Going by figures released today by the Bank of Israel, total credit dropped to 665.8 billion in July. That's from NIS 676.4 billion in June, or 1.6% - the sharpest month-to-month drop in years. The main cause was a NIS 6 billion drop in credit linked to foreign currency, credit denominated in foreign currency and credit taken abroad, due to the 3% appreciation of the shekel against the basket of currencies between June and July. The shekel's appreciation eroded the equivalent shekel value of that credit. Hence the drop can be attributed mainly to exchange rate changes, less to a decision by the banking establishment to reduce the scope of foreign currency-denominated credit whether due to dwindling resources, or to fears of customer risks. Yet the most worrisome thing is the NIS 4 billion drop in unlinked credit, from NIS 185.5 billion in June to NIS 181.5 billion in July. That development is the clearest indication that could be that the Israeli economy is heading for a credit crunch. The crunch is coming because the banks are running out of surplus capital, limiting their ability to extend fresh credit. And that is because of the massive losses the banks have registered, whether from real estate or telecommunications or hi-tech or hotels or LBOs, whatever. The crunch is being exacerbated by the banks' fears that the losses and writeoffs aren't over, which could reduce their liquidity rations even more in the dearth of fresh resources. A rising cost of credit, which depresses investments, is one thing. But a credit crunch is something else entirely. It is a situation in credit cannot be had, it is not available, irrespective of interest rates. That is why it is more dangerous. The business sector relies on unlinked credit to survive from day to day. This is doubly true when capital investment becomes less accessible, as it is now. The banks dont have to be the only source of credit for business. Securitization obtaining credit against financial assets through the capital market is one key source. But whereas securitization is widely employed in development markets abroad, as are secondary sources of credit, there is no such thing in Israel. One reason is apparently the structure of the market. Most of the buyers in such deals institutionals are controlled by the banks, which probably do not want to take part in a race that could hurt them directly. In fact, the banks' profits from their provident funds are one of their most important and reliable - sources of liquidity. Also, Israel's institutionals do not specialize in extending credit. So they need non-banking mediators, and a well-oiled rating system, none of which exists. Another reason is the alternative cost: yields on government bonds are so high anyway, who could compete with that without taking a risk? A fourth reason is the tangle of legal problems that would need resolution before conservative bodies like institutional investors could feel comfortable granting credit. Mix all the ingredients together low liquidity at the banks, fear of mounting losses, a retarded securitization market, an absence of legislation, and high alternative cost what you get is a recipe for an escalating credit crunch, and low availability of financing resources outside the banks. The July figures may incentivize the development of a secondary credit market. But since its development will take a long time, the figures are more likely to simply serve as the harbinger of a genuine real credit crunch to come, a crunch that will hinder business even more, increase unemployment, diminish Israel's domestic product and exacerbate the credit crunch.