TEL AVIV, June 27 (Reuters) - Israel's financial system remains strong despite low interest rates but still faces a "significant risk" from exposure to the housing market, the Bank of Israel said on Tuesday.
Despite a near-zero interest rate environment, financial firms continued to strengthen in the first half of 2017 due to stronger economic growth boosted by low unemployment and an expansion of consumer spending, the central bank said in its semi-annual financial stability report.
"With that, an assessment of the systemic risks to the economy shows that financial institutions and households continue to be exposed to the risk of a possibility that there may be a sharp decline in home prices," it said.
Housing credit and credit to the construction and real estate industry as a share of total domestic credit to the non-financial private sector increased to some 52 percent in 2016 from about 37 percent in 2008, although the growth rate moderated significantly in the past year, the bank said.
"The risk is increasing in view of the large exposure to non-housing consumer credit, which is highly correlated to housing credit," the central bank report said.
"In the event of a shock leading to a sharp increase in the interest rate or a significant negative impact to borrowers income, with a sharp decline in home prices, it may have an effect on the stability of the financial system, and particularly the banking system within it."
The central bank noted that there has been some moderation in housing market activity of late limiting price gains, a decline in the volume of residential housing transactions and a decrease in the amount of mortgages issued.
"A continuation of the apparent moderation in activity in the real estate market and in the pace of housing price increases in recent months will lead to a decline in the risk level of the financial system," the report said.
But the continued significant increase in non-housing credit to households may expose the financial system to credit risks on the part of households, especially as a new reform to increase competition in credit supply is being implemented, it added.
The central bank believes the reform will change the structure of the market and may sharply boost credit to households and debt repayments.
Another possible risk to the system could come from the bond market in the wake of yield spreads on corporate bonds continuing to drop to all-time lows.
"High corporate bond prices expose the financial system to a greater risk of a turnaround in the trend accompanied by a sharp decline in prices," the bank report said.
(Reporting by Steven Scheer; editing by Mark Heinrich)