interest rates in December 2015, reversing years of declines.

In Israel, too, higher costs of borrowing “will have a significant positive impact” on profits, Omer Ziv, Leumi’s chief financial officer, said on March 6. Leumi expects the central bank to start lifting rates towards the end of 2018 but didn’t give forecasts for the following year.

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