After the 2008 financial crisis, banks were not at the top of the buying list among ordinary private investors. 

The reason is that investing in bank shares is more than just buying a part of a company. It constitutes not only an investment in the economy of a given country but also in the global economy due to the assets that banks tend to hold.

Even though Israel is a small country, the same principles that affect the financial sector elsewhere remain relevant in this country as well.

For example, as of the end of June 2022, the total amount of deposits held in the top five Israeli banks was over 1.8 trillion shekels. Therefore, how these funds are being managed, will not go unnoticed by the markets.

In addition to interacting with every sector of the Israeli economy, banks’ operations in the areas of real estate investments, mortgages, credit cards and more are not carried out in isolation. They are equally, if not more so, influenced by what’s happening on the global markets. Therefore, when it comes to adding banking stocks to an investment portfolio, it is critical to take into account factors such as interest rates, inflation, unemployment and other elements that are affecting the health of the capital markets.

The last year has been an outstanding year for Tel Aviv Banks5 Index (which includes the five largest Israeli banks – Hapoalim, Leumi, Mizrahi Tefahot, Discount). Suffice it to say that it managed to appreciate by 60%, beating the main TA-125 Index by 100%. However, this year did not begin as bright as it was anticipated. The worries of investors increased as supply chain issues and later the war in Ukraine that led to the spike in energy prices and inflation raised concerns about the global recession. Central banks around the world could not stand idly and were forced to act. The Bank of Israel followed the suit. And this week, the interest rate was raised by 0.75% to 2%, the biggest increase in two decades.

So far this year, the top 5 have been enjoying a decent year in terms of performance. That is not to say that it was a smooth ride. The fears of a broader sell-off due to the inflated valuations of the tech sector and the exposure to the property market, which is facing its own challenges, have contributed to an almost 18% pullback in the TA Banks index during the June-January period. However, for those who held their nerve, the return in the following two months has been sufficient to regain the lost ground. In fact, the index has entered new high territory. 

So, the obvious question is, given the current economic environment and the turbulent nature of financial markets this year, why would banks be a viable option for an ordinary investor in the Israeli stock market? Well, for starters, the inflation rate at the moment is 5.2%, which increases the value of banks’ assets. Secondly, with the Bank of Israel being forced to act to tame inflation, an increase in interest rates by 1% generates a net annual interest income of NIS 5.6 billion in revenue. And since the banks are not quick to raise the savings rate for their clients, every such rise in lending increases their margins. Furthermore, with revenue rising, all banks have returned to paying dividends. This is not a pivotal point to be taken into consideration when deciding in which company to invest, but the one that underscores, in some ways, the improving financial health of any business entity.

All of the above has been confirmed in last week’s reports published by the top 5 banks: their combined profit in the first half of the year reached over 11 billion shekels. In percentage terms, it is 15% growth compared to the corresponding period last year. Given the global outlook and the headwinds the global economy is facing, this is a result not to be frowned upon.

However, there are risks involved that need to be considered when looking at the top five banks (and banking stocks in general). A steady rise in interest rates raises a risk of increasing of bad debts provisions as consumers may miss or default on the debt payments obligations, which, in return, will reduce profitability. Finally, given a swift recovery from the recent lows, some analysts believe that the current valuations are not cheap and therefore would not be recommending to add those shares just yet.