Sources inform ''Globes'' that a new draft circular by the Bank of Israel may require the banks to make a one-time provision of NIS 3 billion for credit losses in 2013, which will hurt their capital adequacy ratios, ability to extend credit, and chances of distributing dividends.
The draft circular, sent to the banks and the liaison committees of the Institute of Certified Public Accountants in Israel, has aroused strong opposition. The sources added that top bank officials were holding intense meeting with the Bank of Israel in an effort to soften the provision. "This is a big bombshell," said one bank executive. "We're holding intensive discussions with the Bank of Israel, and we hope they will show flexibility."
The banks will shortly have to change how they make group provisions (provisions for future risks that have not yet materialized). In 2013, the method for provisions will change. During the interim period, the Bank of Israel wants the banks to make a one-time adjustment to their credit portfolios. If the amount of the adjustment is less than 0.5% of the total credit portfolio, the banks will have to make another examination and explain why the number is so low. The banks' aggregate credit portfolio (excluding mortgages) is NIS 600 billion, which means that the amount of the provision is NIS 3 billion.
Bankers say that, in practice, they will have to make a provision of 0.5% of their credit portfolios. "The Bank of Israel measure will hurt the banks' ability to grant credit, and will reduce the chances of meeting the capital adequacy ratio targets without reducing the credit tap to a trickle," said one top banker.
Conversely, the Bank of Israel says that a bank which wants to make a provision of less than 0.5% may do so, provided that it provides explanations. The Bank of Israel emphasizes that this is a preliminary draft, and that it is premature to say what the final version of the circular will be.
Some banks are very worried about the circular. The banks must reach a capital adequacy ratio (the ratio between shareholders' equity and credit) of 9% by the end of 2014. The banks are in a race to reach the target, and to do so, they have stopped distributing dividends, reduced lending, and undertaken extensive streamlining to improve their profitability.
Withdrawing an additional NIS 3 billion from the banks' shareholders' equity - 4-5% of their shareholders' equity - together with the 0.4% blow to their capital adequacy, will force the banks to further tighten their belts.
Furthermore, according to accounting interpretations, this provision is not recognized for tax purposes, but is recorded in the deferred tax item. This means that this asset is not recognized in full for the purpose of capital adequacy; in other words, the blow to the banks' capital could reach 0.5%.
Dealing with distortions
The one-time provision is part of the draft circular for group provisions for credit losses. The group provision is intended to deal with risk that a bank has not identified at a customer in time. In other words, the bank makes a uniform provision on the amount of debt for an entire sector.
Currently, the provision is based on the average provisions over the preceding three years, but this method is problematic, since past provisions do not reflect the present, especially in a cyclical economy. As a result, a situation is created in which, during slumps, banks make provisions on the average of the preceding years, which were probably boom years.
To deal with this distortion, it was decided that the provisions would be made on the basis of qualitative variables. The Bank of Israel has set 13 variables, including the trend of balances in arrears, the experience and capability of the credit team, credit management policy, and the quality of the credit oversight system. Each variable is scored and weighted for the final calculation, and on the basis of the final score, the banks will make the provisions. But during the transition from the current method, it was decided to clear the table, and adjust the credit portfolio, which means a large one-time write-off from the banks' capital. The transition between the methods was supposed to take place at the end of 2012, but it will probably be postponed to next year.
Published by Globes [online], Israel business news - www.globes-online.com - on November 7, 2012
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