The other peril

Listing the dangers looming over Israel's foreign currency market, speculators usually include the security situation, the obstacles the treasury has yet to overcome in pushing its NIS 9 billion budget cut through parliament, and developments in the international interest market, where the rates on the dollar may erode.

But there is another peril lurking: the soundness of the Israeli banking establishment.

The Bank of Israel's supervisory department published its annual report last week, showing the rapid deterioration of the system. All the parameters that the supervisor checked were sliding downhill, from operating income, to the quality of the borrowers, from the risks to the doubtful debts, the productivity of the banks' workers clearly, 2001 was a horrible year for Israel's banks, which tumbled to the bottom of the table compared with Western banks.

Against the background of the recession and the hardship thousands of companies are feeling, the banks' down-trend is bound to persist and even intensify in 2002. All the research and supervisory institutes say so. The central bank's supervisory department recently clarified that it won't allow the banks to pay dividends in the year to come, to prevent them from dipping into their emergency capital. Just over a week ago, the international rating agency Moody's downgraded the debt rating of Israel's banks, and its estimates of their performance for the coming year.

How will all this affect the currency market? At present, the banks' situation is actually moderating the volatility that had characterized the market until recently. Since the banks are rubbing against the limit of their capital adequacy, and since their cost of raiding capital abroad has climbed they are doubly cautious when it comes to extending foreign currency loans, which reduces the scope of speculation in the market. If until two years ago anybody could get foreign currency with equity and collateral covering no more than 3% to 5% of the deal, today the range of securities has climbed to 5% to 10%.

Conversely, the banks are preventing the shekel from strengthening too much too fast: despite the wide interest rate gap between the Israeli currency and the dollar, their reluctance to lend dollars has reduced the supply of greenbacks being sold, thus reining in the shekel's gains.

The climbing shekel

Even so, the shekel has been striding ahead impressively. On Sunday it continued its trend from Friday and started the day at NIS 4.668. Currency dealers say the shekel's strength is due mainly to the absence of foreign banks. Their absence is evident in the 50% slide in trading volumes. The average turnover in the currency market from August 1 has been $500 million, of which foreigners are responsible for only $30 million to $60 million a day.

But the more the banks weaken, the more danger they pose to the stability of the currency market, and the more the currency market will imperil the banks. Since each slip in the shekel's value increases the burden of shekel borrowers at exchange rates of NIS 5.2 to NIS 5.3 to the dollar, the banks will discover they are below the minimal capital adequacy ratio and are unable to extend a penny more in credit. They will face even more writeoffs of problem debt.

At the moment, the shekel doesn't seem about to weaken that far. But just two months ago the interbank rate for the dollar was NIS 5.

In parallel, any major scandal such as the collapse of one of their biggest customers, or of a bank itself, would naturally spark a panic among the public and set off a massive wave of flight to the dollar, which the people would then stash abroad.

We aren't there yet. The public and institutional investors are realizing their foreign currency profits and reducing their exposure to the greenback, a trend evident in the withdrawals from foreign-currency mutuals, and even in sales of Israel Electric Corporation bonds traded abroad the interest on which climbed substantially in the last week.

But many currency traders suspect that the respite is temporary. Once the foreign bankers are back from their summer vacations, and our parliamentarians resume their debate on the 2003 budget activity on the foreign currency market will pick up again. And from the current level, the probability of devaluation is greater than the probability that the shekel will strengthen, or even stay firm, they fear.

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